a prescription for assessing drugstores

Journal of Property Tax Assessment & Administration • Volume 7, Issue 2 13

National drugstore chains have grown at a staggering pace dur-

ing the past two decades. To maximize customer convenience, four major drug-store companies pioneered a property concept that has spawned thousands of freestanding drugstores built on prime corners throughout the United States. This rapid growth was made possible by a business model that enabled drug-store chains to operate as tenants in stores built to their specifications. These properties have proven to be attractive to investors who purchase the stores to acquire the optimum combination of a highly rated, reliable tenant and prime real estate. Because of the way drugstores are developed, acquired, and leased, their valuation presents certain challenges. This article examines the valuation factors that affect drugstores in an effort to help assessors adopt an effective approach to estimating their market value.

BackgroundDrugstores have been a fixture in most American cities and towns for over 200 years. Over time, their architecture has evolved from downtown storefronts,

to in-line locations in grocery-store-an-chored shopping centers, to the modern freestanding drugstore so prevalent today. By the mid-1980s, four major drugstore companies emerged as the dominant players in the market: Eckerd, CVS, Walgreens, and Rite Aid. During the next two decades, these four com-panies expanded at a dramatic pace, gobbling up much of their competition through mergers, buyouts, and acquisi-tions. These chains used computers to link stores, fill prescriptions, and track inventory. They easily dominated the smaller and less sophisticated indepen-dents and soon became a familiar sight in the urban landscape.

The New PrototypeIn the 1990s, Eckerd, CVS, Walgreens, and Rite Aid began shifting from their traditional locations to a new store prototype—the freestanding modern drugstore located at a high-profile cor-ner. (See figure 1.) The new profile was designed to maximize customer conve-nience by providing easy store access, storefront parking, and often a drive-through prescription pick-up window. These stores are now a familiar sight in all 50 states.

Tim Wilmath, MAI, is Director of Valuation for the Hillsborough County Property Appraiser’s Office in Tampa, Florida.

A Prescription for Assessing Drugstores

By Tim WilmaTh, mai

14 Journal of Property Tax Assessment & Administration • Volume 7, Issue 2

By focusing on convenience, drug-store chains hoped to offer consumers a shopping experience unlike other retail stores. Big-box discount retailers and grocery stores both offer prescrip-tions and general merchandise, but they do not provide the easy in-and-out expediency drugstores cultivate. In its 2009 annual report, CVS summarized its strategy:

Our goal is to be the easiest pharmacy retailer for customers to use. We believe ease of use means convenience for the

time-starved customer. As such, our operating strategy is to provide a broad assortment of quality merchandise at competitive prices using a retail format that emphasizes service, innovation and convenience (easy-to-access, clean, well-lit and well stocked). (CVS Caremark Corporation 2009, 7)

In 2004, Eckerd was sold and the re-maining “big three” chains—Walgreens, CVS and Rite Aid—expanded to almost 20,000 locations across the country. In 2009, CVS and Walgreens both celebrat-ed the opening of their 7,000th store. Figure 2 illustrates the growth of the four largest national drugstore chains. Table 1 shows the current dominance of the three largest chain stores—CVS, Walgreens, and Rite Aid.

The Business ModelIn addition to a new store model, the national chains also began pursuing a new business concept. To keep growing and funding their core business opera-tions, the drugstore companies created a more effective way to operate their stores without actually owning them. The idea was to enlist a local developer to acquire a site and then build a store to the company’s specifications. The chain would lease the store back from the developer under a triple net lease. Once the drugstore chain occupied the store, the leased package would be sold to an investor.

The prime location and property mod-el concept is so successful for business that drugstore chains can afford to pay rent in excess of $20 to $40 per square foot to obtain the corners and stores that meet their target demographics.

Investors who purchase net-leased drugstores are attracted to the stable and predictable cash flow from the national drugstore chain tenant. Although the real estate itself is appealing, the tenant’s creditworthiness makes the transaction much less risky than other investments. The largest national drugstore chains

Photo credits: Rite Aid photo courtesy of Robert Bender; CVS photo courtesy of CVS Caremark; Walgreens photo by author

Figure 1. The modern drugstore concept

Property characteristicsLocation: Signalized high profile/high traffic cornerStyle: One-story attractive architectural designSite size: Approximately 1–2 acresBuilding size: 12,000–15,000 square feetFeatures: Drive-through windowAccess: Easy ingress/egressParking: Wrap-around style with 50–80 spaces


earn high marks from rating agencies such as Standard & Poor’s and Moody’s, giving investors’ confidence. These drugstores often sell at capitalization rates below those of other quality retail properties, indicating a high degree of faith in the tenant’s dependability.

