Shopping Center Business

MAY 2017

Shopping Center Business is the leading monthly business magazine for the retail real estate industry.

Issue link:

Contents of this Issue


Page 210 of 334

NET LEASE 206 • SHOPPING CENTER BUSINESS • May 2017 says Sean O'Shea, a managing director for the O'Shea Net Lease Advisory group of Los Angeles-based BRC Advisors. "We've been in a bubble, and we're past the peak. Cap rates are going to move up on some schedule," he says, noting that sellers will need to come to terms with this reality. Historically, cap rates have adjusted and stabilized three to six months after interest rate hikes, net lease brokers say. Whether that's the case in this cycle is any- one's guess amid contrary forces at work in the market. High net-worth individuals have joined institutional buyers on the sidelines to wait until net lease property prices adjust to the higher interest rate environment. Typically, a cap rate spread of 25 to 75 basis points separates these buyers from sellers, says Andrew Bogar- dus, a senior managing director for Cush- man & Wakefield's Net Lease Investment Services. "Buyers aren't reaching to pay a low cap rate," adds Bogardus, who is based in San Francisco and is part of a four-person team that closes 40 to 60 net lease deals a year. "They want a little better return than they got last year." Ordinarily, a drop in demand would hasten lower prices. But 1031 like-kind exchange buyers, which make up a sizable share of net lease investors, are helping to maintain low cap rates, particularly for well-located assets occupied by solid cred- it tenants with more than 10 years left on their leases. "There's a tremendous amount of 1031 exchange business in the market, and a lot of sellers are taking advantage of what people consider to be peak pricing," says Ian Schroeder, a senior vice president who specializes in retail net lease invest- ment properties with CBRE in Newport Beach, California. "So long as apartments sell and fuel a bullish exchange market, it's going to keep cap rates as aggressive as they have been." CASH CONSIDERATIONS Typically 1031 exchange buyers need little to no debt, which also allows them to pay higher prices for assets, adds Bill Rose, first vice president and national director of the National Retail and Net Leased Properties groups with Calabasas, California-based Marcus & Millichap. 1031 exchange investors make up a good part of Marcus & Millichap's private client business and they typically pay $3 million to acquire the average net lease property, he adds. "It's not true to say that net lease asset cap rates are completely protected during a rise in interest rates," says Rose, whose firm brokered more than 2,800 retail transactions in 2016. "But they are not impacted as much as multi-tenant shop- ping centers are." Market and regulatory threats could derail 1031 exchanges, however. Higher interest rates could lead to a drop off in demand in other property markets, there- by reducing the inclination of would-be 1031 exchange investors to initiate a sale that would in turn necessitate an acquisi- tion, according to Marcus & Millichap's Net Leased Retail 2017 Outlook. What's more, investors are concerned that tax reform could incorporate chang- es considered by Congress in recent years to water down or eliminate the 1031 ex- change rule. "If something happens to the 1031 exchange regulations, you'll see a huge shakeup in the market," says Jereme Sny- der, director of the NNN Group for Col- liers International in Irvine, California. "A good majority of the buyers in the market are trade buyers." In addition to 1031 exchange buyers, foreign investors are also paying premi- ums for net lease assets in the U.S. and providing resistance to higher cap rates, albeit to a lesser extent, Schroeder and O'Shea say. Indeed, in March Schroeder T he proposed merger between Wal- greens and Rite Aid announced in October 2015 is stunting demand for Walgreens and Rite Aid assets as ques- tions about stores closures, how many locations will be spun to the Fred's Pharmacy chain, and whether the sale will even go through remain up in the air, says Ian Schroeder, a senior vice president specializing in net lease in- vestment properties with CBRE. Subsequently, buyers are displaying a stronger preference for CVS assets, says Schroeder, who focuses on the drugstore category. Put a CVS and Wal- greens with similar terms and locations side by side, and the CVS will likely de- mand a capitalization rate of about 25 to 50 basis points below the Walgreens, he adds. "We had a buyer interested in a Wal- greens in Texas, where there are no Rite Aids," Schroeder recalls. "But he still leaned toward CVS just because of the uncertainty surrounding the merger." Investors searching submarkets where all three pharmacies operate face a more daunting challenge, especially if the properties are at or near the same intersection, says Sean O'Shea, manag- ing director for the O'Shea Net Lease Advisory of BRC Advisors. "You have to realize that one of the stores is not going to be around in the future," he says. "So how lucky are you feeling?" Deerfield, Illinois-based Walgreens Boots Alliance offered $17.2 billion for Rite Aid Corp. — including about $7.8 billion of debt assumption — and the companies have been awaiting Fed- eral Trade Commission approval. Wal- greens in January lowered the price to around $14.3 billion. The final amend- ed price hinges on how many more Walgreens and Rite Aid stores the FTC would require to be divested to Fred's. Some 865 locations have already been sold to the competitor. Still, with the deal in limbo, savvy real estate investors may be able to em- ploy an opportunistic strategy, says Bill Rose, first vice president and national director of the Net Leased Properties Group with Marcus & Millichap. "The merger alone dictates that something will change," he acknowl- edges. "But a number of those locations are 'Main and Main' with great access, and the buildings can be re-tenanted pretty easily." — Joe Gose MURKY MERGER OUTCOME DAMPENS WALGREENS AND RITE AID DEMAND

Articles in this issue

Archives of this issue

view archives of Shopping Center Business - MAY 2017