The market for retail real estate in the Northeast from Westchester to Boston continues its steady growth since last year.. Boston, for example, is one of the hottest markets in the country and its retail sector steadily demonstrates a strong upside. With a vacancy rate of 3.8%, according to a second quarter report by Cushman & Wakefield, rents are facing an upward pressure as tenants battle for the limited available space. However, that may change as mixed-use developments increasingly come onto the market.
The secondary submarkets around Boston have also benefited from increased occupancy and rent-growth. Several months ago we announced the sale of the 21,000-square-foot multi-tenant commercial property located 15 miles south of Boston in Abington, MA. Our firm’s Framingham office handled the transaction. Despite the lack of a national credit anchor tenant, the property sold at an aggressive price equivalent to a 7% capitalization rate on actual net operating income.
Even further afield, we are currently marketing a bank-anchored retail property near Springfield, MA. The market for this asset with a credit anchor tenant has quickly firmed up at or around 7.5% cap pricing as retail investors demonstrated renewed optimism even in tertiary submarket locations.
That said, the greatest impact on retail in the Northeast is the recently announced merger between Walgreens Boots Alliance Inc. and Rite Aid Corp. Walgreens and Rite Aid, the second- and third-largest U.S. drug store chains, respectively, reached a deal in which Walgreens will acquire Rite Aid for $17.2 billion, including acquired net debt.
Taken together, these two companies control 200 million square feet of retail space and 21 million of office and distribution space. Their consolidation, which company executives see generating $1 billion in cost savings, has the potential cause a massive disruption in the retail real estate market not only in the Northeast, but nationwide.
If the merger is approved, it would leave Walgreens and CVS as the two dominant drugstore chains in the country, with Walgreens having more than 8,300 stores in the U.S. The company also has one of the largest global pharmaceutical wholesale and distribution networks, including 11 million square feet of distribution centers and 3 million square feet of office space in the U.S.
In order to receive approval of the merger by the Federal Trade Commission, Walgreens may have to divest as many as 1,000 stores. (Walgreens is no stranger to closing stores, with 84 locations going dark this year alone.) These closings undoubtedly will cause a ripple effect in retail centers in which other tenants have co-tenancy clauses that allow them to opt out of their leases if the main drug store anchor in their centers closes.
To make matters worse, owners with mortgages on pharmacy-anchored shopping centers risk having their loans put into default, facing a “trigger period” in the loan because of a major tenancy clause or by having debt service coverage ratios below the level that the loan allows..
If the companies are allowed to merge, the stores most likely to be closed are ones that chronically underperform, cannibalize sales from each other or are older stores in larger formats that have fallen out of favor with the drugstore industry. According to CoStar data, the two drugstore chains have more than one location in nearly 3,100 zip codes across the country, and they operate more than four locations in 410 zip codes. And those numbers don’t include overlap between neighboring zip codes.
A Silver Lining for Rite Aid Investors?
Several weeks ago, we launched the exclusive offering of a Rite Aid anchored property in East Haven, CT. Prior to the offering, Rite Aid signed a new 10-year lease extension and completed more than $500,000 in store renovations. With an asking price of 7.4% cap on actual NOI, initial interest from retail investors for this multi-tenant commercial property has been strong.
Assuming Walgreens credit will stand behind Rite Aid leases going forward, this merger would be very positive for Rite Aid owners because their store values would increase substantially and trade at Walgreens cap rates, according to CoStar. Depending on the specifics of the deal, all of the top drug store companies could become investment grade, make the whole sector more desirable and likely cause an increase in transactions.
Cap rates for single tenant CVS, Rite Aid and Walgreens properties hit historic lows in the net lease drug store sector in the third quarter of 2015. But with lower credit ratings, Rite Aid cap rates are the highest of the three with a median asking cap rate for a 20-year lease term at 6.15% as compared to 5% for CVS or Walgreens. As Rite Aid’s financial strength improves, investors have gained interest in the additional yield, which can be attributed to Rite Aid not being an investment grade-rated company similar to Walgreens or CVS.
With offices in New York, Massachusetts and Connecticut, our investment sales teams at Northeast Private Client Group are well-positioned to support real estate investors across the region. If you are a property owner or an investor and want to discuss the content of this blog or your investment goals for next year and how we can help you achieve them, please give us a call. We look forward to hearing from you.