Introducing The Commercial Mortgage

Walgreens, CVS or Rite-Aid: Which Tenant Is Best in 2011?

There are 3 major drugstore chains in the US: Walgreens, CVS, and Rite Aid. Below are a heap of key stats in regards to the 3 major drugstore chains as of July 2010:

1. Walgreens
2. ranks #1 with market cap of $29.33 Billion, $66.25 Billion in revenue, and S&P rating of A+. According to Walgreens, 75% US population lives within 3 miles from it is stores. On Oct 1, 2009, Walgreens opened it is 7000-th store in Brooklyn, New York. In April 2010, it acquired 258 Duane Reade drug stores in New York Metropolitan area.
3. CVS
4. ranks #2 with market cap of $42.09 Billion, $99.1 Billion in revenue (CVS revenue alone is less than Walgreens if revenue from it is Caremark group is taken out), and S&P rating of BBB+. CVS opened it is 7000-th store in Little Canada, Minnesota on October 5, 2009 and presently operates 7025 drug stores..
5. Rite Aid
6. ranks #3 with market cap of $869 Million, $25.53 Billion in revenue, 4780 drug stores and S&P rating of B-.

Investors buy properties occupied by these drugstore chains for the following reasons:

1. The drugstore business is very recession-insensitive. People need medicine when they are sick, disregarding of the state of the economy. Both rich and poor people in the US have access to medicine. Some even argue that low-income people use more medicine due to free or low-cost drugs offered by government-assisted programs. So the tenants ought to do well for the duration of tough time and have cash to pay rent to landlords.
2. The drugstore business has a good chance in the US:
   • People are living longer and need more medicine to sustain longevity, e.g. Actonel for osteoporosis, Aricept for Alzheimer’s symptoms. Older people tend to use more medicine than younger ones as they many times have more medical problems. As the 78 million baby boomers are getting closer to retiring age starting from 2008, the drugstore chains expect the demand for medicine to increase in next 20 years.
   • The drug market proceeds to exaggerate as the US population will carry on to grow. More and more Americans suffer from respective diseases. The number of Americans suffers from seasonal allergies doubled in the last 15 years to 37 million people per Fortune magazine. They expended $5.4 Billion in 2009 for allergy drugs. As their waist lines balloon (75% of Americans are forecasted to be either overweight or obese by 2020), more Americans are diagnosed with diabetes, high cholesterol at younger and younger ages. In addition, doctors likewise commend treating respective impairment of normal physiological functions sooner than later due to better understanding when it comes to the diseases. For example, doctors now prescribe antiretroviral drugs for people who are in need of medical care soon after infected with HIV virus rather of waiting for the infection to become AIDS. More doctors combine insulin with oral medicines to treat type-2 Diabetes rather of just oral medicines alone. All these elements increase the size of the drug market.
   • Advance in genetic technology has introduced respective new genetic DNA testing kits which grant the genetic diagnosis of vulnerabilities to inherited sicknesses and disorders. Genetic testing is presently the most eminent growth segment in the diagnostics industry. Some of these genetic tests will in all probability transform into direct-to-consumer testing kits available in drug stores in the near future. Upon FDA approval, these new merchandise will potentially fetch in further and added revenue for drug stores.
   • The passage of Health Care Reform Bill on March 23, 2010 provides insurance coverage to an approximated 33 million more American. This is a major present to the drugstore industry.
   • There are new drugs to treat antecedently untreatable illnesses, and new diseases, e.g. Viagra for men’s unhappiness, Zoloft for depression, Avastin for colon cancer, Herceptin for breast cancer, Nicotine patches for smokers to kick the habit, Tamiflu for a potential bird flu pandemic, vaccine for swine (H1N1) flu pandemic, Tekturna/Rasilez for hypertension and respective new drugs for AIDS and Attention Deficit Disorder (ADD). The new medicines are very expensive, e.g. a year’s supply of Avastin costs when it comes to $55,000. Eli Lilly has sold in regards to $4.8 billion of Zyprexa in 2007 for schizophrenia and yet most people have never heard of this medicine.
   • There are existent drugs now approved to treat new sicknesses and thence increase their sales revenue. For example, Lyrica was in the first place intended to treat pain caused by nerve harm in humans with diabetes. It is now approved by FDA to treat Fibromyalgia which affects 5.8 million Americans per WebMD.
