Finding Value in Dollar-Store and Drugstore Net-Lease Properties

By Bill Rose, National Director, National Retail Group, Marcus & Millichap Real Estate Services Inc.

For net-lease investments, demand for single-tenant assets is steadily increasing. The traditional dynamics are fluctuating and the lines that separate extreme-value stores and drugstores, for example, are becoming less evident.

By Bill Rose,
National Director, National Retail Group, Marcus & Millichap Real Estate Services Inc.

The traditional dynamics of retail are fluctuating and the lines that separate extreme-value stores and drugstores, for example, are becoming less evident. With demand for single-tenant assets steadily increasing, and a dearth of investment-grade properties going on the market, buyer interest will shift toward assets with shorter lease terms or lesser tenants. Cap rates for the few top-tier assets that do trade are already low, minimizing the spread between yields and borrowing costs. The risk of inflation is deterring investors from the low-spread environment, as the devaluation of the dollar could outpace rent growth and diminish returns. We take a look at two segments in more depth.

Dollar Stores: The prolonged effects of the recession have transformed the psyche of consumers, propelling extreme-value retailers to the forefront of the retail market. As many households face significant debt obligations, the thrifty mindset that was prevalent during the recession will persist as well. Dollar stores have benefitted from lingering financial instability and consistently outperform most retail segments. The increased consumer base encouraged dollar-store chains to drastically expand over the last few years, and national chains will continue this trend through 2012.

In fact, Dollar General, Dollar Tree, and Family Dollar will open a collective 1,225 stores in 2012. Dollar General will lead the growth with 600 new locations, mostly in rural communities across the country. Due to their positioning in smaller markets, Dollar General stores are less likely to face competition from big-box retailers. The Dollar General model also favors freestanding locations, with nearly 60 percent of stores standing alone, versus less than 40 percent for Family Dollar.

The credit associated with many dollar stores, along with the relatively high yields, is luring investors into the discount segment of single-tenant retail. Deal flow hiked 42 percent year over year, influencing a 9 percent increase in median sales price to $102 per square foot. Retailers are expected to increase supply throughout the year, and buyers will act quickly to obtain first-year returns in the mid- to high- 8 percent range.

Drugstores: After tempering store openings and broadening online sales last year, national drugstore chains are expected to increase their brick-and-mortar presence in 2012. As Walgreens initiated their “Customer Centric Retailing” format, offering groceries and other consumable goods in stores, other national chains witnessed the profitability and shifted focus to in-store sales.

The top drugstore retailers have found the expansion of their product assortment to be beneficial to their bottom line, although the intrusion of some dollar stores into urban markets has cut some of those profits. As dollar stores become more common, national chains such as Walgreens and CVS Caremark will likely have to meet the reduced price points of extreme-value retailers in order to maintain the daily traffic that comes with consumable goods. In addition, drugstores will attempt to grow at a rate similar to dollar store expansions. Industry-leader Walgreens will set the pace of expansion with 350 new locations, at a 5 percent addition to the current store count. CVS is expected to increase their store count by 4 percent in 2012.

Transaction activity has jumped 18 percent in the last 12 months, driven primarily by investors fleeing the stock market for the less-risky net-leased drugstores. The continued expansion of deal flow has elevated the median sales price 2 percent to $330 per square foot, and subsequently compressed cap rates into the mid-6 to low-7-percent range. As more of these assets come to market, buyers will bid aggressively to acquire these safety plays.