Canada: Open for Business

U.S. retailers will find opportunity and challenges north of the border

From Target Corp. and Big Lots to J. Crew and Express, the list of U.S. retailers expanding into Canada or scouting locations north of the border seems to grow longer every day. With its growing population, enthusiasm for U.S. brands, relatively underserved market and stable, resilient economy, Canada has become a land of opportunity— and a potentially important profit center — for American retailers. In fact, more U.S. retail powerhouses are eyeing Canada as an untapped market to expand their customer base than ever before, according to a 2011 report from the Ryerson University Centre for the Study of Commercial Activity.

Some recent statistics help explain Canada’s appeal. After the global recession, the Canadian job market is rebounding (unemployment fell to 7.2% in March 2012). The country’s total population is more than 34.6 million, up 5.9% since 2006 (the fastest growth of any country in the G8).

Total Canadian retail spending in 2011 exceeded $450 billion, with the highest volumes in the provinces of Ontario ($160 billion), Quebec ($101 billion), Alberta ($64 billion) and British Columbia ($59 billion).

“U.S. retailers should absolutely look to Canada for expansion,” said James Smerdon, director, retail consulting, Colliers International Consulting, Vancouver, British Columbia.

Just as in the United States, one of the key metrics used to gauge retail success in Canada is average sales per square foot. According to the 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.

“A snapshot from November 2011 showed the average sales per square foot at $610 at centers in Canada, compared with $417 sales per square foot at U.S. shopping centers,” said David Bell, senior associate, planning and retail consulting, Colliers International Consulting.

He noted that at Chinook Centre, the premier mall in Calgary, sales hit an average of $1,000 per square foot for the first time last November.

“Retailers should study shopping patterns across major cities and benchmark properties that are leaders in their respective markets,” Bell advised.

In another plus for U.S. retailers, there is no longer a pronounced difference in the value of the U.S. and Canadian currencies. Indeed, the value of the Canadian dollar has increased to be almost on par with the U.S. dollar.

According to the Bloomberg Correlation-Weighted Indexes, Canada’s currency — nicknamed the loonie — was up 3.9% over the six-month period leading up to April, while the U.S. dollar declined 2.4% during that same period. Essentially the two currencies were at virtual parity in early April, when the loonie was valued at 99.11 cents against a U.S. dollar value of $1.0090.

“When the currencies have comparable value and Canadian retail centers are performing that much higher than U.S. shopping centers, the Canadian retail sector looks a lot more attractive to U.S. retailers,” Smerdon said.

A major factor contributing to the higher performance of centers north of the border is that Canada has fewer shopping malls than the United States on a per-capita basis.

“When retailers begin the process of identifying opportunities in Canadian cities, it is very different than in American cities because we don’t have as much space — retail development has been more constrained here,” Smerdon said.

Challenges: Before they start pitching their tents, however, retailers should do their homework. Despite the many cultural similarities, Canada offers some unique challenges.

“The difference between great success and mediocre success in Canada depends on the retailer’s understanding that Canada is a patchwork of very diverse markets,” Smerdon said.

Canada is a network of regional economies and regional markets, Smerdon explained, and each has to be understood on its own merits.

“Rather than looking at Canadian averages for retail across the entire country, one must study the significant differences in economic characteristics from region to region, province to province, city to city,” he added.

Also, as noted earlier, retail space is somewhat limited. Historically, the development of shopping malls has not been as easy in Canada as in the United States due to a number of factors, including stricter zoning regulations and more limited financing options. Compared with the saturated U.S. market, the Canadian market is relatively underserved and ripe with untapped potential. Even during the recession, Canada’s retail real estate occupancy remained resilient, carrying above 97%.

But less mall space and more productive square footage also had a downside: higher rents versus the United States. And with demand for space in Canada’s existing centers, particularly the premium ones, skyrocketing, the situation is not likely to ease up anytime soon. Labor, material and distribution costs are also higher in Canada.

Real estate realities: According to many industry experts, mergers and acquisition represent the fastest, surest means of accessing retail real estate in Canada, and this is true for developers as well as retailers. Both Target Corp. and Big Lots have chosen this route.

In November, Tanger Factory Outlet Centers (Greensboro, N.C.) and RioCan Real Estate Investment Trust (Toronto, Ontario) announced they had jointly purchased Cookstown Outlet Mall, a 161,000-sq.-ft. center with the potential to be expanded to 320,000 sq. ft., located on the outskirts of Toronto. Tanger’s CEO Steven Tanger described the acquisition as the first step in establishing a larger Canadian outlet center portfolio.

Another U.S.-based REIT with one of the largest Canadian portfolios is Kimco Realty (New Hyde Park, N.Y.), which has 65 shopping centers throughout Canada, totaling 12.2 million sq. ft. Kelly Smith, managing director of Kimco’s Toronto-based Canadian operations, acknowledged the majority of Kimco’s Canadian properties were acquired and all of the centers are jointly owned with partners, although Kimco retains at least 50% interest in each one.

