Some Thoughts on the New Year

In the book of happy memories, the 2009 section may come up shorter than most. Our economy suffered, unemployment rose and hopes for a quick recovery were dashed. Terms like “jobless recovery” and “double dip recession” became the hot phrases of the year. Most can’t wait to raise their glasses in farewell.

However, we can look at 2009 another way. Its conditions may have been inclement but for those who survived (without government assistance) it can be seen as a great storm weathered; victory through perseverance. As Thomas Paine so eloquently put it, “these are the times that try men’s souls”. Well consider our souls tried, bent and pushed. For those who remain, the hard part is over.

This is something that could be observed earlier this year at the 2009 ICSC conference in Las Vegas. There were half as many participants but the ones who stayed were worth talking to. So indeed let’s raise our glasses high on New Years but instead of blind faith in 2010, lets toast to the grit displayed in 2009 and the opportunities that will be rewarded to those who grinded it out!

The Ghost of Christmas Past

As the holiday season approaches its crescendo, one can’t help taking a trip down memory lane. Just a few years ago televisions were filled with commercials featuring nice middle-class driveways being populated by two Lexus luxury cars, adorned with giant red bows. Those bows should have been a warning, a form of theatrical foreshadowing, representing the massive amount of debt resting so precariously on those essential luxury mobiles. We could afford the Lexus today, but we would have to pay for the bow later. When that time came, we realized our whole lives, from our homes to our banks were wrapped in similarly styled red tape.

So the season is here when red tape is at its highest demand and everyone gears up to wrap some new gadget or non essential item in it. Even Santa shows up wearing a massive red suit, riding a red sleigh, guided by a reindeer with a red nose. For heavens sake the holiday colors are red and green, debt and cash! This particular year seems the perfect time to take a long honest look at our past, present and future.

No longer can we afford to strip ourselves of equity and finance it into oblivion, for it seems that oblivion actually shows up at some point.

Perhaps it is not a good idea to leverage investments with “ZERO money down” or for banks to fill their balance sheets with assets whose debt to equity ratios would send a seesaw shattering into the ground.

And maybe, just maybe, we should invest in assets which are somewhat safe and secure. Like a well positioned grocery store as opposed to manufactured islands (made out of sand) in the middle of the sea which serve as play grounds to the fabulously opulent.

If you want to look at someone who has staying power, look at Walgreens, its 1Q profits just rose 20%! And who does Walgreens cater too? Only any person who needs some sort of medication at some point in their life. In other words, pretty much everyone. Dollar General, a few years ago the most unheralded name imaginable, is experiencing never before seen growth. McDonald’s and Wal-Mart both continue to prosper. The key point in all of this is that the best investments are the ones which will be there when the weather gets rough, the ones that have staying power. So this year, if you’re going to invest, make sure it is in something that’s lasting, not a heap of red tape.

Free Wi-Fi at McDonald’s (hopefully you’ll want fries with that)

McDonald’s (NYSE: MCD) has recently announced plans to start providing free Wi-Fi service, through a partnership with AT&T, at over 11,000 of their 13,000 U.S. locations. AT&T customers may already be familiar with this benefit, as the company already provides free Wi-Fi to AT&T wireless and wired customers at Starbucks, McDonald's and various other locations. For the rest of us, a $2.95 fee for 2 hours of internet access is charged. Thanks to this recent agreement all Wi-Fi seekers, regardless of their service provider, will have free access at McDonald's.

This development seems to be the latest in a trend started a few years ago, when McDonald's began to refocus it image towards a chicer look, this has covered everything from eliminating trans-fats, redesigning the stores to look higher-end, and in the extreme case in over 100 stores in Germany, changing the color scheme from red to green (for environmental affect). Introducing free Wi-Fi seems to be the next logical step in this campaign. If the goal is to make McDonald’s not just a place to “smash and dash” but to stick around for a while, why not allow customers to surf the web and maybe enjoy an invigorating McCafe while their at it?

