Shopping Center Business

MAY 2018

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

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NET LEASE 102 • SHOPPING CENTER BUSINESS • May 2018 historically low interest rates and fueled asset appreciation, says Richard Chich- ester, president and CEO of Irvine, Cal- ifornia-based Faris Lee Investments. As a result, to a large degree net lease real estate remains fully priced, if not over- priced, he adds. Still, he and other net lease brokers downplay the chances for a dramatic slowdown in sales this year. In fact, in February Faris Lee Investments represent- ed First and Mission Properties, a 1031 exchange buyer, in its purchase of a CVS in San Francisco for $16.8 million. The 4 percent cap rate marked the lowest ever paid for a CVS in a sale exceeding $10 million on a national basis, according to the brokerage. To prepare for CVS's oc- cupancy, the property underwent a major renovation that features rooftop parking. "We're still seeing a lot of demand for single-tenant net lease properties, and I would expect that to continue regard- less of what happens in the economy be- cause these investments are really bonds wrapped in real estate," says Chichester, whose firm has been involved in $20 bil- lion worth of transactions since 1996. "Interest rates are still at historical lows, and there is not quite the same sensitivi- ty to the correlation between the 10-year Treasury bill and cap rates in these assets versus other real estate sectors." Other net lease brokers echo Chiches- ter's sentiments, even with the benchmark 10-year Treasury yield's rapid ascent as the central bank shifted to a tighter monetary policy regimen in 2017. The yield on the 10-year bond rose to around 2.8 percent in early February — up roughly 80 bps from its 52-week low in September 2017 — and has generally hovered at that level even after the Federal Reserve announced in March that it would raise the federal funds rate another quarter of a percent- age point. The central bank also affirmed its commitment to further rate increases this year. CAP RATES HOLDING So far, however, rising interest rates have failed to affect cap rates. At the end of 2017, for example, the average national net lease cap rate declined 10 basis points to 6.33 percent across 11 retail categories despite the Federal Reserve's tightening, according to Calkain's Net Lease Eco- nomic Report issued in February. What's more, in the few cases in which cap rate increases occurred, they were typically miniscule: The average convenience store cap rate, for example, rose to 5.66 percent at the end of 2017 from 5.61 percent a year earlier. "There are net lease properties available for all types of risk tolerance," says Aron- son, who is in Calkain's Fort Lauderdale, Florida, office. "But investors may need to rethink things if they believe the time has come where they can grab a brand new, 15-year 7-Eleven absolute triple net lease at a 6.35 percent cap rate. It's not happening." The healthy spread between the 10- year bond yield and cap rates also reduces the chances for a substantial rise in cap rates, suggests Will Pike, executive vice president and managing director of the net lease property group in the Atlanta KOHL'S CO-TENANCY PROGRAM DRAWS ATTENTION IN BIG BOX SPACE I n early March, Kohl's announced that discount grocer Aldi would share space in five to 10 of its stores in a co- tenancy pilot program. It's part of a broader Kohl's strategy to increase traffic and "right size" its first-generation 80,000-square- foot footprint as its moves to a smaller 35,000-square-foot format. Co-tenancy is a much-discussed solution for net lease big box users, which are searching for ways to shrink space and counteract a disruptive e-commerce environment wreaking havoc on soft goods and general merchandise retailers, says Richard Chichester, president and CEO of Irvine, California-based Faris Lee Investments. "The big box is a risk in the marketplace today; you don't need the large footprint or the operating expenses associated with it," Chichester states. "So finding solutions with cooperating tenants that share a customer base is a great offering." Kohl's is one retailer aggressively re-thinking its real estate as it enhances an omni- channel sales approach. Among other endeavors, the chain is set to expand a recently launched pilot program that not only established small Amazon shops in 10 Los Angeles and Chicago Kohl's stores, but that also allowed Amazon customers to return goods to many additional locations. Kohl's also is looking for more co-tenancy opportunities, and supermarkets are a natural fit, said Kevin Mansell, CEO of Kohl's, during the retailer's 2017 fourth quarter earnings call in March. "But it's certainly not limited to that," he told analysts. "I think companies in the fitness category, for instance, would be a great combination with Kohl's, and there are many others. But they've got to be traffic drivers and strong brands with strong balance sheets, where we know that we can coexist together for a long time." Chris Sands, founder and CEO of Charleston, South Carolina- based Sands Investment Group, predicts that more big box operators are going to follow the lead of Kohl's. "You're going to see an interesting and opportunistic market over the next five to seven years as leases come to term," he explains. "There are going to be different and creative ways to stabilize some of these big boxes." — Joe Gose

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