Describing development in Canada, Smith explained, “You don’t build unless you have tenants — that’s just the way it is here. We do very little in the way of development in Canada, but we do have the potential to increase the size of one of our centers that is currently 700,000 sq. ft. by up to 300,000 sq. ft. Apart from that, we might add a pad here or there, but that’s all.”

The supply of retail real estate is held in check by the banking system and lenders that are largely unwilling to finance speculative development. The constrained market is frustrating for retailers that want to expand, but it contributes to low vacancy rates and healthy competition when spaces do come available.

“There is less concern that a new shopping center will open down the road,” Smith said. “Our entitlement process is more difficult, expensive and time-consuming, which makes it harder to develop — but all these factors point to a low-risk environment with good economic fundamentals.”

When retailers do find a space, the leasing process is similar to that in the United States — but with a few notable exceptions.

“Negotiating power is tilted to the landlord in Canada, so co-tenancy clauses are rare and tenants have [less influence] over restrictions on other uses in a center or what other tenants can do,” Smith explained.

Retailers signing leases in Canada may be moderately surprised by how little leverage they have with institutional owners in Canada compared with the negotiating power they typically enjoy with U.S. landlords. But U.S. retailers are even more surprised by one of the subtle legal differences in Canada.

Mario Paura, senior partner at business law firm Stikeman Elliott in Toronto, explained: “Retailers can expect to operate under two binding agreements on the leasing side. In the United States, you typically have a non-binding agreement (letter of intent) followed by the binding lease. But in Canada, the offer to lease is binding and then [the parties] move into the binding lease.”

When retailers choose to purchase a property, rather than lease, they may encounter more delays and transaction fees than anticipated. Paura noted: “On the purchasing side, transactions may attract a land-transfer tax which, depending on the municipality, ranges from 1.5% to 3% of the transaction value.”

“With regards to permitting and entitlement,” Paura continued, “while there are many similarities between the U.S. and Canada, if questions are raised about the retail use — either by a city or residents or surrounding tenants — then the entitlement process may take longer.”

Additionally, there are unique property laws in the province of Quebec, largely because Quebec’s property laws are civil-code-based as opposed to common-law-based. Paura likened the fact that Quebec is uniquely different from Canada’s other provinces to the way Louisiana is different from other states, but he stressed that retailers should not feel intimidated by the differences.

“From a legal perspective, there are no material differences in regions that would make expanding into one region more difficult or easier than another,” stated Rocco Delfino, another senior partner at Stikeman Elliott. “In some cases, U.S. clients have the initial impression that Quebec, with its Civil Code and French language laws, may be more complex than common-law provinces. However, in conjunction with our Montreal office, we can readily explain the rules and requirements and provide related practical advice [so] clients are better able to focus on what makes sense from a business perspective.”

Geographical challenge: The most inflexible challenge facing retailers interested in expanding in Canada is the country’s geography and the inherent logistics required to effectively distribute goods for coast-to-coast operations.

Eighty percent of Canada’s more than 34 million residents live within 100 miles of the U.S. border. Across this relatively thin continental stretch of populated land, travel distances between major metropolitan areas are much greater than in the United States.

“Toronto, Canada’s largest city, is a five-hour drive from Montreal, the second-largest city,” Kimco’s Smith said. “And the third-largest city, Vancouver, is over a five-hour flight from Toronto — so distribution is quite a challenge if retailers want to open just a few locations in the largest cities.”

Smith has a list of U.S. retail concepts that Canadian consumers are clamoring for, and it includes Trader Joe’s (which has moved to the top of the wish list now that Target has made its commitment), DSW, Ross Stores and any of a number of higher-end restaurants. Perhaps the first step toward luring these brands is to build it, so they can come.

Not only is development in Canada considerably more constrained than in the United States, there is also little variety in the properties that exist.

“While the quality of our shopping centers is high, the range of shopping center formats is more limited in Canada, which to a degree limits consumer choice,” concluded Collier’s Bell. “Since consumer shopping preferences are very similar in both the U.S. and Canada, there are opportunities to bring a broad array of retail formats that are popular throughout the U.S., such as premium outlets, lifestyle centers and integrated mixed-use developments with entertainment, food and employment uses.”

In fact, that is already starting to happen. Indianapolis-based Simon Property Group and Calloway Real Estate Investment Trust, Toronto, have started construction on what is billed as Canada’s first upscale outlet center. The first phase of the planned 500,000-sq.-ft. Toronto Premium Outlets, a joint venture between Calloway and Simon, will open in the summer of 2013.

“We see tremendous opportunity to introduce our top merchants to the Canadian market,” said John R. Klein, president of Simon’s Premium Outlets division.

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