Massive Rite Aid closures leave landlords in the lurch

Rite Aid Corp. store closing signs have replaced orange traffic barrels as Michigan’s unofficial state flower this summer.

All 232 of the bankrupt Philadelphia-based drug store chain’s locations in the state are confirmed on the chopping block, some two months after word started leaking out about the company’s unceremonious — and generally quiet — Michigan exit.

That’s leaving landlords in the lurch with millions of square feet of real estate to repurpose as they barrel toward what the company says is a deadline to close them all by the end of next month.

Some of the first stores to close have been snapped up quickly.

Dollar stores, smaller grocery stores, urgent cares, auto supply stores, veterinary clinics, plasma centers, even car washes — all have ended up taking over the vacated boxes. After all, generally it’s good real estate.

But there are challenges, too, ranging from how much rent other users will pay (hint: not as much) to how to carve up a space if a replacement single tenant can’t be found (another hint: it’s tricky and expensive).

That could leave some landlords holding the keys to empty buildings for awhile — and attempting to weather the pain that comes with it.

At an average of about 13,600 square feet per store, there is an estimated 3.2 million square feet that will be up for grabs, and that’s not including its 407,000-square-foot Waterford Township distribution center that went dark this week.

It’s been consuming for Deno Bistolarides, a founding member and managing partner of West Bloomfield Township-based brokerage house Encore Real Estate Investment Services.

He’s worked on disposing of or leasing up close to 50 of them in the last three or four months alone — and it’s just beginning.

“In all likelihood, I’ll be working on vacant Rite Aids for the next year,” he said.

Invaluable dirt

The plus side is that, in general, Rite Aid and its landlords have good sites with good vehicular traffic and access, assembled over the years before the company slunk into Chapter 11 bankruptcy protection in October.

“Their dirt is, by and large, invaluable,” said Simon Jonna, founder and managing partner of Birmingham-based The Jonna Group, who has done extensive work with Rite Aid and other drug store chains around the country.

But that certainly doesn’t dampen that the company had lost some $3 billion in the last six years, and faced what it described as too much financial risk stemming from federal and state lawsuits alleging its stores filled hundreds of thousands of medically unnecessary opioid prescriptions and contributed to the national addiction epidemic.

The bankruptcy is causing hundreds of Rite Aid boxes coming to the market effectively at once, further complicating the process to fill them up, said Louis Ciotti, managing director for Landmark Commercial Real Estate Services, based in Farmington Hills.

“When they came on the market one at a time, they were interested,” Ciotti said of buyers and potential users.

And high costs of construction have made reusing the buildings more cost effective than razing them and building new, Bistolarides said.

So some new occupants have swooped in, to be sure.

Those that are unable to secure a single user — whoever it may be — can be carved up for multiple tenants, although that’s a really difficult prospect for a host of reasons.

The buildings tend to be deeper than wide, limiting the amount of store frontage for users, Bistolarides said.

And carving up itself for multiple tenants can also be a costly proposition, and result in layouts that are not ideal for prospective users, said Jason Miller, chief investment officer with Farmington Hills-based developer and landlord Grand/Sakwa Properties LLC.

“You’ll probably see a handful of those converted to multi-tenant, but it’s not going to be easy and it’s going to be expensive,” Miller said.

Adding windows and plumbing, for example, isn’t cheap. And while the parking lots for a single Rite Aid may have been sufficient, they may not be for a converted building for multiple users.

To the good, however, the existing drive-thru windows previously used for prescription pick-up them make them candidates for things like restaurants and coffee shops, said Bistolarides.

Yet they are usually in the back of the Rite Aid buildings, Ciotti said, further complicating the matter and limiting the drive-thru tenant’s visibility.

‘Feeding frenzy’ for gas stations

In addition to things like dollar stores and auto parts shops, car washes and urgent care facilities, Jonna said there has been a “behind the scenes feeding frenzy” by gas station operators looking to scoop up Rite Aid sites not only because of the fundamentals — vehicles per day passing the site, signalized intersections and the like — but also because of liquor licenses.

CoStar Group Inc., a Washington, D.C.-based real estate information service, reported last month that in addition to drug stores themselves — not just Rite Aid but also competitors like Walgreen’s and CVS — other primary owners of drug store buildings are individual investors, real estate investment trusts and family offices because they generate steady income and typically don’t need much involvement from the landlord.

That’s a function of the triple-net lease structure, where the pharmacy chain is responsible for virtually all expenses — taxes, utilities, insurance, building upkeep and the like — and the owner can simply cash rent checks while doing very little actual work.

But sale prices for former drug store buildings have also plunged nationwide, CoStar reported, falling from $300 to $350 per square foot two years ago to $235 per square foot today as Rite Aid and its competitors shutter thousands of locations around the country.

But landlords who are highly levered against the properties will face challenges securing tenants willing to pay rents at rates Rite Aid paid for them, perhaps upwards of $350,000 a year locally.

Jonna said drug stores like Rite Aid and others tended to structure lease deals where they paid a flat but elevated rental rate over the duration of the term. That sits in contrast to other lease deals, where there tend to be annual increases of a couple percentage points.

“The drug store users were typically the highest paying in the market for that size box,” Jonna said, adding that drove up purchase prices when they sold.

That, in turn, could lead to loan defaults — although whether banks will actually take the keys is an open-ended question.

“I think lenders will be smart to work with their borrowers as opposed to try to squeeze blood out of a stone,” Bistolarides said. “The value (of the real estate) doesn’t change whether the landlord or the lender owns it.”

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