By Garrick Brown, Vice President of Retail Research, Americas
A couple of big stories have hit over the last couple of days. Big surprise… both of them had to do with retail consolidation…
Walgreen’s announced that they will be closing roughly 600 stores following the closure of their deal with Rite-Aid. As you likely already know, after nearly two years the FTC has approved not a merger, but the sale of nearly 2,000 Rite-Aid stores to Walgreens for $4.4 billion. According to a company spokesman, nearly all of the locations to be closed will be former Rite-Aid stores. Nearly all of them within one mile of existing Walgreen’s units. We had pointed out two years ago when the deal was first proposed that between the two chains there were roughly 3,000 potentially redundant stores (those within a mile or less of each other). We also warned that the most likely closures would be Rite-Aid stores for a number of reasons; many of these (though not all) were larger format than the 16,000 SF +/- footprint that Walgreens likes. Because Rite-Aid’s last big growth spurt was well over a decade ago (since the mid-2000s they have been dealing with debt issues), many of these leases are more mature and in some cases, the real estate itself is inferior to newer product that has since come online. Of course, the biggest determinant in this will be the fact that where there were Walgreens and Rite-Aid stores in close proximity, it was the Rite-Aid stores that typically had the lower sales per square foot levels.
The closures will begin early next year and will likely take place over the following 18 month… so look it to be complete sometime around midyear 2019. They have not yet released a list and my sources there tells me it will be a while before such a list is released.
This was pretty much along the lines of what we predicted two years ago when the proposed merger was first announced but the closure numbers are far less than our original prediction simply because the merger never quite happened. Instead, what we saw was the sale of roughly 2,000 Rite-Aid stores and, thus, a much lower number of redundancies.
Considering that a full merger would have probably led to double or more this number of closures (between the two chains there were 3,000 stores that were within one mile of another), this is actually fairly good news for retail landlords. What does it mean for the market? First, I don’t see much of an impact at all on the single tenant net lease investment marketplace. Walgreen’s, with their 25 to 50 year leases and AAA credit, remains one of the darlings of net lease investors. Cap rates for this product (including their Duane Reade banner in New York) are still typically in the 4% range when the leases have any length remaining. Out in the suburbs, we are still generally looking at 5% caps. The same has held true for CVS stores. The odd man out has been Rite-Aid and that generally was because of their past debt issues. So while Walgreen’s and CVS stores were trading at anywhere from 4% to 6% generally, Rite-Aid deals usually were coming in at cap rates starting at 6.5% and heading up from there. If anything, former Rite-Aid stores that become Walgreen’s location will suddenly see their value climb. Locations with shuttered stores will obviously have the issue of re-tenanting… but junior boxes have a fairly deep potential tenant pool right now.
The trend of larger box users going smaller helps. But while no net lease investor wants an empty property on their hands, at least most of the former Rite-Aid stores to be closed will be in the size range for which there is an active pool of tenants. The real problems tend to be with the larger big boxes, especially from 50,000 square feet and up.
Will there be an impact on drug store cap rates? Not really. There is some slight upward pressure on cap rates simply because investors are nervous about retail. But I see CVS and Walgreens deals pretty much staying close to where they currently are. Meanwhile, though Rite-Aid has just raised a bunch of capital from this sale, I haven’t seen their cap rates falling much. Though the company is financially stronger, it doesn’t change the fact that many of these are mature leases. In the world of net lease investment, a single tenant building with only five years left on a lease is inherently more risky than one with ten. That’s just the name of the game. Plus, rumors continue to circulate as to whether what is left of Rite-Aid may end up being sold to a new owner. Their stock has actually fallen since the deal, despite the fact that they just raised $4.4 billion in cash. Frankly, I think they are way undervalued and are going to make a very attractive target for someone.
I’m not the only one seeing that, so I keep hearing rumors from friends in private equity that seem to suggest PE firms are looking around. Makes sense—a recent study by Merrill Corporation and Pitchbook on US PE trends reported that PE firms in the US were sitting on roughly $560 billion in capital as of the close of Q3 2017. That’s a lot of money looking to land and though PE has been avoiding retail like the plague as of late, you can’t tell me that they aren’t going to come across some diamonds in the rough available at cut rate pricing in today’s retail environment.
The big issue hanging over Rite-Aid’s stock price I think is uncertainty as to what’s next for them. And, of course, there is the issue of Amazon. Amazon has stated that they are looking into possibly getting into the drug store business and that an announcement may be forthcoming as soon as next month. This alone has caused some analysts I know to wonder out loud whether Amazon might buy Rite-Aid. While you can’t rule anything out, I would point out that it would be less critical for Amazon to have bricks-and-mortar retail channels for pharmaceuticals than, say, for food (where your final mile literally needs to be just that). There is no doubt that there are situations where bricks-and-mortar drug stores would have an advantage over online; those times when a new prescription is needed urgently for example. But most prescriptions in the US are written for long-term chronic ailments (asthma, diabetes, high blood pressure, etc.) where next day delivery could work just fine. If anything, the entry of Amazon into the drug store space will prove to be a much greater disruptor than the Walgreen’s/Rite-Aid deal ever was.
The other big news? Sears announced that they will no longer be selling Whirlpool products, ending a 101 year relationship. Shoppers will no longer be able to buy Whirlpool, Maytag or Kitchen Aid products at Sears. So what’s this got to do with commercial real estate?
Sears troubles are well known. They have lost over $2 billion in the last year and the chain hasn’t registered a profit since 2010. The chain has been surviving by selling off assets (real estate, brands, etc.) and barring what would seem like a miracle turnaround in sales, the writing on the wall is not good. Sears Canada is already gone and most Wall Street analysts believe it is not a matter of whether Sears will eventually file bankruptcy, but when? Appliances, tools and automotive are Sears best performing departments. The loss of Whirlpool products means the loss of one of their highest prestige brands.
The initial announcement alone set off speculation… had Whirlpool cut off their credit? If this were the case, it would be a bombshell because it would likely set off a chain reaction of vendors nervously cutting off credit. This has been the precursor of collapse for a number of retailers as of late. But this apparently wasn’t the case—Whirlpool announced that this was over a pricing dispute. Regardless, losing a long-time premier brand is another blow to Sears and just makes the challenge of turning sales around even more difficult.
I had initially planned on exploring the store of tomorrow with this issues, but these were pretty big stories I needed to talk about. Tune in next week where I will explore the issue of showrooms and tell you about my recent visit to Nordstrom’s new store in Los Angeles. Not the newly relocated one at Westfield Century City. I mean the one on Melrose… the one that has no merchandise…
One last thing… our new Q3 2017 quarterly reports are available! Check them out by clicking here.
This post is commentary from the latest weekly edition of our Cushman & Wakefield Retail Newsline, which you can subscribe to for free by e-mailing email@example.com.
Garrick serves as Vice President of Retail Research for the Americas. He speaks frequently at industry events and has been a keynote speaker at symposiums, conferences and market forecasting events for groups like the Appraisal Institute, Urban Land Institute, CREW, ICSC and PRSM. He is also a member of Lambda Alpha International, an invitation-only land use society for those who are involved in the ownership, management, regulation and conservation of land, but also those who are involved in its development, redevelopment and preservation.