According to new reports published by The Boulder Group and Marcus & Millichap, net-leased properties remain attractive to investors, keeping cap rate at very low levels. Cap rates in the third quarter of 2014 for the single tenant net-leased retail sector remained at their historic low rate of 6.5 percent from the second quarter.
Cap rates for the office sector compressed by 37 basis points to 7.4 percent, while cap rates in the industrial sector rose by three basis points to 8 percent. There were no major factors contributing to the leveling of retail cap rates as supply and demand remained near levels from the previous quarter.
During the third quarter, the Ten-Year Treasury Yield fell to its lowest point of the year (2.55) in late August. But by the end of the quarter, treasury rates rose and ended at levels similar to the end of the second quarter. With little movement in the capital markets, retail cap rates have flattened as buyers cannot meet acceptable return thresholds at lower cap rates because of the low interest rate environment.
During the third quarter, the supply of office and industrial properties increased significantly by 30 percent and 21 percent, respectively. According to The Boulder Group, owners of these assets have attempted to take advantage of the current low retail cap rates by enticing investors with higher yields offered by office and industrial properties. The supply of retail properties increased by only 3.1 percent from the second quarter to the third quarter, as new construction remains limited with the exception of the dollar store sector.
Bucking the trend of other retailers, dollar stores have been expanding at an aggressive rate over the past two years, adding more than 2,000 locations during that time, according to The Boulder Group. However, with the recent news regarding the potential Family Dollar acquisition by Dollar Tree for $8.6 billion, many investors have decided to wait and see how the situation plays out as the segment may shrink from three major players to two. According to Marcus & Millichap, Family Dollar declined a more lucrative deal of $9.1 billion from Dollar General. As these industries evolve over the next few years, tenants will shuffle through available single-tenant buildings.
Demand throughout the net lease market will stay high as investors remain attracted to the stable cash flows from asset class. According to The Boulder Group, while some investors wait on the sidelines as the changing dollar store sector takes shape, investor demand for other new construction properties in the $1 to 3 million dollar range (quick service restaurants, casual dining restaurants and auto part stores) will grow. With steady capital markets, market participant expectations are for cap rates to hold steady or rise slightly by the end of 2014.
According to Marcus & Millichap, many baby boomers are moving capital out of the multifamily and equity markets and into net-leased assets as a long-term, low-risk, cash-flowing investment. Low interest rates for 10-year treasuries are encouraging buyers to find alternative options for safe investments as they near retirement.
Although the Fed is expected to raise interest rates in early 2015, the cautious fiscal stance will limit the pace at which interest rates climb, keeping net-leased properties a favored investment vehicle for several more quarters.
In addition to risk-averse buyers, foreign investors from Canada, Asia and former Eastern Bloc countries are moving into the net-leased market to preserve capital. As a result, average cap rates reflect the returns on alternative investments rather than underlying property fundamentals. When interest rates do rise, a more normalized market should emerge.
Net-Leased Retail Market Overview (Source: Marcus & Millichap)
Auto-Part Retailers: Over the past 12 months, average cap rates have dipped more than 50 basis points for auto-part retailers, reaching the low-6 percent range. AutoZone is the most sought-after tenant, which has pushed first-year yields for new properties below 6 percent.
Casual Dining Establishments: Average cap rates for all casual-dining restaurants were in the mid- to high-6 percent range, down 40 basis points year over year.
Dollar Stores: Dollar General stores change hands beginning in the low-6 percent area, though upward pressure on rates is emerging. Family Dollar stores with new leases trade approximately 125 to 175 basis points higher.
Drugstores: When available, new CVS and Walgreens stores typically garner bids at cap rates in the mid- to high-5 percent range. Drugstore cap rates have tightened 40 basis points in the past year as demand remains strong.
Quick-Service Restaurants: Quick-service assets traded at first-year returns in the mid-6 percent range during the past year, down 50 basis points from the prior annual period. Franchisee-owned properties will sell 100 basis points higher.
— Haisten Willis