Velocity for net lease has picked right back up from where we left off in 2015, thanks to a tremendous amount of private capital in the market that is aggressively looking to acquire real estate. Net lease remains attractive because of the continued inflow of 1031 exchange money, coupled with stock market uncertainty. Whether that will change this year depends on an improvement in the stock market, correction in interest rates or an increasing adjustment in cap rates.
The larger volume, $10 million-and-up-priced assets that are typically targeted by REITs and the institutional sector are showing some slowdown. This is because these buyers aren’t willing to compete with the compressed cap rates 1031 buyers are offering. Institutional capital is returning to more fundamental underwriting standards, focusing on the quality of the real estate and replacement ability of rents. There is no slowdown in the $5 million and below asset range, as it continues to remain as active as we’ve ever seen it.
If you’re considering a sale, now is the time. The lack of alternative investment options and stock market volatility will ensure real estate remains an advantageous investment. We continue to advise sellers to take advantage of the current market pricing, which on a cap-rate basis is 15 to 20 percent above historic levels. Taking action today is what can mitigate the risk of market fluctuation in the future. We don’t know when the market will adjust, but at some point it will.
For the long-term investor seeking yield and certainty, we recommend they continue to follow real estate fundamentals. Focus on the replacement of the rent and the quality of the real estate, as well as the credit of the tenant. Look at the profitability of the location as well as the company’s debt coverage ratios on the overall balance sheet.
A current hot button is “value add.” An example of creative value add is junior box opportunities with tenants such as Staples, Office Max and Kohl’s, which are downsizing amid the surging e-commerce market. Buyers can take over these assets, subdivide them, and reposition the real estate into multi-tenant deals, offering tremendous upside.
Sale-leaseback also remains a viable option. A buyer works with the tenant, which may use the sale-leaseback proceeds to support business investment and growth. This is a great strategy for both the buyer and tenant, which can work together to bring greater value. However, it is important to note that the tenant is gaining both a business partner and landlord in this arrangement. The buyer has to ensure they have the long-term viability to manage the asset.
Overall, for the foreseeable future, the good news is that net lease remains ripe for investors seeking certainty amidst greater economic ups and downs.