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Starbucks Loses Ground on Real Estate Front

The announcement that coffee giant Starbucks plans to close 600 locations--500 more than its CEO Howard Schultz had talked about earlier this year--is unwelcome news for frappuccino lovers, but it’s likely to upset real estate owners and investors even more.

For years, Starbucks has served as a mini-anchor for smaller strip centers. The presence of a Starbucks could turn an otherwise ordinary center into a preferred investment vehicle for many buyers because of the coffee giant's ability to pay premium rents and at the same time provide heavy foot traffic. As recently as 2007, Starbucks-anchored properties garnered cap rates up to 100 basis points below the national average. Now that the Seattle-based chain is grappling with problems, however, it might begin to lose ground to rival Dunkin’ Donuts as the go-to anchor for multi-tenanted strips.

“At this point, Starbucks has not published a list of the stores they are closing, they will just let the landlords know 30 days in advance, so you really don’t know whether your Starbucks is closing or not,” says Bernie Haddigan, national director of the retail group with the national brokerage firm Marcus & Millichap Real Estate Investment Services. “And if you were to lose a Starbucks, it would be significant, because they pay premium rents in most markets and it’s going to be hard to replace those rents.”

The chain’s July 1 announcement that it plans to close 600 U.S. stores came after a disappointing second quarter. For the three months ended March 30, Starbucks reported a 28 percent decrease in net earnings, to $108.7 million, and what it described as a “mid single-digit decline in comparable store sales.” The weak results were due to a combination of a turbulent economic climate and an overly aggressive expansion strategy, according to Wall Street analysts, most of whom lauded the store closure move.

Currently, Starbucks’ biggest competitor is Starbucks itself, says Morningstar analyst John Owens, who notes that new locations in close proximity to existing stores cannibalized sales.

The 600 closings represent only 8 percent of Starbucks’ 7,257 company-operated U.S. stores and 5 percent of its total 11,434 U.S. stores, Owens adds. The closings will take place through the remainder of fiscal year 2008 and first half of fiscal 2009. In addition, the chain will limit its new store openings in the U.S. to fewer than 200 this year. Previously, it planned to open about 250 new locations a year through 2011.

But the bitter medicine philosophy will prove of little comfort to owners who will have to replace Starbucks’ spaces, according to Haddigan. He notes that the chain often pays 30 percent to 40 percent above the market average in net rent. To find another anchor willing to pay the same amount in the current real estate market would prove difficult. That means it will be hard for an owner to sell a center that relies on a Starbucks as well, since lenders could prove unwilling to finance a transaction on a property that might be about to lose its anchor tenant.

“It’s not like my phone has been ringing off the hook with people saying they don’t want to buy those properties, but it’s not good, it jeopardizes the credit of the deal and it erodes confidence in the small shop strip centers,” says Chad Firsel, executive vice president with NAI Hiffman, an Oakbrook Terrace, Ill.-based commercial real estate services firm.

Firsel estimates that in view of the store closure announcement, cap rates on Starbucks-anchored centers will rise anywhere from 75 basis points to 100 basis points, to a range of 7.25 percent to 7.5 percent. That comes at a time when investment sales volume for centers in the $1.5 million to $5 million range is already 50 percent down compared to last year, according to Haddigan. “In the short run, if you’ve got a marginal Starbucks, it’s probably not going to trade,” he notes.

Haddigan adds that for the time being, he would stick with Dunkin’ Donuts-anchored properties. The Canton, Mass.-based chain has proven that it can withstand economic downturns with its more affordable selection of coffee and pastries, plus it pays rents that are more in-line with the market average, making it easier to replace if a given location does close.

At the end of 2007, Dunkin’ Donuts operated 5,769 franchises in the U.S. and was planning an aggressive expansion into Western states, including Indiana, Arizona and Texas.

“The fact that Dunkin’ is moving west of the Mississippi is going to have a much greater impact on Starbucks’ future success,” says Keith Politte, senior vice president with the corporate solutions division of Colliers International, a Boston-based real estate services firm. “I think you will see more of an impact a couple of years from now.”

--Elaine Misonzhnik

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