Net Lease as a Hedge Against Market Swings

Jonathan Hipp, Principal & Head of U.S. Net Lease Group, Avison Young. Image courtesy of Avison Young

Savvy investors know the importance of diversifying their portfolios. Investors in commercial real estate can follow that same practice and reap rewards in good times and bad. But many investors tend to be “brand” loyal, focusing primarily on one product type over another. By doing so, they open themselves up to market shifts that can raise or lower the performance expectations of entire classes of assets.  

As we often advise potential clients, it is possible to maintain that brand loyalty and yet achieve the diversification essential to a virtually bulletproof strategy: Building a net lease portfolio.

While net lease focuses largely on the retail market, the diversification comes in the range of lease terms, geographies and product types over which savvy investors can spread risk. Ours is a mutual fund-styled approach and much safer than the stock market―especially in times like we are experiencing right now with wild swings that underscore the market’s volatility. Think more in terms of a bond portfolio wrapped in real estate.

Diversifying Exposure

Consider, for instance, a chain pharmacy that closes some of its doors for whatever reasons―a market upheaval or a geographic realignment (think Walgreens and Rite Aid). In prime markets, that real estate is still a viable asset, backed by strong fundamentals, and a prime location for the next up-and-coming net lease tenant.

In a wisely constructed net lease portfolio, the risk is spread also over the performance variations of many retail formats. Consider the range of cap rate performances in these sectors over the past two quarters. The above-mentioned pharmacy sector experienced a nearly 26-basis-point compression from the second quarter to Q3. Dollar stores, on the other hand, logged a 45-bps expansion.

Within those two extremes, other sectors―from banks to casual dining and medical office to quick-service restaurants―ran the gamut of spreads, laying out a virtual smorgasbord of options for price-conscious buyers. Rest assured that those numbers will change in reaction to market and economic shifts, impacting the investment appeal of this sector or that, but never the security of the overall diversification strategy. 

Pundits seem to think that the economic upcycle―billed as the second longest in US history―has another year to run. Educated guesses aside, a portfolio that embraces diversity is always a great hedge against surprises. For investors with an appetite for commercial real estate but not so much for risk, a net lease portfolio is the way to go.

Jonathan Hipp is founder, president & CEO of Calkain Cos.