While the net lease drugstore sector has been relatively internet-resilient and deemed an essential service during the COVID-19 pandemic, Amazon’s recent launch of Amazon Pharmacy could pose a significant threat to bricks-and-mortar drugstores. For now, however, net lease investors are waiting to see how successful Amazon’s venture proves to be before reflecting it in their underwriting.
The e-commerce giant opened its online and mobile prescription medication ordering and fulfillment service in November, allowing consumers to order medication or prescription refills, which will be delivered to their doorsteps in a couple of days.
Drugstores have already been facing growing competition from non-healthcare powerhouses like Amazon and other online retailers. Amazon, for example, acquired online pharmacy PillPack in 2018 for roughly $750 million. That acquisition was a strong indicator that the e-commerce giant had it sights set high on the retail pharmacy business. Now, with Amazon’s new online store, customers can complete an entire pharmacy transaction on their desktop or mobile device through the Amazon app.
Using a secure pharmacy profile, customers can add their insurance information, manage prescriptions and choose payment options before checking out. Prime members will receive unlimited, free two-day delivery on orders from Amazon Pharmacy included with their membership.
Prime members can also access savings on medications when paying without insurance, and there are more than 50,000 participating pharmacies across the U.S. that offer discount pricing, according to Amazon’s press release.
Amazon’s move was anticipated; but did the pandemic accelerate it?
“I think the pandemic has acted as a catalyst for online prescriptions as more people have turned to digital channels to meet all kinds of needs,” says Neil Saunders, managing director at research firm GlobalData Retail. “However, Amazon had its eyes on this segment long before this year. The whole healthcare and drugs sector is ripe for a shake-up, and Amazon is determined to contribute to this and get a slice of the pie.”
And it’s a big pie. The global online pharmacy market is expected to surpass $131 billion by 2025.
Will this be a major disrupter for drugstores?
“Initially, I don’t expect there will be much of an impact as it will take time for Amazon’s proposition to gain traction and to scale,” Saunders says.
However, over time, Amazon’s success could result in a loss of foot traffic to drugstores as fewer people come in for prescriptions, he notes.
“Traditional drugstores themselves will likely respond by amping up their own digital prescription services, which could exacerbate the issues in their stores,” Saunders points out. “If foot traffic drops, it has an impact on sales across wider categories than just prescriptions and it could, eventually, weaken the economics of running a physical drugstore.”
Bricks-and-mortar pharmacies have been working to beef up their online services and ability to deliver prescriptions and other merchandise as the coronavirus health crisis has resulted in more customers ordering online.
“In 2020, there are obviously a lot of disruptors in the market,” notes Jonathan Hipp, principal in the capital markets group and head of the U.S. net lease group at commercial real estate services firm Avison Young. He says businesses need to adapt to current market conditions to compete.
“I have to assume that CVS and Walgreens—with the scale they are—knew that this [Amazon Pharmacy strategy] was coming,” Hipp says. “They probably didn’t know when this was coming, but they knew this was coming.”
In Hipp’s opinion, that’s part of the reason that CVS Pharmacy and Walgreens have been trying to diversify. For example, in 2018, CVS acquired health insurer Aetna Inc., one of the largest U.S. health insurers, in a roughly $69 million deal.
The chain has also been busy remodeling 1,500 stores into its health-focused HealthHUB concept. These stores offer more health services like nutritional seminars and kiosks helping customers measure and track blood pressure, weight and BMI. They also sell more health-related merchandise
Meanwhile, Walgreens has been investing heavily in partnerships. The retailer has entered into more than a dozen partnerships with companies including FedEx, Kroger, Birchbox, Sprint and LabCorp, which are focused on driving more traffic into its stores.
“At the end of the day, [Amazon Pharmacy] wasn’t a surprise to the drugstores, and they’ve been building a strategic plan around it,” Hipp says.
How can drugstores compete?
Drugstores should respond by improving the retail proposition in their stores, including the look and feel, according to Saunders.
They should aim to be convenience hubs where consumers like to come for all types of products and are enticed to buy some things on impulse, Saunders says. They should also focus on becoming centers for health and wellness, which CVS has already been trying to do, he notes.
“Whether they will do these things remains to be seen,” Saunders adds. “Drugstores are not the best retailers out there. They miss many tricks and have not gotten the basics right for years.”
Hipp also points out that front-end sales have a much higher profit margin for drugstores than prescriptions. Popular categories include health, beauty and wellness.
“The prescription drug business for the drugstores is kind of like gasoline is to gas/convenience stores,” Hipp says. “It’s a very low-margin business. It gets people in to buy other stuff, which is a high-margin business.”
What does this mean for net lease investors?
Amazon entering the sector will make an impact, but the timing and scope of impact is what investors are trying to prepare for, says Tyler Molleson, an associate director at Stan Johnson Co., which specializes in net lease investments.
“How long will it be until Amazon is fully able to provide prescriptions to all states? How will this cut into the traditional drugstore market share for tenants such as CVS Pharmacy and Walgreens?” Molleson asks. “Once more clarity on these questions is found, we will be more prepared to determine the overall impact on the sector.”
Investors who own drugstores are currently keeping a watchful eye on Amazon, but are in “no way running to fire-sale their assets,” Molleson notes.
Drugstores continue to be an essential business, and after what COVID-19 has shown this year, having essential tenants should be a cornerstone for everyone’s portfolio, he notes. “These tenants carry investment-grade credit ratings and continue to be a popular choice for 1031 exchange investors across the country.”
Where are current cap rates?
CVS and Walgreens continue to be the dominant names in the drugstore sector. CVS assets are currently trading at between a 5.5 percent and 6.0 percent cap rates, while Walgreens stores are trading a bit higher, between 5.9 and 6.4 percent, according to Molleson. (This is when comparing properties with an average term of 15 years remaining and absolute net leases that have sold in the trailing 18-months period).
“Any major effect on cap rates will only come once Amazon proves they are truly disrupting the retail prescription drug market,” Molleson says.
“If Amazon is able to take significant market share away from CVS/Walgreens, these tenants’ bottom lines would be affected, which could end up lowering their credit rating. If this domino effect happens, the cap rates for drugstore tenants would likely go up.”