By Randy Blankstein
Cap rates for the single-tenant drugstore sector increased by 11 basis points in the third quarter of 2018 to 6.21 percent over last year. Cap rates for CVS properties remained unchanged, at 5.65 percent, while Walgreens and Rite Aid properties experienced increases of 15 and 7 basis points to 6.15 percent and 7.32 percent, respectively. The increase in cap rates experienced by Walgreens and Rite Aid properties can be best attributed to uncertainty surrounding Rite Aid’s long-term viability and the store closures associated with Walgreens’ acquisition of approximately 1,900 Rite Aid locations.
Transaction volume in the drugstore sector slowed significantly in the first three quarters of 2018 and was down more than 40 percent as compared to each individual year between 2013 and 2017. Recent events in the drugstore sector— including the pending CVS and Aetna merger, Walgreens acquisition of approximately 1,900 Rite Aid stores and the failed merger between Rite Aid and Albertsons—caused concern for investors. The spread between asking and closed cap rates for drugstores widened for all three tenants in the third quarter of 2018 as compared to the prior year. This illustrates pushback sellers are receiving for drugstore valuations from net-lease investors.
The supply of drugstore assets decreased in the third quarter of 2018 when compared to the prior year by more than 16 percent. In recent years, the drugstore sector supply increased as investors took advantage of “blend-and-extend” scenarios. In a blend-and-extend scenario, property owners offer the tenant an incentive in order to increase the lease term creating an arbitrage situation. In the past 18 months, tenants became increasingly more selective of blend-and-extend scenarios, causing a decrease in supply across the drugstore sector.
Transaction velocity for the remainder of 2018 in the net-lease drugstore sector should remain at a similar pace to the current year. Investors will be carefully monitoring the store closure list that resulted from Walgreens acquisition of approximately 1,900 Rite Aid store, as well as the CVS and Aetna merger. Private and 1031 investors will continue to be the primary buyer of drugstore assets. 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.