A significant amount of drugstore loans are in CMBS, and they are dominated by stores leased to the top three U.S. drugstore chains: Walgreens, CVS and Rite-Aid. All of the drugstores are corporately operated (no franchises). Few, if any, drugstore buildings are owned by the three chains. The real estate model for Walgreens, CVS and Rite-Aid is to enter into a long-term net lease (typically 20-25 years, with tenant options to renew thereafter) with a developer that secures the land and constructs the store to the specifications provided by the chain. The developer then often sells the property to investors at a price based on the annual lease payments divided by a market cap rate.
Financing newly built and leased drugstores is easy in CMBS. The chains have good credit and a 10-year CMBS loan based on a drugstore lease of 20-25 years would mean 10-15 years remaining on the lease when the loan matures, providing plenty of time before the lease ends to secure a refinancing. But as it turns out, refinancing drugstores with a maturing CMBS conduit loan into another 10-year CMBS conduit loan is not as easy as it seems because the lease will end when the CMBS loan matures or shortly thereafter, creating a default at maturity: The owner cannot refinance because there is no assurance the tenant will exercise renewal options in the lease.
How does a CMBS lender look at this risk? Primarily the lender analyzes the sales of the drugstore being financed versus chain-wide averages. If the store’s sales are well above chain-wide sales you are likely good to go. The location is likely very profitable and valuable. There is high likelihood, then, that the drugstore tenant options to renew will be exercised. If sales are below chain-wide averages, you will have difficulty getting another CMBS loan approved. To do so, you would need to have lower amortization (15-20 years) to reduce the principal balance at maturity to an amount that supports the market rent for an alternative retail use. Why? The lender is going to assume the drugstore does not exercise any renewal options and elects to vacate the premises at lease expiration.