Retailers in the drug store category have been among the few retail chains opening hundreds of new stores throughout this recession. The "Big Three" -- Walgreens, CVS and Rite Aid -- should account for about 800 new store openings during fiscal 2009, and they plan for continued growth in 2010 and beyond (find specific expansion initiatives and site criteria of each at the end of this article).
Along with this level of expansion, the drug store category has managed to keep comp store sales results positive in the recession. According to the International Council of Shopping Centers' U.S. Retail Chain Store Sales Index, the drug store category has reported positive same store sales results for the past seven months -- this is the only sector to achieve such a feat during the past year. In fact, drug store sales comps in September 2009 came in at +3.7%, which is up 1.3% over the previous month, 1.6% year-over-year and 4.9% over the same period in 2007.
ICSC's figures are calculated only on the sales statistics reported by Walgreens and Rite Aid; but the U.S. government's figures for the sector are positive as well. Seasonally adjusted, U.S. pharmacies and drug stores produced a .34% month-over-month improvement and 3.47% year-over-year improvement in sales in August.
Not only has the category continued to resonate amongst U.S. consumers, but commercial property investors have showed continued interest in the retail property type as well.
Using CoStar's new COMPS Analytic Search tool, we found 111 closed sale transactions totaling $491 million that involved freestanding single tenant drug store properties so far in 2009 (note that third quarter transactions continue to flow in to CoStar COMPS daily, so these numbers will rise). Comparing this activity to the same period in 2007 (pre-recession), the investment sales market for single-tenant freestanding drug store properties has kept up much better than the retail investment sales market has as a whole during this recession.
Specifically, the number of transactions recorded so far in 2009 is already higher than was recorded during the same period in 2007. Pricing is down only slightly. The average sale price per square foot for transactions closed so far in 2009 came in at $320 per square foot, which is down only 6% over the same period in 2007.
Since hitting a low average capitalization rate of 6.4% during the second half of 2007, caps on single tenant freestanding drug store properties have become much more attractive to the buyer. To date in 2009, the average cap rate on these deals stands at 7.3% and that rate continues to climb -- transactions closed in the latest quarter only are averaging a 7.5% cap. This more attractive cap rate seems to be fueling additional transaction activity on drug store properties -- already, more transactions have been recorded during third quarter 2009 than there were closed transactions in the previous quarter.
The sale process on drug store properties is finally starting to speed up as well. At the end of second quarter, the average time a drug store property sat on the market until it was sold peaked at 244 days, however, this average is already down to 136 days based on transactions closed so far in third quarter, which is right in line with pre-recession 2007 averages.
One reason drugstore properties appear to remain attractive to investors is because of their stability. According to CoStar Property Analytics, there are proportionally less freestanding drugstore properties available for lease today than there were at the start of this recession. In fact, the “for lease” availability rate has decreased from 3.7% at first quarter 2008 only 2.5% currently. The average vacancy rate is even lower -- just under 2%. Comparatively, the drugstore property sector has held up much better than freestanding retail buildings in general, where the average vacancy rate came in at 5.5% at the close of third quarter.
Nick Schorsch, Chairman and Chief Executive Officer of American Realty Capital Trust is versed in the drug store sector, as his company specializes in the acquisition of single-tenant net-lease properties. Schorsch provided examples of recent deals his company has completed.
In September, ARCT closed on the acquisition of a portfolio of 10 CVS stores for $40.8 million, where CVS signed a net lease of 25 years with eight five-year options to renew. ARCT financed the deal at approximately 58% loan to value -- it secured a $23.8 million, non-recourse, fixed rate mortgage from Western & Southern Life Assurance Company. In July, ARCT acquired a Walgreens store on a 25-year lease in Texas for $3.8 million at a cap rate of 8.12% (higher than the market average).
Gill Warner, a senior director for Stan Johnson Company, which negotiates several drugstore property sale transactions said that the top reason property sales in this category have kept going is because drugstores, at least the top two offer top credit and long-term leases. "People want safety and credit in this market and longer term leases are easier to finance," said Warner.
"It's Location, Location, Location," said Schorsch. "Drugstores have some of the strongest real estate because they're on essential corners in every market. We find that the corner is the best real estate in general because of the myriad of uses for them -- about 80 to 85 uses for any individual corner," Schorsch added, arguing that investors almost can't go wrong in acquiring such real estate because even if the drug store shuts down, there are plenty of uses that would want to backfill the space. "Typically someone always has a use for that hard corner. You've got accessibility, visibility, etc. It's much easier backfill," echoed Warner.
From an investor's perspective, Schorsch said, "Even with the economy the way it is, high quality real estate still wins out over the fact that there's a dearth of debt." On transaction activity involving drug stores keeping up, Schorsch said, "People have to buy some real estate, they still need some exchanges. These are perfect fodder for exchange vehicles -- they're affordable and great real estate with fine companies as tenants."
Schorsch said that while the 1031 exchange market has been down, drug store properties have maintained their market share with those buyers. Warner said, "Exchanges are back on the rise. We're seeing a pickup due to the down-leg or the original property they were selling for the exchange finally moving after the seller dropped the price after being on the market for a year or two, so now they can do that exchange."
Schorsch said that many people are buying drugstore properties in all-cash transactions, but outside from that, low leverage is the norm. "Most deals are no longer being done at 85% - 95% leverage, instead, most are being done closer to 45% - 50% leverage," said Schorsch. He added that lenders are looking for amortization, which cuts into cash flow, as well as cash flow coverage in the 160s to 180s. "It's actually terrific. It’s the right thing for this economy to have the banks be cautious, prudent, careful."
Warner said there's a niche CTL group (Credit Tenant Lenders) that have stepped up on drug store deals in this market. "There's not much non-recourse money out there, but specifically for Walgreens, I know there's non-recourse 85% loan-to-value money out there, which is great debt. Most are 25-year terms with 25-year Amortization, which is very attractive as well. You're not seeing 30 years Amortization because that's gone - The amortization is matching the lease, which is back to normal market conditions. "
"This is no 6% cap rate market anymore," said Schorsch. "We're seeing mid to high 7s to low 8s for the investment grades and for the non-investment grades, you could see close to a 10 cap. Before it was probably, in certain markets, sub 6, or even sub 5 in New York or California," he added.
Warner said, "On a Walgreens, we're seeing marketed price anywhere from 7.5% to 8% cap rates and that's probably the same range they're getting done more in the 7.75% to 8% cap rate range." Warner added that in general, Walgreens properties trade at lower caps than CVS. Additionally, he expressed significant challenges in moving Rite Aid properties at all.