On a side note, can you imagine sticking around and surfing the web at the McDonald's restaurants of a decade or so ago, the ones with the plastic chairs, bright pastel linoleum cushions and in some cases, large sculptures of those McDonald's monster/mascot things?

With the new image and offerings of McDonald's and their constant pursuit of self improvement, it is easy to see why they enjoy such financial success. As a net lease investment, McDonald's is one of the finest available and adding a service like free Wi-Fi will only enhance its value and drive higher sales. Who knows how many extra coffees or fries may be ordered by the flocks of cheap internet seekers who may congregate their. This development should only encourage interest in McDonald's as a net lease investment.

Are the Golden Arches of McDonald's Still “Golden” to Net Lease Investors?

McDonald’s reputation as a company unassailable by the effects of the recession has come into question with the release of recent sales figures. Specifically, McDonalds saw a 0.6% drop in U.S. sales in November, which follows a 0.1% drop in October. Globally, McDonald’s fared better, posting a 2.5% increase in Europe, which caused the company’s total sales to increase by 0.7%. Though these numbers are not dismal, they are quite different from the numbers McDonald’s was posting last year, increases of 4.5% in the U.S. and 7.7% globally in November 2008. This has many doubting the health of McDonalds and the economy in general.

Traditionally, McDonalds has been the one of the gold standards of net lease investments. It’s been given high investment grade credit ratings by both S&P and Moody’s, maintains low cap rates, and always performs well financially. Demand for McDonald’s properties actually increased recently due to the fallout from high risk investments. Investors are now seeking more stable and safe assets rather than risk fueled ones, for many there is no safer place to invest than beneath those iconic gold arches. This perception was enhanced in 2008 when McDonalds continued to post strong sales figures despite the economic fallout of the recession. With recent numbers looking less promising, should investors be worried?

If history is to be our guide than “no”, these numbers do not represent a trend to be fearful of. Even with the dip in U.S. sales, McDonald’s numbers look better than many of their peers and no indication has been made that their credit ratings will be affected. In reality, McDonalds was most likely suffering from its own success. After the shocking growth of a year ago, it would be natural for a cool down phase to occur, especially in a climate with unemployment over 10% and declining consumer spending.

Despite the recent numbers, McDonald’s remains one of the strongest net lease investments when available and should remain as such for the foreseeable future.

Net Lease Insider Pulse: Jay Bastian of National Retail Properties

Jay Bastian is SVP of Acquisitions for National Retail Properties, Inc., a NYSE traded REIT focused on single tenant, net leased retail and restaurant investments.

(1) Will the commercial real estate market bottom out in 2010?

Our only frame of reference is net lease, so we’ll stick with that. An acquisition we’re evaluating at the moment speaks to the current state of the market, and future implications. It’s a portfolio of drug stores, and we’ll separate out one asset as an example. The seller purchased it for a 9% cap in 2000, put 80% LTV, 25/10 year debt in place at 8%, with a balloon in 2010 at $2.5M. Hope you caught that, a 9% cap for an “A” credit drug store in 2000! Today’s value with 10 years remaining on the lease, may be 9%. In order to refinance, the Seller would have to write a check for $225,000 just to pay off the original lender, and has opted to sell the property instead. While the original mortgage LTV and amortization were a little aggressive, the rent’s only $21 psf, so decent fundamentals.

As far as the industry’s turnaround is concerned, if we have reasonably conservative underwriting on transactions pre-2005 that require additional equity, how does that translate to the scale, valuation, leverage, and lack of amortization in most transactions since? Again this focus is only on performing net lease properties, not the remaining universe of CRE with its pro-forma underwriting based on lease-up and growth in rental income across all property types, with impending debt maturities.


(2) Is commercial real estate’s fate tied to unemployment or any other pertinent economic factors?

Net lease real estate, at least in our retail and restaurant segment, is tied to the health of the consumer and disposable income. There’s been some fallout of various retail and restaurant chains, but for now it seems stabilized, if we’re at the bottom. As far as the balance of CRE, in order to see growth in rent and occupancy, there will need to be workforce expansion, whether existing companies, or new businesses. Obviously, CRE’s health is ultimately tied to the vitality of the real estate capital markets for imminent re-financing requirements and future development.