   • Big advances in genetics, biology and stem cells exploration are expected to manufacture a new class of drugs to treat diabetes, Parkinson’s and respective rare genetic disorders. For example the new drug Ilaris from Novartis targets genetic causes of an inherited disorder that there are only 7000 known cases worldwide. However, Novartis hopes to gradually broaden it is drugs to a blockbuster drug to more mutual disorders caused by similar genetics.
   • Technology and modern life introduce and require new products, e.g. pregnancy test kits, Lamisil for more inviolable clearer toe nails, Latisse for longer & thicker eyelashes, Premarin for menopausal symptoms, diabetic monitors, electronic toothbrushes, contact lenses, lenses cleaners, diet pills, vitamins, birth-control pills, IUDs, nutrition supplements and Cholesterol-lowering pills (Americans expended almost $26B in 2006 on Cholesterol medications alone per IMS Health, a Connecticut-based consulting company that monitors pharmaceutical sales.) There are also more surgeries: C-sections, Kidney transplants, open-heart triple by-pass, and breast augmentations. More surgeries mean more medicines are necessitated such as Vicodin for pain management and Warfarin to prevent blood clots in surgeries.
   • Before the clients may get to the medicine aisles or pharmacy counters, they have to pass by chocolates, sodas, digital cameras, watches, toys, dolls, beers and wines, cosmetics, video games, flowers, fragrances, and greeting cards. Drug stores hope you use the one-hour photos services and interchange your liquid propane tanks there. The stores also carry seasonal items, e.g. Halloween costumes, and “As Seen on TV” merchandise, e.g. Shamwow. As a result, clients buy more than their prescriptions and medicine in these drugstores. Rite Aid sells more 28,000 non-pharmacy items in it is stores while Walgreens has 22,000 dissimilar items on store shelves. CVS reported that non-pharmacy sales represented 30% of the company’s total sales in January of 2007. The figure for Walgreens is 34% and 37% for Rite Aid. Many pharmacy locatings are in effect comfortableness stores in particular ones that are in residential or rural areas. And so Walgreens hopes that clients likewise pick up WD-44, and screw drivers at it is stores rather of at Home Depot; Thai Jasmine rice, and fish sauce to stay clear from a trip to Safeway or Kroger Supermarkets. During the recession, sales of these non-drug items are down as clients buy what they need and not what they want. Walgreens tries to reduce the number of items by 4000. It likewise introduces it is own private label which has higher net income margins.
   • There are more and more generic medications on the market as a number of enormously ordinary brand-name blockbusters will lose their 20-year long patents, e.g. Lipitor (best marketing drug in the world to lower cholesterol) in 2010, Viagra (you know what it’s for) in 2012. Drugstores prefer to trade generic drugs to clients due to higher net income boundary line than the brand-name medications.
   • Some persons are addicted to pain killers, e.g. Hydrocodone and consume a big amount of medicine, e.g. 30-day dosage in a day to get high. According to testimony from the National Institute on Drug Abuse, US merchandising pharmacies dispensed closely 180 million prescriptions in 2007 for opiates, e.g. Hydrocodone. A high part of these prescriptions are in all probability not used for any rightful medical purposes.
   • This author estimates that at least 10% of the dispensed prescription drugs are not employed at all and sit idle in the medicine cabinets. They are at last expired and thrown away.
3. These companies sign very long-term, NNN leases, guaranteed by their corporate assets. This makes the investment in the underlying property reasonably low risk, particularly for Walgreens with an A+ S&P rating. In fact, these properties are now and again referred to as investment-grade properties. Once the drugstore chains sign the lease, they compensate the rent promptly and timely. This author is not conscious of any properties leased by one of these drugstore chains in which the tenants failed to recompense rents. Even when the stores are closed due to weak sales (Walgreens closed 119 stores in 2007), these companies may sublease the properties to other companies and proceed to compensate rents on the master leases.
   • A typical Walgreens lease comprises of 20-25 year necessary term plus 8-10 five-year options. During necessary term and options, there will be no rent increments in most of the leases. This is the main disfavor of laying out capital in Walgreens drugstores.
   • A typical CVS lease comprises of 20-25 year crucial term plus 4-5 five-year options. The rent is normally flat for the duration of the primary term and then there is a 2.5%-10% rent increase in the in each 5-year option.
   • A typical Rite Aid lease comprises of 20-25 year crucial term plus 4-8 five-year options. The lease oftentimes has a rent increase each 5-10 years.