Purchasers also feel secure about the long-term safety of investments in mod-ern drugstores because the industry is expected to be successful far into the future. A growing population, longer life expectancies, the efficiency with which drugstore companies work with

medical insurance companies, and overall store convenience, all bode well for drugstores. Drugstore companies continue to innovate, recently adding limited health-care services in small clinics within some stores. These factors provide assurance to investors that the cash flow from the drugstore tenant will continue without issue.

The drugstore business model has the potential to be a win-win for all involved parties. The drug retailer obtains the most desirable location but avoids tying up capital in property ownership. The developer makes a profit on constructing the building and the sale of the property. The investor owns premium real estate with a low-risk, long-term income stream from a highly rated national tenant.

ValuationFor most jurisdictions, the assessed value of property is based on a fee simple market value. Drugstore valuation, with its leased fee component and other in-dustry-specific issues, presents challenges to assessors. How does one consider the leased fee sales of drugstores to inves-tors who are attracted to the tenant as much as the real estate? Are drugstores special purpose properties? How do above-market land prices factor into the market value as-improved? Are contract

Figure 2. Major U.S. drugstore growth

Table 1. Top 10 drugstore chains in North America—2009Company StoresCVS Caremark 6,981

Walgreens 6,678

Rite Aid 4,901

Health Mart 2,002

Katz Group 1,900

Medicine Shoppe Intl. 1,350

Shoppers Drug Mart 1,149

McKesson Canada 500

Pharmasave 421

Uniprix 387

Total—Top 10 26,269Source: Data compiled from Chain Drug Review (2009)

* In 2004, CVS acquired approximately 1,200 Eckerd storesSource: Data obtained from 10-k filings, annual reports, press releases


rents based on original development costs equal to market rent? Collectively, these and other issues can complicate the valuation process. The sections that follow discuss the most common issues found in drugstore valuation and offer suggestions for determining a reliable market value estimate.

Special Purpose and Limited MarketModern drugstores have a specialized design and also may have a limited market if only the few drugstore users are considered. So it might be tempting to label them special purpose or even limited-market properties. The Appraisal of Real Estate notes:

Many limited-market properties, such as houses of worship, museums, schools, public buildings, and clubhouses, in-clude structures with unique designs, special construction materials, or layouts that restrict their functional utility to the use for which they were originally built. These properties usually have a limited conversion potential and, consequently, are also called specialized, special-use, special-purpose, or special-design proper-ties. (Appraisal Institute 2008, 28)

There is nothing so unique about drugstores that they cannot be physi-cally converted to different uses. When Eckerd was purchased in 2004, most of its stores became CVS stores. Those that did not become CVS stores were ultimately repurposed to non-drugstore uses (often called second-generation space). It is not uncommon to see banks, discount stores, auto parts stores, or other establishments operating in former drugstore space. Although the improvements were not designed for these alternate uses, drug-store buildings can be easily modified to accommodate different occupants.

Limited-market properties have few buyers and lengthy marketing periods—factors that do not apply to drugstores. Even though there are few national chains, the drugstore market is robust.

The reason is that the demand comes primarily from investors, many of whom are willing to pay prices that can exceed the cost to build. Although drugstore properties present valuation challenges, they do not rise to level of special pur-pose or limited market.

Market Value versus Use ValueDespite the fact that many states require tax assessors to estimate market value in exchange, they are still sometimes ac-cused of inappropriately applying “use value” to drugstores. The Dictionary of Real Estate Appraisal defines use value as: “The value a specific property has for a specific use.” (Appraisal Institute 2002, 303) The use value claim may be a re-sult of assessors defending value based, in part, on their observation that the drugstore building enables successful business operation. Some conclude that the assessor has inappropriately focused on the business’ success rather than the real estate.

