Which Net-Lease Sector is Driving Pricing to Cap Rate Record?

By Randy Blankstein, President, The Boulder Group

Cap rates for the single tenant bank ground lease sector continued their descent to a new historic low of 4.3 percent in the first quarter of 2015. This signifies a 40 basis point decrease since the first quarter of 2014. Furthermore, this represents the lowest cap rate across all net-lease sectors, which The Boulder Group tracks. The bank ground lease sector is comprised of both national and regional banks, regardless of credit. Investor demand for bank ground-lease properties remains strong as banks are one of the few single-tenant, net-lease properties offering long term absolute net leases and rental escalations in the primary lease terms. Additionally, many private and 1031 investors look to this sector for safe and stable returns, as 90 percent bank ground leases are leased to investment grade rated companies. This statistic further contributes to the demand and cap rate compression within the sector.

While overall demand has increased over the past year for net-lease properties, the supply of bank ground leases has decreased by 30 percent since the first quarter of 2014. The shortage can be attributed to the limited retail expansion plans for banking institutions. The lack of new supply has led to increased competition amongst buyers as illustrated by the Median Closed Cap Rate Spread chart. In the past twelve months, the spread between closed and asking cap rates decreased to 17 basis points. Additionally, there was a 205 basis point premium in cap rates for bank ground leases when compared to the retail net lease market. The overall cap rate compression for this sector can best be attributed to the supply shortage coupled with a high demand for assets with rental escalations and absolute net leases priced between $2 and $5 million.

Bank ground leases with more than 20 years of lease term remaining are in the highest demand amongst net lease investors. From the first quarter of 2014 to the first quarter of 2015, these ground leases experienced the greatest cap rate compression in this sector (40 basis points). It is rare for a bank ground lease to have a lease with more than 20 years remaining as the vast majority of new leases are for 20 years.

Investor demand for bank ground leases is expected to remain strong as investors are attracted to the security that this asset class provides. Transaction volume should remain concentrated in properties with long term leases; however shorter term ground leases with strong bank branch deposits will generate significant interest. With a shrinking supply of bank ground leases, competition amongst buyers seeking assets leased to investment grade tenants with rental escalations will continue.