A seller’s market

Put a necessity business, like a drugstore or a gasoline station, on a busy corner and give it a long-term lease and what have you got?  A net-lease property — one of the hottest investments in today’s real estate market.

When Peter Snell puts a net-lease on the market, he knows it won’t be around for long. “We’re typically seeing offers on all our net-lease assets the same day (of) [advertising] all the way up to 30 days,” says Snell, who heads the single-tenant, net-lease investment group for Greystar, a real estate investment firm based in Bethesda, Md.  Closing follows soon after, “so we’re in and out in 90 to 120 days.”

It’s a seller’s market for net-lease properties these days, for several reasons. For one, net-lease investments are easy for investors. In a typical triple-net deal, the tenant — often a single tenant such as a CVS, Sheetz or Applebee’s —  signs a long-term lease and handles the taxes, insurance and maintenance. All the investor does is collect a rent check every month.

In double-net leases the tenant generally handles property taxes and insurance. Single-net leases are less common and require the tenant to handle tax payments. The main attraction of a net lease, under any of the arrangements, is that tenants commit to a long-term deal, so there’s little risk on the leasing side and stable income streams. 

Some of the buyers are baby boomers nearing retirement that want a hassle-free investment that will give them money to live on while avoiding capital gains taxes. Net-lease properties do all those things. “The high net worth individuals are really driving an extremely active market,” says Snell, adding that REITs also have also been big players.

Net-lease deals also are popular these days because demand outstrips supply. “For lack of supply you can find the roots of that back in the recession, when construction pretty much went to a standstill,” says Winston Orzechowski, research director for Reston-based Calkain Cos., a national commercial real estate firm that specializes in these leases. With the economy growing stronger, more companies plan to expand, but there’s about a three-year lag time, he says. So the supply of properties isn’t going to catch up anytime soon.

Adding to short supply is the pressure of low interest rates. They have made corporate sellers choose to refinance loans and then hold on to properties that they might otherwise have sold as net-lease deals. “Selling has become less attractive in recent years as rates dropped,” says Snell. Plus, current investors with net-lease properties “don’t want to sell them,” says Steve Gentil of the Richmond office of Colliers International. “Because, what are they going to do with their cash?”

The pressure now is on buyers, who are forced to accept lower returns in the form of lower “cap rates.” That’s been the trend for several years, says Orzechowski.

Cap rates are an estimate of an investor’s potential return on investment. They are figured by dividing the income the property will generate by its total value. A 2012 report by Calkain shows cap rates peaked around 2010 at above 8 percent. Since then, they’ve dropped to just above 7 percent overall, with some sectors even lower. Big-box stores were still at 8 percent in 2012 while banks slipped to just above a 6 percent cap rate, according to Calkain data.

Snells’s recent sale of an Applebee’s property in Henrico County is a good example of what makes for an attractive triple-net lease property. In mid-May Snell put the restaurant up for sale, priced at $3.2 million. It’s already leased on a 1.35-acre West Broad Street site next to a shopping center with national retailers such as Lowe’s, Sam’s Club and CVS. The listed cap rate is 6.5 percent.

Snell’s firm has been working a lot of net-lease properties in the Richmond region lately. Among them are a couple of auto parts stores, a Starbucks, Pizza Hut and PNC Bank. Even though cap rates are down, buyers still want in, he says. It’s not just individual investors, either. “The real estate investment trust groups have been extremely active over the last couple of years.”

Snell says 2013 looks promising for net leases. Transaction volume nationwide in the single-tenant retail net-lease market rose 54 percent in the fourth quarter of 2012 compared with the same period a year earlier, according to Greystar research. By comparison, the net-lease sector saw a 28 percent increase in transaction volume in 2012 year over year, driven largely by private investors returning to the market.
All together, investor interest and the lack of new product “has turned 2013 into a true sellers’ market,” he says. “We anticipate an increase in transaction velocity through 2013 and into 2014, as owners realize the strength of the market and the limited window available to take profits off the table.”

Buyers still will want to get into the market but will have to accept less, says Gentil. “There’re too many people chasing too few investment net-lease properties,” he says. “When there’s too many buyers, the guy that used to say ‘I want a 7.5 percent return,’ in order to get that property, he’s got to take 6.5 percent.” And if interest rates go up, net-lease properties “will function like a bond,” Gentil says. “So if you’re getting a 6 percent return and a similar property is getting a 7 percent return, the value of your property just went down.”

Even as the market continues to heat up, Gentil says all the pressure on returns “is in the downward direction, because it doesn’t look like interest rates on safe investments like CDs or T-bills are going up anytime soon. The yields are going down and the prices are going up,” he says.

Still, Gentil counts himself among those on the outside looking in to the net-lease sector, wishing he had a share of its stable and low-effort returns. “In hindsight, my biggest mistake after 33 years in this business is that I didn’t go buy” land years ago at intersections now marked by traffic lights and lots of traffic. Those sites would probably be home to a bank or pharmacy, he says. “I mean, some of these things throw off $100,000 to $150,000 a year.”