February 09, 2017

Investors Continue to Turn to Drug Stores for Income Security

Investors Attracted to Drug Stores due to Income Security, Long Lease Terms, and Strong Drug Store Sales from Aging Population

Drug Sales Increase from New Pharmaceutical Treatments and Increase of Insured Americans:

Due to a greater number of people with medical insurance and pharmaceutical innovation that offers new treatments for a range of maladies, prescription drug spending has increased 9 percent over the past year. During the same period, the number of insured Americans rose 1.8 percent to more than 289 million. Combined with nearly half of all citizens taking at least one prescription drug, health and personal care stores stand to benefit as these trends persist over the coming year.

Drug Store Sector Strengthens

Over the past year, drug store performance has been robust. The sector generated 6 percent retail sales growth, achieving the strongest performance of any brick-and-mortar retail segment. Also, the sector has grown from 5.9 percent of retail sales in January 2000 to 7.6 percent at the end of 2016, indicating that operators are garnering a larger share of consumer spending as well. Individuals over 65 comprise an estimated 15.1 percent of the population as of the first quarter of this year, which is predicted to rise to nearly 19 percent by 2025. Inevitably, the sector’s prospects remain bright, bolstered by the aging of the U.S. population.

Pharmacy’s Business Model Evolves

Pharmacy services remain a core piece of the drug store business model. However, CVS, Walgreens and Rite Aid have adapted their product mixes to compete more aggressively with internet-based prescription drug vendors. The product expansion at these retailers, cover a variety of necessity-based items such as cosmetics, food, and over-the-counter medicines, which is driving higher revenues and increasing store traffic. Also, operators have developed a variety of store formats and sizes to take advantage of both under-retailed urban and suburban neighborhoods. CVS has also moved toward providing a broad suite of healthcare services directly to consumers, with the number of in-house clinics doubling since 2010 to nearly 1,100 locations nationally. Walgreens is adopting a similar approach, offering preventive health services and assessments for a number of chronic health conditions at more than 300 locations nationwide.

Investors Attracted to Investment Grade Tenants and Long Lease Terms

 CVS and Walgreens hold the leading market share in the drug store sector which are both backed by investment-grade credit ratings. While Rite Aid currently remains a stand-alone entity, a pending merger with Walgreens could consolidate the industry with two leading competitors. The Federal Trade Commission has yet to rule on the proposed merger.

A combination of excellent credit ratings and lease terms that can exceed two decades for new stores has generated tremendous demand for net-leased drug store properties. Thus, buyer competition for the assets typically pushes cap rates into the mid-4 percent range, although marquee locations in primary markets will often descend below 4 percent in some cases.