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Real estate has always been critical to the strategies of chain drug stores, but given the dynamics in the sector today, one could make a strong argument for the necessity of maximizing real estate down to the last square foot.
Andrew Graiser
The drug store business continues to be among the most competitive in retail. It is also no less subject to disruption than other sectors of the economy. Even without a major push by Amazon to get into the pharmacy business, today’s chain drug stores must contend with a lengthening list of online and brick-and-mortar rivals that sell everything from cosmetics to packaged foods to vitamins to O-T-C drugs.
Executing strategic adaptations, whether it is a health-focused rebrand or a game-changing acquisition of a rival chain, is a natural response to such pressures. However, adaptation always requires substantial capital expenditures. Many drug store chains are working to optimize their real estate precisely because this can free up resources to support these larger strategies.
To make a big-picture vision come true, you have to go granular — carefully scrutinizing individual stores, markets, landlords and leases to uncover untapped value. In assessing how to maximize the value of an individual store, for example, the first step is to thoroughly understand the real estate as well as the perspectives and goals of both the landlord and retailer. What are the prevailing market rents? What will it cost the landlord to replace that drug store? How valuable will it be for that landlord if the drug store — a national credit tenant, after all — extends the lease? For its part, will the retailer need to refurbish the store interior, the facade, the parking lot, signage or lighting? The answers to such questions are important variables in what is ultimately possible for a location.
Understanding the overall market is no less essential. Does the drug store chain have several attractive relocation opportunities in the area, or is that market already saturated? If the store in question is high performing, this creates additional opportunity for both the landlord and the retailer to extend the lease, creating a lower cap rate for the landlord.
Back during relatively simpler times, drug stores could wait until a particular location was a year or two away from its lease renewal. At that point, the chain could look at the market rent, compare it to the contract rent, and then embark on a negotiation aimed at lowering occupancy costs. Today, more thought and strategy must be poured into each location.
The volatility of today’s marketplace means that, particularly for more questionable locations, it is imperative for drug store chains to preserve as many options as possible, which is why the average lease length is dropping across retail. Signing shorter leases also tends to promote a competitive mindset in which chains start looking for relocation opportunities almost as soon as the ink is dry.
A variety of non-drug retailers — including dollar stores and specialty food operators — are showing interest in subleasing drug store real estate, with certain health-related retailers favoring freestanding locations, in particular. So subleasing is another option that is becoming more appealing to drug stores looking to optimize their real estate.
Of course, excess warehouse and office space are prime candidates for sale or sublease, with warehouse space in particularly high demand in many markets.
While smaller chains often lack the robust real estate departments of their larger competitors, they are nonetheless paying closer attention to portfolio optimization. For them, it can be helpful to access sophisticated data analytics platforms that help them understand in greater detail the dynamics of the markets in which they operate.
Just like their bigger brethren, smaller chains need to understand which supermarkets with pharmacy operations are heading to their markets. Likewise, if certain tenants are struggling in a particular area and are possibly on their way out, that is key information for the drug store chain. Such knowledge allows you to get ahead of the curve. You could, for example, proactively pursue a sublease arrangement or close a store before a major cotenant exits a shopping center.
Like the rest of retail, the once-stable drug store business is facing big changes. However, the ultimate extent of the so-called disruption is still very much an unknown. As top chains contemplate the uncertain future, they can take decisive action now to cut occupancy costs, bolster competitiveness and free up the resources they need to reinvent themselves.
Andrew Graiser is co-president of A&G Realty Partners, a Melville, N.Y.-based firm that assists national chain drug stores and other retailers seeking to maximize the value of their real estate portfolios. He can be contacted at andy@agrealtypartners.com.
