National asking cap rates for single-tenant drug stores compressed to 5.8% in the third quarter, driven by increasing investor demand, according to The Boulder Group’s most recent net lease report on the sector.

That’s a 59 basis point decrease over Q3 2020 numbers, the firm says. 

“New historic low cap rates levels for CVS and Walgreens of 5.15% and 5.40% respectively were the primary driver of the compression,” says Randy Blankstein, President, The Boulder Group. “Investor demand for essential retailers carried over from 2020 into 2021, propelling cap rates for all three major tenants in the single tenant drug store sector lower.”

Meanwhile, Rite Aid cap rates compressed by 40 basis points to 7.40%.

Analysts say increased demand and transaction volume for drug stores last year created a supply issue this year. The supply of single-tenant drug stores went down by 20% over Q3 2020 numbers, with all three major tenants in the sector posting supply decreases in a range of 14% to 26%.

“The supply of drug stores with long term leases remains low compared to historical standards mainly due to the lack of new store development,” adds Jimmy Goodman, Partner, The Boulder Group. “For the second straight year, the median remaining lease term for the drug store sector was less than 10 years.”

CVS and Walgreens both carry an identical investment grade rating from Standard & Poor’s of BBB, while Rite Aid carries a non-investment grade rating of B-. The latter’s rating is the primary reason for the cap rate discount as compared to CVS and Walgreens.

The Boulder Group experts say the sector will continue to be the target of investor interest.

 “The limited development pipeline of new stores for all three tenants will require that the majority of the supply of long-term leases will be provided by blend and extend of existing leases or larger portfolios of sale leasebacks,” Blankstein said. “Private and 1031 exchange buyers will continue to be the primary acquirer of single tenant drug stores.”

Investors are looking amidst the pandemic to single-tenant and net-lease properties because of their reliable cash flow and traditionally longer lease terms. Research from Colliers suggests single-tenant net lease assets “smooth out volatility and create predictability in a portfolio,” and noted that from 2020 into the first half of this year, retail accounted for 20% of all investment in the STNL space, as opposed to 31% coming out of the Great Financial Crisis. Drug store pricing is strongest within the STNL retail sector and is outperforming the broader retail market, Colliers says.