There are 3 major drugstore chains in the US: Walgreens, CVS, and Rite Aid. The table below ranks the companies by market capitalization and sales as of January 2007:
- Walgreens ranks number 1 with market cap of $46.0B, $50.5B in revenue, 5611 stores and S&P rating of A+.
- CVS ranks number 2 with market cap of $27.2B, $44.5B in revenue, 6191 stores and S&P rating of BBB+.
- Rite Aid ranks number 3 with market cap of $3.2B, $17.3B in revenue, 3329 stores and S&P rating of B+. On June 4, 2007, Rite Aid completed acquisition of 1850 Eckerd & Brooks drug stores from Jean Coutu Group. So now it has annual revenues of more than $27B and 5160 stores in 31 states and District of Comumbia.
Investors purchase properties occupied by these drugstore chains for these reasons:
- The drugstore business is considered recession-proof. People need medicine when they are sick, regardless 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 because they get them for free from government programs.
- The drugstore business has a good prospect in the US:
- People are living longer and need more medicine to help them live longer. Older people tend to use more medicine than younger ones. As the 78 million baby boomers are getting closer to retiring age starting from 2008, the drugstore chains anticipate the demand for medicine to increase in next 20 years.
- The US population will continue to grow, and so the market will get bigger.
- There are new drugs to treat old or previously untreatable illnesses, and new diseases, e.g. Viagra, 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, and various new drugs for AIDS and Attention Deficit Disorder (ADD). The new medicines are very expensive, e.g. a year’s supply of Avastin costs about $55,000.
- Technology and modern life introduce and require new products, e.g. pregnancy test kits, diabetic monitors, electronic toothbrushes, diet pills, vitamins and nutrition supplements.
- Before the customers can get to the medicine aisles or pharmacy counters, they have to pass by chocolates, sodas, digital cameras, watches, toys, dolls, wines, cosmetics, video games, flowers, fragrances, etc. As a result, customers buy more than their prescriptions and medicine in these drugstores. CVS reported that non-pharmacy sales represented 30% of the company’s total sales in January of 2007. The figure for Walgreens is 34%.
- These companies sign very long-term, NNN leases, guaranteed by their corporate assets. This makes the investment in the underlying property fairly low risk, especially for Walgreens with an A+ debt rating. In fact, these properties are sometimes referred to as investment-grade properties. Once the drugstore chains sign the lease, they will pay the rent no matter what. The authors are not aware of any properties leased by one of these drugstore chains in which the tenants failed to pay rents. Even when the stores are closed due to weak sales (Walgreens closed 119 stores last quarter), these companies may sublease to another company and continue to pay on the main lease.
CVS Pharmacy: 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”. It now has close to 6,200 stores in the US, mostly through acquisitions. In 2004, CVS bought 1,200 Eckerd Drugstores mostly in Texas and Florida. In 2006, CVS bought 700 Savon and Osco drugstores mostly in Southern California. It is also buying Caremark, the largest pharmaceutical services company. When CVS bought 1,200 Eckerd stores, it formed a single-entity LLC to own each Eckerd store. Each LLC signs the lease with the property owner. In the event of a default, the owner collects only from the assets of the LLC and not from any other CVS-owned assets. Although the owner loses the security from CVS corporate assets, the authors are not aware of any incident where CVS closes a store and does not pay rent.
Rite-Aid: Rite Aid opened its first store in 1962 as “Thrif D Discount Center” in Scranton, Pennsylvania. It officially incorporated as Rite Aid Corporation in 1968. Rite Aid is the weakest financially among the 3 drugstore chains. It had serious financial problems just a few years ago. However, the worst seems to be over. Rite-Aid is acquiring (as of Feb 07) about 1,850 Brooks and Eckerd drugstores, mostly along the East coast to catch up with Walgreens and CVS. After the acquisition, Rite-Aid will have about 5,000 stores and nearly $27 Billion in revenues.
