Investors are increasingly moving into the net lease property sector, but with few new retail spaces coming to market, cap rates in the arena are expected to continue compressing.
Net lease has become “an in vogue sector at the moment,” says Randy Blankstein, president of the Boulder Group in Northbrook, Ill. Investors are staying conservative and are looking for opportunities that will yield steady, predictable cash flows. Meanwhile, with interest rates low, few investments promise significant yields.
“You still have the dynamic of a lot of people who are not getting a return on their treasuries or checking account, who are looking for a stable, steady income stream,” says Gregg Siebert, senior vice president of investments with Spirit Realty Capital in Scottsdale, Ariz. “The benefactor is the net lease sector.”
In addition, Siebert says, cheaper and more abundant capital is allowing more investors to enter the net lease space.
But few long-term net leased properties are available, according to a Boulder Group market report. Overall supply of net leased assets declined 14.4 percent from the third quarter of 2012 to the fourth quarter.
Some tenants are backfilling second-generation retail space rather than expanding. Owners are also taking advantage of low interest rates by refinancing and holding onto properties instead of selling. Meanwhile, some properties are not reaching the public market before changing hands.
Discount retailers, a subsector of the net lease market, are bucking the trend and expanding. Dollar General and Family Dollar are expected to add a combined 1,000 stores across the country this year. Auto-parts chains are also growing, says Brad Thomas, senior vice president of capital markets at Bull Realty in Atlanta.
However, discount stores tend to sign 10- and 15-year leases, and most investors are looking for larger properties and longer leases. “A lot of people have portfolios that are full of dollar stores and are looking to find other things to diversity their profiles,” Blankstein says.
Meanwhile, business models of retailers such as Best Buy and Barnes and Noble, often net lease tenants, are under pressure, inhibiting their growth, according to Thomas.
Blankstein expects the net lease market to remain active throughout the year. A Boulder survey found that a majority of active participants in net leasing expect this year’s volume to rise between 5 percent and 14 percent over 2012 levels. Investors are bidding up existing desirable properties, keeping cap rates on a continued trend of compression.
According to Boulder, cap rates fell 25 basis points in the fourth quarter of 2012 from the previous quarter, near historic lows for single tenant net lease properties in retail, office and industrial sectors. Median asking vs. closed cap rate spreads for retail properties declined seven basis points, with the most significant cap rate compression occurring among FedEx, McDonald’s and AutoZone sites.
“I think we’re almost scraping the bottom” in terms of cap rates, says Thomas of Bull Realty. “But some folks think there’s more room to go.”
“Everyone is looking for the same thing, long-term investment-grade properties,” Blankstein says. “And since new development is challenged, they’re becoming harder and harder to find.”