Net Lease Retailers Are 'Bastion Of Stability' In A Tumultuous Period
A tremendous amount of equity was chasing single-tenant net lease assets throughout 2019, but the pandemic has chilled the market, with potential buyers reluctant to take chances on properties with tenants closed by government-mandated shutdowns. Transaction volume in the first half of 2020 declined more than 20% when compared to the same period in 2019, according to a new survey by Wilmette, Illinois-based The Boulder Group.
“We’ve had a really good run over the past 10 years, with steadily falling cap rates,” The Boulder Group partner Jimmy Goodman said. “It was smooth sailing until the pandemic hit.”
That 20% decline was less steep than many other portions of the commercial real estate market. Overall investment volume for New York City fell nearly 80% in Q2, as stakeholders there hunkered down to see how the pandemic plays out.
Goodman said the net lease market has a few lifelines that will keep it from going under. Essential businesses such as pharmacies, banks, dollar stores, quick-service restaurants and many industrial properties remain open and have largely seen strong revenue streams, giving investors confidence in their long-term viability, especially outlets with corporate guarantees.
“We focus on the leading e-commerce and recession-resistant retailers,” Agree Realty Senior Director of Acquisitions Andrew Bell said. “Convenience stores, tire shops and grocery, warehouse clubs, general merchandise are prime examples of strong retail sectors to invest in.”
“Buyers want to know that the tenant is open and still doing business regardless of COVID,” Goodman said. “And if 7-Eleven is guaranteeing the lease, you have an investment-grade tenant, and that means you can get a deal done.”
Those investment-grade tenants also mean lenders are not as nervous about much of the net lease sector as they are about large office buildings, shopping centers and other property types.
“The great thing about the net lease market is that there is plenty of debt available for the right product,” Goodman said.
The asking cap rates for industrial net lease properties even compressed a bit in Q2, sinking from 7.05% to 6.99%, while the rate for single-tenant retail properties increased to 6.25% in Q2 after hitting the historic low of 6.07% in late 2019.
A reluctance to buy up properties with nonessential tenants, including casual dining and fitness centers, is acting as a drag, Goodman added.
“These investors are becoming more sophisticated and taking on less risk," he said. "They don’t want to trade into a property and have to deal with lease restructurings or a tenant that is looking for a break. You don’t want to get yourself into that kind of legal fight.”
If overall investment stays depressed, that will eventually impact the 1031 market, Goodman said. It depends on a steady supply of small office buildings, apartment buildings and other properties for the 1031 buyers to trade into, so transaction velocity could slow if potential sellers decide to wait out the pandemic.
With the pandemic showing little sign of slowing down, many do expect the competition for properties to lighten up as investors carefully monitor the economy’s reopening and the financial health of tenants. In The Boulder Group’s recent national survey, 80% of net lease participants said cap rates would increase further by the end of 2020, with 43% expecting an increase of up to 19 basis points.
But that growing conservatism should bring even more benefits to property owners with essential, investment-grade tenants.
“The market is definitely bifurcating into essential and nonessential businesses,” Goodman said.
“Undoubtedly, the certainty of cash flows from high-quality net lease retailers are a bastion of stability in a tumultuous period,” Bell said.
