NEW YORK CITY — As more players enter the market, rising demand for net-leased commercial properties in the United States is leading to higher prices and lower capitalization rates, making it a good time to be a seller of such assets.
According to a new report by national brokerage firm The Boulder Group, average cap rates for net-leased retail, office and industrial properties fell by 22, 15 and 19 basis points, respectively, between the second and third quarters of this year. The number of net-leased retail and office properties on the market both grew between the second and third quarters of this year, but the report noted that the sector is still defined by “significant investor demand combined with a limited supply of quality assets.”
Like any other asset class, certain subcategories of net-leased product are performing better than others. Due to the compounding forces of e-commerce and a global pandemic, industrial remains a pack leader while office is shrouded with uncertainty. By the same logic, in the net-lease retail space, properties leased to essential service retailers and quick-service restaurants with outdoor seating are among the preferred investment vehicles.
But on a broader level, institutional investors are growing their presence in the net-lease space, drawn to its penchant for long-term stability. Private capital sources also continue to target net-lease deals, which often revolve around smaller, single-tenant properties with price points that allow private buyers to compete on equal footing with institutional players.
The supply-demand balance within the U.S. net-lease market and the long-term sustainability of the current dynamics were among the main topics of discussion by the “State of the Industry” panel at the 13th annual InterFace Net Lease conference that took place on Sept. 29.
Hosted by Atlanta-based France Media at the New York City Bar Association building, the event was conducted in both in-person and virtual formats. Gordon Sinclair, director of business development and strategy at Egan-Jones Ratings Co., moderated the opening panel.
Panelist Coler Yoakam, senior managing director at JLL’s Dallas office and co-head of the firm’s net-lease group, kicked off the discussion by providing some basic numbers that illustrated the growth in deal volume within the space. According to his data, in the last 12 months, net-lease deals have accounted for roughly 15 percent of all commercial transactions in the country. Historically, that proportion has been closer to 10 percent, he pointed out.
“The net-lease space is getting a lot more attention based on the migration of capital into it,” Yoakam said, noting that roughly three-quarters of those deals were for single-tenant assets. “The buyer profile is as diverse as it was before the pandemic — a mix of institutional and high-net-worth participants — but in greater numbers.”
Yoakam added that relative to 2019, the number of net-lease transactions that JLL has closed is down slightly, but that deal volume based on dollar amount is up significantly. “Our numbers speak to both asset appreciation and the market preference for larger deals for properties that are stabilized,” he explained, adding that the healthy availability of debt and equity for net-lease deals is also spurring deal volume and pricing of these properties.
Panelist Jon Hipp, head of Avison Young’s U.S. net lease group, gave another reason as to why demand and pricing for net-leased properties are on the rise: more firms are launching funds that are specifically geared for this asset class.
“It seems like every week there’s a new group coming to the table with a new fund with allocations for net-lease deals, which is great for brokers and sellers,” he said. “Some of these newer funds that are trying to get capital out the door tend to be more aggressive than the established funds. That pushes the established funds to be more aggressive in order to compete and potentially buy at lower cap rates.”
Pros & Cons
Other panelists representing investment firms and brokerages weighed in on the positives and negatives of the current demand-heavy market.
“The competition is healthy for the industry, and it’s great that there’s a lot of visibility in the net-lease market right now,” said Gino Sabatini, managing director and head of investments at New York City-based REIT W. P. Carey. “There are some big names that are interested in getting behind net-lease platforms, and that’s lending credence to the industry as an asset class that legitimately stands on its own.”
The InterFace Net Lease State of the Union panel, from left to right: Gordon Whiting of Angelo Gordon; Jon Hipp of Avison Young; moderator Gordon Sinclair of Egan-Jones Ratings Co.; Daniel Taub of Marcus & Millichap; Coler Yoakam of JLL; and Gino Sabatini of W. P. Carey.
In qualifying that statement, Sabatini added that the net-lease space has not historically been viewed as one of the major food groups in commercial investment — a perception that he believes is changing as more capital flows into the market.
Yet the steady, growing stream of capital looking for placement in net-leased assets — on both the debt and equity sides — can be a double-edged sword, according to panelist Gordon Whiting, managing director at New York-based alternative investment firm Angelo Gordon & Co.
“A rising tide lifts all boats, but there are concerns that as more capital enters the market, investors will chase deals based on structure as well as pricing,” he said. “Inflation is starting to tick up, and there’s going to be a shift in the market. When that happens, a lot of these deals in the net-lease market could go south because they weren’t structured properly and buyers overpaid.”
Whiting’s analysis contended that owners that overpaid for these properties could default on their loans in a inflationary environment, thus hurting the debt markets. In addition, he stated that such a scenario could hinder investors’ ability to raise equity contributions for future net-lease deals.
“People are so anxious just to do deals that sometimes they start to put irrational terms into those transactions, and that hurts the entire industry in the long run,” he said. “In this market, it’s important to remember that once you’ve struck a lease, it’s usually there for 20 years. So any poor structure that’s been created is going to come out when the owner tries to sell.”
Sabatini agreed with the logic behind Whiting’s analysis but invoked an age-old industry maxim to explain why the potentially overpriced market may not spell immediate danger for investors. “In net-lease, you can do dumb deals today, and nobody will know for 10 years,” he said. “But if you’re a long-term holder and the investment isn’t that great, it can catch up with you.”
On the brokerage side of the panel, Yoakam concurred that the inability of new capital sources to “remain disciplined” could eventually be a big problem for the industry. “At this point in the cycle, we’ve definitely seen some investors reaching on deals and taking softer returns. But the extent to which it becomes a problem is still to be determined.”
Panelist Daniel Taub, national director of Marcus & Millichap’s retail and net lease division, also assessed the market dynamic through the eyes of a broker. Taub did not dispute the strong growth that other panelists had ascribed to the demand side of the equation, but instead touched on the supply side and the relative shortage of product within it.
“Right now, buyers and sellers should be extra cautious in how they’re looking at deals, because there’s a massive imbalance between capital for deployment and available product for placement,” said Taub.
“That gap continues to expand in the wrong direction, and consequently we see buyers accepting more aggressive terms and more direct deals being done preemptively in order to access supply,” he continued. “So there are some levels of frothiness, and the lack of product is really having an impact, even as more capital is added to the market.”
— Taylor Williams