Most pharmacy owners will be familiar with the concept of capitalisation rates and their relevance to pharmacy valuations and sales.
However, for those starting out on their ownership journey, who may not be across all the industry jargon, below is some information to help you understand this important component of pharmacy transactions.
What is a capitalisation rate?
A capitalisation rate (often shortened to ‘cap rate’) is a financial metric used to show an expected ‘return on investment’ or ‘yield rate’ associated with an asset, in this case a pharmacy business.
It is calculated by dividing the business’s annual operating income (aka. net profit, EBITDA or FME) by the business’s value.
For example, if a pharmacy generates $170,000 per annum in operating profit and has a value of $1,000,000 then the capitalisation rate is 17%.
$170,000 / $1,000,000 = 0.17 (17%)
The cap rate correlates with the “earnings multiple”. I.e. a 10% cap rate is equivalent to a 10x earnings multiple, and a 5% cap rate is equivalent to a 20x earnings multiple.
The capitalisation method is the most common way of valuing pharmacies in Australia. Essentially, a pharmacy valuer or prospective purchaser will take the business’s operating profit, then apply an appropriate cap rate, giving them a business valuation figure.
For example, Pharmacy X generates $250,000 a year in operating profit and the assessed cap rate is 16%, therefor the business value is = $1,562,500.
$250,000 / .16 = $1,562,500
What determines the capitalisation rate of a pharmacy?
Various factors can influence the cap rate assigned to a pharmacy, but it will reflect the perceived risks and opportunities associated with the business.
In general, a lower cap rate represents a ‘lower-risk assessment’ and therefore means the business value will be higher relative to the annual earnings.
On the other hand, a higher cap rate represents a ‘higher-risk perception’ and therefore means the business value will be lower relative to the annual earnings.
Factors that influence pharmacy cap rates include the business’s location, historical performance, revenue security, growth potential, local competition, tenancy terms etc.
Macro-economic factors also play a role. For example, market supply/demand, regulatory frameworks and monetary policy can all impact the cap rate.
What capitalisation rates are used in the Australian pharmacy sales context?
Current capitalisation rates for Australian PBS-approved pharmacies range between 13% – 22%.
Pharmacies that are viewed as more desirable or less risky tend to sit in the 13-16% cap rate bracket, while less desirable or more risky pharmacies will be in the vicinity of 20%.
In most cases, pharmacies in large metropolitan areas will be assessed at a lower cap rate because there is strong market demand for these opportunities. Conversely, pharmacies in remote locations tend to have higher cap rates because there is less market demand for them.
For example, strip pharmacies in Metro Melbourne are generally valued at somewhere around 15% cap rate, while pharmacies in regional Victoria will be in the 16-19% range, depending on how remote the location is.
Cap rates for shopping centre pharmacies are often higher compared to strip pharmacies because rental costs in shopping centres are higher, which increases the perceived risk associated with the location.
It is important to note that ‘valuation cap rates’ and ‘sale price cap rates’ will not always be aligned.
Pharmacy valuations are completed by accredited pharmacy valuers, usually for the purpose of supporting a finance application for a pharmacy purchase, and they tend to be more conservative than the market.
AP Group managed over 100 pharmacy transactions in FY24, and during that time average cap rates used in valuations for AP Group listings remained steady at around 17%, with valuers balancing both the risk of 60 Day Dispensing (60DD) and the potential upside of new revenue streams.
However, due to prevailing seller-friendly conditions, where demand for pharmacies generally outweighs supply, pharmacies often sell at a ‘market premium,’ meaning they sell at a lower cap rate than what was assigned in the valuation.
For example, in the case of Pharmacy X where we have an operating profit of $250,000 per annum, the pharmacy valuer might assign a cap rate of 16% which produces a valuation of $1,562,500. However, when the business is offered to the market for purchase, if there is strong competition among buyers and multiple offers tabled, it could ultimately sell at a 14.5% cap rate for $1,724,138.
$250,000 /.16 (cap rate) = $1,562,500 (valuation price)
$250,000 /.145 (cap rate) = $1,724,138 (market premium sale price)
Of course, there are always exceptions to this, and pharmacy sales is not a precise science. Sometimes, a pharmacy will sell at, or below, valuation level.
In any case, it is important for aspiring pharmacy owners to understand what capitalisation rates are being discussed when assessing a pharmacy listing.
They should consider the following questions: What cap rate was assigned in the valuation and what factors influenced it? What cap rate is being proposed in the asking price? What cap rate am I willing to allocate to my offer in order give myself a chance to purchase the business?
Written by Will Brown, VIC & TAS State Manager – AP Group
AP Group are the leading pharmacy experts in Australia, helping hundreds of pharmacists into ownership every year – our team can help with sourcing finance for your purchase, as well as providing the right legal advice to help you navigate the process.
We connect existing pharmacy owners with over 5000 ready and eager investors via our cutting-edge online Data Room. Our Data Room keeps confidential listing data secure and allows buyers to make informed decisions on each of our pharmacies for sale.
About the Author:
Will Brown always seems to bring a good mood to the AP Group office. So, perhaps it’s no surprise he’s so positive and pro-active at helping clients with buying, selling, and negotiating pharmacy transactions. In more recent years, he’s added lease negotiations to his offerings, complementing his genuine love for helping pharmacists achieve their goals.
Will understands that pharmacy sales is all about people. Luckily for him, he’s been described as approachable, transparent, reliable and responsive. In his early career, he worked as an English Teacher and Journalist, giving him exceptional communication skills and the ability to present data in its most clear and meaningful form. An asset to negotiations and the AP Group team!