Walgreens-Rite Aid Uncertainty Impacts Net Lease Drug Store Sector
- Nov 01, 2017
Cap rates for the single-tenant drug store sector increased 14 basis points in the third quarter of 2017 to 6.10 percent versus the prior year. Cap rates for CVS properties declined by 5 basis points to a 5.65 percent cap rate, while Rite Aid and Walgreens properties experienced significant increases of 25 and 20 basis points to 7.25 percent and 6.00 percent, respectively. The increase in cap rates experienced by Walgreens and Rite Aid properties can be best attributed to drug store landlords adding a supply of lower-quality assets to the market.
Transaction volume in the drug store sector slowed over the past 18 months due to investor trepidation of the failed Walgreens-Rite Aid merger. Walgreens originally proposed a complete acquisition of Rite Aid, but those plans were halted due to regulatory concerns. The final iteration of the Walgreens and Rite Aid transaction calls for Walgreens’ acquisition of 1,932 Rite Aid stores, three distribution centers and existing inventory. The acquisition has begun, but it isn’t expected to be fully completed until the spring of 2018.
Impact of Uncertainty
The unknown consequences of this acquisition caused investors to carefully monitor the cues from Walgreens to understand how store overlap and other real estate decisions will be solved in the future. Walgreens recently announced it will close 600 stores in 2018 to 2019.
The supply of drug store assets significantly increased in the third quarter of 2016 compared to the prior year by more than 40 percent. Rite Aid properties experienced the greatest increase of approximately 55 percent. Rite Aid owners held on to Rite Aid assets in 2016, while there was still a possibility that Walgreens would acquire all Rite Aid stores. As the complete merger is no longer viable, these owners have brought a significant amount of supply to the market.
The Federal Trade Commission has provided Walgreens and Rite Aid with clearance for the partial Rite Aid acquisition and there is some insight as to which Rite Aid stores will be acquired by Walgreens.
Transaction velocity for the remainder of 2017 in the net lease drug store sector should remain at a similar pace to 2016, as landlords and investors wait to see the ramifications of the Walgreens acquisition of more than 1,900 Rite Aid locations. However, drug store assets with strong sales performance in top-tier markets and no Walgreens/Rite Aid overlap will garner demand from investors.
Private and 1031 investors will continue to be the primary buyer of drug store assets. Investors will be carefully monitoring the news, as it was recently reported that CVS has made a bid to acquire health insurer Aetna and Amazon recently received wholesale pharmacy licenses in 12 states.