Pharmacy Rents - dealing with your landlord in this climate

The economic and financial climate has added further pressures to pharmacy rents

Medici Capital will shortly be releasing the 2009 Pharmacy Rental Kit which includes the data for the year ended June 30, 2008.

Dealing with your Landlord in this Economic Climate

While I believe that pharmacy generally performs reasonably well during economic downturns and financial crisis, every business is facing new challenges arising from the current economic climate that you must take account of.

For some, the economic climate provides opportunities to exploit and build a stronger, perhaps better, pharmacy.

Ask yourself the following questions to assess both the impact and opportunity:

Question	Reason - which means	Landlord
What is the likely impact of the economic downturn on your pharmacy?	The impact will vary for each pharmacy. Retailers are more exposed. High prescription businesses will have the question of PBS reforms to consider.	If the impact is material, consider whether you should alert your landlord. Early warning can enable a reasonable approach.
Cash is king	While you may be profitable, cash flow is critical to the survival of your business: Manage working capital (Debtors, Creditors, and Stock) Consider refinancing to reduce costs Take action to better manage the business	If your business is strong, now might be a good time to approach creditors and landlords with a 'deal'.
Do you have a choice?	Are you able to take action? Many leases allow some flexibility. This may be a function of timing.	If you do have a choice, seize the opportunity.

Pharmacy Rents

Medici Capital recently developed a new measure for use in assessing fairness and equity of tenancy arrangements.

Who takes the risk? Whose business is it?

Most pharmacy owners and managers know that pharmacy rents and occupancy costs are a significant and increasing cost. Generally occupancy costs are the third highest expense (after Cost of Goods & Salaries). In some locations, they may be the second highest expense.

Pharmacy often pays the highest rent in a centre!

Based on Medici Capital data, the 2007 Australian average rent & outgoings per square metre (per annum) was $544.69 (95% confidence interval ranges from $491 to $599). The average rent as a percentage of turnover was 4.19% (95% confidence interval ranges from 3.85% to 4.52%).

Rent & Outgoings per square metre

The distribution of rents is highly skewed, with a few pharmacies paying well above the average rent and outgoings of $545. Any industry benchmark analysis is highly misleading, as the median (50% mark $398) is significantly lower than the average. Chart 1 illustrates the rent and outgoings per square metre. In simple terms, the vast majority of pharmacies pay less than the average, and the average is skewed by a number of pharmacists that pay extraordinarily high rates of occupancy costs - up to 6 times the average.

Any effort to bring pharmacy rents up to the technical average is misguided. Landlords should be examining industry median levels as well as averages to make a fairer assessment. Any alternative approach places enormous pressure on the viability of such businesses.

Rent as percentage of sales

As Chart 2 demonstrates, rent as a percentage of sales also varies dramatically. This chart alone does not indicate the viability of a pharmacy business. To determine the viability, the mix of the three categories - prescription medicines, scheduled non-prescription medicines, and general retail - needs to be further analysed. One factor is certain, however, that those businesses, highly dependent on the PBS, are unable to meet the demands of a high rental percentage of turnover. The analysis provided in the previous section of this report demonstrates that over time, while a percentage rate may have been sustainable at the commencement of a long lease, Government regulation and control now places that same previously viable pharmacy in jeopardy.

Examining the data highlights that 75% of the sample pay less than $684 per square metre whereas 25% pay more. Similarly, 75% pay less than 5.61% rent as a percentage of turnover.

Table 1 : Rental Distribution

% of Sample	25%	50%	75%
$ Rent & Outgoings per sq.mt. p.a.	$259.29	$398.23	$684.21
Rent % Turnover	1.88%	3.26%	5.61%

Rent and outgoings per square metre by shopping centre type

Table 2 below highlights the dramatic variation in rents by shopping centre throughout Australia. While these differences have been known for some time, pharmacy owners and their advisers, as well as landlords, need to consider "what constitutes a fair market rent"?

