By Bill Asher & Jeff Lefko
What has been the most remarkable change in the single-tenant net lease sector over the past 12 months?
Overall, there has been a substantial increase in net lease inventory and a significant decrease in demand in the last four to six months of 2022. This is due to fewer industrial, land and multifamily sales, which translates to a smaller pool of the typical 1031 exchange buyers trading into single-tenant net lease retail. Additionally, a large number of passive buyers are on the sidelines, waiting to see if they can get a better deal in 2023 rather than paying the compressed cap rates of 2022 and 2021.
In the third quarter of 2022, there was a 15 percent decrease in the number of single-tenant retail transactions and a 16 percent drop in the total value of the transactions compared to the previous quarter. There were 2,568 single-tenant transactions valued at $9.6 billion with an average sale price of $3.74 million in the third quarter of 2022, according to CoStar, for the number of transactions between $1 million and $35 million (and removing any portfolio sales from the data). In the second quarter of 2022, there were 3,028 single-tenant retail property transactions valued at $11.45 billion with an average sale price of $3.78 million.
Now, as we are nearing the close of the fourth quarter of 2022, CoStar is reporting that 1,642 single-tenant retail properties were sold totaling $5.58 billion (with an average sale price of $3.4 million) between October 1st and December 20th, representing a 9 percent decrease in the average sale price and a 36 percent decline in total transactions and a 42 percent drop in total sales volume between third and fourth quarter 2022.
However, despite rising interest rates, 2022 was one of the best years in the company’s history. Although there has been a slowing of transaction velocity compared to the blistering pace of 2021 (in the fourth quarter of 2021, Hanley Investment Group closed 90 deals in 90 days), as of December 2022, Hanley Investment Group had exceeded the number of deals and sales volume of all previous years outside of 2021 and is looking forward to taking that momentum into 2023.
What properties are most in demand?
The most popular product type, which represents a “flight to security” for the net lease buyer, is a single-tenant quick-service restaurant with a drive-thru. This is where we are seeing the most demand from individual investors, 1031 exchange buyers and family trusts, especially for corporate leases priced at $5 million or less. These buyers will also consider well-located single-tenant drive-thru properties operated by successful franchisees with a long-term lease. Other popular product types within the single-tenant net lease sector include grocery, express car washes, convenience store/gas stations, healthcare and medical tenants, childcare/daycare, dollar stores, and auto-related services and stores.
Generally speaking, investors have become more selective as they have more inventory to choose from, resulting in longer sales cycles than we have experienced in a while. This means that most buyers are looking for an A+ location with an A+ tenant and know they do not have to pay the same premium that they had to pay six to 12 months ago. As inventory is up, these buyers have an opportunity to get a better deal now with fewer buyers in the market, while sellers still have the opportunity to achieve premium pricing historically.
What positives are there for the STNL sector at present?
If we look back at history, we can say with certainty that people WILL continue to invest in single-tenant retail real estate, especially as an alternative to the volatility in the stock market or other available investment vehicles. Investors will continue to pursue single-tenant retail properties, including those that allow for depreciation. For example, in 2022 we saw an increase in the number of non-1031 exchange buyers who were focused on investing into retail and closing by year-end to take advantage of depreciation and cost segregation tax strategies.
Sellers who have owned their properties for many years will still be able to take advantage of the fact that, although pricing is not at its 2021-early 2022 peak, the current sale prices are still historically high. Even if these sellers are not long-term holders and still want to realize a historically good profit, 2023 is a good time to sell, whether or not interest rates continue to increase.
Will velocity be at a much slower pace in 2023? Yes, but you never know what can change from a macro-economic standpoint that could accelerate the market again. For example, if rates stabilize and investors become confident about the market’s direction and inflation is down, transaction velocity could increase. Remember, we have been at these interest rate levels before (2009-2010). We know it will be an exciting year in 2023 and we look forward to continuing to create and provide value for our clients and uncovering new opportunities.