Net Leased Retail Remains Resilient

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WMRE (Wealth Management Real Estate)

By: Bill Asher & Jeff Lekfo

When the World Health Organization (WHO) declared COVID-19 a pandemic on March 11th, no one could predict how it would impact retail sales transactions and the future appetite of retail investors, specifically based on the immediate effects of a nationwide lockdown. Investors scrambled to reevaluate their positions while the U.S. tried to determine if COVID-19 would be a temporary episode or a longer-lasting event. “Cautious” became a frequently used term describing retail investor behavior in the months to follow during the initial stages of the coronavirus. Some buyers proceeded for-ward with deals that were in process, while others pulled back based on growing uncertainty whether or not some businesses would open their doors again or be sustainable in the long-term.

During the second quarter (April, May and June), 4,329 retail transactions were completed, compared to 7,206 retail transactions in the same period in 2019, as many investors focused their acquisition efforts on retail properties that were deemed essential businesses and services. Transaction velocity got a boost with the extension of the 1031 exchange deadline to July 15th. This enabled many investors valuable time to more carefully consider their options and gain a better grasp on overall market conditions to complete their exchange, as various states began to loosen lockdown restrictions and retailers began to open for business again.

Over the summer, July 15th became a prospective benchmark if retail investment sales would dissipate thereafter and the 1031 exchange extension deadline was a just temporary tool to help maintain some form of sales velocity. Although overall economic conditions had started to improve with federal financial aid programs, unemployment was at a record high, stock market volatility continued, and stay-at-home orders were still being enforced in many regions; not to mention the presidential election was only months away. However, investors refused to stay on the sidelines and continued to show their pursuit to put their money to work, whether in a 1031 exchange or not.

By the end of the third quarter (July, August and September), 6,243 retail transactions were completed.

(Over a 44 percent increase in transactions over the pre- previous quarter, but 29 percent less compared to the same period in 2019.) The U.S. economy also was a relative bright spot as efforts continued to reopen businesses and resume activities that were postponed or restricted due to COVID-19. Real GDP increased at an annual rate of 33.1 percent in the third quarter of 2020, the strongest ever in records going back to 1948. (In the second quarter of 2020, real GDP decreased by 31.4 percent). Furthermore, since April 2020, retail sales in the U.S. have reported six months of consecutive positive monthly gain. Overall, retail sales were up 10.6 percent in October 2020 versus October 2019, and for the first 10 months of 2020, retail sales were up 6.4 percent versus the first 10 months of 2019.

As of this writing, we are nearing the finish line of the fourth quarter and are seeing continued velocity and activity similar to pre-COVID-19 levels as investors look to complete their transactions by year-end. From March 11th through December 11th, Hanley Investment Group completed 90 transactions valued at over $483 million and anticipates a record fourth quarter with more than $400 million in escrow and available for sale.

Transactions over this period included anchored and unanchored shopping centers, inline shop and freestanding multi-tenant pad buildings, single-tenant grocery and drug stores, convenience stores and fuel stations, coffee and quick-serve restaurants, financial institutions, dollar stores, learning and day- care centers, auto parts and services, express car washes, healthcare (medical, dental and vision), mixed-use retail and residential, and government-leased buildings. Some category highlights include:

Grocery

Although institutional owners pressed pause for a majority of 2020 while they worked on restabilizing their portfolio due to the pandemic, single-tenant grocery investments have remained one of the most sought-after as an essential business and daily needs tenant. From organic (Whole Foods, Sprouts) to Hispanic (Cardenas, El Super) to discount (ALDI, Grocery Outlet, Smart & Final), investors see a flight to safety and security in the grocery sector. Hanley Investment Group has marketed numerous single-tenant grocery stores this year and experienced significant demand including structuring a best and final offer process with multiple competitive bids that exceeded the list price for an organic grocer in the Mountain West. Amazon is not only raking in sales online but opened its first brick and mortar store, Amazon Fresh grocery store in Woodland Hills, Calif., in September 2020, and opened its second one in Irvine, Calif., in October. Amazon is expected to open four Amazon Fresh stores in the Chicago area: Naperville, Bloomingdale, Oak Lawn and Schaumburg, Ill. Other upcoming Amazon Fresh stores that have been reported include Northridge, North Hollywood, Long Beach and Whittier, Calif. Additionally, Amazon has been reported to be pursuing a multi-format growth strategy in both urban and suburban locations including taking over approximately 38,000 sq. ft. of the 88,000-square-foot space owned by Kohl’s in La Verne, Calif. This is not the first partnership between Kohl’s and Amazon. Kohl’s sells Amazon smart home products in its U.S. stores, and last year began accepting Amazon returns at its stores, a move which helped boost foot traffic at Kohl’s.

Car washes

With the lack of supply of high-quality, net lease investment properties, single-tenant net lease car washes, especially express car washes, are gaining more favor with private investors. In 2020, 56 single-tenant car wash investments traded hands compared to 87 in all of 2019. In the last 24 months, Hanley Investment Group has sold or has in escrow 41 single-tenant car wash properties across the country valued at more than $166 million, including 11 express car wash properties in 2020.

