Walgreens Delivers Healthy Rx For NNN Investors
Buyer Demand Fuels 1200+ Walgreens Transactions Over The Past 2 Years.
CVS made headlines recently when the retailer announced that it would close 900 of its existing drugstores. Although it was a strategic move to rightsize its footprint, it automatically sparked a bigger question for real estate investors: Are brand name drug stores still a wise choice? We’ll take a deeper dive into the space, starting with the CVS’s core competitor – Walgreens.
Walgreens net lease properties have long been considered prized possessions for passive rental income investors. And frankly, that hasn’t changed one bit in the wake of the CVS announcement. The healthy supply and demand for Walgreens net lease assets is fueling a robust investment market with more than 1,200+ transactions closed over the last ~24 months. According to Costar, the average transaction price ranged from $4M - $8M with cap rates between 4% - 6.6%. The price variation is a function of NOI, locations, years left on the lease, double net (NN) or triple net (NNN) lease terms and periodic rent increases amongst other factors.
Walgreens is a perennial favorite among net lease buyers. Some even refer to it as the “granddaddy of net lease". In this blog, we will explore the three key attributes that make Walgreens net lease properties such an appealing choice for investors.
#1. Stellar Credit Rating
Walgreens has size, brand name recognition and solid business performance. So, it’s no surprise that it also has an enviable investment grade credit rating (S&P:BBB, Moody’s:Baa2). Walgreens stores are operated by parent company Walgreens Boots Alliance (Nasdaq: WBA), which is the largest retail pharmacy, health and daily living destination across the U.S. and Europe combined. It also is one of the largest global pharmaceutical wholesale and distribution networks, employing some 415,000 people. The company reported $136.9 billion in global sales and ranks #19 on the Fortune 500 list. In fact, Walgreens has made the Fortune 500 list every year for the past 25+ years. As those numbers show, the company is a heavyweight leader in the drugstore sector, touching millions of customers every day though the sale its prescription medicine, healthcare services and variety of retail products.
#2. Top Shelf Locations
Walgreens stores have long been prized possessions for investors, largely because the real estate locations are almost always the best in town. The company has a large footprint with more than 18,500 stores in 11 countries, including 9,500 in the U.S. Its stores are usually located on “Main & Main” intersections and some of the best traffic corners in any given city. Their NNN leases can be up to 50 years or more and are typically structured with a 15- to 20-year base lease term and up to 10 or more 5-year renewal options.
The name of the game for drug stores is convenience, visibility and finding those locations that are firmly in the path of their customers. Typically, they are willing to pay a premium to secure – and keep – those coveted locations. For example, on a standard 14,000 square foot store, Walgreens would pay between $250K – 350K in rent yearly depending on the specific location. At a sample 5.25% cap this translates to $4.7M - $6.7M valuation on a 15-year NNN.
As a real estate investor, if you own real estate at a busy traffic signal-controlled intersection in a highly sought-after retail trade area with good traffic flow (e.g. 20K – 50K+ vehicles per day), you will have a valuable property. If the intersection is at a core shopping center in a major metro, such as San Francisco, Dallas or St. Louis, the location can reach the level of “generational” – meaning the location is so valuable that you can potentially own it forever, and then pass it on to your kids as part of estate planning strategy. So, with or without Walgreens, that property is a golden ticket as it will likely be in high demand in the event that Walgreens should decide not to renew its lease at some point in the future.
#3. Long-term guaranteed leases
Walgreens makes a point of selecting only best-in-class A-quality real estate locations. Those locations don’t grow on trees, and there are plenty of users chasing them. So, once Walgreens leases a location, they generally do not give them up. It is common to find Walgreens stores with 15- to 25-year initial base term and 5 to 10 renewal options of 5-years each – for a total lease time frame of up to 50 years or more. Its leases also are fully guaranteed by the corporate office, meaning that the lease acts as a contractual agreement that is backed by a $40 billion global company. Essentially, Walgreens Boots Alliance is agreeing to pay rent for the full base term of the lease, even if they decide to close that particular Walgreens store at some point in the future.
Walgreens’ leases can be either NN or NNN, depending on the location and how long they have been there. As NNN leases have continued to gain popularity amongst investors over the last 20+ years, the majority of Walgreens leases initiated over the similar period also have kept up with market dynamics and shifted toward NNN leases. Under a NNN lease structure, the investor/landlord is completely immune from any responsibility on the premises as the tenant is responsible for all maintenance, insurance and property taxes.
If you are looking for the fine print, here it is. One caveat with a Walgreens lease is that, historically, many have no built-in rent increases into perpetuity. The lease would have zero rent increases, meaning that Walgreens would continue to pay the same initial rent amount across the full length of the lease, and any future lease renewals, for up to 50 years. This could be a big negative for investors as the rent payment likely would not be able to keep up with inflation. Some investors are willing to take that trade-off depending on their investment hold period, or in other cases, the fixed income and appreciation are incentive enough to offset the lack of increases to rental income. In recent years, Walgreens also has been shifting gears and is accepting lease terms on select locations with 10% rent increases every 5 years on a 15-year base term, as well as increases on renewal options. However, it is important to work with a seasoned net lease broker who can help to navigate those negotiations and factor current and future rent into the investment analysis.
Based on the three pillars to net lease investments – tenant credit, quality of the real estate and lease structure – Walgreens has an impressive resume. Yet it also is important to look at those net lease investments with an eye towards the future. The COVID-19 pandemic has served as both market disruptor and accelerator across industries. Healthcare services and retail have both been profoundly impacted. Add changing demographics and consumer behavior to the mix, and forward-thinking retailers such as Walgreens are planning for the future. In part two of our analysis of Walgreens we will take a closer look at Walgreens latest business and real estate initiatives and the impact they might have on net lease investment opportunities.
Dynamic changes occurring within the broader drugstore sector highlight the importance of partnering with an experienced real estate professional. It is vital to collaborate with a Broker that has the experience and acumen, not only as it relates to real estate issues, but also has the ability to dissect the business issues, distill findings and provide well-informed data-driven advice. Such a partner that can add value, serve as your trusted partner and act with integrity should definitely be the quarterback of your Net Lease A Team. Please reach out to Andrew Vu at 415-539-1120 for a complimentary NNN consultation.