The most common application of use value in many states occurs on agricul-tural land. Intended as a tax break, this classification usually requires assessors to ignore highest and best use (often development), and instead assign a value based on the actual agricultural use. This approach can result in a value substantially different than what would be found if a highest and best use value were the goal.

Although it is true that use value is based solely on a property’s actual use, it is not always different from market value in exchange. If the actual use is the high-est and best use, then it stands to reason that the value in use would equal the value in exchange. Use value and mar-ket value in exchange are only different when the current use is not the highest and best use. If an appraiser concludes that the current use of a drugstore is also the highest and best use, then use value and market value are the same, and this becomes a non-issue.


Highest and Best UseDetermining a drugstore’s highest and best use as improved may seem obvious and even unnecessary, but highest and best use analysis serves more than one purpose. According to the Appraisal of Real Estate:

There are two reasons to analyze the highest and best use of a property as improved. The first is to help identify potentially comparable properties. Each improved property should have the same or a similar highest and best use as the improved subject property, both as though vacant and as improved. The second reason to analyze the highest and best use of the property as improved is to decide which of the following options should be pursued:

• Maintain the improvements as is.

• Cure items of deferred maintenance and retain the improvements.

• Modify the improvements (e.g., renovate, modernize, or convert).

• Demolish the improvements

(Appraisal Institute 2008, 139)

Given the success of the new drugstore model, it is easy to conclude that for most stores, the highest and best use as im-proved is to maintain the improvements as is. After making that determination, the best comparables would likely be sales of other drugstores. Note that the Appraisal of Real Estate text indicates that the subject and comparables should have the same highest and best use. The selection process is an important aspect of drugstore valuation because there are many choices for comparables and the choice will have a significant impact on the ultimate value conclusion.

Some might say that describing drug-store use as a specific highest and best use is too narrow and that such a clas-sification more accurately describes the business—not the real estate. Are drugstores a market unto themselves or just a different flavor of general retail?

Drugstore chains have developed a specific property concept with charac-teristics that when combined, achieve a unique product. Drugstores are indeed a highest and best use and classifying them as “general retail” is too broad.

applying the Three approaches to ValueFor drugstores, all three approaches to value have the potential to provide a reliable estimate of market value. In many jurisdictions, there are sales of drugstores, making the sales compari-son approach useful. Most freestanding chain drugstores are relatively new, so the cost approach can be applied. Finally, modern drugstores are almost always leased, which makes the income ap-proach pertinent. Despite the availability of the three approaches, each one con-tains factors specific to drugstores that need to be considered. In the next sec-tions, the application of each approach is discussed with an emphasis on some of the challenges inherent in assessing this property type.

Cost ApproachGiven that the modern drugstore concept is relatively recent, the cost approach would seem particularly useful in valuing these properties. However, estimating the land value under the cost approach requires the assessor to face one of the more common problems in drugstore valuation. Because the modern drug-store model requires at least one acre of land, assemblage of two or more parcels is sometimes necessary. This need may require developers to negotiate with several owners to obtain enough land to accommodate a new store. In addition, the most desirable corners are often already occupied, forcing developers to pay for improvements that ultimately will be demolished.

A premium for optimum locations has become a common land acquisition cost for drugstore development. Drugstore


companies seem to pay almost whatever price is necessary to acquire certain high-profile corners. Prices paid by drugstore chains for land may exceed those paid by other typical corner users such as banks, convenience stores, and fast-food restau-rants. This practice is most common in neighborhoods where few high-profile signalized corners remain vacant. The drugstore chains’ desire for (oftentimes improved) sites that may not even be for sale can drive up prices. When estimating land value under the cost approach, the assessor should avoid using sales where evidence shows the price paid was above market, a distinct possibility in drugstore-related land purchases.

The replacement cost of the drugstore buildings can be estimated by using cost services such as Marshall & Swift. However, an analysis of actual drugstore construction costs can uncover expen-ditures that are not included in the cost service estimates. Because drugstore de-velopers often buy improved properties, they incur demolition costs, remedia-tion costs, and other engineering costs that would not be necessary if the site were vacant. Impact fee credits may also be available when improved sites are redeveloped, sometimes offsetting demolition and other site engineering costs.

Physical depreciation for modern drugstores is easily estimated because most were built in the past 10 years. Mar-shall Valuation Service estimates the useful life of these properties to be 40 to 45 years (Marshall & Swift 2008). This figure is supported by drugstore leases, which including renewal options, often span 40 years or more. Most modern drugstores are well maintained and exhibit little deferred maintenance. Part of the ap-peal of these stores is their cleanliness and attractiveness.

It is difficult to imagine that modern drugstores might contain functional obsolescence. As the store concept has been refined, modern drugstores have become relatively uniform. This trend

would suggest that any design flaws have been corrected and that functional obso-lescence ranges from minimal to none. However, some argue that drugstores are “superadequate” because they are of a size and contain features that other users would not want.

Superadequacy is defined in the Dictionary of Real Estate Appraisal as “an excess in the capacity of quality of a structure or structural component; determined by market standards.” (Ap-praisal Institute 2002, 282) The question is: who determines market standards? If the market is drugstore users, few would argue that the improvements serve the purpose for which they were intended. If highest and best use as improved is de-termined to be continued drugstore use, then assigning functional obsolescence based on the needs of non-drugstore tenants would seem improper.

If an auto parts store were to occupy a former drugstore, it most likely would not need 12,000–15,000 square feet of floor space. In this circumstance, applying a functional obsolescence ad-justment due to superadequacy would probably be appropriate. However, if the improvements are still being utilized as a successful drugstore, then no adjustment should be made. If functional obsoles-cence were measured by contrasting the subject with alternate uses, then movie theaters (slanted floors), oil-change facilities (underground service pits), and bowling alleys (bowling lanes) would all inherently contain functional obsolescence. Although drugstore im-provements are not optimal in location, size, or design for non-drugstore uses, they function perfectly when used as intended. When these improvements are put to their highest and best use, they do not suffer from obsolescence due to superadequacy.

Once the depreciated value of im-provements is calculated and added to the land value estimate, the value by the cost approach can represent a reliable estimate of a drugstore’s market value.


Sales Comparison ApproachAlthough drugstore sales are relatively plentiful, they are almost always leased fee. This leaves the assessor with four options in the selection of comparables: (1) unadjusted leased fee drugstore sales; (2) leased fee sales of drugstores, but adjusted for property rights; (3) non-drugstore sales; and (4) sales of former drugstores that were sold to a second-generation user. The selection of comparables is extremely important because it will have a significant impact on the final value. This section examines potential comparables offering sugges-tions for adjustments to resolve the most common limitations of utilizing the sales comparison approach for drugstores.

Fee simple purchases of drugstores by drugstore users would be the ideal comparables since they would remove any issues related to leased-fee owner-ship. Although national drugstore chains occasionally buy their own buildings through build-to-suit arrangements, this type of sale is exceedingly rare. The more common transaction involves the sale of a leased drugstore to an investor. The opportunity to obtain a prime piece of real estate and a reliable long-term cash flow has been so successful in attracting investors that this type of sale has become commonplace. Many jurisdictions have responded to these sales by assessing drugstores at values that are unaccept-able to drugstore chains, often resulting in appeals and litigation. The drugstore chains have argued that these are leased fee sales and the prices include business consideration and therefore do not rep-resent market value.

The courts have sent mixed signals to assessors about the use of leased fee drugstore sales. In Eckerd Corp v. Semon (2007), a New York appellate court rejected the assessor’s use of national leased fee drugstore sales as comparables in favor of sales of local small businesses and second-generation drugstores. By contrast, other courts, including some in New York, have consistently upheld

the assessment when there was an actual sale of the subject property, even under the same net lease conditions. In several cases, including Rite Aid of New York v. Assessor of the Town of Colonie (2008), Rhodes v. Hamilton County Board of Revi-sion (2008), Eckerd v. Gilchrist (2007), and Brooks Drugs, Inc., v. The Board of Assessors of the City of Schenectady (2008), the courts ruled that a sale of the subject outweighs property rights issues. These seemingly conflicting opinions could be attributed to nuances of state law, confusion in the courts, or both.

To avoid the pitfalls of using leased fee drugstore transactions, the assessor can estimate a fee simple market value by adjusting these sales for property rights. A property rights adjustment can be calculated by comparing the difference between capitalization rates of leased fee drugstore sales and cap rates from sales of other high-quality retail real estate. A difference could indicate that the pay-ment included a premium to acquire the cash flow from a superior tenant and/or that the price reflected a premium for above-market site acquisition.

