Are Grocery Store Lease Terms Increasing the Cost of Food?

A recent report from the Competition Bureau confirmed what most Canadians know to be true: 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.

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.

Could such commercial lease clauses be adding to rising food prices? What would banning exclusive use clauses mean for retailers, location selection and commercial real estate guidance?

We spoke to Matthew Jackson, Vice President with CBRE’s National Retail Group, to find out.

Devil’s in the details

It may not be common knowledge among shoppers, but exclusions are typical across the retail industry.

“Every retailer from grocers to dry cleaners, even your favourite coffee shop, likely has a clause barring a similar use from the property they are in,” says Jackson. “Only car dealerships and furniture stores don’t generally negotiate for exclusions because they do better when there is more traffic around.”

Banning this widely-used lease clause would be no small adjustment, and a retail veteran like Jackson says it would represent a once in a generation shift. “I think a ban would trigger significant changes in how grocers and landlords approach leases.”

When grocers negotiate leases with landlords, they will typically stipulate that they don’t want competition within the same centre (or adjacent centres that the landlord controls), and they pay a premium on the lease rate to secure that control.

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,” says 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,” Jackson adds, “I’m not sure we’ll see the increase in competition the Competition Bureau is looking for due to some other important factors.”

Not a real estate problem

Real estate isn’t necessarily where the solution to lower grocery prices will be found, Jackson says.

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.

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.

And though there is plenty of room in bigger markets for smaller-footprint competitors like Farm Boy or new entrants like Aldi to co-exist nearby to the bigger grocers and potentially draw some business away, those supplier agreements represent the biggest barrier to entry.

“Real estate isn’t prohibiting new entrants to the market,” says 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.”

Grocers shopping spree

Jackson advises grocers and other retailers on their long-term real estate decisions.

He anticipates there are a number of ways landlords and grocers might respond in the event that government seeks to limit property controls. 

Grocery giants might decide to go on acquisition sprees, snatching up all available properties around their locations as a hedge against competition.

“If they own all the desirable land and key retail centres, then they can dictate which stores open and control their own destiny, versus the unknowns with a lease,” says Jackson. “So it could lead to a grocer shopping spree which then limits competition regardless of the suggested change to lease terms.”

Shorter leases, higher rents, more food inflation

While doing away with exclusive use clauses could increase competition between grocers in sought after locations, Jackson says the change could have unintended consequences that actually result in higher prices for shoppers.

Due to the substantial investment required to build out a grocery store, landlords amortize the cost, typically over a 20-year term, knowing that a grocer could be in that location for 50 years or more.  

“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,” he says, “I don’t want to be stuck paying a premium for 17 years.”

“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.”  

A more effective course of action would be to focus on the aforementioned supplier agreements and how they thwart competition by restricting who can sell what on their shelves and/or at what price they can purchase goods.

“You can attempt to solve for food prices through real estate lease clauses and rents and other things,” says Jackson.

“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.”