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M&M: Positive Economic Forces Buoy Net-Leased Retail Sector, Despite Rising Interest Rates

Marcus & Millichap arranged the sale of a retail property net leased to Burger King in Walworth, Wis., for $1.1 million earlier this year. Burger King fully remodeled the property last year and signed a new 20-year lease.

Marcus & Millichap arranged the sale of a retail property net leased to Burger King in Walworth, Wis., for $1.1 million earlier this year. Burger King fully remodeled the property last year and signed a new 20-year lease.

Steady growth of the U.S. economy will likely continue through 2017, benefitting a wide range of single-tenant, net-lease retail concepts that will dominate the development pipeline over the coming year, according to Marcus & Millichap’s latest Net-Leased Retail Research Report. The report details three aspects of the U.S. economy that are proving to be positive forces for the net-leased retail sector: job growth, consumer sentiment and core retail sales.

Job growth gains averaged 195,000 positions per month over the last year, and the unemployment rate has fallen to 4.7 percent, the lowest level since 2007. The report also references an annual increase in average hourly earnings of 2.8 percent.

Consumer sentiment posted its highest level since 2000, with expectations also elevated. The U.S. consumer confidence index is 11.9 percent above the average reading since the survey began in 1967.

Core retail sales, defined as aggregate sales excluding automobile and gasoline sales, vaulted 5.7 percent year-over-year in February. Lead growth categories within the retail sector include e-commerce, food and drink establishments and health and personal care stores.

As For Rising Interest Rates

The postelection surge of the 10-year Treasury yield, as well as the Federal Reserve’s decision to increase the federal funds rate by 25 basis points in December 2016, forced many investors to reconsider their strategies.

Still, the pronounced downward pressure on net-leased asset yields during the cycle has flattened in response to higher interest rates. The popularity of these assets will minimize any upward pressure on cap rates, according to the report. Well-located properties in major metros backed by strong credit tenants and long lease terms remain in demand.

One variable of particular consideration for net-leased assets will be the future of the section 1031 tax-deferred exchange, with activity potentially increasing over the coming year due to uncertainty regarding potential changes to the statute. The scrutiny of this provision by Capitol Hill amid a broader tax reform plan is raising concerns among investors and developers.

Net-leased properties recorded a 3.9 percent advance in the average asking rent last year, more than doubling the pace of multi-tenant shopping centers over the same period. Asking rents for net-leased properties average $19.62 per square foot nationwide, less than 2 percent below the pre-crisis peak.

— Kristin Hiller

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