It is also apparent from the data that the distribution of pharmacy rents is skewed. That is, the average is not representative of pharmacy rents as the median, for all shopping centre categories, lies below the average. It can therefore be said that a move towards the average would mean that you are paying more than most pharmacies.

It should also be noted that the circumstances leading to a particular rent being paid may include centre exclusivity.

Table 2: Australian pharmacy rents and outgoings by shopping centre type

Centre Type	Mean	Median	-95%	+95%
Strip	$346.65	$304.61	$313.83	$379.47
Sub-Regional & Community	$505.89	$428.53	$420.93	$590.85
Medical Centre	$532.55	$395.40	$328.44	$736.67
Regional	$792.65	$661.87	$612.49	$972.81
Major Regional	$1,024.97	$1,005.46	$833.90	$1,216.05

Rents also vary by state.

Landlord's share of income

Traditionally the argument has been, "you pay for what you get". That is, higher rents relate to more productive sites and locations. Better sites attract a higher cost.

An alternative view of rent could be considered whereby the landlord and tenant join together to share the rewards. The landlord seeks a return from the capital and recurrent expenses associated with operating the site or providing suitable premises. The tenant seeks a return from the capital and recurrent expenses associated with operating in the site.

To examine this further, Medici Capital re-examined pharmacy profit to measure the landlord's share of income.

To determine the landlord's share, the following calculation was made:

Calculation of Landlord's Share

Table 3: Calculation of Landlord's Share

Step	Calculation	Resulting in
Net Profit before interest	As reported after an owner's salary	Starting point
+ Rent and Outgoings	As paid by the tenant	Net income available to be shared between the landlord and tenant
Landlord's share	Rent ÷ Profit available to Share = Landlord's Share

How much is the landlord's share?

Table 4: Landlord's Share - Australian Pharmacy Average and Quartile Analysis

Mean 25% 50% 75% -95% +95% Rent % of Business Profit before Rent - 2007 29.0% 12.3% 22.3% 36.7% 26.5% 31.4%

On average, the landlord received approximately 29% of the Net Income before rent and outgoings. However, the landlord's share varied dramatically by shopping centre type.

Landlord's share of Net Income before rent and outgoings by centre type

Table 5: Landlord's Share - Australian Pharmacy Average by shopping centre type

Centre Type	Mean Rent % of Business Profit before Rent - 2007	Median	-95%	+95%
Strip	22.16%	16.62%	19.04%	25.28%
Sub-Regional & Community	26.70%	22.68%	22.45%	30.95%
Medical Centre	22.69%	18.25%	16.17%	29.21%
Regional	37.54%	31.06%	32.03%	43.05%
Major Regional	52.35%	41.00%	39.88%	64.82%

While the average was approximately 29%, in major regional shopping centres, the average landlord's share exceeded 52% in 2007.

However, this share also varied dramatically by location. In some locations, landlords are earning more than the pharmacy owners.

New Service Launched at APP

Medici Capital is launching a new service for Pharmacy at the forthcoming APP. The new service will offer pharmacy owners, and their advisers, a Pharmacy Rents Report.

The report will include:

1. Pharmacy general rent issues;
2. Comparative leases for pharmacies and other retailers located in similar shopping centres. Where the data is available, this will include specific lease data;
3. Summary of the pharmacy's own lease; and
4. Suggested course of action.

If required, an offer for further negotiation assistance will be provided. Pharmacists can call, fax, email, or complete on-line the details of their lease and state their requirements (ie. purpose of the report). We will then email a PDF copy of the report together with the comparative data.

The take-away

• Know what you can afford. Check with Medici Capital for a quick assessment.
• Understand the potential of the site and seek to set a fair market share of profits between you and your landlord based on a reasonable business outlook for the site.
• Work to a plan and assess results against that plan.
• Establish a professional and open exchange/relationship with your landlord.
• Take careful notes of all discussions and maintain files of information.
• Communicate regularly.