Drugstores are offering a healthy alternative for buyers of commercial real estate. Even as chains add new locations at a record pace, they're quietly overtaking grocery-anchored centers as a preferred product type among retail investors.

The fervent demand for drugstores, most of them freestanding, triple-net-leased properties, has created a shortage of investment opportunities, says Bernie Haddigan, managing director of the national retail group for Marcus & Millichap in Atlanta.

“There's a lot more demand than product, so cap rates are staying low — in the 5s to mid-6s, depending on location,” says Haddigan. “That's slightly less than they were about a year ago, by about 25 to 50 basis points.”

Drugstores also are luring customers away from grocery stores. They're doubling in size, from about 7,000 to 14,000 sq. ft., and adding food staples, including refrigerated items, along with photo processing centers and drive-thru windows.

“Drugstores are evolving into convenience-oriented stores,” Haddigan says. “They're looking to lower-volume, higher-profit convenience items to create more value.”

With the first baby boomers turning 60 and a new Medicare drug benefit kicking in this year, the biggest factor driving drugstore sales and expansions is prescription drugs. Both major chains are scrambling to add new stores and capture the growing demand.

In late January, CVS Corp., the Northeast giant, announced plans to buy 700 Sav-on and Osco drugstores in a $4 billion deal, adding to the 1,260 Eckerd stores it gobbled up in 2004. Walgreens plans to build its way to greater market dominance.

The Deerfield, Ill.-based company says it will open a record 475 stores during the fiscal year ending in August — or about one store every 20 hours — as part of a $1.5 billion building spree that also includes new distribution centers. It aims to have 7,000 stores in place by 2010.

Walgreens raked in more than $43.6 billion in sales during the 12 months ending Dec. 31, compared to CVS ($37 billion) and Rite Aid ($17.1 billion). About 64% of Walgreens' revenue comes from prescription drug sales, says Mitchell Corwin, equity analyst at Chicago-based Morningstar. The analyst estimates that Walgreens generates sales at least 30% higher than CVS, thanks to an average of 275 prescriptions filled per store per day, compared to CVS's average of 215.

“Besides riding the tailwinds of a growing industry, the larger drugstores will continue to take market share away from smaller chains and independents,” Corwin says.

Third-ranking Rite Aide is trying to fund an expansion of its own, but the brewing drugstore war will largely be between the two giants, Walgreens and CVS, says Haddigan.

Though it was founded more than a century ago, Walgreens stores are, on average, about 6 years old. Walgreens has targeted growing Sunbelt states with large retirement-age populations — Georgia, the Carolinas, Texas, Florida and southern California — as hot spots for new stores.

The company uses local developers across the country to complete build-to-suits, leasing about 80% of its stores. Leasing, rather than taking on the debt of purchasing so much real estate, helps support the company's rapid growth, according to a Walgreens spokesperson.

Some experts worry the drugstore sector could become overbuilt. David Sacher, senior vice president at The Retail Connection, a Dallas-based commercial real estate firm, says some core markets have already become oversaturated. “You're going to see neck-and-neck competition between Walgreens and CVS and the super-anchor pharmacies,” he predicts.

“There's going to be cannibalization and there's going to be overbuilding. It's very much a survival-of-the-fittest situation,” Sacher continues. “It's all going to come down to who has the best real estate, and who has the best business model.”

DRUGSTORE TITANS AT A GLANCE

Chain	Stores*	Sales**
Walgreens	5,080	$43.6 billion
CVS	5,471	$37.0 billion
Rite Aid	3,330	$17.1 billion
*as of Dec. 31, 2005
** for 12 months ending Dec. 31, 2005
Sources: Walgreen Co., NREI