Cap rates for drugstores and other re-tail property types can be obtained from sources such as Real Capital Analytics. The company’s 4th quarter 2009 drug-store report lists the weighted average cap rate for drugstores as 7.3 percent, while cap rates for all other retail prop-erties during the same period were 7.9 percent (Real Capital Analytics 2009). The 0.6 percent difference between these two cap rates could be the basis for an 8 percent downward property rights adjustment to leased fee drugstores sales. In this case, a downward adjustment is appropriate because the drugstore sale cap rate is superior to (lower than) those to which it was compared. Once an adjustment for property rights has been considered, leased fee drugstore sales can be reliable comparables.

Another alternative is to use non-drug-store comparables. Other businesses commonly found at signalized corners


include convenience stores, banks, and restaurants. Although similar in corner location to modern drugstores, they are often dissimilar in use, site size, and building characteristics, requiring large adjustments. Sales of general retail comparables without a premium corner location could require sizeable adjust-ments for both location and building characteristics.

National drugstore chains rarely con-vert and occupy non-drugstore buildings. Drugstore chains have largely settled on a property concept that is distinct and works extremely well for their purposes. Other building and land combinations are usually not acceptable, which calls into question the true comparability of general retail property sales for drug-store valuation.

Some argue that the best way to value drugstores is by sales of former drugstores to secondary users. When a drugstore chain abandons a store, its actions indicate there may no longer be market support for drugstore use at that location. Even though the building may remain physically similar under its second-generation occupant, the mar-ket’s rejection of drugstore use makes these sales questionable for comparison to first-generation operating drugstores. This is not a new concept. Sometimes grocery-store buildings “go dark” and ultimately are sold at a fraction of the first-generation price. They are often occupied by furniture stores, indoor flea markets, second-hand merchandise retailers, or similar “second-tier” users. These sales are often rejected as com-parables for first-generation grocery stores because they represent a different market.

A more compelling reason to reject second-generation drugstores as com-parables is the restrictions that are often placed on these stores. The optimum user of a closed drugstore, a different drugstore occupant, is almost always prevented from purchasing or leasing

it. In 2004, CVS acquired more than 1,200 Eckerd stores. At that time, both chains operated stores in close proxim-ity to each other, sometimes just across the street. CVS was able to convert and occupy many of these stores at a relatively low cost. The reason is that the modern design works very well for drugstore use, regardless of the drugstore company that occupies it. The stores that CVS didn’t need were leased or sold to non-drugstore users, usually at rents or prices far below what drugstore chains typically pay.

Why didn’t other drugstore chains obtain surplus Eckerd stores from CVS? Because they never had the opportunity. Not only were these stores not offered to Walgreens or Rite Aid, but competitors were specifically blocked from buying or leasing via deed restrictions and lease clauses. A shame for assessors, because those transactions would have clearly demonstrated fee simple market value. An example of this restriction can be found in CVS’ sale of a former Eckerd store that was subsequently converted into a bank branch. In the deed trans-ferring the property, the relevant clause states:

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. (Hillsborough County Clerk of the Circuit Court 2007, 589).

Similarly, when drugstore companies occupy buildings as tenants, they often include language in their leases that restrict the landlord from participating in any activity that would result in a rival drugstore appearing on an opposite corner. A common clause included in drugstore leases is:


It is further agreed that Landlord will not directly or indirectly lease, rent, sell or otherwise permit any property in which it has any interest (direct or indirect) located within 1,000 feet of the exterior boundary of the leased Premises to be used as a drug store or a business which sells or dispenses prescription drugs without the written permission of tenant. (Hillsborough County Clerk of the Circuit Court 2002, 327).

Understandably, drugstore chains have no desire to sell or lease drugstores to their competition. But for valuation purposes, these restrictions artificially alter the forces of supply and demand, preventing the most likely market par-ticipants from illustrating through their actions, the true fee simple market value of these properties.

By adjusting for property rights and other factors such as time of sale and physical differences, the assessor can estimate an appropriate fee simple market value for drugstores via the sales comparison approach. This estimated value should reflect what a hypothetical buyer would pay for the property under a drugstore use—free of any premiums attributable to factors such as an inflated land price or a particular tenant.

Income ApproachSince drugstores are commonly leased, the income approach is a valid method to estimate their value. In the direct capitalization income approach, an es-timate of fee simple value requires the use of market rent. Utilizing contract rent would be ideal for estimating leased fee value, but without adjustment, it might not produce an estimate of fee simple value. Unless contract rent mir-rors market rent, an adjustment may be warranted.

Drugstore contract rent is typically a function of the original development costs. These costs include land acqui-sition, site preparation, and building construction. Analysis of actual original

construction costs and leases indicates that annual rent is often established by multiplying the total facility development cost by a factor of about 10 percent. For example, a 15,000-square-foot store with a total development cost of $3.5 million might have an annual rent of $350,000, or $23.33 per square foot ($3.5 million x 10% = $350,000/15,000 sf).

Since contract rent is based on the original development costs, it is im-portant to ascertain if those costs were inflated, particularly by the land acquisi-tion cost. If any costs were above market, then contract rent may not represent market rates. Utilized unadjusted, it could result in over-assessment.

In Walgreen Co. v. City of Madison (2008), the court specifically rejected the assessor’s use of above-market contract rent to estimate fee simple market value for a Walgreens drugstore. Both sides agreed the rent was above market, so the court was left to decide whether its use in the assessor’s income approach valua-tion was warranted. The court sided with Walgreen’s position saying:

A lessor may be more than fully com-pensated for an encumbrance through above market rent in cases such as the present one, but that does not transform the lease from an encumbrance to part of the “bundle of rights” appertaining to a property, nor does it transform the rent payments into anything more than com-pensation for an encumbrance. Rather, it may just make the property owner a wise investor. (Walgreen Co. v. City of Madison 2008, 25).

If the original land costs were inflated, an adjustment to the contract rent could be made to bring the rent in line with the market. For example, a 15,000-square-foot drugstore that was built in 2008 has a lease rate of $23.00 per square foot. Research indicates that the developer paid $450,000 more for the land than the sale prices recorded for similar corner sites. Most drugstore rents are based on an original cost factor of approximately


10 percent. Therefore, the excess land cost of $450,000 translates into an excess rent of $3.00 per square foot ($450,000 x 0.10 = $45,000/15,000 sf). This $3.00 excess rent should be subtracted from the contract rent of $23.00 to obtain a fee simple market rent of $20.00.

Because contract rent is established in the year of construction and is typically fixed for the lease term, the rent may become outdated. Older stores typically have different rental rates than newer ones since construction costs change. For this reason, the assessor should care-fully analyze contract rents to determine if an adjustment for time is necessary.

An alternative to adjusting drugstore contract rent is the use of rental rates from non-drugstore properties, such as big-box stores or other single-occupant retail stores. The same limitations that impact the use of non-drugstore sale comparables exist for non-drugstore rent comps. Many properties contain some of the trademark characteristics of drugstores, but few possess all. The modern drugstore’s combination of the highest quality corner location, specific site and building-size requirements, and other features severely limits comparabil-ity with non-drugstore rents.

Former operating drugstores are usu-ally leased to non-drugstore tenants. Although these second-generation drugstores are physically similar to first-generation stores, they have been rejected for drugstore use by the mar-ket. More importantly, when drugstores are closed, deed restrictions and lease clauses often prevent one national chain from leasing the vacated property of another. This practice limits the ideal user from negotiating and establishing market rent. Although a competing drugstore might be willing to pay higher rent than a secondary user, a drugstore chain’s apparent desire to block the com-petition outweighs the need to offer the most profitable sublease opportunities for closed stores.

Given the many sources of rent data available to the assessor, adjusting the drugstore contract rent seems to be the most accurate and effective way to determine a current market rent for an operating drugstore.

Because drugstores are leased on a triple-net basis, property operating and maintenance expenses are mostly borne by the tenant. Although landlords incur few out-of-pocket costs, time may be re-quired for oversight of the investment. In addition, landlords can be responsible for major capital repairs, such as the roof and structural walls. An assessor may want to account for these two factors by including a nominal expense estimate in the income approach.

