Single-Tenant Dollar and Drug Stores Offer Investor Appeal

Widespread orders to stay at home and close businesses during the coronavirus pandemic signaled potential doom for retail properties that house restaurants, salons, sellers of soft goods and other shops considered non-essential in many states.

Retail sales initially dropped in the spring due to closures, according to data from the Census Bureau, and the value of malls and strip retail properties plunged.

However, certain retail categories in the net-lease sector that remained open were able to prove their worth. Owners of single-tenant buildings housing Walgreens, CVS, McDonald's, Dollar General, Trader Joe's, Chick-fil-A, 7-Eleven and other operators deemed essential businesses largely continued to receive rent. In fact, San Diego, Calif.-based Realty Income, a real estate investment trust (REIT) that owns net-lease properties, said that it received almost all of the rent due in April from essential retailers, when other retail businesses were forced to close. Essential retailers make up 37% of the portfolio's rental revenue.

“In a frothy market, dollar stores can be overlooked by investors. But buyers of them over the last few years are looking pretty smart right now [during the pandemic] because they aren't getting requests for rent reduction."

Joey Odom, Stan Johnson Co.

Investment demand is typically high for these assets in any economic environment, and right now they are one of the few properties trading hands as most buyers have headed to the sidelines, observers say. According to CoStar News, investors across the country bought more than 300 single-tenant properties in the spring when the first cities and states started shutting down, according to data from the company.

“Investors know that essential assets [remained] open and paying rent, and they can see how many of these companies are doing on Wall Street," said Randy Blankstein, president of the Boulder Group, a net-lease brokerage based in Chicago. “There's going to be a flight to quality, and investors will be willing to pay a bigger premium for safety."

As we have seen during the pandemic so far, purchasing a net lease asset can provide a steady income stream for owners while strengthening real estate portfolios, so that even in uncertain times investors can feel confident that their assets won’t falter. Properties up for auction, like this Dollar Tree Center in Atoka, Oklahoma, for example, can be a good place for interested investors to start.

Often referred to as a “bond wrapped in real estate," net-lease properties require tenants to pay the ongoing expenses of the property, including maintenance, real estate taxes and insurance. In addition to essential retailers, tenants in the net-lease space include fast casual restaurants, oil and lube shops, childcare centers, bank branches, and Walmart and Target stores. Tenants typically lease the properties for 10 to 15 years and provide stable annual income at yields ranging from 4% to more than 7%, depending on the property and location.

The steady income and hands-off features are attractive to a range of investors, from individuals rotating out of labor-intensive apartments as they near or enter retirement, to multi billion-dollar REITs. Similarly, investors often pull money from the equity markets and buy net-lease assets for diversification during turbulent times, net lease experts say.

The lack of decent fixed-income yields in the low interest rate environment over the last several years has driven more investors into net-lease assets. Consequently, buyers have been willing to pay more for properties across the board, regardless of the category or whether corporations with investment-grade credit or franchisees backed the leases, Blankstein said.

The pandemic is now exposing some of those net-lease assets and others that were supposed to be e-commerce resistant as more risky. That's especially true of casual restaurants and movie theaters. Not only are they operating at a lesser capacity or completely closed, but the era of social distancing has created a lot of uncertainty about consumers' willingness to return even as venues reopen.

“Even as bad as the financial markets were in 2008 and 2009, it amazed me how many people were still going out to eat and to movies," said Jonathan Hipp, a principal with property brokerage Avison Young in Washington, D.C., who is the head of the firm's U.S. Net Lease Group. “Obviously, that's not the case today. Everyone now is trying to figure out what retail, restaurant and entertainment operators are going to do to survive."

Net-lease experts anticipate that buildings housing essential retailers will come out of the pandemic in decent shape. Median capitalization rates for newer Walgreens and CVS stores ranged from 5.15% to 5.7% in the first quarter of the year, and cap rates for newer 7-Eleven properties hovered around 5%, according to the Boulder Group.

The same expectations hold true for dollar store capitalization rates, which on a median basis ranged from 6.75% to 7.9% for newer properties. Tulsa, Okla.-based net-lease brokerage Stan Johnson Co. is marketing 40 Dollar General stores and is seeing brisk interest from buyers of individual assets and portfolio investors, said Joey Odom, a regional director and partner in the firm's Atlanta office. His team has facilitated 25 letters of intent for property sales in the spring, and most were either for Dollar Generals or grocery assets, he added. CoStar data shows more than 80 Dollar General stores sold in the spring while other retail assets stalled.

“In a frothy market, dollar stores can be overlooked by investors," Odom said. “But buyers of them over the last few years are looking pretty smart right now because they aren't getting requests for rent reduction."