The Rise and Rise of Net Lease

By Randy Blankstein, President, The Boulder Group

Randy Blankstein, The Boulder Group

Cap rates for the single tenant net leased retail market continued their downward trend to 6.7 percent in the first quarter of 2014, surpassing the previous quarter’s historically low rate of 6.8 percent. During the same time period, cap rates for the industrial sector compressed by 15 basis points. The main factor contributing to cap rate compression in the industrial sector can be attributed to competition amongst institutional investors for this product. The higher average price point for this asset class allows institutional investors to allocate larger pools of funds in single transactions rather than multiple smaller transactions.

Following a dynamic 2013 with more than $44 billion of net lease transactions, according to Real Capital Analytics, the net lease market experienced a significant amount of additional supply in the first quarter of 2014. The supply of net lease properties increased to more than 3,000 properties available in the first quarter, a 17 percent rise when compared to the previous quarter. Owners of lower quality assets, with shorter lease term or limited credit, have added supply to the market to take advantage of the low cap rate environment as the consensus of net lease participants believe that the market strongly favors sellers.

Despite the influx of supply, a lack of quality offerings remains in the single tenant market across all sectors. The main challenge facing investors is the limited pipeline of properties with long-term leases to investment grade tenants in primary markets. Even with lower quality retail assets more prevalent in the market, cap rates for the entire net lease retail market continued to decline to historically low levels. After vigorous fundraising years and accommodating capital markets, investors are struggling to acquire assets that fit acquisition criteria while meeting return thresholds.

Transaction volume for the single tenant net lease market for 2014 is expected to be on par with 2013 assuming the 10-year treasury remains stable. Regardless of the increase in supply of assets, current demand greatly exceeds today’s inventory levels. Demand should remain consistent as positive price and transaction momentum continues to attract investors.