6 Important Net Lease Market Trends

As we find ourselves at the dawn of the third quarter of 2014 here are six net lease market trends that are important to note:

  1. Investor demand is still far exceeding supply in the net lease market, which is continuing to drive cap rate compression.
  2. As a result of the limited supply, institutional investors are forced to become more and more creative in finding their acquisition opportunities. In most cases, institutional investors are being out-bid by private investors. In an effort to counteract this, REITs have began changing their focus to large industrial assets. The general thought is the private investor would not be competitive on an asset with a price point above $5 million. With e-commerce driving the demand for large industrial space the vacancy in that market is steadily decreasing.
  3. Investors chasing yield in a market with such limited supply has resulted in an uptick of activity of the “sub-investment grade” sector.
  4. Healthcare has become another sector with increased activity. Healthcare reform is projected to provide coverage for an additional 15 million Americans; creating a higher demand for medical office space for many years to come. Additionally, Healthcare properties tend to have more favorable lease terms over retail assets.
  5. Inflation looms as a huge concern for most investors. While cap rates on assets with long-term, flat rents, such as Walgreens, are starting to see higher cap rate, assets with rent increases in the primary term are trading at premiums today.
  6. Trending upward is the demand for Junior Box properties (20,000 – 40,000 sf), while, largely due to e-commerce, the Larger Box tenants are beginning to downsize into the Junior Box category.

Cap Rate Trends:

  • Big Box cap rates have compressed by 90bp since Q2 2013.
  • Drug Store cap rates have compressed by 70bp since Q4 2013.
    • This is mainly due to Rite Aid becoming a stronger guarantor, and trading in the 7% range as opposed to low 8%. We have actually seen Walgreens cap rates start to tick upward slightly.
  • Dollar Store cap rates have compressed by 10bp since Q4 2013.
  • QSR cap rates on corporate guaranteed stores have compressed by 80bp since Q3 2013.
  • Automotive retail cap rates have compressed by 50bp since Q3 2013.

Limited supply is still the primary theme of the net lease market. It has completely negated the effects of increased interest rates and caused large buyers to be creative in finding acquisition opportunities; in turn creating activity in another market on its own. Investors tend to be concerned about a bubble forming in the net lease market. A market where interest rates exceed cap rates is completely inconceivable, but I believe the market is sustainable in its current state.

Limited supply is always going to be a problem. Since supply is mainly retailer driven as opposed to real estate speculator driven, it is fair to say there will not be a massive influx of supply anytime soon.

The only thing that can flip cap rates is decreased demand due to alternative investments that provide the same mix of security and return. Either way, plan on this market lasting for at least another 12 months.