Investment Risks: Although the pharmacy business in frequent is recession-insensitive, there are risks involved in your investment:

1. The main downside regarding investing in pharmacies is there is little or no rent bump for a long time, e.g. 20-50 years, in particular for Walgreens. So the rent is efficaciously scaled down after inflation is factored in. This is one of the main reasons these properties do not appeal to younger investors.
2. The 3 drugstore chains now have a new formidable competitor, Wal-mart. Wal-mart sells prescription drugs in more than 4000 Wal-mart, Sam’s Club and Neighborhood Market stores in 49 states. The merchandising giant is known for launching in 2006 a highly-publicized $4 generic prescription drug program which now sells 350 generic medications for a 30-day supply. The actual number of medications is less as the medications with dissimilar amount of energy are counted as dissimilar medications. For example, Metformin 500 mg, 850 mg, and 1000 mg are counted as 3 medications. Wal-mart probably makes very little profits on these medications if any. However, the retail campaign–created by Bill Simon, the President and CEO of Wal-mart US, generates a lot of promotion for Wal-mart. Wal-mart hopes to draw clients to it is stores with other prescriptions where it has higher earnings margins. In an unscientific survey with just one brand-name prescription of Lyrica, this author finds the lowest price at Costco, the most eminent price at Walgreens and Wal-mart at the middle. Other drug chains try to counter Wal-mart in dissimilar ways. Target now offers the same 350 generic medications for $4 for a 30-day supply. Walgreens has a Prescription drugs club with membership fee which offers 1400 generic medications for as little as $1/week. CVS says it will match any offers from it is competitors.
3. Chief Business Correspondent Rick Newman from US World & News Report anticipated that Rite Aid might not survive in 2009. While Rite Aid is still around in 2010, dire foretellings continue. The study by Audit Integrity gave Rite Aid in regards to a 10.5 percent probability of filing for bankruptcy in 2010.
4. Drugs are likewise sold in thousands of supermarkets, Target stores, and Costco warehouses. However, there are no drive-thru windows at these stores or Walmart to conveniently drop off the prescriptions and pick up medicines. Customers will not be competent to pick up their prescriptions for the duration of lunch hour or after 7PM at Target stores or supermarkets. They need to have membership to buy medicines at Costco. Others may not fill their prescriptions at Walmart because they don’t want to mingle with typical Walmart clients who are in lower income brackets. And a lot of babyboomers don’t want their prescriptions filled at Target or Walmart because there are no comfortable chairs for them to sit down to wait for their medicines.
5. Many leases in areas with hurricanes and tornados are NNN leases with the exception of roof and structure. So if the roof is damaged, you will have to pay for the expenses.
6. The tenant may move to a new emplacement down the road or throughout the street when the lease expires. This danger is high when the property is located in little town where there is low barrier for entry, i.e. a large total of vacant & developable land.
7. The tenant may ask for rent concession to improve it is bottom line. The possibleness is higher if the tenant is Rite Aid and if the store has low sales revenue and/or higher than market rent.
8. More Americans are walking away from their prescriptions, exceptionally the most costly brand-name medicines. This may have negative affect on the sales revenue and profits of drug stores and consequently may cause drug store closures. According to Wolters Kluwer Pharma Solution, a health-care info company, almost 1 in 10 new prescriptions for brand-name drugs were abandoned by humans with mercantile health plans in 2010. This is up 88% equated to 4 years ago just before the recession began. This trend is driven in percentage by higher and higher co-pays for brand name drugs as employers are shifting more insurance costs to their employees.

