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NREI Research Series
Research Series 2017

Part 2: Challenges and Opportunities

As part of the survey, we asked respondents to write about what they saw as the biggest changes in the space from 12 months ago and what they saw as the biggest opportunities and challenges for the net lease sector.

By far the change noted by most respondents was the interest rate environment. And some uncertainty about what lies ahead may be leading to a last spike in deals.

“There seems to be a greater sense of urgency among investors and developers,” one respondent wrote. “They seem to sense that activity will not last long.”

An increase in interest rates is already causing cap rates to creep higher and there could be more price adjustments ahead for 2017.

“Going into this year, the big question mark is going to be how much the recent rise in interest rates is going to affect the single tenant market, as well as investment sales overall,” says Britton Burdette, a director with the Stan Johnson Co. in Atlanta. During the fourth quarter, the 10-year Treasury yield increased about 80 basis points from 1.63 percent at the start of October to 2.45 at year-end and it continues to hover around that same level.

Pricing on net lease assets has been at all-time highs for the past two to three years, and many in the industry believe that higher interest rates will likely have a cooling effect on pricing and cap rates. In fact, there are signs a correction is already starting to occur. According to a fourth quarter report released by The Boulder Group, a Northbrook, Ill.-based real estate services firm specializing in single tenant properties, cap rates for the single tenant net lease sector increased or remained the same for all three asset classes during the fourth quarter. Retail cap rates climbed a slight 9 basis points to 6.19 percent—their first increase since the third quarter of 2013. Cap rates for the industrial sector increased by 3 basis points to 7.17 percent, while cap rates in the office sector remained unchanged at 7.08 percent.

It is still a bit early to gauge the full impact of higher interest rates. “Overall, it hasn’t had a huge effect on demand or pricing quite yet. But that is something that we certainly expect to see a little later down the road,” says Gary Chou, first vice president and senior director at brokerage firm Matthews Real Estate Investment Services in Los Angeles.

For example, among the 40 to 50 active deals that Chou is working on currently, the increase in interest rates has only had an impact on one or two deals. There are a couple deals coming together where the buyer came in very aggressive and then re-evaluated their offer due to higher financing costs, he adds. “So it has had an effect, but it hasn’t had a drastic effect yet,” he says.

It also remains to be seen whether a shift in pricing expectations will slow sales activity. “Buyer demand is still very strong. There is still a lot of liquidity on the sidelines chasing solid assets,” says Chou. That being said, single tenant transaction volume has declined compared to the near record highs achieved in 2015. That could be a reflection of the bull run the market has been on in recent years, with a lot of opportunistic sellers that have already pulled the trigger and completed transactions.

Last year was another strong year for single tenant investment sales, with total transactions of $54.1 billion—on par with 2014. However, that volume fell short of 2015 by about 16 percent, according to research firm Real Capital Analytics (RCA), which tracks single tenant property sales valued at $2.5 million and higher.

TAGS: Net Lease News
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