Amazon’s Lease Concerns After Whole Foods Purchase

NEWPORT BEACH, CA—Since its purchase of Whole Foods this past summer, Amazon is finding it quite a bit more difficult to innovate in this new environment largely governed by preexisting binding legal agreements than in the freewheeling world of online commerce, Landmark Capital Advisors managing director Adam Deermount tells Deermount has an inside perspective on many aspects of CRE, so we spoke with him about some of the issues he has noted that the online giant is facing and how it is navigating the unfamiliar brick-and-mortar grocery space. What problems is Amazon facing with regard to Whole Foods’ leases?

Deermount: When Amazon purchased Whole Foods, many—including yours truly—assumed that the e-commerce behemoth would be able to do as it liked with existing Whole Foods stores, making a relatively clean transition into the brick-and-mortar retail space. However, Amazon is finding it quite a bit more difficult to innovate in this new environment largely governed by pre-existing binding legal agreements than in the freewheeling world of online commerce.

When an anchor tenant signs a lease at a retail center, it’s common practice that its attorney’s will insert language that governs certain things that the landlord can and can’t do. These provisions include exclusive rights to sell certain goods and services, disallowing certain uses and outright bans of competitors. These clauses typically make sense from the perspective of both parties. The landlord benefits of having a strong anchor that draws foot traffic, which allows it to lease to other smaller tenants that aren’t primary draws on their own. As such, it’s in their best interest to put the anchor tenant in the best possible position to succeed. The anchor tenant doesn’t want a competitor coming in next door, nor do they want certain uses that could lead to lower foot traffic or offend potential customers. For an extreme example, an anchor that caters to families wouldn’t want a strip club becoming a tenant in the same center. So, how is this putting Amazon at a disadvantage?

Deermount: One of Amazon’s primary objectives in buying Whole Foods was to gain the ability to sell certain Amazon items in Whole Foods’ 473 stores. Amazon also planned on installing lockers in Whole Foods stores for customers to pick up items that they purchased online. The problem, as Amazon is now finding out, is that each of those stores is subject to a lease agreement, and that agreement likely puts restrictions on certain activities that may conflict with Amazon initiatives.

Jeffrey Dastin of Reuters wrote an article earlier this week that detailed just how much of an issue this could become:

“A Reuters examination of real estate agreements and interviews with 20 retail landlords, lawyers and brokers show that the strings attached to operating in malls like City Center present an emerging and little-scrutinized challenge to Amazon’s quest to reshape Whole Foods.

“Across the United States, large retailers including Target, Bed Bath & Beyond Inc. and Best Buy Co. Inc. have legal rights in many lease agreements that allow them to limit what Amazon can do with nearby Whole Foods stores and where it can open new ones.

“Documents reviewed by Reuters show bans on Amazon lockers and delivery operations near a Target store in Illinois and also in Florida, where a new Whole Foods is set to open. Lockers for retrieving online orders are a way for Amazon to spur sales through the grocery chain.

“In Manhattan and other locations, the leases of Whole Foods’ big box neighbors bar it from selling a range of goods that Amazon has in its massive online inventory, from electronics to toys and linens.

“Even Whole Foods stores that do not share space with major rivals can face constraints imposed by local governments. A city council resolution in White Plains, NY, restricted the hours when Whole Foods can use a loading dock prior to the grocer locating in the mall.” How are these rights playing out for Amazon?

Deermount: According to Reuters, Target has been particularly aggressive in its lease negotiations, leading to outright prohibitions on lockers and online fulfillment in the same centers where they are an anchor. However, it is far from the only anchor tenant that does this, and I think that it’s fair to say that traditional brick-and-mortar retailers are going to use every advantage that they have to avoid getting steamrolled by the Amazon juggernaut. So, what is the upshot of all this?

Deermount: My main takeaway is that overlooking this was a major legal/due-diligence screw-up. How did the restrictive lease provisions get by the Amazon legal and due-diligence team during the Whole Foods acquisition? These lease provisions represent a massive roadblock to so much of Amazon’s Whole Foods strategy, and yet they are only coming to light now based on a Reuters investigative report.

Also of note is that this is not a short-term problem. Anchor-tenant leases typically run 10 to 20 years with renewal options, so the tenants in question likely aren’t going anywhere for years to come. Amazon is apparently trying to negotiate with Target and others to revise agreements, but Reuters sources seemed to indicate that the talks had gone nowhere. Sure, Amazon’s latest filings show that it is planning on opening +/- 80 new Whole Foods stores, but those will also be subject to existing leases or city ordinances as mentioned above. Seems like an awfully large due-diligence blunder.