A prescription for Assessing Drugstores

Introduction

A Prescriptio

n for Assessing Drugstores

TIM WILMATH, MAITIM WILMATH, MAIDIRECTOR OF VALUATIONDIRECTOR OF VALUATIONHILLSBOROUGH COUNTY PROPERTY APPRAISER’S OFFICEHILLSBOROUGH COUNTY PROPERTY APPRAISER’S OFFICE

“There is a neighborhood drug store within five miles of nearly every American.” Craig Fuller, former president and CEONational Association of Chain Drugstores

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“There is a neighborhood drug store within five miles of nearly every American.” Craig Fuller, former president and CEONational Association of Chain Drugstores

VALUE IN USEVALUE IN USEVALUE IN EXCHANGEVALUE IN EXCHANGELEASED FEELEASED FEEFEE SIMPLEFEE SIMPLENNN LEASED NNN LEASED MARKET VALUEMARKET VALUEBUSINESS VALUEBUSINESS VALUEGOING CONCERNGOING CONCERNSPECIAL PURPOSE SPECIAL PURPOSE CONTRACT RENTCONTRACT RENTMARKET RENTMARKET RENTABOVE-MARKET LAND PRICESABOVE-MARKET LAND PRICESSECOND GENERATION USERSSECOND GENERATION USERS

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BEFORE DRUGSTORES,BEFORE DRUGSTORES,ENTREPRENEURS ENTREPRENEURS (SOMETIMES CALLED (SOMETIMES CALLED ““SNAKE OIL SALESMEN”)SNAKE OIL SALESMEN”)SOLD REMEDIESSOLD REMEDIESOUT OF COVERED OUT OF COVERED WAGONS.WAGONS.

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DURING THE CIVIL DURING THE CIVIL WAR WAR DRUGSTORES DRUGSTORES BECAME MORE BECAME MORE COMMON WHEN COMMON WHEN BATTLEFIELD BATTLEFIELD DISPENSARIESDISPENSARIESWERE NEEDED.WERE NEEDED.

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Source: IMS National Sales Perspectives

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Grocery Store and big-box stores don’t offer the quick shopping experience that drugstores do.

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“Our business strategy is to be the easiest pharmacy retailer for customers to use. We believe ease of use means convenience for the time-starved customer.” Source: CVS 2009 Form 10-K

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STARTING IN THE MID 1980STARTING IN THE MID 1980SS, FOUR DRUGSTORE CHAINS , FOUR DRUGSTORE CHAINS EMERGED AND EVENTUALLY DOMINATED THE MARKET.EMERGED AND EVENTUALLY DOMINATED THE MARKET.

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Company # StoresCVS Caremark 6,981Walgreens 6,678Rite Aid 4,901Health Mart 2,002Katz Group 1,900Medicine Shoppe Intl. 1,350Shoppers Drug Mart 1,149McKesson Canada 500Pharmasave 421Uniprix 387Total - Top 10 26,269

Top 10 Drug ChainsNorth America - 2008

Source: Chain Drug Review, 10/2008

A snapshot of the Top-10 Drug chains by store count

Introduction

MODERN DRUGSTORE PROPERTY CHARACTERISTICS MODERN DRUGSTORE PROPERTY CHARACTERISTICS LOCATION: LOCATION: SIGNALIZED HIGH PROFILE/HIGH TRAFFIC CORNERSIGNALIZED HIGH PROFILE/HIGH TRAFFIC CORNERSTYLE: STYLE: ONE-STORY ATTRACTIVE ARCHITECTURAL DESIGNONE-STORY ATTRACTIVE ARCHITECTURAL DESIGNSITE SIZE: SITE SIZE: APPROXIMATELY 1.5 ACRESAPPROXIMATELY 1.5 ACRESBUILDING SIZE: BUILDING SIZE: 12,000 - 15,000 SQUARE FEET12,000 - 15,000 SQUARE FEETFEATURES: FEATURES: DRIVE-THROUGH WINDOWDRIVE-THROUGH WINDOWPARKINGPARKING: : WRAP-AROUND STYLE WITH 50-80 SPACESWRAP-AROUND STYLE WITH 50-80 SPACESACCESS: ACCESS: EASY INGRESS/EGRESSEASY INGRESS/EGRESS

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Moving to a freestanding location can increase sales by

as much as 35%.

