Net-Lease Drug Stores at Record Prices

By Randy Blankstein, President, The Boulder Group

Cap rates for CVS and Rite Aid properties reached their historic low in the net-lease drug store sector in the third quarter of 2014. Walgreens cap rates remained stable at their previously reached historic low level in the first quarter of 2014. While the overall cap rates for Walgreens properties held steady; cap rates for Walgreens properties with more than 20 years of lease remaining compressed by 20 basis points to 5.30 percent. These levels can be attributed to the low interest rate environment coupled with high demand amongst 1031 exchange buyers for long-term leased properties.

With cap rates for Walgreens and CVS at all-time low levels, the ratio of long-term leased drug store properties (20+ years) to the total supply has decreased by 15 percent. In the first quarter of 2014, long-term leased Walgreens and CVS properties accounted for 50 percent of the market compared to 35 percent in the third quarter of 2014. Walgreens recent change from 25 year initial lease terms to 20 year initial lease terms has left a limited supply of drug stores with more than 20 years left on the lease.

The supply of net lease drug store properties increased across all three major tenants by 33 percent in the third quarter of 2014. Most notably, properties tenanted by CVS experienced the largest increase, with an overall gain of 64 percent. The biggest contribution to the supply of CVS properties is from former zero cash flow properties where the owner has defeased the fully amortizing loan.

Cap rates for Rite Aid properties continued to compress as investors value the additional yield associated with Rite Aid. The additional yield is attributed to Rite Aid not being an investment grade rated company similar to Walgreens or CVS. However, with a limited supply of Rite Aid properties available (13 percent of the net-lease drug store sector) owners have been aggressively pricing their assets as evidenced by the 35 basis point decline in cap rates since the first quarter.

Transaction velocity for 2015 across the net-lease drug store sector should remain at a similar pace to 2014 as drug stores continue to be at the forefront of investor demand. As cap rates for new construction properties with long-term leases continue to compress, expect 1031 exchange buyers and private investors to remain the primary buyer.