Cap rates for the single tenant net lease sector decreased across all three major sectors (retail, office and industrial) in the third quarter of 2019. The retail and office sectors compressed by 2 and 7 basis points to 6.21 percent and 7.00 percent, respectively. Cap rates for single-tenant industrial properties reached an all-time low of 6.95 percent resulting from limited supply and the continued growth of e-commerce. The decrease in cap rates is most likely related to the Federal Reserve’s monetary policy objectives. Following the recent rate cut provided by the Federal Reserve in early September, most prognosticators expect one additional cut in the prior to year-end. The current monetary policy has increased the buying power of investors due to favorable cost of capital and debt terms.
The 10-year Treasury yield continued to decline in the third quarter of 2019, bottoming out in early September at 1.46 percent after starting the third quarter at 2.03 percent. The 10-year Treasury yield, however, has since increased and ended the third quarter at 1.67 percent. This figure still represented a rate that was lower than any other point throughout the first two quarters of 2019. As a point of reference, the 10-year Treasury yield has not been below 1.50 percent since July 2016. Accordingly, the net lease market strongly favors sellers after falling into a neutral position earlier this year.
Despite the low cap rate environment, some investors have shifted their focus to atypical investment strategies. Historically, investors were willing to sacrifice quality for location and lease term in the quest for higher yield. More recently, however, some investors feel more comfortable with the risk-reward of speculative credits in primary markets with strong real estate or store level profitability. Recent examples of these speculative credits include Tesla, Rite Aid, Applebee’s and other franchisee-leased properties.
While many net lease participants feel that we are in the late stages of the real estate cycle, there is no expectation of transaction volume slowdown for the remainder of 2019. Historically, the fourth quarter represents that largest quarter in terms of transaction volume as institutional investors look to meet annual acquisition targets. As a low interest rate environment is expected to remain for the near term, investors will continue to seek the stability and predictable cash flows that this investment class offers.
Randy Blankstein is President of net lease advisory firm The Boulder Group.