Are grocery store lease terms increasing the cost of food?
Recently commercial real estate firm CBRE posed that question following a report from the Competition Bureau which confirmed that food costs are on the rise and significant changes may be required to bring grocery prices back down to earth.
“One unexpected idea floated by the Competition Bureau is to ban clauses in commercial leases that stop landlords from having competing uses or similar tenants at a property or in the surrounding area,” said the CBRE.
“Exclusive use clauses, known as restricted covenants in leases, effectively make it impossible for landlords to allow rival stores to open up near one of Canada’s Big 5 grocery chains (Loblaws, Metro, Sobeys, Walmart, Costco), who control more than two-thirds of domestic grocery sales.
“Those lease clauses allow grocery stores, and other retailers, to ensure that their investments are safe from excessive competition.”
Matthew Jackson, Vice-President with CBRE’s National Retail Group, said every retailer, not just grocery stores, likely has a clause barring a similar use from the property where they are located.
“I personally think looking at the Competition Bureau and talking about the lease terms, I just don’t think that should be the specific focus. It’s not just in the real estate,” he said.
“What I understand the government basically is just saying if they’re able to take away the restrictive covenants within a lease in a centre and prohibit any restrictions going forward on a property, if a grocery store leaves, then it would allow new groceries to go on, other smaller deli’s, bakeries and other types of retailers to go into the centre.
“From what I understand what they’re saying, if we take the control away from the top five then there will be more competition. From reading the articles it says the UK, New Zealand and Australia have put in measures that have been successful. So I think they’re saying do that here.
“But my personal opinion and I know some people disagree with me – I do predominantly tenant representations – when we go into a centre and there’s a ground up development and you’re wanting to negotiate a deal and get prime positioning and you’re the first one to the table, you sometimes will pay to get the right spot and the right centre.
“If I’m Metro or Loblaws or Sobeys and I’m up in a centre paying $25 a foot and all of a sudden in year three they put in a Giant Tiger and then potentially a Farm Boy and other smaller grocery in a bigger plaza, my profits might be eroded away and I shouldn’t be paying the same rate as I did before because I did the pro forma to do the build out.”
He said a ban would trigger significant changes in how grocers and landlords approach leases.
CBRE said landlords are happy to land a grocery store because they bring in shoppers multiple times a week and that traffic helps boost sales and surrounding tenants. If there were no exclusions, grocers would likely pay landlords a lower rent, which could impact the value of that retail property.
“Government tools are rarely subtle and this change could have a domino effect,” said Jackson. “If there aren’t any restrictions, grocers would offset the rent offering for the potential decrease in sales due to competition. And if they pay less rent, that translates into a lower value for the retail centre.
“So does the landlord want to have the highest rents and the highest value for their retail property and give a grocer exclusions, or not have that exclusivity and have a diversity of other grocery options but lose some value?
“Even if that decision is taken out of the landlords hands.I’m not sure we’ll see the increase in competition the Competition Bureau is looking for due to some other important factors.”
Jackson said real estate isn’t necessarily where the solution to lower grocery prices will be found.
CBRE said smaller communities are where this change is likely to have the greatest impact. If a town only has one property that can house a grocery store, then exclusive use terms would stop butchers, bakeries and other independent businesses from locating in that centre. This would limit competition in a significant way.
“But the bigger culprit in most communities would be supplier agreements,” said CBRE.
“Large chains have agreements with suppliers to put their products on shelves. Independent stores don’t generally get the same deals as the Big 5, and so they are at a significant disadvantage in accessing the product and competitive pricing they would need to compete, even if they could sign a lease wherever they wanted.”
“Real estate isn’t prohibiting new entrants to the market,” added Jackson. “It’s more the control that grocers have through supplier agreements.
“If potential new entrants want to profit off the success of a Big 5 grocer’s presence, they can’t do it because those grocers have a strong hold on suppliers.”
While doing away with exclusive use clauses could increase competition between grocers in sought after locations, Jackson said the change could have unintended consequences that actually result in higher prices for shoppers.
“But if I’m a grocery store looking at signing up for a 20-year term and then I know in year three the landlord will bring in competition, I don’t want to be stuck paying a premium for 17 years,” he said.
“So length of term will be affected. And unfortunately if you shorten term, the investment is amortized over a shorter period, and that means higher rents for the grocery stores. Which is the domino effect again. Because higher rents will eventually impact grocery prices.
“You can attempt to solve for food prices through real estate lease clauses and rents and other things. But if you have 20 new competing grocery stores that can’t get the product on the shelves, then you realize that real estate wasn’t really the problem to begin with.”
Dr. Sylvain Charlebois, Senior Director, Agri-Foods Analytics Lab, Dalhousie University, said there are different levels of what’s happening in the grocery business.
“Leases are certainly a concern. The fact that some grocers are really trying to control certain micro markets, whether it’s a shopping mall or a small district, I don’t think it’s a secret for Canadians. But I think what has changed is our collective tolerance towards some of that control,” he said. “I think a lot of people are saying well maybe that’s a problem.
“And the other issue of course is our non-written deals between certain retailers. I do know for a fact that some discount stores nearby major grocery stores aren’t allowed to sell certain products, like bread for example, and staples . . . Those are things that I think people are less and less tolerant about.
“The other thing I can tell you is there are a lot of pieces of land owned by grocers all over the place that have been basically sitting there idle, vacant, and nothing is going on and they just basically bought land to make sure that the competition doesn’t come in and buy that property and build a new store. I’ve always believed that urban Canada, people in big cities, we’re fine. We have options. But it’s in rural communities where often you basically have one option unless you want to drive half an hour.”