Retail, Real Estate, and Recession

The retail landscape has some undoubtedly difficult times ahead, as new legal woes for Starbucks (NASDAQ:SBUX) demonstrate. The brouhaha isn't just bad news for the java giant and its shareholders (like me); it also reveals the ripple effects touched off by slowing and recessionary economies.

Changing plans doesn't make friends
According to The Wall Street Journal, Starbucks is being sued by property owners and developers who claim the company needs to pay up for rent or other expenses at stores that have been closed or are no longer opening as formerly planned. Whole Foods Market (NASDAQ:WFMI) recently faced a similar lawsuit for canceling a planned store in Seattle, and I suspect that some retail investors will notice more such cases in the weeks and months to come, given the recessionary climate.

Many retailers are deciding to pare down store counts, or put the brakes on expansion plans, as consumer spending slows. Talbots (NYSE:TLB) and Ann Taylor (NYSE:ANN) in particular are shutting some of their stores, and mounting retail bankruptcies like Linens 'N Things promise even more empty retail space on the market. So does consolidation in the banking industry, such as Wells Fargo's (NYSE:WFC) takeover of Wachovia; these deals mean fewer bank branches, and fewer branches mean more buildings sitting empty.

Needless to say, all this desolate retail space does many property owners no good. I'm no expert on commercial real estate, but I'd say some of the companies in that industry face major ramifications, too. Their fortunes were tied to the bubble -- and some retailers' possible overexpansion -- so these real estate firms are feeling the pain in full as the weak get winnowed out.

The news isn't all bad
On the other hand, an interesting CNN article about Circuit City's (NYSE:CC) woes mentioned that sometimes, when a company is beleaguered enough, property owners might actually try to help out by lowering rents or allowing early lease termination. For landlords, a retailer faring as poorly as Circuit City probably isn't worth fighting with; giving it a helping hand to stay in its current location will at least ensure it pays something.

By that logic, perhaps some real estate companies simply figure that stronger companies like Starbucks and Whole Foods are worth the skirmish; however slow their current traffic, they've historically attracted an upscale clientele.

On a brighter note, companies that have managed their resources well enough to keep growing amid the downturn, tough times like these could mean cheaper rent. American Apparel (NYSE:APP) recently said that it jumped on the opportunity to get bargain rents on spaces left open by the Sharper Image bankruptcy. Some stock watchers might argue that it's silly for a company like American Apparel to try to grow in what looks like a major consumer recession, but it's not hard to imagine that locking in good, cheap retail space could prove to be smart, strategic moves in the long term.

Worst of times, best of times
In truth, retailers' operating leases are considered debt-like, even though they aren't required to be disclosed on balance sheets. Since they represent contractual obligations that must be paid, they can therefore be considered hidden debt, even for retailers that appear otherwise debt-free. While that's just part of the retail business, it might bite some of our companies particularly hard in the present climate.  

It's easy enough not to think about these obligations when times are good, and it's taken for granted that well-run retailers pay them. But many retailers are obviously finding that "business as usual," and the models they used in planning their growth, no longer apply. If shopfrontss and offices start emptying out amid a deteriorating econony, commercial real estate will only suffer.

These may be the worst of times, but nimbler, savvier retailers could come through them in better shape than before. In addition to grabbing cheap retail space, they may also be able to steal away market share from weaker, failing rivals. In the retail world, survival of the fittest now prevails, and the coming months should distinguish the sector's winners from its fair-weather friends.

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