Net Lease Investments Offer Stability

Net Lease Investments Offer Stability

Interest in alternative assets among both institutional and individual investors has been growing in recent years, and that trend is expected to continue for some time. As a key source of alternatives, the net lease sector can expect to reap benefits as well, observers say.

Globally, alternative investments across individual and institutional segments doubled in assets under management from 2005 to 2011, to $6.5 trillion, according to a June 2012 McKinsey and Co. report. That growth outpaced that of traditional asset classes over the same time period.

Investors surveyed by McKinsey expected to increase allocations by the end of 2013 to most forms of alternatives and to maintain that focus over the next three years.

“Growth is expected to continue, fueled by increasing allocations by institutional investors and the movement of alternatives into the retail investment mainstream,” the report said. Every U.S. investor who responded to McKinsey’s surveys expected growth in alternatives to exceed that of traditional management products.

More capital is freeing up and, due to the merger of Spirit Realty Capital and Cole Credit Property Trust II and also of Cole Credit Property Trust III with Cole Holdings Corp. The mergers will continue to fuel growth, says Kevin Shields, CEO of Griffin Capital Corp. in El Segundo, Calif.

Shields and other executives say that investors turn to net lease deals due to the promise of higher yields as compared to traditional assets. Yield from real estate exceeded that of 10-year U.S. Treasury securities by 467 basis points as of November 2012. And trends in cap rates have generally lagged behind bond markets.

For investors, net lease offers relative stability compared to more volatile options, with durable and predictable yields. The promise of stable yields is expected to appeal in particular to individual investors approaching retirement and therefore seeking consistent annual returns.

Furthermore, “investments in single-tenant, net-leased real estate are also significantly more tax-efficient than investments in treasuries or corporate bonds,” wrote Brandon Duff and Brad Feller, of Stan Johnson Co. in Tulsa, Okla.. Tax codes allow rental income from net lease investments to be sheltered in property depreciation, and Code 1031 allows investors to defer capital gains taxes following sales.

Unlike a treasury bond, a tangible property will also retain value even in the case of a default on a lease, Duff and Feller noted.

“We want to deliver to our constituencies the kinds of products they’re looking for,” says Jason Mattox, executive vice president of Dallas-based Behringer Harvard. “It’s clear they’re looking for investments that focus on capital preservation, but certainly also repeatable cash distributions. And the net lease platform addresses that.”

Underfunded pension funds are starting to see the appeal of the net lease sector, says Brad Watt, executive vice president of net lease investment at Behringer Harvard—a position the firm added in November 2012.

The California Public Employees’ Retirement System, the country’s biggest public pension fund, recently increased allocations to net lease, Watt says. “It really is starting to become a very large portion of the fixed-income strategy within these pension funds,” he notes.

Another advantage of net lease is the smaller size of the assets involved, Watt says. “The granularity of net lease allows for multiple strategies.... You can’t necessarily have that with $30 million to $40 million office buildings.”

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