NEW YORK CITY – As more players enter the market, the growing demand for net leased commercial properties in the United States is driving higher prices and lower cap rates, making it a good time to sell such assets.
According to a new report from national brokerage firm The Boulder Group, average capitalization rates for net leased commercial, office and industrial properties fell 22, 15 and 19 basis points, respectively, between the second and third quarters of This year. The number of net leased retail and office buildings in the market both increased between the second and third quarters of this year, but the report notes that the sector is still defined by “significant investor demand combined with supply. limited quality assets “.
Like any other asset class, some net leased product sub-categories outperform others. Due to the combined forces of e-commerce and a global pandemic, the industry remains a leader while the office is surrounded by uncertainty. Likewise, in the net rental commercial space, properties leased to essential service retailers and patio quick-service restaurants are among the preferred investment vehicles.
But at a broader level, institutional investors are increasing their presence in the net lease space, attracted by its penchant for long-term stability. Sources of private capital also continue to target net leases, which often involve smaller, single-tenant properties with prices that allow private buyers to compete on an equal footing with institutional players.
The supply-demand balance in the US net rental market and the long-term sustainability of the current momentum were among the main topics of discussion of the State of the Industry panel at the 13th annual InterFace Net Lease conference. held on September 29.
Hosted by Atlanta-based France Media in the New York Bar Association building, the event took place both in person and in a virtual format. Gordon Sinclair, director of business development and strategy at Egan-Jones Ratings Co., moderated the opening panel.
Panelist Coler Yoakam, senior general manager of JLL’s Dallas office and co-head of the company’s net leasing group, kicked off the discussion by providing some basic numbers illustrating the growth in transaction volume in the space. According to his data, over the past 12 months, net rental agreements have accounted for about 15% of all business transactions in the country. Historically, that proportion has been closer to 10 percent, he said.
“The net rental space is getting a lot more attention because of the migration of capital into it,” Yoakam said, noting that about three-quarters of those deals were in single-tenant assets. “The buyer profile is as diverse as it was before the pandemic – a mix of institutional and high net worth participants – but in greater numbers.”
Yoakam added that compared to 2019, the number of net rental transactions that JLL has entered into is slightly down, but the volume of transactions based on dollar amount is up significantly. “Our numbers speak both to asset appreciation and the market’s preference for larger deals for stabilized properties,” he explained, adding that the good availability of debt and equity for Net rental transactions also boosts the transaction volume and pricing of these properties.
Panelist Jon Hipp, head of Avison Young’s U.S. net leasing group, gave another reason why demand and prices for net leased properties are on the rise: More companies are launching funds specifically adapted to this asset class.
“It seems like every week a new group comes in with a new fund with allocations for net rental transactions, which is great for brokers and sellers,” he said. “Some of these new funds that try to raise capital tend to be more aggressive than established funds. This causes established funds to be more aggressive in order to compete and potentially buy at lower cap rates. “
Advantages and disadvantages
Other panelists representing investment firms and brokerage houses weighed in on the positives and negatives of the current high demand market.
“Competition is healthy for the industry, and it’s great that there is a lot of visibility in the net rental market right now,” said Gino Sabatini, Managing Director and Head of Investments at REIT WP Carey , based in New York. “There are some big names out there who are interested in supporting net rental platforms, and that gives the industry credit as a legitimately self-sustaining asset class.”
Qualifying the statement, Sabatini added that net rental space has not historically been seen as one of the major food groups in business investment – a perception that he says changes as more capital flock to the market.
Yet the constant and increasing flow of capital seeking an investment in leased net assets – both on the debt and equity side – can be a double-edged sword, according to panelist Gordon Whiting, chief executive of New York-based alternative investment firm Angelo. Gordon & Co.
“A rising tide lifts all boats, but there is concern that as more capital enters the market investors will seek deals based on structure as well as price,” he said. “Inflation is starting to rise, and there is going to be a change in the market. When this happens, many of these transactions in the net lease market could collapse because they were not properly structured and buyers are paying too much.
Whiting’s analysis argued that homeowners who overpaid for these properties could default on their loans in an inflationary environment, hurting debt markets. In addition, he said that such a scenario could hamper the ability of investors to raise equity contributions for future net rental transactions.
“People are so anxious to make deals that sometimes they start to put irrational terms in those deals, which hurts the entire industry in the long run,” he said. “In this market, it’s important to remember that once you’ve entered into a lease, it’s usually there for 20 years. So any bad structure that has been created is going to come out when the owner tries to sell. “
Sabatini agreed with the logic behind Whiting’s analysis, but cited an age-old industry maxim as to why the potentially overvalued market does not pose an immediate danger to investors. “In net leasing, you can make stupid deals today, and no one will know for 10 years,” he said. “But if you’re a long-term holder and the investment isn’t that big, it can catch up with you.”
On the brokerage side of the panel, Yoakam agreed that the inability of new sources of capital to “stay disciplined” could potentially be a big problem for the industry. “At this point in the cycle we’ve certainly seen investors make deals and get lower returns. But the extent to which this becomes a problem remains to be determined. “
Panelist Daniel Taub, national director of the retail and net leasing division of Marcus & Millichap, also assessed market dynamics through the eyes of a broker. Taub did not dispute the strong growth other panels attributed to the demand side of the equation, but instead referred to the supply side and the relative scarcity of products within it.
“Right now, buyers and sellers need to be very careful with how they view transactions because there is a huge imbalance between capital for deployment and product available for placement,” Taub said.
“This gap continues to widen in the wrong direction and as a result we see buyers accepting more aggressive terms and more direct deals made preemptively in order to access the offer,” he continued. . “So there are some levels of foam, and the lack of product really does have an impact, even as more capital is added to the market.”