How would Interest Hikes Impact Net Lease?

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GlobeSt.com

IRVINE, CA—An anticipated rise in interest rates will affect all sectors of commercial real estate, and net lease is no exception. In this exclusive discussion with net-lease experts, GlobeSt.com gets their take on the specific ways the sector could be impacted. Stay tuned for a more in-depth feature in Real Estate Forum on new strategies for net-lease investors.

With interest-rate hikes looming, what dynamics would this create for the net-lease sector? “As interest rates rise, cap rates tend to follow over time,” says Gino Sabatini, managing director and head of net-lease investments forW.P. Carey, tells GlobeSt.com. “However, there is often a lag between interest rates and the corresponding increase in cap rates. Particularly in the current competitive environment with the participation of investors with shorter time horizons, we would anticipate there to be a lag.”

Chris Sands, founder of Sands Investment Group, tells GlobeSt.com that there typically is a lag time between a rate increase and any following change in cap rates. “Therefore, we expect this would cause some hesitation with the buyers to continue to make offers as aggressively as we have been experiencing now. This is due to the uncertainty of how much of a correction will occur. Eventually, as with all markets, once we see some consistency in rates following the rate hike, the gap between buyers’ interest and sellers’ demands will once again align, and the market will move back into a healthy growth pace.”

Sean O’Shea, managing director for the O’Shea Net Lease Advisory, a BRC Advisors Co., tells GlobeSt.com even with interest-rate increases, demand will still be there going forward, since these NNN properties continue to afford a predictable, stable income stream. “So, even if we have a 25-bps adjustment with the Fed this month, prices may not be adjusted for another couple of months by the sellers. Competition will be even more fierce for the ‘best-of-breed’ NNN assets, so solid market intelligence is critical.”  

Ed Hanley, president of Hanley Investment Group Real Estate Advisors, tells GlobeSt.com a significant interest-rate hike would decrease overall transaction velocity and force sellers to adjust their pricing expectations as the market recalibrated. Meanwhile, Matthew Mousavi, senior managing director of Faris Lee Investments, tells GlobeSt.com, “Debt is the foundation of much of the capital deployed within the net-lease sector. A significant hike in interest rates could potentially negatively impact the value of net-lease properties since the higher interest rates charged by lending institutions could limit the prices investors are willing to pay for net-lease investments. Also, higher interest rates could result in higher yields and lower prices offered by alternative investments that could take capital away from the net lease space, thereby further reducing demand and lowering values.” 

However, several factors exist that could potentially negate the negative impact of higher interest rates within this sector, Mousavi adds. “First, many net-lease transactions, particularly those under $5 million, are purchased by all-cash investors, including 1031-exchange buyers, private individuals (located domestically and offshore), partnerships, etc. Since these investors aren’t utilizing debt to purchase net-lease properties, they are less sensitive to interest rates. In the case of all-cash offshore capital, from Asia, Europe and elsewhere, many of these investors are eager to deploy capital within the US net-lease market for preservation of capital purposes, long-term growth potential, perceived security and the low-risk profiles of the US net-lease market. Second, higher interest rates tend to reflect higher inflation, a sign of positive growth within the economy. As inflation increases, consumers pay more, thereby increasing profits for goods and services offered by occupiers of net lease properties, who then can grow, expand and pay higher rents for properties. Higher rents will cause developers to construct more properties as tenant demand for space increases.”

Nevertheless, due to the slower pace of the economic recovery, and anemic—and in some cases negative—growth abroad, “we do not see a significant interest rate hike as a likely outcome,” says Mousavi. “Rather, we see the Fed increasing their federal funds rate at a slower pace, which bodes well for lower cap rates and higher values.”

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