Drug Stores Continue to Dole it Out... and Consumers and Investors Eat it Up...
Retailers in the drug store category have been among the few retail chains opening hundreds of new stores throughout this recession. The "Big Three" -- Walgreens, CVS and Rite Aid -- should account for about 800 new store openings during fiscal 2009, and they plan for continued growth in 2010 and beyond
(find specific expansion initiatives and site criteria of each at the end of this article).
Along with this level of expansion, the
drug store category has managed to keep comp store sales results positive in the recession. According to the International Council of Shopping Centers' U.S. Retail Chain Store Sales Index, the drug store category has reported positive same store sales results for the past seven months -- this is the only sector to achieve such a feat during the past year. In fact, drug store sales comps in September 2009 came in at +3.7%, which is up 1.3% over the previous month, 1.6% year-over-year and 4.9% over the same period in 2007.
ICSC's figures are calculated only on the sales statistics reported by Walgreens and Rite Aid; but the U.S. government's figures for the sector are positive as well. Seasonally adjusted, U.S. pharmacies and drug stores produced a .34% month-over-month improvement and 3.47% year-over-year improvement in sales in August.
Not only has the category continued to resonate amongst U.S. consumers, but commercial property investors have showed continued interest in the retail property type as well.
Using CoStar's new COMPS Analytic Search tool, we found 111 closed sale transactions totaling $491 million that involved freestanding single tenant drug store properties so far in 2009
(note that third quarter transactions continue to flow in to CoStar COMPS daily, so these numbers will rise). Comparing this activity to the same period in 2007 (pre-recession),
the investment sales market for single-tenant freestanding drug store properties has kept up much better than the retail investment sales market has as a whole during this recession.
Specifically, the number of transactions recorded so far in 2009 is already higher than was recorded during the same period in 2007. Pricing is down only slightly. The average sale price per square foot for transactions closed so far in 2009 came in at $320 per square foot, which is down only 6% over the same period in 2007.
Since hitting a low average capitalization rate of 6.4% during the second half of 2007, caps on single tenant freestanding drug store properties have become much more attractive to the buyer. To date in 2009, the average cap rate on these deals stands at 7.3% and that rate continues to climb -- transactions closed in the latest quarter only are averaging a 7.5% cap. This more attractive cap rate seems to be fueling additional transaction activity on drug store properties -- already, more transactions have been recorded during third quarter 2009 than there were closed transactions in the previous quarter.
The sale process on drug store properties is finally starting to speed up as well. At the end of second quarter, the average time a drug store property sat on the market until it was sold peaked at 244 days, however, this average is already down to 136 days based on transactions closed so far in third quarter, which is right in line with pre-recession 2007 averages.
One reason drugstore properties appear to remain attractive to investors is because of their stability. According to CoStar Property Analytics,
there are proportionally less freestanding drugstore properties available for lease today than there were at the start of this recession. In fact, the “for lease” availability rate has decreased from 3.7% at first quarter 2008 only 2.5% currently. The average vacancy rate is even lower -- just under 2%. Comparatively, the drugstore property sector has held up much better than freestanding retail buildings in general, where the average vacancy rate came in at 5.5% at the close of third quarter.
Nick Schorsch, Chairman and Chief Executive Officer of American Realty Capital Trust is versed in the drug store sector, as his company specializes in the acquisition of single-tenant net-lease properties. Schorsch provided examples of recent deals his company has completed.
In September, ARCT closed on the acquisition of a portfolio of 10 CVS stores for $40.8 million, where CVS signed a net lease of 25 years with eight five-year options to renew. ARCT financed the deal at approximately 58% loan to value -- it secured a $23.8 million, non-recourse, fixed rate mortgage from Western & Southern Life Assurance Company. In July, ARCT acquired a Walgreens store on a 25-year lease in Texas for $3.8 million at a cap rate of 8.12% (higher than the market average).
Gill Warner, a senior director for Stan Johnson Company, which negotiates several drugstore property sale transactions said that the top reason property sales in this category have kept going is because drugstores, at least the top two offer top credit and long-term leases. "People want safety and credit in this market and longer term leases are easier to finance," said Warner.
"It's Location, Location, Location," said Schorsch. "Drugstores have some of the strongest real estate because they're on essential corners in every market. We find that the corner is the best real estate in general because of the myriad of uses for them -- about 80 to 85 uses for any individual corner," Schorsch added, arguing that investors almost can't go wrong in acquiring such real estate because even if the drug store shuts down, there are plenty of uses that would want to backfill the space. "Typically someone always has a use for that hard corner. You've got accessibility, visibility, etc. It's much easier backfill," echoed Warner.
