Investors looking for low-maintenance investments with reliable and predictable cash flow are increasingly choosing single-tenant net lease (STNL) properties. In the retail sector, interest in pharmacy investments is driving cap rates to historic lows, with private investors and 1031 exchanges continuing to be the primary buyers of pharmacies.
In this article, we’ll explain why the demand for investing in pharmacies is so strong, the pros and cons of STNL properties, and discuss why some buyers believe that pharmacies are a recession-resistant investment.
Why Demand for Pharmacy Investments is Increasing
National asking cap rates for single-tenant net-leased pharmacies compressed to 5.8% in the third quarter of 2021, with cap rates declining by 59 basis points (0.59%), according to a recent report from GlobeSt.com. In fact, cap rates for CVS and Walgreens STNL investments reached historic lows of 5.15% and 5.40%, respectively.
Demand for pharmacy investments is outpacing the supply thanks to investors preferring to focus on essential retailers, the low supply of drug stores with leases of more than ten years, new pharmacies’ limited development pipeline, and the investment-grade credit rating of pharmacy tenants.
Benefits of Investing in Pharmacies
As GlobeSt notes, pharmacy pricing is strongest within the STNL retail sector and is outperforming the broader retail market. Some of the top benefits of investing in pharmacies include:
- Lease lengths generally run between 20 and 25 years, including renewals, which means the odds of a pharmacy property “going dark” are relatively low.
- Lease structures are typically single-tenant net lease (STNL), with the pharmacy tenant responsible for maintenance and repairs, insurance, property taxes, and build-outs.
- Pharmacies are usually built on prime real estate on the corner of roadways with high traffic counts,highly visible pad sites, or outparcels of shopping centers.
- Shifting demographics support pharmacy investments because as the US population grows older, the demand for healthcare services, medications, and pharmacies should increase.
- Credit ratings of CVS and Walgreens receive an investment grade of BBB from Standard & Poor’s. At the same time, Rite Aid has a non-investment grade of B-, which may be why Rite Aid occupied properties offer a relatively affordable cap rate of 7.40%.
- Cap rates for STNL pharmacy properties have declined over the past five years, from an average of 6.08% in 2007 to 5.8% today, with buyers willing to pay more for the same amount of net cash flow.
Pros and Cons of STNL Investments
STNL or single-tenant net lease properties have lease structures that require the tenant to pay landlord expenses such as utilities, property taxes, insurance, and repairs and maintenance.
Pharmacy tenants such as Walgreens or CVS often purchase the land, construct the building to their specifications, then sell the drug store to an investor and lease it back. In effect, STNL properties pass most ownership risk to the tenant in exchange for a more predictable cash flow stream.
While there are plenty of advantages to investing in pharmacies, there are also some potential drawbacks to consider as well:
- Simple STNL lease structure minimizes ownership services, allowing an investor to enjoy the benefits of owning commercial real estate without the need for day-to-day property management.
- The predictable lease structure of pharmacies makes it easier to forecast future income streams, providing ownership with stable and reliable cash flows throughout the entire lease term.
- STNL pharmacy leases may also be much more stable because a regional or national pharmacy tenant means there is less likelihood of default with the agreed-to rent being received over the multi-year term of the lease.
- STNL properties are often purpose-built for a specific use and tenant. They may be difficult to re-lease if the current occupant vacates, which is why investors prefer pharmacy tenants with investment-grade credit ratings.
- Upside may be limited by a fixed annual rent increase below the inflation rate to cap rate compression created by the growing demand for STNL pharmacies.
Are Pharmacy Investments Recession Resilient?
A recession resilient investment is less affected by fluctuating economic conditions – or most recently, by a pandemic. There are many reasons why some investors believe pharmacies will continue to perform very well regardless of the economy’s state.
The population of the US is growing older and living longer, which will likely increase the demand for medication in the years ahead. There are currently about 46 million people in the country 65 or older, which is expected to increase by another 18 million in the next eight years. That means by 2030, nearly 1 in 5 Americans will be aged 65 or older.
Brand-name drugs are continually being introduced to replace less costly treatments, help with previously untreatable conditions, or discover expanded uses for existing medications. As the population increases, insurance coverage may be increased for prescription drugs, with pharmaceutical manufacturers marketing directly to consumers.
In 1997 there were nearly one million surgical procedures performed in the US. That number grew to almost 1.5 million in 2019. While the pandemic forced hospitals to put many elective surgeries on hold, it’s likely the number of surgeries will increase in the years ahead. A growing increase in surgeries means people will require more medicine from pharmacies after leaving the hospital.
Where to Look For Pharmacy Investments
There are over 27,000 pharmacies and drug store businesses in the US with options for investing in every state. Here are the top non-supermarket pharmacy chains, based on the number of stores and the states with the most and fewest pharmacies per capita:
Top 3 pharmacy chains by store
- CVS Health: 9,900 locations in 49 states, Washington DC, and Puerto Rico
- Walgreens: 8,965 locations in all 50 states, Washington DC, Puerto Rico, and the US Virgin Islands
- Rite Aid Corp: 2,500 locations in 19 states
States with the most and fewest pharmacies
Perhaps somewhat surprisingly, some of the most densely populated states have the fewest pharmacies per capita. The top five states with the most pharmacies per 10,000 residents are:
- North Dakota: 3.38 pharmacies per 10K residents
- Nebraska: 3.11
- Kansas: 3.03
- West Virginia: 2.90
- Kentucky: 2.89
On the other hand, the five states with the fewest number of pharmacies per 10,000 residents are:
- Oklahoma: 1.19 pharmacies per 10K residents
- California: 1.45
- Rhode Island: 1.57
- Hawaii: 1.63
- Arizona: 1.66
The demand for pharmacy investments continues to grow. Investors seek to profit as an aging population creates an increased need for medications. Investing in pharmacies can help to reduce volatility and increase predictability in an investment portfolio due to the bond-like returns that STNL pharmacy leases provide.
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