Gary Ralstonformer President Commercial Net Lease Realty

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THE MODERN DRUGSTORE DEVELOPMENT MODELTHE MODERN DRUGSTORE DEVELOPMENT MODEL1.1.DRUGSTORE CHAINS WORK WITH DEVELOPERS TO IDENTIFY AND DRUGSTORE CHAINS WORK WITH DEVELOPERS TO IDENTIFY AND ACQUIRE SITE(S).ACQUIRE SITE(S).2. 2. DEVELOPER BUILDS STORE TO DRUGSTORE CHAIN’S SPECS.DEVELOPER BUILDS STORE TO DRUGSTORE CHAIN’S SPECS.3.3.DRUGSTORE LEASES STORE FROM DEVELOPER IN A NNN LEASE.DRUGSTORE LEASES STORE FROM DEVELOPER IN A NNN LEASE.4. DEVELOPER SELLS LEASED PACKAGE TO INVESTOR.4. DEVELOPER SELLS LEASED PACKAGE TO INVESTOR.

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BECAUSE DRUGSTOREBECAUSE DRUGSTORECHAINS ARE SOCHAINS ARE SOSUCCESSFUL, INVESTORS SUCCESSFUL, INVESTORS ARE ATTRACTED TO THESEARE ATTRACTED TO THESEPROPERTIES. PROPERTIES.

INVESTORS GAIN BOTH INVESTORS GAIN BOTH PRIME REAL ESTATE AND PRIME REAL ESTATE AND A HIGH-QUALITY TENANT.A HIGH-QUALITY TENANT.

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SO WHAT’S THE PROBLEM?SO WHAT’S THE PROBLEM?

1.1. THE LAND PRICES DRUGSTORE CHAINS PAY SOMETIMES EXCEED THOSE THE LAND PRICES DRUGSTORE CHAINS PAY SOMETIMES EXCEED THOSE PAID BY OTHERS FOR SIMILAR CORNERS. PAID BY OTHERS FOR SIMILAR CORNERS.

2.2. ARE DRUGSTORES SUPER-ADEQUATE?ARE DRUGSTORES SUPER-ADEQUATE?

3.3. THE PRICES INVESTORS PAY FOR THE REAL ESTATE INCLUDE THE STICKS THE PRICES INVESTORS PAY FOR THE REAL ESTATE INCLUDE THE STICKS AND BRICKS BUT MAY ALSO INCLUDE A PREMIUM FOR THE AND BRICKS BUT MAY ALSO INCLUDE A PREMIUM FOR THE DEPENDABLE CASH FLOW FROM A HIGHLY-RATED TENANT. DEPENDABLE CASH FLOW FROM A HIGHLY-RATED TENANT.

4. 4. THE RENT DRUGSTORE CHAINS PAY IS A FUNCTION OF THE TOTAL THE RENT DRUGSTORE CHAINS PAY IS A FUNCTION OF THE TOTAL DEVELOPMENT COSTS, WHICH MAY INCLUDE ABOVE-MARKET LAND DEVELOPMENT COSTS, WHICH MAY INCLUDE ABOVE-MARKET LAND COST.COST.

Valuation

Value in Use versus Value in Exchange

Use value and exchange value are the sameunless the current use is not the highest and best use.

Special Purpose Property?

Modern drugstores have a very specific design thatis ideal for drugstore use. Does that mean they areSpecial Purpose properties?

When Eckerd was sold in 2004, most of its stores became CVS. This conversion was

relatively easy and inexpensive.

Special Purpose Property?

Other stores not needed by CVS wereconverted to other uses (second generation).

Special Purpose Property?

Drugstores can easily be converted to other uses.They are not special purpose properties.

Special Purpose Property?

Highest and Best Use

There are two reasons to analyze Highest and Best Use1.Help identify potentially comparable properties. 2.To decide which of the following options should be pursued:

• Maintain the improvements as is?• Convert to something else?• Demolish the improvements?

The option you choose determines the comps

you should pick

Cost Approach

1. Replacement Cost2. Depreciation3. Land Value

IN MAY 2009, IN MAY 2009, WALGREENS BOUGHT WALGREENS BOUGHT THIS CORNER FOR THIS CORNER FOR $2,900,000, OR $95.54 $2,900,000, OR $95.54 PER SQUARE FOOT FOR PER SQUARE FOOT FOR 30,353 FEET 30,353 FEET ( ¾ ACRE)( ¾ ACRE)

Cost Approach

¾ OF AN ACRE IS NOT ENOUGH LAND FOR A MODERN ¾ OF AN ACRE IS NOT ENOUGH LAND FOR A MODERN DRUGSTORE. BUT THERE WAS ANOTHER ACRE OF LAND DRUGSTORE. BUT THERE WAS ANOTHER ACRE OF LAND SURROUNDING THE SITE – UNFORTUNATELY, IT IS A RETENTION SURROUNDING THE SITE – UNFORTUNATELY, IT IS A RETENTION POND FOR THE ADJOINING SHOPPING CENTER. POND FOR THE ADJOINING SHOPPING CENTER.

Cost Approach

WALGREENS PURCHASED THIS SEPARATE WALGREENS PURCHASED THIS SEPARATE RETENTION POND, WHICH GAVE THEM ENOUGH RETENTION POND, WHICH GAVE THEM ENOUGH LAND FOR THE WALGREENS STORE. LAND FOR THE WALGREENS STORE.

BUT HOW DOBUT HOW DO YOU BUILD ONYOU BUILD ONA RETENTION A RETENTION

POND?POND?

Cost Approach

WALGREENS IS BUILDING AN UNDERGROUND DRAINAGE WALGREENS IS BUILDING AN UNDERGROUND DRAINAGE “VAULT” FOR RETENTION, WITH THE PARKING LOT ON TOP“VAULT” FOR RETENTION, WITH THE PARKING LOT ON TOP

Cost Approach

But does this cost

equal value?

Cost Approach

Cost Approach

Why would Walgreens go to all this trouble to build on this site?

DOES THE PRICE WALGREENS PAID AND THE MONEY THEY DOES THE PRICE WALGREENS PAID AND THE MONEY THEY SPENT TO BUILD THE VAULT REPRESENT “MARKET VALUE”?SPENT TO BUILD THE VAULT REPRESENT “MARKET VALUE”?

Cost Approach

Folio Street Name Sales Price Sale Date SF $/SF Comments208136.0000 Collins $165,000 Feb-08 10,000 $16.50 Bldg demo'd by fire055013.0020 College $175,100 Jun-08 11,668 $15.01 own adj lot as well194162.0000 Kennedy Blvd $975,900 Nov-09 21,978 $44.40 Parking lot88080.0208 Fishawk $950,000 Aug-08 27,878 $34.08 Arbys78895.0027 us301 and 674 $666,200 Apr-08 29,216 $22.80 Murphy Oil098884.0000 Busch Blvd $525,000 Jan-08 31,200 $16.83 Used Car lot002100.0125 Van Dyke $600,000 Mar-08 38,650 $15.52 Vacant205160.7058 James Redman $722,300 Jun-08 41,952 $17.22 restaurant82411.0000 92 & Branch 1,970,000 Sep-08 42,106 $46.79 Auto Zone014524.0100 Van Dyke Rd $762,300 Dec-08 43,560 $17.50 St Joseph health care 003711.2000 Linebaugh $1,300,000 Dec-08 65,298 $19.91 RaceTrac Petroleum038178.0000 78th $735,000 May-09 88,862 $8.27 Future retail044544.0000 US Hwy 301 $3,155,100 May-08 101,494 $31.09 Tire Kingdom

Average $23.53

Traffic Light Corner Land Sales - 2008-2009

Cost Approach

Marshall & Swift has a specific section for drugstores.

Cost Approach

DepreciationDoes a drugstore suffer from functional obsolescencedue to Superadequacy?

