The Retail Pharmacy sector has been considered a “safe” investment sector for investors and 1031 exchange buyers for many years. The two companies dominating the retail pharmacy investments are Walgreens (NYSE: WBA) and CVS Pharmacy (NYSE: CVS). Walgreens and CVS both have investment-grade credit ratings of BBB. These companies have both been very active in strategic mergers, acquisitions, and updating their brick and mortar footprint. This is an effort to grow their market share in the pharmacy sector, compete with their online competitors and maximize profits. In 2018, Walgreens closed on its acquisition/merger of 1,932 Rite Aid stores. Of those 1,932 Rite Aid stores involved, they will either be transformed into a Walgreens store, closed, or still operated as Rite Aid with a Walgreens pharmacy. In 2018, CVS finalized a major acquisition of Aetna, a healthcare company, aiming to offer more accessibility to lower cost and higher quality healthcare, as well as a more integrated healthcare experience.

These acquisitions and mergers are just one of the many strategic steps Walgreens and CVS are taking to look toward the future and stay “Amazon proof”. This term has been getting thrown around a lot lately in the net lease retail world by brokers and investors as Amazon seems to have a hand in every business sector. Amazon’s most recent move to try and break into the pharmacy sector was with their acquisition of PillPack. PillPack is a pharmaceutical company who does most of their business through online platforms and delivery. This is just one of the steps Amazon has been taking in order to gain market share in the Pharmacy Sector.

Despite the moves being made by online competitors, the success of these pharmacy companies also come from the attractive real estate locations they occupy. Just drive down main street in any U.S. city and you will likely see Walgreens on one hard corner and CVS across from them on the other corner. Their physical retail locations are usually located as a stand-alone store on a pad site shadow anchored by a large retailer or shopping center to capture foot traffic. They also utilize multiple drive through lanes to facilitate their prescription business which is their real money maker.

The most recent boost to the brick-and-mortar pharmacy locations came from being deemed “Essential Businesses”. Due to the COVID-19 pandemic, many businesses were forced to shut down during the government mandated quarantine. CVS and Walgreens have been open during the entire pandemic due to the essential healthcare services they provide. As the vaccine rolls out across the country, many investors are bullish on CVS and Walgreens knowing that they will be on the front lines administering the vaccine and thus boosting their gross sales.

Investment Fundamentals
Aside from the attractive real estate locations that possess solid real estate fundamentals, these investments come with a long-term lease and a passive cash flow. The lease structure varies but, typically Walgreens and CVS will sign 15-20-year absolute triple-net (NNN) leases that are backed by a desirable Standard & Poor’s BBB investment-grade credit rating. These leases are extremely attractive to investors as they require the tenant to pay for the roof, building maintenance, landscaping, parking lot, taxes and insurance. Essentially giving the landlord zero responsibilities other than to collect a check each month from the tenant. Older leases with these two tenants are typically double-net (NN) while locations built after 2002 are typically absolute triple net (NNN). The double net leases are riskier purchases as the landlord is then typically responsible for the roof, structure, and parking lot maintenance/repair. The rent for these two tenants is generally flat or without rental increases throughout the primary lease term which, can hurt an investor if inflation exists. However, there can be some exceptions in which there are rental increases every 5 years in a ground lease scenario. The price points for retail pharmacies vary depending on location with some investments reaching as low as $1 million and others as high as $37 million. The varying price points work especially well for 1031 exchange buyers who need to replace a set amount of equity in a wide array of price points.

Retail Pharmacy Sector Performance
The retail pharmacy sector has averaged around 20 basis points (bps) lower than single-tenant net lease (STNL) investments the past few years. This is especially true for 2017, as Walgreens and CVS investment properties were achieving aggressively low cap rates. After 2017, the cap rates have leveled out to be more in line with the national average for STNL retail investments. The most recent change in cap rates and the demand for pharmacy assets came during the COVID-19 pandemic. There has been a large shift amongst investors looking for quality properties with tenants that have been able to pay rent throughout the pandemic. Due to the Pharmacy sector being deemed “Essential Business”, the ability to keep their doors open and remain extremely profitable has greatly affected the way investors evaluate pharmacy properties. They have proven to be reliable, passive investments and able to withstand these unprecedented circumstances. There are many commercial property types that were once seen as hot ticket items to investors that now get passed on, because of various scenarios forcing the tenant to shut down. This renewed interest and shift in property types that investors now look for has caused an increase in demand for the pharmacy product. As a result, we have seen a compression in cap rates in the pharmacy sector as more investors are interested in acquiring them. California, Florida and most coastal markets across the U.S. are still demanding premium cap rates for their desirability to live there and their densely populated demographics.

Looking Ahead
There is still a high demand for retail pharmacy investments due to several factors. A major positive for the pharmacy sector is the aging American population and the number of prescriptions this demographic requires. The aging population mixed with a great return on investment, the lease structure, the “Essential Business” designation, the desirable highly visible locations and the crediting rating guaranteeing the lease. CVS, Walgreens and Rite Aid now have an opportunity to continue to offer essential healthcare services through COVID-19 vaccinations. Once the vaccine is distributed to these pharmacies, people will have to go into the physical locations in order to receive a COVID-19 vaccination. This is one aspect that gives these retail pharmacies a leg up on their online competitors. The fact that they will be able to offer COVID-19 vaccinations among others that they already offer, adds to their essential service need.

Both Walgreens and CVS tenants have been taking measures to help boost their in-store sales and increasing their healthcare services and efficiency. CVS just recently announced that they would be incorporating new “HealthHUBs” to 1,500 of their stores. The HealthHUB will take up to 20% of the space that CVS operates and will be feature three to four exam rooms, health kiosks, chronic care management services and in-house dietitian and nutrition counseling. In select areas and markets, CVS and Walgreens have been testing out smaller store prototypes. The smaller footprint allows for these companies to enter markets that they had yet to grow into, while also cutting some overhead costs. It is another way for them to ensure profitability while also offering only certain services that may be necessary to the location.

Its no secret that the buyer pool has shifted for the retail pharmacy sector. There has been a significant slowdown in larger institutions and Real Estate Investment Trusts (REITs) buying pharmacy assets as they have typically been the largest buyers and owners of Walgreens and CVS properties across the country. However, there has been some renewed interest from larger private institutions over the last 6 months. The renewed interest from those larger buyer types comes from the fact that there aren’t many quality essential retail properties on the market, and they have a large amount of pressure to deploy capital while it’s still cheap. The smaller private capital companies and 1031 exchange buyers are still the most active investors in the pharmacy net lease sector. They are currently paying the premium cap rates today due to tax pressure and time constraints.

Walgreens and CVS have also looked to stay ahead of the changing landscape for the retail world and trying to stay steps ahead of their online competition with Amazon. As tenants they have become more focused on unit level store sales and their biggest expense which, is of course rent. Walgreens is currently contacting their landlords with short term leases looking to reduce the rent in exchange for a 5-year lease renewal or they will close the store. This dangerous game of chicken can be costly to a landlord who calls their bluff when the tenant opts not to renew their lease. This scenario is best handled in conjunction with a qualified triple-net brokerage team (Barr & Bennett Net Leased Investments Group) who, can advise on how to come out of this scenario as best as possible.

Overall, the retail pharmacy sector is one of the most liquid and popular investment options out there today. They provide a long-term investment grade credit income stream that requires the property owner to do virtually nothing but, collect their rent check each month.

Written by Ryan Bennett & Drew Olson of Barr & Bennett Net Leased Investments, a Lee & Associates team based out of San Diego, CA.
Sources: Globe Street, Business Insider, BISNOW