Since lease terms for drugstores typi-cally span 20 to 25 years with numerous renewal options, vacancy is an insig-nificant factor, with the only risk the unlikely default of the drugstore chain. However, in an estimate of fee simple value, the assessor should incorporate a vacancy rate appropriate to a well-located net-leased property.

Capitalization rates from drugstore sales reflect investor motivation to obtain both quality real estate and a depend-able income stream from a highly rated national tenant. Although sales of other property types reflect similar motives, the security of national drugstore chains is particularly appealing. Investors are willing to pay more for these assets in exchange for the low risk and freedom from day-to-day management. For these reasons, cap rates extracted from drug-store sales may not reflect fee simple value of the real estate. A reasonable alternative might be to use cap rates from other high-quality retail properties.

Once contract rent has been adjusted to market and the appropriate expenses and cap rate applied, a fee simple value for drugstores can be determined through the direct capitalization method of the income approach.


mass appraisalOnce all of the issues specific to drug-store valuation have been identified and addressed, mass appraisal models can be created and applied to all drugstores in a jurisdiction. Utilizing mass appraisal ensures equity and provides efficiency in drugstore assessment. Following is a prescription for assessing drugstores that utilizes mass appraisal while still addressing the most common issues sur-rounding these properties.

Most computer-assisted mass appraisal (CAMA) systems include a cost approach that sums the value of the land, site im-provements, and depreciated building costs. The best source for developing a building cost rate for drugstores is the actual construction costs incurred by the developer. In the absence of that data, building cost estimates can be found in cost manuals like Marshall Valuation Service (Marshall & Swift 2008), which has a section dedicated to drugstores. Most freestanding modern drugstores are of masonry construction, so the Class C category in the Calculator Method section of the Marshall Valuation Service would be appropriate. After selecting the appropriate quality classification, the resulting rate should be refined for heat-ing and cooling (HVAC), fire sprinklers, story height, perimeter, and current cost and local multipliers.

The building costs estimated by Mar-shall & Swift do not include certain land improvement costs such as demolition, grading, fill, or required off-site improve-ments such as sidewalks, crosswalks, or drainage. The assessor may not be able to determine the cost of these items without access to the actual costs. The absence of these costs may understate the value in the cost approach.

In addition, drugstores typically have a covered entry and most have a sheltered drive-through window. The Marshall Valuation Service reports the costs for re-tail canopies to be approximately 20–40 percent of the adjusted building cost. These costs should be added to the cost

of the main structure. Site improvement costs such as paving, walls, landscaping, walkways, and exterior lighting also are not included in Marshall’s building cost estimate and therefore should be added separately.

The resulting value can be adjusted using depreciation tables to reflect the subject’s age and condition. As men-tioned earlier, the expected life of a modern drugstore is estimated to be 40 to 45 years. Once a cost model is created and applied, site-specific adjustments, such as for functional or external obso-lescence, can be applied if necessary.

The Marshall & Swift building costs include contractor overhead and profit but not entrepreneurial profit, a factor usually included in the cost approach. For drugstores, the entrepreneur is usu-ally the developer who expects to earn both a fee for the development of the property and a profit when the property is sold to an investor. This latter gain, if realized, is entrepreneurial profit. It could be argued that a portion of this profit is an intangible, attributable to the attractiveness of a reliable tenant, not the real estate. Allocating the profit between real estate and business value could be attempted, but probably would not ac-curately reflect the motivation of buyers. Therefore, entrepreneurial profit could be excluded from a drugstore cost ap-proach to ensure that only the real estate is being assessed.

To develop the site value in a drug-store mass appraisal cost model, the assessor should review and analyze land sales from high-profile signalized cor-ner locations. Care should be taken to avoid using land sales in which prices were above the typical, a possible occur-rence in drugstore-related purchases. Land codes reflecting signalized corner prices can be created and applied to drugstores, with adjustments for size, location, shape, and other property-specific characteristics.

Many CAMA systems include stand-alone market approach modules. Market


approach models can be created by utilizing sales of operating drugstores, but adjusted for property rights (if necessary), since most are sold under long-term leases. As mentioned earlier, property rights adjustments can be ac-complished by comparing the cap rates from leased fee drugstore sales to those from other high-quality real estate.