Do’s and Don’ts: If you are interested in investing in a property leased by drugstore chains, here are a few things you should consider:
- If you want a low risk investment, i.e. you want a “bullet-proof” investment, go with Walgreens. The degree of safety is the same whether the property is in California where you get a 5% cap or Texas where you may get a 6.5% cap. So, there is no significant advantage to invest in properties in California.
- If you are willing to take more risk, then go with Rite-Aid. Some properties outside of California may offer up to 8% cap rate.
- All 3 drugstore chains have similar requirements. They all want highly visible, standalone, rectangular property around 12,000 - 14,000 SF on a 1.5 - 2 acre lot, preferably at a corner with about 75 - 80 parking spaces in a growing and high traffic location. They all require the property to have a drive-thru. Hence, you should avoid purchasing an inline property, i.e. not standalone and property with no drive-thru, as there is a chance that these drugstores may not want to renew the lease. 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 aware of these requirements.
- 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 location draws customers.
- Some properties may have a percentage lease. If so, you want to determine the store’s sales figures. Of course, you want to invest in a location where the store’s sales are higher than the average for that drugstore chain.
- Many properties have an existing loan that the buyer must assume. If you have a 1031 exchange, do not buy this property. Should you fail to assume the existing loan (because assuming an existing loan is a lot more difficult than getting a new loan), you may run out of time for a 1031 exchange and have to send a big check to the IRS.
- About 10% of the drugstore properties for sale and typically CVS pharmacies allow an investor to down less than 15% of the purchase price but require the investor to assume an existing fully-amortized loan with zero cash flow. That is, all of the rent paid by the tenant must be used to pay down the loan. The cap rate may be in the 7% range, and the interest rate on the loan could be in the 5.5% to 6% range. Hence, the investor pays off the loan in 10 to 20 years. However, the investor has no positive cash flow during the year, which forces him to pay income tax on any rental profits (the difference between the rent, mortgage interest and other operating costs) from outside sources and not from the property’s rental activity. The longer you own the property, the more outside cash you will need to pay income taxes as the mortgage interest will get less and less toward the end. So who would buy this kind of property?
- The misinformed investors who failed to consider that they have to raise additional cash to pay income taxes.
- The investors who have rental losses from other properties. By acquiring this zero cash flow property, they may offset the income from the drugstore tenant against the rental losses from other properties. For example, a property has $105,000 of rental profits a year, and the investor also has rental losses of $100,000 from other properties. As a result, the combined profits are only $5,000.
- The investors who are motivated by a low down payment and high cap rate.
Disclosure: The investment strategy and information presented in this article should not be construed to be formal financial planning advice or the formation of a financial manager/client relationship. The authors intend to provide information to the general public based on our recommendations of investment strategies and is not designed to be representative of your own financial needs. Please do not make any decisions about an investment strategy without consulting with a qualified professional.
To ensure compliance with requirements imposed by IRS Circular 230, we hereby inform you that the U.S. Federal tax advice contained in this article is not intended to be used nor has this article been written to be used, and it cannot be used, by any taxpayer for the purpose: (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. No tax advice is being given by this article for any specific transaction. If you desire advice about any particular transaction, then please consult a professional tax advisor.
David V. Tran is the President/CEO of eFunding Inc., a commercial real estate & loan brokerage, property management & leasing, and TIC company in San Jose, CA. His website is http://www.efundingcom.com He may be contacted at (408) 288-5500. eFunding does business in all 50 states. He is selected as Pensco Trust’s (a major self-directed IRA custodian) Preferred Professional and is the #1 among over 120 commercial real estate expert authors on ezinearticles.com. David currently offers 3 FREE real estate investment seminars till 12/07:
How to invest in commercial real estate for retirement income NOW. How to maximize cash flow with 1031 tax-deferred exchange. TIC/Syndication: strategy for small investors and self-directed IRA investors to acquire high-valued properties.