From an investor's perspective, Schorsch said, "Even with the economy the way it is, high quality real estate still wins out over the fact that there's a dearth of debt." On transaction activity involving drug stores keeping up, Schorsch said, "People have to buy some real estate, they still need some exchanges. These are perfect fodder for exchange vehicles -- they're affordable and great real estate with fine companies as tenants."
Schorsch said that while the 1031 exchange market has been down, drug store properties have maintained their market share with those buyers. Warner said, "Exchanges are back on the rise. We're seeing a pickup due to the down-leg or the original property they were selling for the exchange finally moving after the seller dropped the price after being on the market for a year or two, so now they can do that exchange."
Schorsch said that many people are buying drugstore properties in all-cash transactions, but outside from that, low leverage is the norm. "Most deals are no longer being done at 85% - 95% leverage, instead, most are being done closer to 45% - 50% leverage," said Schorsch. He added that lenders are looking for amortization, which cuts into cash flow, as well as cash flow coverage in the 160s to 180s. "It's actually terrific. It’s the right thing for this economy to have the banks be cautious, prudent, careful."
Warner said there's a niche CTL group (Credit Tenant Lenders) that have stepped up on drug store deals in this market. "There's not much non-recourse money out there, but specifically for Walgreens, I know there's non-recourse 85% loan-to-value money out there, which is great debt. Most are 25-year terms with 25-year Amortization, which is very attractive as well. You're not seeing 30 years Amortization because that's gone - The amortization is matching the lease, which is back to normal market conditions. "
"This is no 6% cap rate market anymore," said Schorsch. "We're seeing mid to high 7s to low 8s for the investment grades and for the non-investment grades, you could see close to a 10 cap. Before it was probably, in certain markets, sub 6, or even sub 5 in New York or California," he added.
Warner said, "On a Walgreens, we're seeing marketed price anywhere from 7.5% to 8% cap rates and that's probably the same range they're getting done more in the 7.75% to 8% cap rate range." Warner added that in general, Walgreens properties trade at lower caps than CVS. Additionally, he expressed significant challenges in moving Rite Aid properties at all.
CONTINUED EXPANSION IN THE DRUG STORE CATEGORY...
Schorsch said part of the reason drugstores have kept up sales performance, solidifying their standing as reliable tenants, is because closures of stores that had regional draw has had the effect of "driving people into a smaller driving radius," benefitting convenience-oriented drug stores. "Pharmacy companies have been very bright in the way they market - they've been able to maintain their margins and have become mini shopping stores. So they have a broad spectrum of deliverables in the convenience items as well as some very high margin items that are essential to healthcare and it's working for them," said Schorsch.
Jeremy Just, CEO of LandMark Retail Group, which is a preferred developer for CVS, echoed Schorsch's sentiment. "The drug store industry remains strong because they sell daily need items that are not impacted by whether the economy is strong or weak. It’s a recession proof industry."
"I will note that all these guys are slowing down expansion, but in comparison to other retailers, its still a lot of activity," said Warner adding that drug stores still have plenty of room for expansion in the U.S. "Walgreens, CVS and Rite Aid are all committed to be national retailers. They still have a lot of geographic areas they can go into. These are only 15,000-square-foot stores, so you can put a lot of them in," said Warner.
"There's still lots more room for expansion," said Schorsch. "These companies are aggregators and they have built a business around providing healthcare, pharmacy materials and support for the general population, hospitals and doctors offices. The fact is, they had a fairly decent penetration, but not great. They want to be demographically and regionally diverse," he said adding that pharmacies have even more room when you consider they can enter small markets. "They don't want to be in the highest or lowest income markets only, or only in the cities or country only, they want to be wherever people are, wherever there's traffic patterns that will drive business, so they can do very well in small markets where they have an 18-mile draw if there's no other pharmacy in the area, and they can do well in urban infill locations," said Schorsch.
Aside from expansion generated from simply penetrating more areas, Schorsch pointed out that the drug store industry's customer base continues to grow. "The government says there is $2 trillion of additional capital that will be spent per year in the healthcare space over the next decade. On top of that, you have people that are aging and living longer despite major health problems. So the population is coming their way -- people have longer and more needs for healthcare."
Schorsch added that the big drugstore operators have definitely been leveraging their position during this recession; taking the opportunity to upgrade store locations to prime spots at lower real estate prices. Additionally, Schorsch said the big pharmacies are buying out small mom and pop and regional operators, acquiring their book of clients, shutting down their stores and consolidating accounts into one new store.
What position will drug store operators be in post-recession? Scorch says, "these businesses are even more powerful and are better positioned to take that uptick when the recession ends. They are thinking forward and besides that, look at their balance sheets -- they have tons of money [referring to CVS and Walgreens]."
