Net Lease in an Election Year: More of the Same or Change on the Way?

By Colby Moore, Director, Net Lease and Sale-Leaseback, Transwestern

Credit: ©2016 John Swanda

Most of what I’ve read about the overall net lease sector during the past three-and-a-half years has come to have a familiar ring to it: Cap rates are compressing (or in many instances, are already compressed), interest rates remain at historic lows, and demand for well-located net-leased assets with creditworthy, long-term leases (especially those with rent bumps) exceeds supply. So as we near the halfway mark of this election year, are there any catalysts on the horizon that hint at meaningful change for net lease investors?

Let’s start by looking at the macro level:

• We did see a rate bump for the first time in nearly a decade at the end of 2015, and depending on how you read Fed-speak, I don’t think it will surprise anyone if we see another hike by year-end. However, until there’s real consensus that hikes are the new norm, net lease sellers will continue to achieve favorable pricing.
• Even assuming a relatively stable interest-rate environment, if the primary is any indication of what’s to come in the general election, it’s reasonable to expect a pause in investment activity in the fourth quarter. Investors will be looking for consensus on what sort of business climate we’ll be operating in for the next four years.
• Perhaps of most immediate and long-term concern to net lease investors are the proposed changes (among them an outright elimination) to 1031 exchanges included in the President’s 2017 budget proposal. Estimates of commercial real estate transactions involving exchanges are as high as 65 percent, so to say the impact on net lease would be significant is an understatement. If you haven’t done so already, visit www.1031taxreform.com to become more informed.

At the property level:

While the impact of low interest rates and steady demand on record pricing has been the consistent macro theme over the last several years, there have been tremendous changes at the property level within the net lease world.

• Medical net lease offerings are much more plentiful than they were just a few years ago, and asking caps are more aggressive. With a quarter of a million Americans turning 65 each month, expect to see this product type continue to expand.
• The grocery industry has been in flux, with players like Aldi, Trader Joe’s and Natural Grocers complicating what were once relatively conforming supermarket deals.
• Casual dining offerings have taken a back seat to the emergence of fast casual. It will be interesting to see if casual dining will mount a comeback with an improving economy.
• E-commerce continues to wreak havoc on once safe net lease plays like Staples, while bank branch counts consistently post a net quarterly loss. Expect retail deals to be classified as
  “e-commerce resistant” versus everything else and industrial distribution product to grow in popularity.
• The dollar stores just keep coming.

So while the macro story in net lease will likely remain consistent through the end of the year, headwinds in the interest rate and political environment, coupled with real economic structural shifts in the tenant mix, make a post-election net lease market a bit less predictable.