By Elizabeth Szep on August 27th, 2018
U.S. drugstore cap rates have begun to edge up as interest rates start to climb. However, certain drugstore franchises are noticeably less affected by rate increases than others. Comparing cap rate trends for Walgreens, CVS and other drugstores reveals investors’ preference for particular retailers as interest rates shift.
Single tenant net-lease properties, such as drugstores or other franchised properties, can be thought of as bond alternatives because the structure of these long-term leases provide stabilized cash flows which mimic fixed-income securities.
While it is clear that cap rates and interest rates do not move in a one-to-one fashion – many factors besides interest rates affect real estate prices – one can expect single tenant net-lease properties to be more sensitive to rate increases than multi tenant properties. In properties that are not net-leased, owners can turn over tenants and adjust rents more easily as rates and inflation change.
Because of this relationship, cap rates for drugstores have begun to edge up recently; however, not all brands have moved at the same pace. The below chart plots cap rates for Walgreens, CVS, and other drugstores alongside the 10yr US Treasury.
While the series for other branded drugstores has increased at a faster clip with interest rates, Walgreens and CVS properties are retaining their value better. Interest rates are up almost 130 basis points (bps) from two years ago and cap rates for other drugstores have pushed up nearly 70 bps. Cap rates for both Walgreens and CVS, meanwhile, have increased less than 30 bps over the same time.
From this analysis, the value of a strong tenant becomes clear and understanding how to quantify that value is becoming increasingly important. Investors expect one or two more interest rate hikes by the end of 2018 and having high quality tenants like Walgreens or CVS in place should dampen the impact of those rate increases.