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NREI Research Series
Research Series 2017

Part 3: Medical Offices, Drugstores Lead the Way

Respondents to the survey work across the spectrum of net lease property types. The most prevalent net lease property type identified was industrial (45 percent). That was followed by restaurants/fast food (44 percent), office (42 percent), medical office/healthcare (37 percent), drugstores (37 percent), miscellaneous retail (36 percent), convenience store/discount (33 percent), bank/financial (29 percent), grocery stores (27 percent), auto (19 percent), government (16 percent) and fitness (16 percent).

In terms of those property types, respondents ranked medical office/healthcare and industrial as having the best outlook, giving both sectors scores of 3.8 on scale of 1 to 5. That was followed by convenience store/discount (3.5) and grocery stores and drugstores (both at 3.4). But, generally, the outlook for all net lease property types was fairly consistent. Every sub-sector ranked between 3.0 and 3.8.

Those results roughly match what respondents said were the property types in greatest demand. Medical office/healthcare scored 37 percent on that question, followed by drugstores and industrial (both at 36 percent). Those sub-sectors were followed by restaurants/fast food (29 percent) and convenience stores (20 percent). Auto and fitness tied for the lowest score at 4 percent each.

The results were largely in line with the 2016 numbers. The sector that moved the most was industrial, which saw its favorability numbers jump in both questions.

In a deal announced in late 2016, Walgreens Boots Alliance said it would sell more than 1,000 Rite Aid locations to help it meet regulatory approvals before completing its planned $7.4 billion merger and expanding its footprint across the United States.

But in an environment where retailers across all categories are feeling the effects of previous years of overbuilding, industry insiders are left wondering who will buy the properties, and how the stores will be used after they are divested. Virtually no Rite-Aid stores changed hands during the third quarter of 2016, according to data from Calkain, a research firm based in Herndon, Va. Owners of net-leased Rite Aids were likely holding onto their properties until they understood how the proposed merger with Walgreens would evolve, says Vinky Marolia, a research analyst with Calkain.

Cap rates on both Walgreens and CVS stores increased by 58 basis points and 46 basis points, respectively, from the previous quarter, according to Calkain data. Sales of Rite Aid locations made up only 13.0 percent of all transactions. During the period, Rite Aid units experienced a 67 basis point drop in cap rates, a rate movement that is uncharacteristic for the retail pharmacy sector.

Investors began buying Rite Aid locations again in the fourth quarter. Going forward, some industry professionals believe that 1031 exchange investors are likely to be among the most active Rite Aid store buyers, according to Tim O’Brien, managing partner at Calstar Partners, a real estate services firm and investor based in Laguna Niguel, Calif.

“They have to buy a property within a certain time frame to complete their exchanges,” O’Brien says. He adds that such investors end up overpaying for the properties—which trade at between $200 and $400 per sq. ft., according to Calkain,—because they are under deadline pressure to complete their exchanges within the legal window. Calstar, a more strategic buyer, would consider $200 per sq. ft. a worthwhile price for a Rite Aid location, O’Brien notes.

Much of the subdued trading of Rite Aid properties stems from the fact that Walgreens has not identified which Rite Aid stores it will divest of or close during the merger.

Rite Aid properties have always traded at higher cap rates than Walgreens or CVS units because the company has not had a lot of new store development in the last 20 years. The company has a weaker credit profile than its two larger peers in the business, according to John Feeney, a vice president at Boulder Group, but Rite Aid properties have several important merits independent of being fodder for 1031 exchanges. The stores are usually triple-net-leased and often occupy high demand corner locations. That might explain why cap rates on the properties have generally been dropping, even if cap rates on Walgreens and CVS properties are still tighter, according to Calkain’s data. 

TAGS: Net Lease News
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