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Hanging Tough

Single-tenant retail assets remain in favor among cautious investors.

Single-tenant retailers will operate cautiously in 2010 as the economy enters a choppy recovery and consumer confidence increases slowly. That sobriety — along with how the sector performed during the recession — makes single-tenant net lease acquisitions an attractive prospect for cautious investors.

Investment activity for single-tenant net lease (NNN) retail assets slowed more modestly than for most other commercial property segments in 2009, and the sector should be among the first to recover this year. Buyer demand will pick up as the stabilizing economy moderates the frequency of tenant-initiated rent renegotiations. Cap rates, which rose approximately 100 basis points in 2009, should stabilize this year, especially at properties occupied by national-credit tenants.

Having successfully raised cash in the secondary market, traditional NNN buyers, particularly REITs, will actively pursue large properties with national-credit tenants. Demand from private buyers may take a while longer to fully materialize but should strengthen as the economy improves. In addition, the acceleration of sales velocity, especially among apartment properties, could result in an upswing in 1031-exchange activity this year as investors cross over from more management-intensive commercial property segments.

However, obtaining financing will remain a challenge for individuals in 2010, as traditional lenders, including many local banks, will attempt to limit their exposure to real estate debt.

Outlook by sector

Consolidation among retailers, rather than new construction, will likely serve as the primary tactic for gaining market share for the strongest performing chains. For example, Walgreen Co.'s pace of expansion is approximately 40 percent lower than what it was during the boom. Instead, the company will gain market share through the acquisition of more than 250 Duane Reade stores.

Similar acquisitions by single-tenant firms ultimately will lead to closures of some underperforming or overlapping stores. In 2010, this trend will be most pronounced among major banks, where firms such as PNC and JPMorgan Chase, both of which made considerable acquisitions in recent years, will shutter hundreds of branches.

The severity of the recession and the resulting surge of long-term unemployed have spurred tighter personal budgets that favor dollar stores. While the economy will improve this year in most metro areas, the national unemployment rate will remain elevated, stimulating consumer demand for deeply discounted goods. As a result, major industry players will expand.

Healthy performance at dollar stores drove consistent investor activity in 2009, resulting in stable sales velocity, while nearly all other NNN sectors recorded declines. Cap rates for dollar stores, which ended 2009 in the mid- to high-8 percent range, will have to remain near the high end of the NNN spectrum to attract buyers. Cap rates in secondary and tertiary metro areas often exceed 9.5 percent.

Sales also surged at convenience stores/gas stations through the recession and investors continued to pay premium prices for well-located properties. Reflecting the strength of the sector, 7-Eleven plans to open more than 550 stores over the next two years.

Sales velocity for convenience stores and gas stations has held up better than for most other NNN property types, dropping 15 percent last year, after peaking in 2008. Despite the recent decline, velocity remains considerably higher than as recently as 2006, and strengthening tenant sales should drive investment activity this year. Cap rates averaged in the low- to mid-7 percent range in 2009 and will likely stay relatively steady in 2010 as property owners feel little pressure to discount performing assets.

Senior vice president and managing director of Marcus & Millichap Real Estate Investment Services and the director of the firm's Net Leased Properties Group and National Retail Group

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