Cost Approach

DepreciationDoes a drugstore suffer from functional obsolescence due to Superadequacy?

Yes it might…but only if occupied by a non-drugstore use.

Cost Approach

DepreciationDoes a drugstore suffer from functional obsolescence due to Superadequacy?

Not if the improvements are used as intended – a drugstore.

Sales Comparison Approach

Occasionally drugstores sell directly from developer to drugstore chain. These are thevery best sales because they are not leased fee.

Sales Comparison Approach

Drugstore Sales are almost always “leased fee”, meaning the buyer purchases the real estate and the income stream.

Sales Comparison Approach

Some argue that investors overpay for drugstores in order to obtain a highly-ratedcreditworthy tenant.

Sales Comparison Approach

Compare CAP rates from leased fee drugstore sales to sales of other high quality retail.

Sales Comparison Approach

Non-Drugstore sales at corners?

Other property types typically found at traffic-light intersections are not verysimilar to drugstores.

Sales Comparison Approach

Non-Drugstore sales at inferior locations?

Other single-occupant retail stores are notsimilar in location and other features. Plus, they have their own issues.

Sales Comparison Approach

Sales Comparison Approach

When a store is abandoned by a drugstorechain, it no longer functions at its H&B use

Second Generation drugstore sales

Second Generation drugstore sales

“Further, Grantee covenants and agrees that the Subject Property shall not be used for the operation of a pharmacy, drug store, health and beauty aid business, a vitamin store and/or a mail order drug store or pharmacy until January 1, 2016. This restriction will run with title to the Subject Property and shall be binding upon the successors or assigns of Grantee.”

Sales Comparison Approach

Of the 3 options, I think drugstore sales are the best comps (with consideration for land prices and leased fee property rights).

Sales Comparison Approach

Drug Store Sales 1 2 3 4 5 6

Drugstore DataName Walgreens Walgreens CVS Walgreens Walgreens WalgreensFolio# 003117.0020 018006.0000 056816.0700 088080.0652 130069.0100 059228.3006Location 7925 Gunn Hwy. 802 W. Fletcher 105 S. Pebble Beach 5605 Fish Hawk Blvd. 4401 W. Gandy 20741 Bruce B. DownsSales Price $4,700,000 $7,320,000 $2,601,000 $6,015,800 $4,700,000 $4,508,000Sales Date 01/29/09 06/11/07 04/30/08 05/14/08 01/29/09 11/13/06Land Size 1.66 acres 1.49 acres 1.03 acres 1.81 acres 1.66 acres 1.93 acresBuilding Size 15,000 14890 10793 14615 15000 14,600B/L Ratio 1.23 1.49 1.27 1.20 1.23 1.19Construction Type Masonry Stucco Masonry Stucco Masonry Stucco Masonry Stucco Masonry Stucco Masonry StuccoDrive-Through Yes Yes Yes Yes Yes YesYear Built 2001 2006 1996 2008 2001 2005Price/Sf $313.33 $491.61 $240.99 $411.62 $313.33 $308.77

Income Approach

RENT:RENT: $25-$40 SF$25-$40 SFTERMS: 20-25 YEARS, WITH OPTIONSTERMS: 20-25 YEARS, WITH OPTIONSLEASE: TRIPLE NETLEASE: TRIPLE NET

Income Approach

THE ANNUAL RENT ORIGINATES THE ANNUAL RENT ORIGINATES FROM THE ORIGINAL TOTAL FROM THE ORIGINAL TOTAL DEVELOPMENT COSTS.DEVELOPMENT COSTS.

Income Approach

Rent Calculation ExampleStore Size 15,000 sfTotal Development Costs $4,000,000x Rent Factor x 10% Annual Rent = $400,000Rent/SF = $26.67 sf

Income Approach

IF THE SITE ACQUISITION COSTS WERE ABOVE IF THE SITE ACQUISITION COSTS WERE ABOVE MARKET – THEN THE RENT MIGHT ALSO BE ABOVE-MARKET – THEN THE RENT MIGHT ALSO BE ABOVE-MARKET.MARKET.