You are welcome to share this report, unedited and in its entirety, with anyone you like. You may not remove this text. © 2007 eFunding, Inc
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When it comes to commercial real estate investment, investors often want to know which types of properties they should consider investing. This article discusses about 5 groups of properties and reasons why you should or should not consider them.
1. Land: the people who invest in raw land often hope to buy agricultural land near commercially-zoned land at a few thousand dollars per acre. They dream their lot will be re-zoned to commercial in the near future which is worth hundreds of thousand dollars or more an acre. People who convince you to invest in raw land often try to sell you this dream. While this dream actually happens just like it’s possible to hit the jackpot in Las Vegas, the reality is most investors lose money or get little return in land investment. It is a very risky investment as land generates either no or very little income. From an income tax viewpoint, land does not depreciate in value so you cannot claim depreciation. On top of that the interest rate to land loan is also very steep compared to other types of commercial properties. So each month, you would need to come up with money to pay for the mortgage while collecting none. You should consider invest in land if you
- Know how to develop so you could convert raw land into a shopping center.
- Know exact what you do and have deep pocket.
- Own the land of a shopping center (you don’t own the buildings).
2. Apartments: this is a management intensive investment as the turn over rate is high. The leases are short-termed often at one year of month to month. As tenants move in and out, you would need to spend money to get the unit ready for occupancy. Apartment tenants tend to have higher late payments history than other tenants as they are more often have a tighter budget. If you don’t like the headaches dealing with lots of tenants, you probably want to stay away from apartments. The key to successful apartment investment is to
- Control or minimize the expenses. This may sound like a trivial task until you see the expense list provided by the property manager. These expenses include: advertising, accounting, bank fees (for insufficient funds), capital improvement, coin laundry subsidy, cleaning, collection fees, garbage disposal, insurance, landscaping, legal (eviction) fees, maintenance, offsite property management, onsite property management, pest control, painting, repairs, sweeping, security, property taxes, utilities and water.
- Invest only in properties in a good location with no deferred maintenance.
- Stay away from areas with rent control, e.g. Berkeley, Los Angeles.
Otherwise you may end up getting little cash flow or even having negative cash flow. If one of your investment objectives is to get high cash flow, you may want to stay away from apartments. In California, if you own a 16 or more units apartment you must have an onsite manager. This increases the expenses further. In general, apartments are easy to buy and harder to sell. There are always lots of them on any markets. The upside about apartments is they tend to have high occupancy rate as everyone needs a roof over their heads. Due to this fact the interest rate for apartments is often ¼- to ½ percent lower than other commercial properties.
3. Special Purpose Properties: These are properties designed for a specific business, e.g. restaurants, gas stations, and hotels/motels.
- Restaurants: some investors like to invest in brand name fast food restaurant like Burger King, Pizza Hut, Jack In The Box, KFC. These are single tenant properties with long term absolute triple-net lease which often require no management responsibilities from the landlord. However, the rental income or cap rate for these restaurants is often lower in the 5-7% range. Emerging regional brand name restaurants like Johnny Carino’s, Back Yard Burger, Zaxby’s or Tia’s TexMex tend to offer higher cap rate in the 7-8.5% range. However, when you look deeper in the financial statements they may not make a profit yet. The restaurant operators sell the real estate to investors higher cap rate and lease back the property for 20 years. They in turn use the sale proceeds to expand their business by building more restaurants. So if you are willing to take higher risks, you will be rewarded to high income with these emerging restaurants.
- Gas stations: when you buy a gas station, you buy both real estate and the gas station business. Most gas stations also have convenience stores and sometimes several car repair bays. The profit margin for gas is fixed at 10-20 cents per gallon [many customers wrongly blame the high gas prices on the innocent gas station operators] but is pretty high for convenience store. This is considered an owner-occupied property which qualifies you to a SBA loan with as little as 10% down payment is required. If you don’t plan to get involved in running the gas station, auto repair and convenience store business, you may want to stay away from gas stations as gasoline is a chemical that could contaminate the soil. Once a leakage occurs and contaminates the environment, it takes years and lots money to clean up the soil. You may even be liable to damages from owners of adjacent properties as contamination may spread out to their properties. It’s almost impossible to sell your property as no lenders want to loan the buyers the money to buy it.
