Starbucks Stops Paying the Rent

The Wall Street Journal “Starbucks Leases in Dispute” reports that Starbucks (SBUX) is playing hardball with landlords for existing stores that it is vacating and new stores that it does not intend to occupy. Starbucks claims that its leases contain a clause allowing it to negotiate early terminations. When landlords refuse to negotiate, Starbucks simply stops paying the rent for unoccupied stores. Starbucks will let the courts decide how much it owes.

Starbucks’ attitude is particularly harsh on developers that build custom buildings or engaged in custom renovations for them. Starbucks sold themselves as partners with developers; now they say shareholder interest tops all. This could make for tough public relations for the virtuous company. Does the Barista’s health insurance come next?

The Journal points out an interesting twist. While landlords covet the traffic that Starbucks brings to their development, Starbucks has not been able to leverage this into attractive lease rates. Starbucks typically pays top rent for the best locations with shopping centers.

Stand alone locations might be willing to be paid for an empty store for a long period of time, before settling on a termination fee. But, good economy or bad, an empty store in a mall or shopping center spells trouble. First, empty stores in a mall or shopping center present a depressing environment for shoppers. Shoppers will migrate to malls and shopping centers with more life. Second, landlords typically get a percentage of sales (above threshold) in retail leases. Some mall and shopping center leases even require tenants to remain open for the length of the lease.

Replacement tenants are likely to pay a lower rent than Starbucks, so Starbucks needs to provide incentives for the landlord to find a new tenant quickly and mitigate the landlord’s damages. In these difficult times if landlords refuse buyouts, Starbucks should pay a negotiated percentage of the rent for the length of the lease to subsidize a future tenant.

Once Starbucks core values begin to erode, the company’s decline will accelerate. As I wrote in "Starbucks became Day Old Coffee Long Ago", the aspirational lure of Starbucks is already fading.

Disclosure: No positions

Comments

[Greg Weston:]

Interesting. I am a real estate lawyer, and Starbucks is quite typical with these hardball tactics.

Commercial real estate is imploding because of news like this. Assumptions about rent and rent growth were too high, as was the degree of leverage in these deals.

If you have a real estate contract dispute, DO NOT assume the other party is going to work things out with you in a fair matter. Especially if the other party is a big corporation like Starbucks or DR Horton. Instead, hire a lawyer immediately. Too many people wait until too long before hiring a lawyer, and in the mean time take actions that hurt their positions.

2008 Oct 23 04:14 PM

[Kevin_S:]

Well, I don't own starbucks, but this is easy to understand. You share room and you used to pay too much. Now, you can rent or even buy much cheaper, so why not negotiate first. This is actually a constructive step.

If the other side (landlord) doesn't want to negotiate, then he/she really got lost with all things going in real estate market.

2008 Oct 27 10:10 AM

[weiwentg:]

I remember a similar incident where a San Diego superior court ordered Starbucks to compensate baristas for tips the company had made them share with shift managers. Starbucks of course announced its plans to appeal the ruling, but also said it refused to comply with the ruling. The company also said it would disobey an injunction preventing supervisors from sharing tips in the future.

When investing with a visionary CEO, one of the possible risks is that the CEO will act as if he/she is above the law. While the court could have got it wrong, the company should have at least complied with the injunction.

I hope the company considers the effect of actions like these on its public image. Americans don't generally like scofflaws.

Disclosure: long Starbucks.

2008 Oct 27 04:47 PM

[Jimmy Jo Me...:]

Another commented that Starbucks management should at lest comply
with
a court injunction rather than act as if they are "above the law". How can
you be physically above an abstraction? Besides, will you do evil because
a court orders you to? Do you want to burn in hell? Godly people SUBMIT
to authority: SUBMIT means be willing to obey, and not obey. See
Daniel 12, KJV. Also, Acts 5:29, KJV. You ought to obey God rather than
men. OUGHT means "moral obligation", as in "debt", and not "should".
A person who submits to authority is willing to obey, but might not. In my
opinion, the court injunction ordering Starbucks not to share tips with
others is immoral, because Starbucks should be allowed to decide how
to compensate their own employees. Or is government now going to do
payroll, as well as collect taxes?

Anyway, the main problem Starbucks faces is one that McDonald's does
not face: McDonald's tries to make sure that they own the property upon
which their restaurants sit. Landlords may keep raising rental costs such
that they absorb all the profits that would have gone to Starbucks. At
some point Starbucks will have to start buying real estate to avoid this
escalating rental cost structure. For landlords are collecting what could
go to shareholders as dividend income, or to the company as retained
earnings. The "partners" are competing with shareholders, customers,
and the Company itself.

2008 Oct 28 04:31 PM

[Jimmy Jo Me...:]

On the other hand, when a customer tips an employee, he is
"paying" that employee, and Starbucks should not be allowed to
tell a customer who he can, and cannot give a gift to. So, in this
case, the court was right, and should move to fine Starbucks, or
arrest the person who violated the court injunction, for that would
be morally correct. The point is, you decide for yourself what is
right, and what is wrong, but the question is, will you decide
correctly? Having known that the tip would have been shared with
the "shift manager" the "customer" might have decided to wait until
the waitress had left the building, or tipped her "under the table".
Of course, maybe the waitress didn't really want the tip that badly,
and was happy taking a percentage while passing the rest on to
her "shift manager"? Does this sound like "prostitution" (sales) to
anybody else? I think I should have put more thought into this
blog post before hitting the "send" key.

2008 Oct 28 04:42 PM