Achieving Net Lease Equilibrium

By Randy Blankstein

Randy Blankstein, President, The Boulder Group

Cap rates for the single-tenant net lease retail sector rose by 10 basis points in the second quarter of 2018, representing the largest such increase since the second quarter of 2011. Cap rates compressed for the office and industrial sector by 5 and 25 basis points, respectively. The upward trend in cap rates should persist as the Federal Reserve continues to implement its monetary policy objectives.

As investors expect increased cap rate pressure to remain, the supply of single-tenant net lease properties on the market continues to increase, too. Owners of single-tenant properties are bringing those assets to market in an attempt to maximize value before cap rates increase further. In the second quarter of 2018, the net lease sector experienced an uptick in supply of more than 11 percent, with the majority coming from net lease retail properties.

Also illustrating the upward movement on cap rates, the spread between asking and closed cap rates continued to widen for the retail and industrial sectors, while the spread for the most desired assets—including long-term leases, credit and primary market locations—remained similar to recent years. On the other hand, properties with short-term leases, weak credit, limited or no rental escalations and tertiary locations have experienced the greatest expansion in cap rates.

Proponents of the retail net lease sector have pointed to its strengths, such as steady retail cap rates despite a rising interest rate environment. They’ve also argued that the net lease retail sector is the beneficiary of the shift away from the traditional shopping mall. By contrast, the opposition has cited rising interest rates, a recent flood of net lease retail property supply and concentration of new construction with limited credit. Despite the rise in retail cap rates in the second quarter, the perception remains that the net lease retail market has kept in a neutral position recently: Cap rates for the retail sector have primarily ranged from 6.10 percent to 6.25 percent since the third quarter of 2015.

The primary sentiment among net lease investors is that cap rates should remain relatively stable and within the range of the past few years for retail, office and industrial assets. Consistent with that view, investors will be carefully monitoring the monetary policy decisions of the Federal Reserve in 2018, as well as the capital markets effect on pricing.

Randy Blankstein is president of net lease advisory firm The Boulder Group.