Walgreen’s Rite Aid Purchase Could Lower Cap Rates Further

Drug store cap rates–which reached new lows in the third quarter–could fall further resulting from Walgreen’s plan to acquire rival Rite Aid, reported the Boulder Group, Northbrook, Ill.

Walgreens announced last week that it will acquire Rite Aid for $17.2 billion and assumption of Rite Aid debt. The transaction would create the nation’s largest drug store chain with more than 13,000 stores.

“This transaction should lower [Rite Aid’s] cap rate a bit,” said Boulder Group Vice President John Feeney. He said Walgreens ended the third quarter with a 5.50 percent cap rate compared to Rite Aid’s 6.63 percent cap rate. CVS stores traded at 5.75 percent.

Feeney said both Walgreens and CVS are institutional-grade investments, while S&P gives Rite Aid a Single-B rating. But he noted that investors have showed growing interest in Rite Aid stores even before the Walgreens purchase announcement because of the extra yield associated with Rite Aid properties. “The additional yield is attributed to Rite Aid not being an investment-grade-rated company similar to Walgreens or CVS,” he said but added that Rite Aid property cap rates have decreased by 77 basis points since the third quarter of 2014 because of improving property fundamentals.

“The question now is how many stores will Walgreens will have to shed to keep the regulators happy,” Feeney said. “In some markets there are Walgreens right across the street from CVSs and Rite Aids. Rest assured, if there is a store right across the street from a Walgreens, one of the two–generally the poorer-performing store–will close.”

Feeney said transaction velocity for 2016 in the net lease drug store sector should remain similar pace to 2015 as drug stores remain at the forefront of investor demand. “As cap rates for new construction properties with long-term leases continue to compress, expect 1031 exchange buyers and private investors to remain the primary buyer,” he said. “It has become increasingly difficult for institutional investors to acquire long-term-leased drug stores due to the low cap rates associated with these properties. Additionally, investors searching for higher yields for drug store properties will seek short-term leased assets with strong store sales.”