New CVS Store Strategy Creates Fresh Opportunities For NNN Investors

Store Closings Are Paving The For Strategic Change And A Future “One-Stop-Shop” Drugstore Model.

Roll the clock back a few years, and major drugstore retailers such as CVS, Walgreens and Rite Aid were locked in a competitive battle for market share, while also going head-to-head with in-store pharmacies at Walmart, Target, Kroger and others. The race was on to open new stores and land the best locations. That growth created tremendous opportunities for net lease real estate investors.

Fast forward to today and drugstore retailers are racing to adapt business models to accommodate an increasingly digital world. At the same time, the COVID-19 pandemic has pushed them to step into a bigger role in delivering health care services. That new paradigm is further fueling investor demand for net lease assets within the drugstore sector. In this three-part series on drug stores following Walgreens Part 1 and Walgreens Part 2, we take a closer look at the evolving business model of CVS.

CVS made headlines in late 2021 when the retailer announced that it would close 900 of its existing drugstores over the next 3 years at a pace of about 300 stores per year starting in spring 2022. The announcement was part of a pivot in strategy to rightsize its footprint to deliver on its “reimagine primary care” vision and build a nationally-scaled next generation primary care model. The news automatically sparked a bigger question for real estate investors: Are brand name drugstores still a wise choice?

Similar to Walgreens net lease properties, CVS net lease properties have long been considered prized possessions for passive rental income investors. The healthy supply and demand for CVS net lease assets (some would argue investor demand that is higher than Walgreens) is fueling a robust investment market with more than 1,015 transactions closed over the last ~24 months. According to Costar, the average transaction price ranged from $4.6M to over $20M, with median cap rates in the low 6% range. 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.

CVS and Walgreens are both perennial favorites among net lease buyers. Some even refer to them as the “granddaddy” of net lease. In this blog, we will highlight transformative changes in CVS’ store strategy and explore the implications on CVS net lease investments.

Fortune 500 company

CVS Health Corporation is the behemoth corporation behind the CVS Pharmacy retail stores. The company also owns CVS Caremark, a pharmacy benefits manager, and the health insurance provider Aetna among other brands. CVS Health currently ranks 4th on the Fortune 500 list. It generated $268.7 billion in revenues in 2020, and revenues are projected to grow to $304 billion in 2022. There are more than 9,000 CVS retail locations in the U.S. that serve 110 million members in 49 states. A majority of Americans – 85% – live within 10 miles of a CVS store, and the company has an enviable investment grade credit rating (S&P:BBB, Moody’s:Baa2).

Rightsizing its footprint

CVS made a big splash when it announced plans to close 10% of its stores. In its press release, the company stated that it wanted to “ensure it has the right kinds of stores for the right locations,” and the company plans to start a process of changing its store format to “drive higher engagement” with consumers. Moving forward, CVS is embracing three distinct store models that will serve as community health destinations:

• Traditional CVS Pharmacy stores that provide prescription services along with health, wellness, personal care and other convenient retail offerings

• An enhanced version of HealthHUB™ locations that provide products and services designed for everyday health and wellness needs

• Sites dedicated to offering primary care services.

Let’s break down these store formats to gain more insight on the type of stores CVS will carry moving forward.

Traditional CVS Pharmacy stores

These stores are what most people associate with a CVS store – a pharmacy section toward the back of the store and the retail section taking up the rest of the space all around the store. Over the last few years, CVS has ramped up its MinuteClinics initiative with 1,500 locations outfitted with these convenient drop-in clinics thus far. MinuteClinics offer basic care from a nurse practitioner or physician assistant at about 40% the cost of urgent care. They typically deliver immunizations and treat common ailments, such as ear infections and strep throat, and refer patients to doctors and/or hospitals for more serious illness. The MinuteClinics help to drive foot traffic and sales at the store level.

HealthHUBs and primary care services

CVS began piloting its HealthHUB locations in 2019, and the company expected to have up to 1,500 locations operating throughout the U.S. by 2022. CVS HealthHUBs feature a broader range of health care services, such as offering routine exams and helping patients better manage chronic conditions. They also stock more health & wellness products. Overall, the HealthHUBs are more staff-intensive and aim to offer a more comprehensive and personalized experience to visitors.

CVS views HealthHUB as a core tenet in its consumer-centric care delivery model, and it’s also another example of how drugstores are stepping up their game to create a “pharmacy of the future” with a one-stop shop for prescription and over-the counter drugs, health & wellness related retail products and the delivery of health & wellness services. Some industry observers believe that CVS has the potential to leverage its other brands to drive more traffic to its stores. For example, the company’s strategic acquisition of Aetna gives it access to Aetna’s 22 million members and creates an opportunity to pull millions of patients / customers to HealthHUBs for healthcare services and prescriptions.

In addition, CVS has said that it plans to add primary care centers to several hundred locations. The primary care centers would provide patients with care teams that include doctors, nurses and pharmacists, as well as specialists such as dieticians and social workers at select locations. Services will be available both in-person and via telehealth. In order to facilitate this primary care initiative, CSV is currently stepping up its efforts to acquire more physician practices and clinics.

New Rx for NNN investment opportunities

These new models show that, similar to its competitors, CVS is aggressively transforming itself to be a key cog in the consumer healthcare realm. Such moves will position the brand well in the post-pandemic digital world. This corporate vision could potentially have a ricochet impact on its real estate strategy as it reformats stores into hubs for integrated healthcare offerings – the pharmacy of the future. Consequently, the natural question here is how do such business-model innovations impact your existing net lease CVS properties, or new assets you may be looking to buy?

To critically assess CVS net lease investment opportunities, it is important to consider a deal from all angles. It is imperative to assess how a particular store may be affected by the shift in corporate strategy. For example, the HealthHUBs will require carving space out of existing stores to accommodate expanded healthcare services. One key question, would a store that you own or are thinking of purchasing be able to accommodate this transition? The risk here is that a particular location may no longer be the right fit. Once the existing lease term expires, CVS may decide to vacate, and you may be left with an empty building – albeit in what is likely a prime location.

Dynamic changes occurring within corporate strategy and the broader drugstore sector highlight the importance of partnering with an experienced real estate professional. It is critical to work with someone who has the experience and acumen, not only as it relates to real estate issues, but also someone who 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.