WALGREENS
On October 1, Walgreens (NYSE:WAG
)(NASDAQ:WAG ) celebrated the grand opening of its 7,000th U.S. store. On average, this retailer has expanded at a rate of 400 stores annually, as it was a 3,000-store chain a decade ago. In its fourth quarter report on Sept. 29, Walgreens said it opened 554 net new drugstores over the past year.
These new stores account for 70 stores Walgreens acquired during the year, including 29 Drug Fair stores in central and western New Jersey and eight Rite Aid locations in San Francisco and eastern Idaho -- the retailer also continues to strategically acquire local and regional drug store operators in smaller markets.
In the coming year (its fiscal 2010), Walgreens is planning organic store growth of 4.5% to 5%, or about 315 to 350 new stores -- this rate of growth is more aggressive than the company's first quarter stated goal of 4% to 4.5% growth. Beginning in 2011, Walgreens plans to pull back to 2.5% to 3% store growth annually, which in 2011 would equate to about 183 to 220 new stores.
Walgreens seeks the "best corners" in America, which it describes as 75,000 square feet of land that can accommodate parking for 70+ cars and a 14,560-square-foot freestanding building with a pharmacy drive thru. The location would be at a signalized intersection of two main streets with significant traffic counts in a trade area of at least 20,000 people. While this is its preferred site criteria, the company will also consider being an anchor to a strip center or co-anchor to a grocery-anchored center and opening in central business districts.
CVS
On October 31, 2008, CVS Caremark Corporation (NYSE: CVS ), completed its $2.9 billion acquisition of the 521-store Longs Drug Stores chain. The deal had the retailer surpassing its long-term rival, bringing the CVS chain to 6,800 stores, while Walgreens had 6,479 stores at the time.
The two have since continued to fight for market share and are now neck-and-neck -- CVS announced the opening of its 7,000th store only one week prior to Walgreens' 7,000th store opening. One big difference, however, is that CVS has yet to create a presence in nine U.S. states.
During the six months ended June 30, 2009, CVS opened 90 new retail pharmacy stores, but closed 64, for a net of 26 new stores. Additionally, 79 stores were closed and re-opened in new locations during the period. During the last half of 2009, CVS expects to open 125 - 150 additional new or relocated retail pharmacy stores.
CVS' new store site criteria calls for a 1.5 to 2-acre piece of land that can support a 12,900-square-foot building with drive-thru and 75-80 parking spots. The retailer's population requirements are slightly smaller than Walgreens, calling for a minimum of 18,000 people in the trade area. The location must be "highly visible" with "easy access and traffic control" at high traffic counts. The company prefers to open new stores under a "fee for service" or "self development" contract, but will consider build-to-suit deals with a 22-year term and five-year option periods.
RITE AID
While still a member of the "Big Three" in the drugstore world, Rite Aid (NYSE:RAD) is struggling. While its revenues are in excess of $6 billion, the company has been challenged to produce positive results in this recession, reporting net losses and store closures. As of September 26, 2009, the retailer operated 4,809 stores in 31 states, representing a net closure of 113 stores over the course of the prior year. The company has continued marginal new store openings -- during the first half of the year, it opened 13 new and 27 relocated stores.
Some of Rite Aid's troubles are related to its acquisition of 1,854 Brooks and Eckerd stores. The $3 billion deal was completed in August 2007 and during 2008, the company worked on integrating the stores, warning that during 2009, many stores would be sold or closed in an attempt to rationalize its store network -- many stores were consolidated as they were located too close to each other. Additionally, the company said a strategy to generate capital would be completing sale-leaseback deals.
In one point of relief, Rite Aid was successful in refinancing $1.9 billion in debt that was set to mature in 2010 -- this restored a lot of investor confidence and shortly after, the company regained its compliance with the NYSE's minimum share price listing rule.
Rite Aid's site criteria calls for a freestanding building of 14,673 square feet situated on a 60,000 to 70,000-square-foot parcel of land located at a high traffic, high profile signalized intersection with two points of access.
(Editor's Note: To keep up on happenings and trends in retail real estate, subscribe to CoStar's Retail News Roundup, a weekly column covering retailer expansions and new concepts, store closings, bankruptcies, cutbacks, acquisition, mergers, sales. new shopping centers, personnel changes, and sustainability. Follow this link for access to back issues of the roundup. In addition to appearing every week in the national news and retail news sections of our web site, you may also receive the Retail News Roundup for free via email by requesting to be added to the distribution list by contacting senior editor, Sasha Pardy at spardy@CoStar.com Also, click here to subscribe to CoStar's dedicated Retail RSS Feed.