- Hotels/Motels: once you buy a hotel/motel, you buy the real estate and a 24-hour-a-day 365-day-a-year business. This business requires hard work, and marketing skills to get the rooms filled. The rooms are worthless if they are vacant. The business tends to be seasonal and may be affected immediately by economic downturns and political events, e.g. 9-11. Many of these properties are owned by Indians with the last name Patel as they seem to work harder and know this business well.
4. Office Buildings: these properties are single or multi-story buildings. The older two-story office buildings without elevators tend to have trouble finding tenants on the upper floor as many service businesses may have physically-challenged customers who cannot walk up the stairs.
- Single-tenant buildings: the properties are used as corporate headquarters of big corporations like Cisco. These big buildings tend to be more sensitive to the economy. Once vacant, it’s hard to find a replacement tenant.
- Multi-tenant buildings: these properties are leased by small businesses, e.g. real estate, tax accountants. Investors who purchase these properties want to spread out the investment risks. When one tenant vacates a unit, you lose just a small percentage of rental income.
- High Quality Tenants: most of them have good credits, lot of assets and promptly pay the rent when due.
- Leases: The leases for office building vary from full service [landlords pay property tax, insurance, maintenance and utilities] to NNN [tenants pay property tax, insurance, maintenance and utilities]. The NNN lease is a litmus test on whether the office building is in high demand by tenants or not.
- Medical buildings: these properties are leased primarily by doctors and dentists. A good medical building should be in front of or across the street from a hospital. This makes it convenient for doctors to go back and forth between hospital and their offices. Some investors prefer medical buildings as medical tenants are very recession proof.
5. Shopping/Retail Centers: These centers are mostly single-story and can accommodate wide varieties of tenants: retail and service businesses, restaurant, medical, school, and even church. As a result, this is the most popular type of commercial properties that investors look for. They are always in high demand as there are more buyers and few sellers.
- Multi-tenant strip: the advantage of this investment is when a tenant moves out, you only lose a portion of the total income while you are looking for a new tenant. So you spread out the risks in this property.
- Single-tenant building: The advantage is you just have to work with one tenant. Some of the tenants, e.g. Costco, Home Deport, Walmart, CVS Pharmacy sign 10-20 year lease and guarantee with their corporate assets which could be worth billions of dollars. This makes your investment very safe.
- High Quality Tenants: most of them have good credits, lot of assets and promptly pay the rent when due. They often sign long term 5-30 year leases so you don’t have worry about finding new tenants every year. They keep your property in good condition and sometimes even spend their own money to make it look better in order to attract the customers to the stores.
- Triple Net (NNN) Leases: the leases for retail centers are often in favor of the landlord. The tenants pay a base rent and reimburse the landlord for property taxes, insurance, maintenance and sometimes even property management fees. This takes away a lot of risks from you as an investor. The NNN lease in a sense is a litmus test on whether the property is in high demand by tenants or not.
- Ground Lease: occasionally a retail center with ground lease is for sale. When you buy this center, you only own the improvement but not the land underneath. It could be a trophy property but you should think thrice about investing. Once the ground lease expires and the land owner refuses to extend the land lease, you own nothing! So it’s easy to buy this center but very hard to sell.
David V. Tran is the CEO at eFunding, Inc., a commercial real estate brokerage, commercial loan broker, property management, self-directed IRA investment and syndication company in San Jose, CA. His website is http://www.efundingcom.com He may be contacted at (408) 288-5500. eFunding does business in all 50 states. You are welcome to share this report, unedited and in its entirety, with anyone you like. You may not remove this text. © 2007 eFunding, Inc.
Article Source: http://EzineArticles.com/?expert=David_V._Tran
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