Owning Drugstore Properties in times of Record Inflation

Considering the recent inflation levels, drugstore interest among investors has shown a decline. With Core Inflation Rates at 6.50%, the historically flat rents don't compute with the Consumer Price Index (CPI) of 287.71 points, making holding of Drugstore assets less secure of late.

Traditionally, drug stores have been coveted in the net lease market. Corporately guaranteed leases, minimal landlord responsibilities, higher rents, and price points offered a safe haven for 1031 exchange investors seeking long term passive income. 1031 exchange capital surged transaction volume throughout the pandemic but supply of these blue-chip properties remained low. As a result, cap rates in the single tenant drug store sector decreased by 53 basis points to historic lows into the end of last year.

*Figures presented by the Boulder Group

Cap rate compression presented a window of opportunity for drug store owners to capitalize on their investment. This optimistic sentiment acutely shifted when the Feds announced interest rate hikes to combat inflation.  The desirable attributes of drug stores were now overshadowed by their long-term flat leases, unable to withstand inflation. 

Press releases of national drug store closures also shifted ownership sentiment. On November 22, 2021, CVS announced the closure of 900 locations, 10% of their total occupied square footage. Rite Aid followed on December 22, 2021, announcing 63 store closures, and updated that figure on April 14, 2022, to 145 equating to 4.6% of their total brick and mortar footprint. 

Drug stores drive 75% of their revenue in the 3,000 square foot pharmacy questioning the necessity for 12- 13,000 square foot stores and rents exceeding $300,000. As a result, dispositions began occurring in droves and the supply of net lease drug stores hit a 3-year high. 

*Figures presented by Crexi.com 

Interest rate hikes also adversely affected buyers. The increasing cost of capital continues to sideline investors, no longer able to achieve lucrative financing. All-cash buyers with the ability to absorb drug store risks and move quickly or tailor acquisition timelines to meet 1031 exchanges remain the ideal candidate to purchase these assets during this transitory shift in the market. 

Expected Outcomes:

1: Should you decide to hold: The Fed’s response to the inflation crisis and the agenda of major drug store retailers will provide avenues of opportunity and exit for current owners. Investors with fundamental belief in the dirt of their property may hold with intentions to add value through redevelopment.  Drug stores often reside on hard signalized corners within main retail corridors. The drawback to this strategy is finding a tenant that will be able to replace the drug store rent at a healthy operating level. Current owner’s may be benefiting from the lucrative depreciation of their drug store and value the tax benefits over the risks. High performing drug store properties will remain in operation and continue to take extensions in their options or negotiate new leases with their landlords. Unfortunately,  lack of sales volume transparency may inhibit value add negotiations for these landlords. 

2: Should you decide to exchange: Active investors and institutional buyers will continue selling their drug store assets and exchange into properties with escalations that meet or exceed CPI expectations as a hedge against inflation. The large price points of these drug stores also provides an opportunity for portfolio diversification. Owners can sell their drug store and exchange into two or more properties after obtaining financing. This strategy will shelter investors from inflation and vacancy risks while growing their total AUM. Investors not willing to take on debt can exchange into a Delaware Statutory Trust (DST). This ownership structure allows investors a hands-off opportunity to invest percentages of their proceeds across a diverse portfolio of assets. 

3: Should you decide to liquidate: Lastly, investors exiting  the net lease market will look for a liquidity event. The sale of their drug store allows for a lump sum of equity to be captured for deployment into personal aspirations, the stock market, crypto, and other investment vehicles. For these investors, time is of the essence as the market floods with drug stores.

Connect with Ben Lipscomb: