Cap Rates Going Down, Prices Up but Shrinking Supply, Capital Market Concerns Holding Back Sales

Could investors finally be feeling net-lease fatigue? When stocks plunged, hordes of mostly mom-and-pop investors surged into the single-tenant, net-leased property market, snapping up drugstores and restaurants at record numbers, and helping lead commercial real estate out of the last Great Recession.

But sales of net-leased property has slumped dramatically in the first three months of this year. According to preliminary totals for the first quarter, CoStar Group shows that single-tenant, NNN sales totaled almost $2 billion. And while there are still additional deals to collect and confirm this month for that period, the current volume number is about 70% less than the total single-tenant, NNN sales racked up in the first quarter of 2015.

Analysts point to the usual suspects for the muted net lease sales market this year, including uncertainty in the capital markets, a shrinking supply of new product and changing consumer demand away from fast food to fast casual dining, according to research from net lease sales specialists.

The bright spot in the numbers is that NNN retail sales are down only about 30% and sales in the drugstore and restaurant segments are holding even, according to CoStar data. And we’ll start there.

Drugstores, an Rx for Softening Sales

Sales of retail property leased to drugstores accounted for about $425 million in sales in the first quarter of 2016, almost equal to the same quarter as last year. Average sale prices have climbed dramatically from about $385/square foot at the start of last year to about $485 through last month, according to CoStar data.

“2015 was a historic year for single-tenant drug stores sales in California,” said Bill Asher, executive vice president with Hanley Investment Group Real Estate Advisors, a real estate brokerage and advisory firm specializing in retail property sales. According to CoStar, 16 single-tenant drug stores sold in California for an average cap rate of 4.94% compared to 10 transactions for an average cap rate of 5.40% in 2014. Seven long-term leased drug stores traded hands in California in 2015 with a 4% in the cap rate.

“Given the continued market conditions and lack of supply of alternative quality single-tenant investments for investors to choose from, sellers are taking advantage of peak pricing while investors have lowered their minimum return requirements to invest into drug stores as a flight to security,” said Hanley Investment Group Senior Vice President Patrick Kent.

“Drug store buyers are not only looking at the tenant credit of Walgreens when making purchasing decisions, but evaluating how that is complemented by the lease structure and fundamental quality of the real estate,” added Kent.

Fast Casual vs Fast-Food

First quarter property sales for fast-casual restaurant properties also were in line with year-ago numbers, totaling about $275 million in each period. Here too, average sales prices have been climbing, moving up from about $455/square foot at the start of last year to about $540/square foot through March 2016, according to CoStar data. The category has been faring vastly better this year compared to the fast-food segment.

Triple net fast-food property sales so far total just $125 million in the first quarter of 2016. That is down about half from a year ago. Average prices have varied little over the last five quarters starting and ending the 15-month period at around $535/square foot.

Stock and bond rating agencies have been mostly negative in their assessments of fast-food companies. Rating agencies hit Wendy’s, McDonald’s and Yum! Brands, owner of Kentucky Fried Chickens, Pizza Hut and Taco Bell, with downgrades for their recent build-up of debt, noted Calkain Cos.

Despite the outlook, Calkain noted that all of the firms reported increased fourth quarter sales.

NNN Office, Industrial Sales Lead Decline

First quarter sales of triple-net industrial property came in about two-thirds less in the first quarter of 2016 compared to the year-ago period. This despite the fact that cap rates in the first quarter of 2016 for the single-tenant industrial sectors reached a low rate of 6.18, according to research from The Boulder Group, a net lease advisory firm.

Pricing was also strong for industrial properties during the first quarter, swinging up from $90/square foot on average in the first quarter of 2015 to more than $110/square foot in the first quarter of this year.

As demand continues for the net lease sector, the supply of available property for sale has remained constrained, according to Boulder Group. Overall supply decreased 3% in the first quarter of 2016 compared to the previous quarter.

New construction properties are in the highest demand among 1031 and private buyers as they typically have the longest lease terms, the firm noted. However, they remain in short supply as construction levels have been lower than previous years.

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