Single-Tenant Retail Cap Rates Headed For A Plateau

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GlobeSt.com

Despite the retail bankruptcies and concern about back-filling box spaces, cap rates for single-tenant retail properties have continued to compress. Bill Asher, an EVP from Hanley Investment Group, is on the front lines of investment sales for the asset class, and recently brokered the sale of a Rite Aid property in Antelope Valley at a record low cap rate—a trend that is becoming more common in the market. However, Asher says that cap rates may be plateauing, especially as a result of the recent interest rate increase. To get more insight into the single-tenant market, we sat down with Asher for an exclusive interview.

GlobeSt.com: What is continuing to drive cap rates down in this single-tenant NNN retail?
Bill Asher: 
The lack of a supply of quality inventory for prospective buyers to choose from that is leased to national credit tenants with long-term leases and scheduled rental increases in the initial lease terms, along with minimal or no landlord responsibilities. Additionally, the continued velocity of apartment and industrial owners selling at compressed cap rates and trading into passive retail investments have driven cap rates down or kept them steady in 2017, depending on the retail category. Months leading up to the election in November 2016, investor demand was tepid and most prospective buyers had a “wait and see attitude” with most proceeding with caution. Cap rates and pricing for single-tenant retail showed signs of softening for 3-4 months. After the conclusion of the election in November 2016, and since January 2017, we’ve seen investor activity bounce back, demand increase, and cap rates in some retail categories actually compress; especially single-tenant Starbucks, specifically those with a drive-thru priced under $4 million are continuing to sell with the most velocity and contain the largest audience of any single-tenant retail investment product in today’s market; therefore, generating the most demand. In California, four single-tenant Starbucks properties sold below a 4.25% cap rate in Q4 2016, and three more closed below a 4.15% cap rate in Q1 2017, according to CoStar research.

GlobeSt.com: Do you see cap rates continuing to compress through the end of the year?
Asher:
 No, I think they will remain steady or start to soften depending on the retail tenant type, initial lease term remaining, and price point. The Fed raising short-term rates in the future will also play a factor; however, the 10-Year Treasury rate hit a low for 2017 in June at 2.12% (as of 6/26/17) keeping financing at overall historical low levels and investor demand consistently better this year compared to 2016.

GlobeSt.com: There have been a lot of retail bankruptcies this year and last year. Have you seen demand wane as a result?
Asher:
 Investors are beginning to take longer to evaluate certain acquisitions and using more caution in their decision making in purchasing certain assets. Big box investments are taking longer to sell as tenants transition through bankruptcies, consolidation, and the “right-sizing” of their square footages. Whether its grocery or soft goods, investors are taking their time to commit to big box investments depending on location and type of tenant. Cap rates are starting to increase in this category.

GlobeSt.com: Daily use properties, like the Rite Aid that you just sold, continue to be most popular for investors in this sector?
Asher:
 Yes, daily needs tenants will continue to be the most sought-after in retail. The most compelling characteristics about the Rite Aid sale in Rosamond were the hard corner signalized location, a strategic relocation to a stand-alone building with a drive-thru, and its 20+ year history in the trade area. Those were important selling points that provided the buyer security in the investment and that the tenant would be there for the long-term, even with the potential Walgreens/Rite Aid merger.

FROM THE PRESS RELEASE: “There have only been two other Rite Aids that have traded hands in Kern County in the last 12 months,” said Asher. “According to CoStar, 12 Rite Aids with more than 10 years remaining on their initial lease have sold in California in the last 12 months for an average cap rate of 5.1% compared to four transactions in the 12 months prior to that for an average cap rate of 6.09%. This speaks to the market picking up steam rather than slowing down.”
GlobeSt.com: How have merging grocery and drug stores changed the market for this product?
Asher:
 It’s been minimal. Daily needs tenants, whether a grocery or drug store, continue to be in high demand. Even with the potential Walgreens/Rite Aid merger, cap rates have compressed in the last 12-18 months on the sale of Rite Aids in southern California by approximately 100 basis points.