Shopping Center Business

MAY 2016

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NET LEASE 166 • SHOPPING CENTER BUSINESS • May 2016 H unger for yield and still-low in- terest rates — the dynamics that have fueled a robust net lease in- vestment market for retail properties over the past few years — remain in place so far in 2016, but emerging signs suggest that prices are nearing their peak as recession worries continue to mount. Institutional, high net-worth and for- eign investors make up a good chunk of net lease buyers, who are plowing money into Family Dollar stores, Walgreens prop- erties, quick-service restaurants, conve- nience stores and similar retail properties that are geared to provide steady income from stable long-term tenants. But 1031 Exchange buyers, who roll the proceeds from a property sale into a similar prop- erty for tax benefits, have increased their appetite for net lease properties over the last six to nine months to become some of the most active buyers in the market. "The market is red hot; there's a tre- mendous amount of money wanting to get into net lease real estate," says Ralph Cram, president of Northbrook, Illi- nois-based Envoy Net Lease Partners, a private lender focused on ground lease, construction and bridge loans for net lease properties. "Investors want stable cash flows and non-volatile assets." David Sobelman, an executive vice president and managing partner with Herndon, Virginia-based net lease bro- kerage Calkain Companies, says that his firm has generally served two categories of buyers over the last several months: 1031 Exchange buyers and institutional investors "starved for a passive, stable and above-market" yield for the long term as an alternative to bonds. In turn, feisty demand is maintaining low capitalization rates, states Sobelman, who operates in Calkain's Tampa, Florida, office. Well-located properties housing credit tenants like Walgreens and McDonald's in major markets with longer lease terms are commanding typical cap rates from 4.5 percent to 5 percent, he says. For example, in January, Calkain brokers oversaw the sale of a newly constructed Taco Bell with a 20-year lease in Pompano Beach, Florida, at a cap rate of 4 percent. Meanwhile, assets with more risk — those leased by non-credit tenants, those that have shorter lease terms or those in sec- ondary and tertiary locations — are gener- ally trading some 100 to 250 basis points higher, Sobelman says. "Until there is an investment, real es- tate or otherwise, that offers the stability, growth, passivity and/or yield that to- day's net lease properties provide, then cap rates will stay in the lower ranges," Sobelman says. Higher cap rates typically found in the Heartland have also stimulated the ap- petite of buyers, says Randy Blankstein, president of net lease brokerage Boulder Group. In early 2016, the Northbrook, Illinois-based firm arranged the sales of a Walgreens in suburban Kansas City, Mis- souri, for $6 million and an LA Fitness in Chicago for $9.5 million. The deals fea- tured cap rates of 5.86 percent and 5.63 percent, respectively. The LA Fitness sale was to a 1031 Exchange buyer. "Investor demand in the Midwest is strong, as it has historically been a mar- ket with higher cap rates than that of the coasts for similar assets," Blankstein says. In some cases, however, sellers are pric- ing net lease retail assets too aggressively and have begun to encounter resistance, especially for properties in less-than-pre- mier locations, with lease terms of fewer than 15 years, or that lack reasonable rent bumps, observers acknowledge. By way of example, a Walgreens landlord may hear that a Walgreens property in the area trad- ed for a cap rate of around 5 percent, and so he decides to test the waters and seek the same cap rate, re- ports Joey Odom, a di- rector with Stan John- son Co. in Atlanta. "But those proper- ties they're trying to sell may have only five years left on the lease, and not 20 years like the one that sold at the five cap," says Odom, whose team recently handled the sale of 25 Dollar General stores in the Midwest at a cap rate of less than 7 percent. "People are bringing properties to the market with un- realistic pricing, and I don't think they're trading." Some investors worried about a pos- sible recession and tightening credit have in general become more cautious, adds Ian Schroeder, a se- nior vice president specializing in net lease properties with CBRE in Newport Beach, California. Last year it was common to put assets up for sale at prices higher than market to take advantage of demand. Ear- ly this year the philosophy shifted to ask- ing for a price closer to market to create a bidding war, ideally between five to six parties, he says. "I believe right now we're in the middle of an adjustment on aggressive capitaliza- tion rates. I'm getting a lot of email blasts Net Lease Investment Sales Activity Maintains Brisk Pace 1031 Exchange buyers and private investors looking for yield drive demand, but stabilizing cap rates suggest this cycle is nearing the top. Joe Gose Sobelman Schroeder Odom

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