Challenges And Opportunities In Net Lease

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GlobeSt.com

Rising interest rates are having a direct impact on investors’ purchasing decisions, but the single-tenant net-leased market has always been the place to find high-quality, low-management investment real estate, HIG’s Jeremy McChesney tells GlobeSt.com.

CORONA DEL MAR, CA—Rising interest rates are having a direct impact on investors’ purchasing decisions, but the single-tenant net-leased market has always been the place to find high-quality, low-management investment real estate, Hanley Investment Group EVP Jeremy McChesney tells GlobeSt.com. We spoke with McChesney about how he would characterize the state of the sector today. (For a more in-depth feature on the net-lease market, see the July/August issue of Real Estate Forum.)

McChesney says the market is still very vibrant, and although the frothiness of the sector has slowed some, investor demand for new, well-located single-tenant triple-net-leased properties with credit tenants and properties with a long-term, corporate-guaranteed lease remains very strong. “Buyers seeking long-term stable cash flow with relatively low risk and little to no maintenance are continuing to pay premium prices for these types of properties.”

He adds that even though we are slightly off of the peak of last year, high-quality, well-located, credit-tenant, net-lease-retail assets are still trading at very aggressive cap rates. “Although, pricing for net-lease investments that have fewer years remaining on the initial lease term has softened.”

McChesney also says that rising interest rates have been at the top of everyone’s mind and have a direct impact on investors’ purchasing decisions. Most commercial retail real estate lendingis tied to the 10-Year Treasury, which has been rising and falling in recent months. “Investors do not like uncertainty, and there is considerable uncertainty about the economic impact of President Trump’s policies. However, once the tax reform is finalized, and depending on what that looks like, then this news could be very positive for investors.”

Since demand for assets with corporate-backed tenants with long-term leases such as banks, QSRs and drugstores has caused significant compression in cap rates, investors are looking for alternative investments with more favorable cap rates, such as auto-parts stores, convenience stores or some in secondary markets with the same credit rating, says McChesney. “We expect that sales volume for auto-parts stores as net-leased investments will stay strong in 2017. Existing properties with an extensive history and newly minted long-term leases, along with newly constructed assets should continue to be in the highest demand and trade in the 5% to 6% cap-rate range. However, properties with a shorter lease term located in areas with strong real estate fundamentals will also remain in high demand.”

Another category with promise is the convenience store, such as 7-Elevens. McChesney says from January 2016 through May 2017, 132 7-Elevens traded hands across the country, with an average cap rate of 5.21%, and he expects sales volume for single-tenant 7-Eleven net-leased investments to stay strong this year. “Existing properties with an extensive history and new long-term leases should continue to be in the highest demand, trading in the low-5% to 6% cap-rate range. Properties with a shorter lease term located in areas with strong real estate fundamentals will also remain in high demand.” He adds that investors like single-tenant 7-Eleven properties for their resistance to Internet intrusion and residual value since they are typically well located at high-traffic-signaled intersections.

Lastly, McChesney says he expects quality single-tenant fast-food and coffee assets like Chick-fil-A and Starbucks to remain in high demand throughout the year. “Existing properties with a documented history as well as brand-new long-term leases should continue to be in the highest demand and trade from a 4% to 5% cap-rate range depending on their location—even sub-4% for some West Coast MSAs.”