Among 3 drugstore chains, Walgreens and CVS pharmacies in popular have the best locations-at major intersections while Rite Aid has less than premium locations. Walgreens have a tendancy to hire only the top graduates from pharmacy schools while Rite Aid settles with bottom graduates to save costs. When possible all drugstore chains try to fill the prescriptions with generic medications which have higher net income margins

Walgreens: the company was founded in 1901 by Charles Walgreen, Sr. in Chicago. While the company has existed for more than 100 years, most stores are only 5-10 years old. This is the best managed company amongst the three drugstore chains and also amid the most admired public companies in the US. The company has been run by executives with proven track records and hires the top graduates from universities. Due to it is superior financial strength–S&P A+ rating– and premium irreplaceable locations, properties with leases from Walgreens get the most eminent price per square foot and/or the lowest cap rate amidst the 3 drugstore chains. In addition, Walgreens gets flat rent or very low rent increase for 20 to 60 years. The cap rate is often times in the low 6% to 7.5% range in 2009. Investors who buy Walgreens tend to be more mature, i.e. closer to retirement age. They are looking for a safe investment where it’s more essential to get the rent check than to get appreciation. They oftentimes compare the returns on their Walgreens investment with the lower returns from US treasury bonds or Certificate of Deposits from banks. Walgreens opened numerous new stores in 2008 and 2009 and thence you see some new Walgreens stores for sale. It will slow down this elaboration in 2010 and focus on renovation of existent stores instead

CVS: CVS Corporation was founded in 1963 in Lowell, MA by Stanley Goldstein, Sidney Goldstein, and Ralph Hoagland. The name CVS stands for “Consumer Value Stores”. As of 2009, CVS has regarding 6300 stores in the US, for the most part through acquisitions. In 2004, CVS purchased 1,200 Eckerd Drugstores for the most part in Texas and Florida. In 2006, CVS purchased 700 Savon and Osco drugstores largely in Southern California. And in 2008 CVS acquired 521 Longs Drugs stores in California, Hawaii, Nevada and Arizona for $2.9B dollars. The acquisition of Long Drugs appears to be a good one as it CVS does not have any stores in Northern CA and Arizona. Besides, the price also included real estate. It is likewise purchased Caremark, the biggest pharmaceutical services company and changed the corporation name to CVS Caremark. When CVS purchased 1,200 Eckerd stores, it formed a single-entity LLC (Limited Liability Company) to own each Eckerd store. Each LLC signs the lease with the property owner. In the event of a default, the proprietor may only legally go after the sum totals of the LLC and not from any other CVS-owned assets. Although the proprietor loses the guaranty security from CVS corporate assets, this author is not conscious of any incident where CVS closes a store and does not compensate rent.

Rite-Aid: Rite Aid was founded by Alex Grass (he just passed away on Aug 27, 2009 at the age of 82) and opened it is original store in 1962 as “Thrif D Discount Center” in Scranton, Pennsylvania. It officially integrated as Rite Aid Corporation and went public in 1968. By the time Alex Grass stepped down as the company’s chairman and chief executive officer in 1995, Rite Aid was the nation’s greatest drugstore chain in terms of total stores and No. 2 in terms of revenue. His son, Martin Grass, took over but was ousted in 1999 for overstatement of Rite Aid’s net profit in the late 1990s. Rite Aid is now the weakest financially amid the 3 drugstore chains. In 2007, Rite-Aid acquired regarding 1,850 Brooks and Eckerd drugstores, largely along the East coast to catch up with Walgreens and CVS. In the process, it added a huge long term debt (currently owes over $5.69 Billion) and is the most leveraged drugstore chain based on it is market value. The integration of Brooks and Eckerd did not seem to go well. Revenue from some of these stores went down as much as 20% after they change the sign to Rite Aid. In 2009, Rite-Aid had over 4900 stores and over $26 Billion in revenues. The figures went down in 2010 to 4780 stores and $25.53 billion in revenue. On January 21, 2009 Moody’s Investor Services downgraded Rite Aid from “Caa1″ to “Caa2″, eight notches beneath investment grade. Both ratings are “junk” which indicate very high credit risk. Rite Aid contacted a number of it is landlords in 2009 attempting to get rent concession to improve the bottom line. In June 2009, Rite Aid with great success finished refinancing $1.9 Billion of it is debts. However, it proceeds to struggle in 2010 as same store sales decreased 2.5% in June, 1.7% in May, 1% in April,.1% in March, 3.2% in February, and 2.1% in January..

