Net Lease Property Investing Today
The single tenant net lease investment market attracts all kinds of investors: institutional, private, crowdfunding and REITs. Nancy Miller, SVP National Net Lease Investment Group at Bull Realty and Scott Lindstrom, Director of Real Estate and Development with Garrard Group joined me to discuss the basics of the sector, current trends and tips for investors.
A single tenant net lease property is a freestanding building leased to one tenant. Typically, leases for these properties are long-term and triple net, meaning the tenant takes care of everything (operating expenses, taxes, and insurance).
Miller described these investments as “hands-off.” In addition, they are also “safe” because the majority of tenants are national credit tenants.
One way of looking at a cap rate is that it is your cash-on-cash return in the first year if you pay all cash on a property.
Currently cap rates are trending down in the sector. In 2014, cap rates averaged 6.67% year-over-year for properties in the $1-3 million range, (which Miller said is the most common price point range). In 2015, rates compressed to 6.25%.
The greatest sales volume is still with Dollar General and Family Dollar, said Miller. Other active tenants are QSRs: Wendy’s (most active), Starbucks (active again after a quiet period), and others such as Burger King, KFC and Taco Bell. Lindstrom also mentioned the rise of specialty grocery stores.
Sales volume overall has increased year-over-year. In 2014, there were 900 transactions. In 2015, there were 1,072 transactions, which is an 18% increase.
Some of the lowest cap rates for the sector are drugstores. For Walgreen’s and CVS, you will see cap rates in the 5-5.5% range, said Miller. Drugstores typically will have a 15, 20 or 25 year lease with 5 year options.
Speaking of drugstores…akin to last year’s dollar store merger, Walgreen’s and Rite Aid have a pending merger. Together, the stores have 12,500 locations and they are going to keep separate names, said Miller. Cost efficiency is the driver. “We may see some stores close, but not to a huge extent.” Ultimately, she believes the FTC will scrutinize the deal and approximately 1,000 stores will close.
Changes on the Horizon: Rising Interest Rates and FASB
Industry experts seem to agree that the impact of rising interest rates depends on how fast they are rising. Typically, cap rates lag 6 months behind interest rates. Miller expects that rates won’t go up more than 50 basis points over the next 12 months. However, once they go higher than that, cap rates will have to start adjusting. Miller estimates around 75% of people are paying cash right now since there are so many 1031 exchange buyers. And currently, cash is so cheap, even potential cash buyers are choosing financing. “Right now with 60 or 65% down, you will get a 3.9% interest rate on a five-year balloon, a 4.25% interest rate on a seven-year balloon and 4.5% percent on a 10-year balloon,” said Miler. But be careful of debt-leverage. As interest rates go up, we will lose some of the positive leverage in the market today.
The upcoming Financial Accounting Standards Board (FASB) lease accounting changes could potentially put even more strain on supply in the STNL sector. Since these changes will require leases to be capitalized, eventually, retailers may start doing more self-development and there may be an inclination of more tenants wanting to own over lease or to have shorter leases.
Tips for Investors
- Pay attention to your lease terms: Lindstrom says that some of the trends are favored toward the tenant.We’re seeing the elimination of percentage rent clauses, the rise of confidentiality clauses and tenant improvements (TI) as part of the rent structure which could create a rent above market value (and thereby making the property harder to sell).
- Request your due diligence as early as possible. Depending on the complexity of your leases, gather your third-party reports and things that the seller or the developer may have so you can feel confident that you understand what you're doing early on.
- Actually visit the property! Make sure to do a site visit if you can.
- Make sure that when you are reading the lease that it is a true triple netand that you as the landlord aren't responsible for roof structure, parking lot, etc. If you are responsible, sometimes with a new property, there is a transferable warranty on the structure on the roof which you want to make sure does come to you, the buyer.
- Increase your yield. If you're really concerned about all these low cap rates we’ve been talking about, it may be a great time to look at a really high-quality double versus a triple net lease because it's going to increase your cap rate or yield on the property.
Michael Bull, CCIM, is the host of the Commercial Real Estate Show, heard around the country on 47 radio stations, iTunes, YouTube and the show web site CREshow.com. Michael is an active commercial real estate broker with Bull Realty, a U.S. commercial real estate sales, leasing and advisory firm headquartered in Atlanta. Michael on Twitter, LinkedIn or 404-876-1640 x 101.