The reason for this uptick is that net lease express car washes have proven to be pandemic- and recession-resistant, and in most cases, express car wash operators are experiencing an increase in customers due to their convenient locations, speed of service and lower cost with monthly membership plans. Also, the express “do it yourself ” model aligns directly with COVID-19 guidelines and social distancing since no car wash worker is entering a person’s car to clean it. Even more, investors have taken advantage that express car washes offer a larger tax deduction, through depreciation, than virtually any other net lease asset. Investors often ask, “What would happen to the location if the car wash operator closed?” Now more than ever, car wash business operations are selling at such high multiples that the business, in many cases, can be worth just as much as the real estate which provides an investor with another layer of security. We expect that the supply of net leased car washes will continue to increase over the next 12 months as developers and operators continue to take advantage of this low-cap rate environment.

Quick-service restaurants

The winners in this category during the pandemic have been those operators that have maximized their drive-through, curbside pick-up and mobile ordering business. Chains such as Chick-fil-A, Chipotle and McDonald’s have spent a lot of money bolstering the technology and other capabilities of their drive-throughs. McDonald’s generated double-digit same-store sales in September even though most of its dining rooms were closed. Chipotle’s CEO Brian Niccol said that the brand’s digital sales are on pace to exceed $2.5 billion in 2020, according to QSR magazine. Since late March, Chipotle has retained 80 to 85 percent of digital sales while recovering 50 to 55 percent in-store sales. Some of the largest chains like Burger King, Starbucks and Del Taco are either planning or building seatless restaurants and other chains could follow. Dutch Bros. Coffee, which generated 15 percent system sales growth in the U.S. last year, according to Restaurant Business, has been opening 800-sq.-ft. drive-through coffee outlets and now has 400+ locations in Oregon, California, Washington, Idaho, Nevada, Colorado, New Mexico, Utah and Arizona.

Convenience stores

7-Eleven (AA- S&P Rating) is one of the largest, most successful retailers in the U.S., and the company’s operating success as an essential business during the pandemic further accentuates the attractiveness of this investment grade tenant. As investors look to the future and have concerns about economic instability and potentially another pandemic lockdown, buyers are looking to essential businesses with a high credit rating like 7-Eleven that can do well during these challenging times and provide a reliable cash flow. We expect that sales volume for single-tenant 7-Eleven, Circle K, QuickTrip and Wawa net leased investments will stay strong throughout the remainder of 2020 and into 2021. Hanley Investment Group has experienced the highest volume of investor activity this year on convenience store/gas stations, more than any other asset type, due to the average price point and tenant use. In less than four years, Hanley Investment Group has sold 50 7-Eleven and Circle K stores valued at $120 million.

Auto parts and service Investors continue to have a high level of confidence in the auto repair industry and many of the quality properties that we are seeing like Advance Auto, AutoZone and O’Reilly, remain in high demand, representing a flight to safety for many single-tenant private investors. Other auto service-related tenants, such as Christian Brothers, TBC Corp. and GB Auto, Inc. in the auto repair space and Valvoline and Jiffy Lube in the oil change space, have also been a great alternative to traditional net leased retail and are priced at a cap rate level that is a sweet spot for what private capital is seeking—around a 6 percent return. Deemed an essential business during the lockdown, service-based, internet-resistant assets like auto parts and auto service centers are poised for long-term success through future economic downturns; historically, in a down economy, consumers look to repair their car as opposed to purchasing a new car. Over 253 million cars are on the road in the U.S. and 80 percent are repaired professionally over self-repair. The Automotive Aftermarket Network is optimistic that the sales of car parts and accessories will be worth $433 billion by 2021. Hanley Investment Group has sold or has in escrow 21 single-tenant auto repair and service centers in the last 22 months, valued at over $48 million.

A flight to safety

There is no doubt the level of investor demand and trans-action velocity in the retail industry in 2020 has been a pleasant surprise given the uncertain macro-economic circumstances this year. Even with record rising COVID- 19 cases in November and various government shutdowns initiated in different states around the country during Thanksgiving, retail investment sales activity in the last six months has been unexpectedly impressive. Hanley Investment Group’s 2020 total retail investment sales transactions and volume are on track to achieving close to its statistics set in 2019, a record-high year for the firm, and has already exceeded the company’s 2018 achievements.

A flight to safety has been a reoccurring theme of 2020 retail investing but so has the lack of supply of quality retail real estate investment product. This has pushed some private and institutional investors to lower their return expectations to acquire high-quality retail properties rather than take on more risk. With demand outpacing the supply of best-in-class retail investments, we expect to continue seeing premium pricing for properties that represent a flight to quality in tenancy, length of lease and location. Comparatively, there will continue to be a downward shift or separation in pricing for “B” and “C” asset types mostly due to the continued impact of COVID-19.

Although there is a feeling the U.S. is reverting back to the initial stages of the pandemic as the year comes to a close, the anticipation of a successful vaccine indicates the economy overall will rebound more quickly in 2021 and instill further confidence that retail investor demand will continue to be robust in the future.