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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+.

According to USFDA, a combination product is one composed of any combination of a drug and device; biological product and device; drug and biological product

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 arg

; or drug, device, and biological product and fixed dose combination would include two or more combinations of drug.

Examples of combination products may in

ue 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

lude drug-coated devices, drugs packaged with delivery devices in medical kits, and drugs and devices packaged separately but intended to be used together.

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 pro

here is enormous increase in the number of combination products entering the market in the recent years. Combination products have proven advantages but fixe

ucts, 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

d dose combinations are still in the process of convincing regulatory authority on their advantages over the single ingredient formulations.

Combination pro

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 ten

ucts have become life saving products for the pharmaceutical companies who doesn’t have many innovative molecules in their product pipeline and have been inc

ants 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.

Walgreens: Walgreen 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. The company plans to open 500 new stores in 2007. This is the best managed company among the three drugstore chai

easingly used in the product life cycle management. Even the companies having product patents are trying to extend their product life cycle through the combi

ns and also among the most admired public companies in the US. Due to its superior financial strength and premium locations, properties with leases from Walgreens get the highest price per square foot among the 3 drugstore chains. In addition, Walgreens gets a flat rent or very low rent increase for 20 to 30 years. The cap rate is often in the 5% range for properties in California and up to 6.5% outside of California. Investors who buy properties leased by Walgreens look for a safe investment. They often compare the

nation products and maximize the revenues. But the companies involved in this practice are overlooking that they are burdening the patients both economically

eturns on their investment with the returns from US treasury bonds or Certificate of Deposits from banks.

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.

and physically. They need to rightly judge the benefits of the combination products and they have to even look at the risks involved when combining the produ

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

ts. Some of the combination products were well accepted by physicians while others suffered. Companies involved in development of combination products are fi

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 nea

ding difficulty in defining their combination products and facing various challenges from selecting a combination to marketing it.

Following aspects would a

rly $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 willi

dd to the challenges in developing combination products:

Which markets to tap where the combination products can do fairly well?
Which combination prod

g 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

cts are meaningful and rational?
Which therapeutic categories to select?
Which Combinations can address unmet needs of the patients?
Do combin

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 th

tions increase the patient compliance?
What would be the developing cost?
How to tackle the risks encountered during combination product developmen

e 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 prope

t?

As combination products don't fit into the traditional categories of drugs, medical devices, or biological products, the USFDA is in the process of devel

rties 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 pa

ping new procedures for reviewing their safety, efficacy and quality.

Professional from academic institutions, pharmaceutical industries, health care indust

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 rent

y and representatives from various regulatory agencies are working out to design the regulatory requirements for manufacture and sale of combination products

al 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 t

.

As there is an increasing trend of the combination products companies manufacturing such products should be able to tackle the problems involved in the de

his 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 t

elopment. They need to be wiser in analyzing the market trends and the regulatory requirements.

Companies that provide selfless information through particip

hat 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

tion in industry events and feedback to regulatory authorities would be able to face the challenges and will be successful in developing combination products

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