Rents – space, rate, negotiate
Are you in a good space when it comes to rent – both now and throughout the remaining years of your lease? Do you expect your sales to increase at a faster rate than your rent? Are you satisfied that you occupy the optimal amount of space at a commercially competitive rate?
These questions are relevant to all retailers but especially shopping centre pharmacy owners operating with agreements that have often arisen from a process of competitive badgering which has delivered more space than necessary at a higher rate than comparable retailers.
Based on the last five years of Pitcher Partners client data averages, it is clear that total pharmacy rents have been increasing at rates higher than both inflation and sales growth. Figure 1 below reports the 5 year results for rent, sales, gross profit and inflation.
Alarmingly, the cost of rent has increased 20% over the 5 year period while total sales (excluding high cost dugs) have been static and GP$ have decreased by 3%. Importantly, Table 1 highlights the effect of compounding rental uplifts over the term of a lease. The 20% increase in the cost of rent over the past 5 years (per Figure 1) equates to an average annual increase of between 4-5% (per Table 1) which is double the average annual inflation rate of 2%. Unsurprisingly, the effect of this has been that on average, pharmacies net profit has declined over the same period.
The trend is even more acute once large shopping centre pharmacies (Figure 2) are isolated. For this subset group, the cost of rent has increased by over 28%, which is an average annual increase of greater than 6% (incorporates rent reviews as well as annual percentage uplifts), while sales have declined by 1.5% and GP$ by 6.5%.
The average rent to sales for shopping centre pharmacies is significantly higher than average at 9% and is almost double where it was 10 years ago. As such, a decade ago an average shopping centre pharmacy could achieve a sustainable profit at a turnover level of approximately $15k per sqm however this is no longer the case. The new PP sustainability target is $25k per sqm.
Over the past 5 years, all pharmacies (and especially those in large shopping centres) have experienced:
Declining foot traffic brought about partly by a consumer shift which now incorporates online and big box discount retailing into their shopping habits;
Downward pressure on retail sales margins emanating from the same competitors; and
Declining dispensary sales and gross profit margins resulting from Government led PBS reform
Achieving a sustainable rent level requires pharmacy owners to consider how to:
Increase sales - Difficult proposition given sales have been flat for the past 5 years and shopping centre customer numbers are in decline
Reduce rent per sqm - Negotiations are typically difficult while any rate reduction achieved is usually less than the required level
Reduce space - Can be a win/win for both the pharmacy and the landlord if the reduced space has an acceptable alternate use for both parties and the rent rate can be largely maintained
If a pharmacy is not producing the requisite sales per sqm and can reduce space, the saved costs will be for not just rent but also other costs required to service the stock and space. Points 2 & 3 are simple but not easy strategies. They require time and negotiation skill in order to achieve. Often, experienced assistance is required to navigate through a usually difficult negotiation process. Ideally, pharmacy owners and landlords will constructively work together to achieve mutually beneficial outcomes although this is rarely the case. Positively, we are seeing landlords becoming more receptive to propositions that strengthen the tenant’s financial position because a strong tenant makes for happier customers and a stronger landlord.
The trending disparity between rent and sales/gross profit is becoming increasingly problematic and will prove unsustainable for many large shopping centre pharmacies. Fortunately, solutions that benefit all stakeholders can generally be achieved with sufficient time, foresight, planning and negotiation. As always PP will be pleased to assist owners and supporting advisers to achieve sustainable profitable change.