Canada lacks room for new U.S. box stores: Analysts
The logo of a Target store is seen in Arvada, Colorado February 24, 2009. (Reuters/Rick Wilking)
The long-awaited expansion of Target Inc into Canada, announced last year, raises the question, why haven’t more big U.S. chains made the seemingly easy move north into a market where established retailers are doing well.
One of the biggest obstacles holding them back is a dearth of suitable commercial space in Canada, analysts say, and the difficulties involved in building more shopping malls and free-standing retail locations.
“Finding space is really difficult, but even if they can find it, it’s expensive,” said Maureen Atkinson, senior partner at J.C. Williams Group, a Toronto-based retail consulting firm.
Expansion into Canada might seem like an obvious move for chains based south of the 49th parallel.
Canada’s economy is healthy, having held up more strongly than the U.S. economy during the global recession, and its recovery has been more vigorous. Its banking sector is the soundest in the world, and a buoyant housing market is one of the engines that has kept consumer spending robust. Canadians and Americans are similar in their shopping habits.
More to the point for retailers, Canada’s shopping malls are 43 percent more productive than their southern counterparts, in terms of sales generated per square-foot of space, an important industry metric.
“U.S. retailers are looking at the Canadian marketplace because of the productivity,” said Daniel Baer, national retail industry leader at Ernst & Young. “Traditionally the retail in Canada has been quite profitable, and that’s why it leads more competitors into the marketplace.”
Nordstrom Inc, a high-end department store chain with locations throughout the states, is on record as saying it wants to move north. Kohl’s Corp, the Menomonee Falls, Wisconsin-based mid-range department store chain, also has its eyes trained north, but neither company has announced specific plans.
“We’ve been looking at Canada for over a year now,” Erik Nordstrom, president of the Seattle-based company that bears his family’s name, said in February. “The challenge ... is the real estate. It’s a tough real estate market.”
The company declined further comment, saying only it has no specific plans to share yet. Kohl’s would not return calls.
FEWER SHOPPING MALLS
Why the higher productivity? Mostly it’s because Canada has fewer shopping malls than the United States on a per-capita basis, with about 15 square feet of space versus about 24 square feet south of the border, according to John Crombie, senior managing director and national retail director for Cushman & Wakefield, a commercial real estate firm.
“Canadian malls do substantially better than American malls,” said Sam Winberg, co-founder and principal for Northwest Atlantic (Canada), a real estate consulting firm in Toronto, said. “But it is not because Canadian consumers are better, but because we have a lot less retail per capita than in the U.S.”
The development of shopping malls in Canada isn’t as easy as in the United States, experts say. Financing options are more limited, zoning regulations are stricter and the Canadian tax structure can be an obstacle, they said.
“The Canadian development business is different. It’s slower and more expensive, and more complicated,” Winberg said.
Indeed, only two enclosed malls - Vaughan Mills near Toronto, and Cross Iron Mills near Calgary - have been built in Canada since 1989, he said.
As a result, demand for space in the existing centers - especially premium locations such as the Yorkdale Mall and Eaton Center in Toronto, and Pacific Center in Vancouver - has skyrocketed, Crombie said.
“A lot of locations are running out of space,” he said. “They can’t accommodate newcomers.”
Upscale chains such as Victoria’s Secret - the U.S. based-lingerie retailer that made the move to Canada in 2010 - want to set up shop in premium locations. The chain, owned by Limited Brands, has opened 14 outlets in Canada so far, a tiny addition to its stable of more than 1,000 U.S. outlets.
Premium Canadian malls generate about $1,000 to $1,300 in sales per square foot a year, nearly as twice much as the national average. By comparison, Roosevelt Field, a comparable mall in the New York City suburb of Garden City, Long Island, generates between $650 and $750 per square foot, Crombie said.
“So there is an absolute frenzy as retailers try to get into these malls,” Crombie said.
According to International Council of Shopping Centers, Canadian shopping malls overall outshine U.S. rivals, with average sales of $589 per square foot in 2011, compared with the American average of $412 per square foot.
To be sure, higher sales mean higher rent. Yorkdale, a mall in north Toronto, charges about $200 per square foot in rent, while Long Island’s Roosevelt Field charges about half at $100 per square foot, according to Crombie.
Labor, material and distribution costs are higher in Canada, too, while some retailers have to pay for higher duties on imported goods from China and other countries.
Even so, profit margins tend to be higher in Canada, Atkinson at J.C. Williams said, because retailers can charge more than the U.S. counerparts.
The more concentrated Canadian retail environment enables retailers to set higher prices. In Canada, the four largest retailers have 28 percent market share, versus only 12 percent in the United States, according to BMO Capital Markets research.
When comparing similar goods in two countries, prices are 20 percent higher in Canada than the other side of the border, according to the BMO research, published in April 2011.
The high cost of retail space presents a conundrum of sorts. Only the biggest chains, such as Target, can contemplate the expense, but at the same time, the size of such chains makes it difficult for them to find enough suitable locations.
“The larger the space, there are not that many opportunities,” warns Crombie. “The premium malls can’t accommodate them.”
In Canada, five top landlords - RioCan, Calloway REIT, Ivanhoe Cambridge, Cadillac Fairview, and First Capital Realty, - control 33 percent of retail inventory in shopping centers, Crombie said. “It’s a tight and small market,” he said.
After years of anticipation, Target announced last year that it was following in Wal-Mart Stores Inc’s footsteps and making its debut in Canadian market. Its strategy highlights some of the difficulties faced by other U.S. retailers looking to expand northwards.
In Target’s case, the second-largest U.S. retailer, took over leases for up to 220 Zellers stores, owned by Canada’s storied Hudson’s Bay Co. That will quickly give the Minneapolis-based chain an immediate coast-to-coast footprint when it opens for business in Canada early next year.
“It was a smart play,” Crombie said. “They can get an immediate traction in the market.”
Crombie said Target’s expansion could hold some valuable lessons for other U.S. retailers, and many are sure to be watching to see how the discounter fares in the Canadian market.
“Everyone wants to see what the degree of the success will be,” he said.