As the new year begins, the net lease market remains strong on the demand side. The supply side, however, is another story. The Boulder Group believes that the number of available net leased properties of all types has reached a ten-year low.
Many net lease investors think that the inventory is at least two years away from catching up with the demand. Once the sluggish economy fully turns the corner, development activity will increase and only then can the market equalize.
As of November, The Boulder Group tracked 3,198 net leased properties with a combined value of $11.2 billion. While noone knows for sure how many net lease properties exist, estimates value the total market at about $20 billion a year. Of those company's followed by Boulder, 1,872 properties, or 59 percent of the sample, are retail, accounting for $4.3 billion, or 38 percent of the total.
This disproportionate share of properties to value is due to retail properties having the lowest median selling price, $1.47 million, in the net leased market. Based on this low median, the average investor only has to provide about $300,000 of equity to purchase a retail net leased property. Therefore, despite common notions to the contrary, the net lease market is open to investors with smaller amounts of equity.
More than 75 percent of all retail properties are either free-standing buildings or restaurants, a figure that should rise to 80 percent in coming years. The expected increases in free-standing buildings vs. the typical strip center is of great utility to the net lease investor as most free-standing buildings, including the Wal-Marts of the world, are net leased properties.
Based on the current demand, there are significantly fewer high-yield properties available relative to the industrial sector. Comparatively, in the retail sector properties over $6 million have an average CAP rate of 7.52 percent, far lower than the 8.7 percent for similarly priced properties in the industrial sector. Therefore, investors seeking to purchase properties over $6 million have higher yielding alternatives available to them in the industrial or office sector, in which similar properties have an average CAP rate of 8.55 percent.
As CAP rates go up, prices go down. The highest CAP rate investments available in the retail sector are the lower-cost, higher-yield properties. However, many of these properties face market challenges such as short-term leases.
About 75 percent of available retail properties cost less than $3 million. Only 1.6 percent cost more than $10 million — representing less than 1 percent of the entire net lease market. This is significantly less than that for the industrial and office sectors, which represent 2.4 percent and 3.4 percent respectively.
In retail, the most sought-out properties are those retailers with investment grade credit ratings — those with a Standard & Poor's rating of BBB or higher. Walgreens, Home Depot, CVS, Wal-Mart, Lowe's, Costco, Kohl's and Sam's Club are examples. But many investors are still interested in borderline credit tenants such as Bed, Bath & Beyond, Albertsons, Eckerd, Staples, Toys “R” Us, and Best Buy. Moreover, investors remain interested in corporate-backed restaurant properties, which comprise almost 25 percent of the available retail net lease properties.
Based on a ratio of available properties by state to state population (as measured by the 2000 Census), Georgia, Arizona, Florida, California and Texas offer the greatest number of available properties, or 56.3 percent of those tracked by Boulder. This trend can be attributed to high levels of new construction commensurate with the strong population growth.
Currently, the more difficult states in which to locate investment properties are in the Northeast. New York, New Jersey, Michigan, Pennsylvania and Massachusetts have the least number of net lease opportunities as compared to the population. These more mature states only represent 2.7 percent of the available properties on the market.
Jeff Rothbart is an attorney and research director of The Boulder Group, an investment real estate company. He can be reached at 847-753-8446 or [email protected].
Northbrook, Ill.-based The Boulder Group provides brokerage, advisory and financing services to clients including corporations, REITS, individuals, partnerships, developers and institutional investment funds. Founded in 1997, it's one of the only firms focused exclusively on 1031 exchanges and net leased income properties.
RETAIL SECTOR OVERVIEW