2014 Net-Lease Market Ripe for Sellers

By Jonathan Hipp, President & CEO, Calkain Cos., Inc.

The net-lease market is currently highly advantageous for the potential seller. Demand for net-lease properties – especially credit tenants in prime locations – heavily outweighs supply. Cap rates are dropping to levels not seen since 2007 and more investors are getting comfortable with franchisee credit, shorter lease terms, or private non-rated companies. In short, we could be witnessing an historic sellers’ market of which intelligent investors should take advantage.

The entire net-lease market has seen compressing cap rates. Over the past five years net-lease cap rates steadily decreased from an 8 percent average in 2009 to 7.03 percent in 2014. Sectors such as Banks and Quick Service Restaurants average even lower cap rates – 5.93 percent and 6.38 percent respectively for 2014. Net-lease assets featuring highly sought after characteristics such as new construction, long-term leases and investment grade tenants routinely achieve even lower cap rates. It’s not unusual to see long-term Bank leases trade for cap rates in the low 4 percent range. McDonald’s properties – featuring an “A” credit rating from S&P – have traded in mid to high 3 percent range. Even Dollar Stores, the sector with the highest cap rate average at 7.81 percent, have properties featuring long leases trading in the low 6 percent range. A combination of multiple factors has led to this declining cap rate environment. First, low interest rates and a low yield investment environment have heavily impacted cap rates. Because cheap debt is available and the risk-free investment returns are so low, investors are able to pay premiums (lower cap rates) for net-lease assets and still achieve a spread that is appealing in today’s market. Unlike the 2007 environment where interest rates hovered in the mid to high 4 percent range – current interest rates are in the mid to low 2 percent range. This environment has fostered an unbalanced demand for net-lease properties.

Furthermore, there is limited net inventory available due to slow retail expansion and growth plans since 2008. It’s no secret that construction fell to a near standstill during the recession and only recently has begun picking up again. This has created an ever dwindling pool of net-lease investments on the market.

Finally, with a flight to quality by investors the simple fundamentals of supply and demand are driving cap rates lower. Among the most demanded properties are well situated urban retail within high traffic locations in diverse residential, office and retail communities.  These provide investors with broadly adaptable real estate – ensuring a long lasting intrinsic value. High-quality urban properties provide a stable income stream with real upside potential that far exceeds anything offered by a suburban pad site in the shadow of a big box store.

This current collusion of factors has exceptionally given net lease sellers high negotiating leverage. Furthermore, some of these advantages are not likely to exist for long. Interest rates remain low today but have incrementally increased from their sub 2 percent lows in 2012-13. This upward trend is expected to continue in the future. Lack of construction has led to a dearth of properties but the wheels of development are slowly getting underway again. Potential net-lease sellers will not likely ever see such an advantageous environment.