Institutional Investors Look to Net-Leased Property

By Brandon Duff, Director, Stan Johnson Co.

Institutional investors—pension funds, insurance companies, public and private REITs—are having a hard time finding yield in these economically uncertain times. Interest rates are likely to remain historically low, perhaps for years. The bond market is steady but uninspiring. The performance of commercial real estate is less predictable than ever; development is depressed; cap rates are low.

In these circumstances, yield-driven investors with good access to capital are more likely to put their money into single-tenant, net-leased real estate. Such assets generally provide a better yield than bonds, and are just about as safe and worry-free. Institutional investors’ interest in these assets is likely to grow as the national economy remains shaky. Publicly traded REITs, in particular, might be drawn more to single-tenant properties, as they try to attract individual investors who are also seeking yield. REIT stocks continue to gain popularity, mainly due to a shortage of alternative investments that promise a comparable return.

Single-tenant net-leased properties require little to no management on the part of the owner, and only minimal oversight. The cash flow, in most cases, is dependable. And if a crisis befalls, and the tenant goes out of business—an unlikely outcome in a building with a long-term net lease on it—the owner will still have a valuable, tangible asset to trade or re-tenant.

Although cap rates are tight, and not likely to improve (from the buyer’s point of view) any time soon, there still exists a wide spread between yields on Treasury bonds and most other debt securities, and the yield derived from a building that’s net-leased to a credit tenant. Moreover, institutional investors with an appetite for risk are now more likely to work with non-credit tenants and non-traditional assets.

Even a conservative institutional investor will sometimes consider an asset that’s net-leased to a non-credit tenant if they understand that tenant’s story and are confident enough in the tenant’s balance sheet to underwrite the risk. Some institutions will also consider unconventional net-leased properties such as vineyards, ski slopes, and racetracks, to bring in a little higher yield. An investor with a large portfolio can blend those assets with others purchased at much more aggressive cap rates, such as building that’s net-leased to Walgreens or AutoZone, to get a return somewhere in the middle.

The tendency of institutional investors to pay more attention to single-tenant net-leased properties—including some less-than-conventional assets—will probably increase as these investors consolidate and expand. This month’s purchase of American Realty Capital Trust by Realty Income (a REIT that specializes in net-leased retail buildings) might serve as a harbinger. By buying American Realty (for about $1.9 billion in stock), Realty Income diversifies its portfolio to include non-retail net leased properties. It will probably be looking for more properties outside of its traditional model—and because of its size, Realty Income will have amazing access to cheap capital.

We can expect mammoth institutional investors—especially those who seek capital from the public markets—to dominate the net-leased market in the future, squeezing smaller investors out of the most attractive deals because they’re better capitalized and can make more aggressive offers.