Some jurisdictions utilize a cost/market hybrid method. This model com-bines both the cost approach and the sales comparison approach to generate a single value. Using this method, a build-ing cost rate per square foot is typically extracted from the cost manual and then blended with unit prices from sales. If a hybrid cost/market approach is used, the assessor should consider adjustments for property rights before blending with the building cost rate. Once a blended rate is established, it can be applied against the square footage of the building to obtain a market replacement cost new. The resulting value is depreciated and added to the contributory value of the site improvements and land value to ar-rive at an estimate of fee simple market value.

Finally, mass appraisal income models using the direct capitalization approach can be created with estimates of market rent, vacancy, expenses, and capitaliza-tion rates. Although modern drugstores vary in age, location, and features (such as the existence of a drive-through window), few drugstore income models likely will be needed, since most stores can be grouped into a few categories. Applying these models to all drugstores, regardless of the tenant, will ensure a consistent and equitable value.

To estimate market rent for the in-come model, the assessor should review current rents from recent leases of op-erating drugstores (if available). If the original land costs for any of the rent comps were inflated, the lease rates may be above market. Adjusting these rent comparables to market should help the

assessor arrive at a reasonable estimate of market rent for the income model.

Since drugstores are typically leased to dependable national chains, most landlords expect and experience zero va-cancy. However, it would be appropriate to include a minimal vacancy allowance to reflect fee simple valuation and the negligible risk of a tenant default. Similarly, a nominal expense allowance should be included for management to reflect the time necessary to oversee the investment and the possibility of major capital repairs. Utilizing capitalization rates extracted from other high-quality retail sales will avoid the possibility of estimating a leased-fee value.

With all the variables for the direct capitalization approach estimated, a mass appraisal income model can be cre-ated and applied to all drugstores.

Once all three value approaches have been modeled and applied, assessors can weigh the applicability of each approach. For drugstores, all three approaches to value have merit. Depending on the availability and quality of data and the amount of judgment required in mak-ing adjustments, one approach may be preferable to the others. As always, the as-sessor makes the final estimate of market value based on the best available data.

ConclusionThe issues surrounding drugstore valuation can make for a challenging assessment. Even though drugstore sales are usually leased fee transactions, adjustments for property rights can be made to reflect a fee simple value. Even though development costs and rent may be inflated if developers pay above-mar-ket prices for premium corners, these factors can be measured and adjusted. Understanding these issues can help assessors develop mass appraisal models that result in an accurate estimate of fee simple market value and ensure equity for all drugstores in their jurisdiction.


ReferencesAppraisal Institute. 2002. Dictionary of real estate appraisal, 4th ed. Chicago: Appraisal Institute.

Appraisal Institute. 2008. Appraisal of real estate, 13th ed. Chicago: Appraisal Institute.

Brooks Drugs, Inc. v. Board of Assessors of City of Schenectady, 51 A.D.3d 1094 (3d App. Div. N.Y. 2008).

Chain Drug Review. 2009. Top 50 drug chains by store count. April 20.

CVS Caremark Corporation. 2009. Form 10-K. http://investor.cvs.com/phoenix.zhtml?c=99533&p=irol-IRhome.

Hillsborough County Clerk of the Circuit Court. 2002. Official book 11686. Tampa, FL: Hillsborough County Clerk of the Circuit Court.

Hillsborough County Clerk of the Circuit Court. 2007. Official book 17367. Tampa, FL: Hillsborough County Clerk of the Circuit Court.

Eckerd Corp. v. Gilchrist, 44 A.D. 3d 1239 (3d App. Div. N.Y. 2007).

Eckerd Corp. v. Semon, 35 A.D. 3d 931 (3d App. Div. N.Y. 2006).

Marshall & Swift. 2008. Marshall valuation service. Los Angeles: Marshall & Swift.

Real Capital Analytics. 2009. Drug stores 4th quarter special report. New York: Real Capital Analytics.

Rhodes v. Hamilton County Board of Revision, 885 N.E.2d 236 (Ohio 2008).

Rite Aid of New York, No. 4928 v. Assessor of Town of Colonie, 58 A.D. 3d 963 (3d App. Div. N.Y. 2009).

Walgreen Co. v. City of Madison, 752 N.W. 2d 687 (Wis. 2008).

a prescription for assessing drugstores

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