Filling Canadian Target locations won't be simple

Target Corp.'s retreat from Canada will leave a gaping real estate hole that won't likely be filled quickly or easily.

Canadian real estate investors viewed the Minneapolis-based retailer as a white knight when it aggressively moved into the market in one fell swoop by gobbling up nearly 15 million square feet of space vacated by a Canadian department store chain, Zellers. But Target isn't staying for long, which presents a new problem for the landlords.

The company said Thursday that it will close all 133 of its existing storefronts in the next four to five months and will cease work on seven new locations that will never open. The general merchandiser owns three of the existing stores, while the rest are leased from about 20 different property owners.

In addition to stores, Target owns three distribution centers in Canada and leases several other warehouses. The company also leases office space at more than a dozen locations across the country.

"This is a surprise to everybody, including us. When they came in, we were very happy because we were worried about Zellers' space at the time," said Rai Sahi, chairman and chief executive of Morguard Corp., a commercial real estate landlord with 15 store leases to Target. "We knew they had some trouble, but the last thing that anyone expected was that Target was going to pull out that fast."

In January 2011, Target Canada agreed to pay $1.8 billion to purchase the leases from Zellers, ultimately paying a net purchase price of $1.6 billion. The company also entered into leases on four non-Zellers sites, then turned around and poured 1.45 billion Canadian dollars into store renovations, according to court filings.

How Target sheds its lease liabilities remains to be seen, but a Canadian court granted Target Canada's initial request for that country's equivalent of bankruptcy, offering it some protection. Target Canada has retained Lazard Freres & Co. to advise the company as it tries to sell its real estate assets.

"In terms of what that looks like — in the selling the leaseholds or subletting them — it is just too early to know," said Molly Snyder, a Target spokeswoman. "That process will begin in earnest soon."

The real estate is a mixed bag of good to mediocre locations.

"I would call much of it second- and third-tier retail locations, many of them built several decades ago. It isn't a pristine tier 1 set of real estate," said Joe Jackman, chief executive of Toronto-based customer experience consultancy Jackman Reinvents.

When Target entered the market, there were rumors that several major U.S. retailers were eyeing Canada, said Jeffrey Berkowitz of Montreal-based Aurora Real Estate Agency. The Zellers portfolio was a way to leap ahead of others and snatch up market share, he said.

But the Canadian consensus: something like that won't likely happen again.

"What is more likely is that retailers here in Canada will take pieces of it, with Wal-Mart Canada at the top of that list," Jackman said.

Sahi said there is already a competition brewing between some major retailers in Canada for his company's most desirable Target locations. But apart from those top-tier locations and some possible property bundling, Jackman said, "It will be a little bit of a pickover situation."

Berkowitz said some of it might also get demolished and reconfigured.

Target's own experience shows some of the limitations of the real estate, though a complicated mix of factors contributed to the retailer's difficulties.

The company broke from its standard format in several ways when it entered Canada. The sheer size of its initial real estate footprint and the locations of some of its stores were among the issues that some think contributed to its failure.

Unlike Target's traditional free-standing, big-box layout, many of its stores in Canada are anchor tenants in big shopping centers or strip malls.

"Target in the U.S. is basically a single level, but here they were two," Sahi said. "Their structure was just not compatible."

The company, accustomed to owning its own real estate, was leasing its Canadian space for between $6 and $7 a square foot, which landlords say is far below the market rate of $20, sometimes even $40, a square foot.

"It is a little less painful because they were paying less in rent," Sahi said, "But some spots will struggle because they were the largest anchor in malls and so the smaller stores will feel that impact."

One concern for Canada's real estate community is that Target's failure could give the market a bad reputation.

"It may erroneously give other retailers the impression that Canada is a bad market. The reality is that this has nothing to do with Canada's economy or Canada's consumers," Berkowitz said. "It is fundamentally a mishandling of entry to a new market. And it would be terribly unfortunate if it would reverberate that Canada's retail and real estate is at fault. This is Target's fault."

Berkowitz had his own anecdote to illustrate what went wrong.

"The Canadians expected the U.S. experience," he said. "Every time we are in the U.S. my wife insists that we stop at Target. Now, we have one near our house and she never goes. She went once and never went back."

Kristen Leigh Painter • 612-673-4767