Income Approach

MOST DRUGSTORE LEASES ARE BASED ON FIXED MOST DRUGSTORE LEASES ARE BASED ON FIXED RENTAL AMOUNT OVER 20-30 YEARS. A TIMERENTAL AMOUNT OVER 20-30 YEARS. A TIMEADJUSTMENT SHOULD BE CONSIDERED WHENADJUSTMENT SHOULD BE CONSIDERED WHENUSING OLDER DRUGSTORE RENT COMPS.USING OLDER DRUGSTORE RENT COMPS.

Income Approach

JUST LIKE THE SALES JUST LIKE THE SALES COMPARISON APPROACH, COMPARISON APPROACH, AN ALTERNATIVE TO AN ALTERNATIVE TO DRUGSTORE RENT COMPS DRUGSTORE RENT COMPS IS NON-DRUGSTORE IS NON-DRUGSTORE PROPERTIES.PROPERTIES.

THE SAME PROBLEMS EXIST THE SAME PROBLEMS EXIST FOR THESE PROPERTIES AS FOR THESE PROPERTIES AS DID IN THE SALES DID IN THE SALES COMPARISON APPROACH.COMPARISON APPROACH.

1.1. NON-DRUGSTORE USES AT OTHER CORNERS ARE PROBABLY TOO NON-DRUGSTORE USES AT OTHER CORNERS ARE PROBABLY TOO DISSIMILAR TO USE AS RENT COMPS.DISSIMILAR TO USE AS RENT COMPS.

2.2. RETAIL USES AT NON-CORNERS MAY HAVE INFERIOR LOCATIONS RETAIL USES AT NON-CORNERS MAY HAVE INFERIOR LOCATIONS AND ARE OFTEN VERY DISSIMILAR IN SIZE AND OTHER FACTORS.AND ARE OFTEN VERY DISSIMILAR IN SIZE AND OTHER FACTORS.

3. 3. 22NDND GENERATION DRUGSTORES THAT WERE REJECTED BY GENERATION DRUGSTORES THAT WERE REJECTED BY DRUGSTORE CHAINS AND/OR BLOCKED FROM BEING LEASED BY A DRUGSTORE CHAINS AND/OR BLOCKED FROM BEING LEASED BY A COMPETING DRUGSTORE ARE NOT VERY COMPARABLE. COMPETING DRUGSTORE ARE NOT VERY COMPARABLE.

Income Approach

Non-Drugstore rent comps ?

Just like the Sales Comparison Approach, of the 3 options, I think drugstores are the best rent comps, with adjustments for time and potential above-market land prices.

Income Approach

CAP rates from Drugstore sales reflect investors’ desires for both quality real estate and dependable income stream from a highly rated tenant.

Income Approach

All 3 approaches can be automated to arrive at an estimate of fee simple market value.

Cost Approach – avoid using land sales where prices were inflated or above-market.

Sales Comparison Approach – ensure drugstore sales are adjusted for property rights to account for any premium paid by investors for highly-rated tenant and above-market land cost.

Income Approach – Adjust contract rent to market, and consider using CAP rates from high quality retail properties.

Mass Appraisal

The Future

1.1. AGING POPULATIONAGING POPULATION2.2. E-PRESCRIBINGE-PRESCRIBING3.3. HEALTH CARE BILLHEALTH CARE BILL4.4. MEDICAL CLINICSMEDICAL CLINICS

The Future

1.1. AGING POPULATIONAGING POPULATION2.2. E-PRESCRIBINGE-PRESCRIBING3.3. HEALTH CARE BILLHEALTH CARE BILL4.4. MEDICAL CLINICSMEDICAL CLINICS

The Future

The Courts

The Case Assessor Taxpayer

1.Eckerd Corp v. Semon (2007)

2.Eckerd v. Gilchrist (2007)

3.Brooks Drugs v. Schenectady (2008)

4.Rhodes v. Hamilton County (2008)

5.Walgreen v. City of Madison (2008)

6.Rite Aid v. Town of Colonie (2009)

Conclusion

THANK YOU!THANK YOU!

TIMWILMATH@HCPAFL.ORGTIMWILMATH@HCPAFL.ORG