CHICAGO—Drug stores have been one of the most sought-after investments in the single tenant net lease market, but after several significant events roiled the sector this year, overall transaction activity declined during the first three quarters of 2018, and potential buyers have now taken a wait-and-see attitude, according to a new report by Chicago-based The Boulder Group.

According to the firm's Net Lease Drug Store Report, transaction volume was down more than 40% when compared to each individual year between 2013 and 2017.

“Various events, or non-events, including Walgreens' acquisition of approximately 1,900 Rite Aid stores, the failed merger between Rite Aid and Albertsons as well as the pending CVS and Aetna merger are taking its toll and causing concerns for investors,” says Randy Blankstein, president and founder of Boulder. “Investors don't like uncertainty. Currently, there is heightened uncertainty in the sector, especially when it comes to the long-term viability of Rite Aid.”

Retail experts are uncertain whether the Rite Aid stores not acquired by Walgreens can thrive in today's market. And the merging of Walgreens and the other Rite Aid stores ran into hiccups that may take some time to sort out.

The uncertainty also had an impact on drug store cap rates, which increased to 6.21% in the third quarter, 11 bps higher than last year. On an individual tenant basis, cap rates for CVS properties remained unchanged at 5.65%. In contrast, Walgreens and Rite Aid properties experienced increases of 15 and seven bps, to 6.15% and 7.32%, respectively.

Blankstein adds that the spread between asking and closed cap rates for drug stores, when compared year over year, widened further for all three tenants. The spread was the smallest for Walgreens, 30 bps, followed by CVS, 33 bps, and Rite Aid, 40 bps. This shows net lease investors are pushing back against sellers' store valuations.

The supply of drug store assets decreased by more than 16% in the third quarter of 2018 when compared to the prior year, reversing a trend caused by investors leveraging blend and extend strategies. This strategy, says Blankstein, creates an arbitrage situation when property owners offer the tenant an incentive in order to increase the lease term. In the past 18 months, tenants became increasingly more selective in which blend and extend scenarios they accepted. The by-product has been a decrease in the inventory of drug store offerings.

According to year over year comparison, the number of Walgreen's stores on the market continues to equal the CVS and Rite Aid offerings combined. The number of available CVS properties decreased the most, 18.3%, from 120 properties one year ago to a current level of 98 properties. There are 158 Walgreens properties currently available, a 17.7% decrease from one year ago when there were 192. The number of Rite Aid stores declined the least, 10.8%, from 65 to a current level of 58.

Blankstein expects that drug store sector transaction velocity for the remainder of 2018 likely will remain at a similar pace to the current year. The vast majority of transactions will consist of stores with high quality real estate and superior store sales as investor concern lingers surrounding the potential Amazon effect in this sector. Private and 1031 investors will continue to be the primary buyer of drug store assets.

Instant Insights /

Drug Store Mergers Bring In Uncertainty

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