Net Lease Update
Multiple factors create a competitive market.
How low can you go seems to be the capitalization rate question in the single tenant net lease market. Particularly for retail properties, cap rates have reached historic lows, according to the first quarter 2015 Boulder Report, which reports a retail cap rate of 6.40 percent, 10 basis points below 4Q 2014's rate. Strong demand for STNL retail properties is being propelled by private and Section 1031 investors.
But the bigger problem, according to CCIMs participating in the net lease roundtable discussion, is the lack of available product. Seller hesitation, among other issues, is helping to limit the amount of available product, as is current speculation about interest rates and their effect on the STNL market. Commercial Investment Real Estate discussed interest rates and other STNL issues with four CCIM designees active in the net lease market:
Nancy Miller, CCIM, senior vice president, National Net Lease Investment Group, Bull Realty, Atlanta;
Camille Renshaw, CCIM, senior director and lead broker for the New York City office of Stan Johnson Co.;
George L. Renz, CCIM, owner/ broker of Renz & Renz Investment & Commercial Brokerage in Gilroy, Calif.; and
Ken Wimberly, CCIM, chief visionary officer for KW Net Lease Advisors in Fort Worth, Texas.
CIRE: Describe the state of STNL activity in your market today, based on your experience.
George L. Renz, CCIM: The STNL market is very active but not balanced. Due to a high number of Section 1031 exchanges, low construction levels and supply, well-priced financing, and other factors, there are far more buyers than sellers. This is not only a California trend but a national trend.
Camille Renshaw, CCIM: It's very hectic, with cap rates continuing to compress in the lower credit tranches.
Ken Wimberly, CCIM: Extremely aggressive. For top quality assets, we are receiving multiple offers and prices are still trending up.
CIRE: What is the STNL cap rate environment in your market? Is it affecting buyer decisions?
Nancy Miller, CCIM: We are seeing a slight increase in cap rates in the dollar store sector in more tertiary markets. The recent uncertainty of the Family Dollar buyout caused a glut of dollar stores on the market - both new construction and existing stores - while buyers and sellers waited for the outcome. [Dollar Tree acquired Family Dollar Stores.] The 1031 buyers have entered the market again, after a slowdown in the last two years. They are forced to consider lower cap rate replacement properties with lower yields.
First-time or non-1031 buyers have unrealistic cap rate (higher) and lease term (longer) requirements. Many of them are staying on the sideline unless they are able to use leverage to purchase. Low interest rates make up, in part, for lower cap rates.
Renz: Cap rates are at historical lows but stable. NNN cap rates have always been lower than some investment types, but then STNL is usually about stability. Often buyers are all cash so the vehicle is as important as the cap rate; primary concern is security. In California a typical cap rate on a long-term lease with a quality tenant would be 4 percent to 5 percent.
Renshaw: Many buyers are finally able to sell lower credit deals or weaker assets that they may have had to hold through the recession; they are bringing their 1031 exchange dollars to our sector, creating intense demand for product. The market is very competitive.
Wimberly: Several of our clients are walking away from deals they would have completed a year ago, due to worries about increasing interest rates affecting their long-term returns. It is baffling when we see B-location strip centers with mom and pop tenants and short-term leases being brought to the market at sub-8 percent cap rates.
CIRE: What types of STNL transactions are most prevalent in your market today in terms of tenant and lease length.
Renshaw: We are seeing the most activity in retail, although demand in industrial equals it; there's just less product. Buyers need more certainty of lease longevity for office assets.
Wimberly: We still see lots of short-term dollar stores trading in the market and quite a few quick-service restaurant franchisee sale-leaseback transactions being proposed with 20-year lease terms.
Miller: The dominant tenants that we have worked with include Dollar General, Family Dollar, Applebee's, Arby's, Wendy's, Hardee's, Hooters, Kaufman Tire, and Fresenius. Most buyers are looking for longer lease terms of 10-plus years. They are willing to buy at a lower cap rate to get the long-term lease. QSR buyers, in particular, also see the long-term impact of periodic rent bumps to improve their yield over time, justifying the lower cap rate.
Renz: We are seeing dollar stores, drugstores, automotive retail, and fast food, with general lease length of 10 to 15 years with leases that are flat or have minor increases every five to 10 years.
CIRE: What are the challenges facing buyers and sellers?
Renshaw: Buyers can't find product.
Miller: Sellers are saying “Find me a good property to buy and then I will sell” - sort of the chicken and the egg problem. As a result, brokers are bringing more off-market properties to buyers.
Also, out-of-state buyers who want to leverage are having a harder time getting financing. Most of the larger banks require the buyer to reside in the same state as the property. Further, most commercial lenders will offer 15- or 20-year financing, which does not offer enough cash flow incentive for the buyer, given the low cap rates. Thus, cash is king if purchasing out of state.
Wimberly: For sellers, one challenge is that when buyers accept their aggressive pricing strategy, the buyers are carefully scrutinizing the assets during the due diligence period. If they find any deferred maintenance issues, they are going back to the sellers and seeking a price reduction.
Renz: For developers and merchant builders, the issue is finding additional opportunities to create STNL properties.
CIRE: How will rising interest rates later this year affect STNL transactions?
Renshaw: It won't.
Miller: Rising interest rates will cause cap rates to increase to maintain the spread to ensure cash flow viability. I believe the increase in cap rates will lag behind interest rate increases. However, both will occur very gradually.
Renz: STNL cap rates are not likely to rise as much as other investment real estate - their popularity helps to keep the cap rates lower.
Wimberly: As the cost of capital increases, the available yields on the assets being offered today decrease. This will push many buyers out of the market at today's prices. It is hard for me to believe that cap rates won't rise. The question is exactly when that will happen.
CIRE: How has your CCIM education helped you in this specialty?
Miller: In the STNL world, understanding how to discuss and express long-term values is especially important in the current environment. These tools, as well as the various services such as STDB, make the designation very valuable.
Renz: CCIM education has helped me take a more thorough look at investment instead of just considering leasing income. And I have nationwide connections I can reach out to get location specific info without having on-site access and market area access.
Renshaw: Many of the brokers who work for me are now pursuing their CCIM pin, and the education helps all of us underwrite the credits, the cash flows, and other return metrics, so we can more accurately price deals for sellers and buyers alike. The CCIM pin has helped me execute deals at a much higher level for clients.
Wimberly: The financial analysis techniques and tools provided by my CCIM education are instrumental. I use the spreadsheets and financial calculators almost every single day. I believe in the program so much that I have a tuition reimbursement program for those on my team.