Cap rates in the single-tenant net lease retail, office and industrial sectors reached a new all-time low in the third quarter of 2020.
When compared to the second quarter of 2020, cap rates compressed by 19, 10 and 11 basis points, respectively, for retail, office and industrial. The cap rate compression in the third quarter of 2020 can be primarily attributed to the recent announcement by the Federal Reserve, which suggested interest rates will remain near zero at least through 2023. Combining this with a “flight to quality” by real estate investors caused cap rate compression, especially for strong credit and essential net leased assets.
As COVID-19 continues to impact the real estate market, net lease investors are limiting the type of properties they are willing to acquire. Sellers of retail assets that experienced the greatest negative impact included movie theaters, gyms and second-tier casual dining. Accordingly, owners of these assets are holding from the market as they are uninterested in selling at unfavorable pricing. Accordingly, the supply of net lease properties experienced a sharp decline of approximately 9 percent in the third quarter.
As supply decreased, an investor move toward assets with high-quality tenants and long-term leases continued in the net lease sector. Properties with long-term leases to investment-grade tenants are in the highest demand. The retail sector experienced its largest cap rate move since 2014 as private and 1031 exchange investors aggressively sought the lower-priced assets this sector provided. Consequently, sellers of high-quality net lease properties priced assets at a level not previously seen as they look to take advantage of investors’ more conservative acquisition criteria.
Net lease transaction volume for 2020 is expected to be significantly lower than 2019 as a result of COVID-19’s impact on the real estate sector. Investors will be carefully monitoring COVID-19, the economy and the upcoming election as each individual aspect could significantly alter the net lease landscape. Despite the normal hesitancy of buyers during an election year, the majority of net lease participants expect fourth-quarter transaction volume to be the strongest quarter of the year.
Randy Blankstein is president of net lease advisory firm The Boulder Group.