Things to consider when invested in a pharmacy

If you are mesmerized in investing in a property leased by drugstore chains, here are a few things you ought to consider:

1. If you want a low risk investment, go with Walgreens. In stable or growing areas, the degree of safety is the same whether the property is in California where you get a 6% cap or Texas where you may get a 7.5% cap. So, there is no substantial vantage to invest in properties in California as the property value is based mainly on the cap rate. In 2010, the offered cap rate for Walgreens seems to come down from 7.5%-8.4% in 2009 to 6.5%-7.5% for new stores.
2. If you are more than willing to take more risk, then go with Rite-Aid. Some properties outside of California may offer up to 10% cap rate in 2010. However, among the 3 drug chains, Rite Aid has 10.5% prospect of going underneath in 2010. Should it announce bankruptcy, Rite Aid has the option to pick and choose which emplacements to keep open and which emplacements to terminate the lease. To denigrate the risk that the store is shuttered, choose a emplacement with strong sales and low rent to revenue ratio.
3. Financing ought to be an primary consideration. While the cap rate is lower for Walgreens than Rite Aid, you will be competent to get the best rates and terms for Walgreens. A 7.25% cap Walgreens with 5.25% interest rate on the loan will generate more cash flow than a 10% cap Rite Aid with 9% interest rate (if you could find a lender for Rite Aid).
4. If you are not a conservative capitalist or peril taker, you may want to consider a CVS pharmacy. It has BBB+ S&P credit rating. Its cap rate is higher than Walgreens but lower than Rite Aid. Some leases may offer better rent bumps. On the other hand, some CVS leases, peculiarly for properties in hurricane areas, e.g. Florida are not veritably NNN leases where landlords are responsible for the roof and structure. So make sure you adjust the cap rate down accordingly. Some of the CVS emplacements have onsite Minuteclinic staffed by registered nurses. Since this clinic idea was introduced recently, it’s not clear having a clinic inside CVS is a plus or minus to the bottom line of the store.
5. All 3 drugstore chains have similar requirements. They all want highly visible, standalone, rectangular property around 10,000 – 14,500 SF on a 1.5 – 2 acre lot, preferably at a corner with in regards to 75 – 80 parking spaces in a growing and high traffic location. They all require the property to have a drive-thru. Hence, you must stay clear from purchasing an inline property, i.e. not standalone and property with no drive-thru windows. There is a prospect that these drugstores may not want to renew the lease unless the property is located in a densely-populated area with no vacant land nearby. In addition, if you acquire a property that does not meet the new requirements, for example a drive-thru, you may have a problem getting financing as lenders are conscious of these requirements.
6. If the pharmacy is opened 24 hours a day, it is in a better location. Drugstore chains do not open the store 24 hours day unless the emplacement draws customers.
7. Many properties may have a percentage lease, i.e. the landlord may get further and added rent when the store’s annual revenue outperforms a sure figure, e.g. $5M. However, the revenue employed to compute percentage rent many times excludes a page-long list of items, e.g. wine and sodas, tobacco products, items sold after 10 PM, drugs salaried by governmental programs. The excluded sales revenue could account for as much as 70% of store’s gross revenue. As a result, this author has seen only 2 stores in which the landlord is competent to gather further and added portion rent. The store with a portion rent is required to report it is regularly every month sales to the landlord. As an investors, you want to invest in a store with strong gross sales, e.g. over $500 per square foot a year. In addition, you also want to check the rent to revenue ratio. If the figure is in the 2-4% range, the store is likely to be very profitable so the prospect the store is shut down is low.
8. It does not matter how good the tenants are, keep out of the way of investing in declining and/or low-income areas or little towns with less than 30,000 residents within 5 miles ring. In a little town, it may be the only drug store in town and captures most of the market share. However, if a contender opens a new emplacement in the area, revenue may be gravely affected. These properties are easy to buy now and hard to trade later. In 2009 where the credit market is tight, you may have difficultnesses finding a lender to finance these properties.
9. Many properties have an existent loan that the buyer will have to assume. If you have a 1031 exchange, think twice with regards to buying this property. You will have to without doubt or question perceive loan assumption requirements of the lenders before moving forward. Should you fail to assume the existent loan (assuming an existent loan is a lot more difficult than getting a new loan), you may run out of time for a 1031 interchange and may be liable to compensate capital gain.
10. With few exceptions, drugstore chains do not own the stores they occupy for assorted reasons. Here are just a couple of them:
    • They recognise the pharmacy business but don’t recognise real estate. Stock investors also don’t want Walgreens to become a real estate investment company.
    • Owning the real estate will require them to carry a large total of long term debts which is not a brilliant idea for a publicly-traded company.
11. About 10% of the drugstore properties for sale and distinctively CVS pharmacies require very little amount of equity to acquire, e.g. 10% of the buy price. However, you are required to assume an existent fully-amortized loan with zero cash flow. That is, all of the rent salaried by the tenant will have to be applied to compensate down the loan. The cap rate may be in the 7% range, and the interest rate on the loan could be beautiful in the 5.5% to 6% range. Hence, the capitalist pay off the loan in 10 to 20 years. However, the capitalist has no positive cash flow. This requires you to come up with outside cash to compensate income tax on the rental profits (the divergence among the rent and mortgage interest). The longer you own the property, the more outside cash you will need to recompense income taxes as the mortgage interest will get less and less toward the end. So who would buy this kind of property?
    • The investors who have significant losses from other properties. By acquiring this zero cash flow property, they may offset the income from the drugstore tenant versus the losses from other investment properties. For example, a property has $105,000 of rental profits a year, and the capitalist likewise has losses of $100,000 from other investment properties. As a result, the combined taxable profits are only $5,000.
    • The uninformed investors who fail to consider that they have to raise further and added cash to compensate income taxes.

Out of the Box Thinking If you put too much weigh on the S&P rating of the tenants, you may end up either taking a lot of risks or passing up good opportunities.

1. Good emplacement must be the key in your decision on which drug store to invest in. It’s many times said a lousy business ought to do well at a great emplacement while the best tenant will fail at a lousy location. A Walgreens store that is closed down later on (yes, Walgreens closed 119 stores in 2007) is still a bad investment even though Walgreens proceeds paying rent on time. So you don’t want to blindly invest in a drug store plainly because it hasa Walgreens sign on the building.
2. No company is crazy sufficient to close a profitable location. It does not take a rocket scientist to understand that a financially-weak company like Rite Aid will make each venture to keep a profitable emplacement open. On the other hand, a financially-strong Walgreens will need justifications to keep an unprofitable emplacement open. So how do you determine if a drug store emplacement is profitable or not if the tenant is not required to disclose it is earnings & loss statement? The answer is you cannot. However, you may make an educated guess based on store’s annual gross revenue is many times reported to the landlord as required by the part clause in the lease. With the gross revenue, you may determine the rent to income ratio. The lower the ratio, the more likely the store is profitable. For example, if the annual base rent is $250,000 while the store’s gross revenue is $5M then the rent to income ratio is 5%. As a rule of thumb, it’s hard to make a net income if this ratio is more than 8%. So if you see a Rite Aid with 3% rent to income proportionality then you recognise it’s likely a very profitable location. In the event Rite Aid declares bankruptcy, it will keep this emplacement open and proceed paying rent. If you see a Rite Aid drug store with 3% rent to income ratio supplying 11% cap, chances are it’s a low peril investment with good returns. The weakness of corporate guaranty from Rite Aid is in all probability not as critical and the peril of having Rite Aid as a tenant is not actually that significant.
3. Drug stores with new 25 years leases tend to trade at lower cap, e.g. 7-7.5% cap on new stores versus 8.0-8.5% cap on conventional emplacements with 8-10 years remaining on the lease. This is because investors are affrighted that the tenants may not renew the leases. Unfortunately, lenders likewise have the same fear! As a result a good deal of lenders will not finance drug stores with 2-3 years left on the leases. The fact that drugstores with new leases have a premium on the price means they have potential of 10% dispraise (buying new at 7.3% cap and merchandising at 8.3% cap when the leases have 10 year left). Some investors will not consider investing in drug stores with 5-10 years left on the lease. They might merely ignore the fact that the established stores may be at irreplaceable emplacements with very strong sales. Tenants plainly have no other selections other than renewing the lease.