(3) When recovery does begin, what areas will grow first and fastest?

Our sense is that a recovery in lodging and casual/upscale dining occupancy levels and sales, along with increasing travel center revenues will provide evidence of the start of a recovery. This will hopefully indicate that employees on expense accounts are back on the road building business again, and trucks are delivering new inventory and product.

(4) Are there segments of commercial real estate that you find appealing even in this economy, including the net lease market?

Our bias is net lease, and especially so in this economy. I am sure there will be value-add plays out there, but if you’re investing in real estate, net lease offers stability and growth if well underwritten. Our targets are a 20 year lease, strong tenant, annual rent bumps for growth, conservative rent and valuation fundamentals, on a property that’s profitable for the tenant? With this uncertain economy, can’t imagine investing anywhere else.

(5) Would you prefer to invest: Close to home or in a stronger metro market?

What are your top two choices in your preferred area?
We focus first on unit level performance, strong real estate fundamentals, with a good operator as the tenant. We’re probably shy on some markets in the upper Midwest, but have investments and interest in the entire country.

Buffalo Wild Wings Has Keys to Success

The Restaurant Association's performance index may show that the restaurant industry has been shrinking for the past 23 months but Buffalo Wild Wings (NYSE: BWLD) has continued to profit and expand, bucking that trend. According to new analysis by MSN Money, Buffalo Wild Wings tops the list of restaurants that are succeeding during this recession. It offers an atmosphere which contains both value based products and entertainment, perfect for the climate of negative news today.

This year, Buffalo Wild Wings has seen profits increase 34% and overall revenue increase by 31%. This growth is not contained to recent events, but in-fact has been a measurable trend. Over the past four years Buffalo Wild Wings has seen revenue growth of at least 19% per year. Last year it pulled in $422 million in revenues, by 2014 Value Line predicts yearly revenues to increase to $1 billion.

Expansion has been a key to Buffalo Wild Wings success. Currently it owns 197 stores and 363 franchises. According to its 2008 report, Buffalo Wild Wings aims to grow that number to 1000 outlets nationwide. In order to reach this goal, it plans on opening 60 stores a year. So far this expansion has been both achievable and profitable. Last year the company recorded revenues of $2 million per store.

Though many companies are finding it hard to maintain operations, let alone flourish in this economy, Buffalo Wild Wings has done so. It is always encouraging to look upon those that have managed to find success and companies such as Buffalo Wild Wings demonstrate that the correct business model can function in this climate. It also represents a rare opportunity to invest in an expanding business in an environment marred by foreclosures and bankruptcies. This is why we have seen a continued supply of Buffalo Wild Wings flowing through the net lease investment market, investors like profitable and successful companies.

Can Commercial Real Estate Have a “Debtless” Recovery?

Like so many things over the past decade, commercial real estate experienced a boom by way of unprecedented debt financing. This debt was securitized and transformed into CMBS bonds, lending otherwise unsavory debt high credit ratings. Thus, people were allowed to have their cake and eat it too, taking out huge amounts of debt while retaining investment grade status. The loans this debt was culled from are now fast approaching their due dates, with over half predicted to default. Without a new source of debt financing, it is clear the commercial real estate market will be rocked by a gale force crisis.

Currently, our economy is already suffering from many ailments. Unemployment stands above 10%, our government is trillions of dollars in debt and the dollar is weakening. Many say a commercial real estate crisis would crush what little recovery we have experienced and we should go to all lengths to stop it. However, this is a flawed premise. The outstanding debt on commercial real estate is not like some group of foreign barbarians ready to sack our recovery, it is an integrated part of the economy. It is tied to things like unemployment and low consumer spending; there is no feasible way for commercial real estate to recover unless the economy itself is healthy. Conversely, a crisis in commercial real estate would naturally impact the rest of the economy as well; it is a complex ecosystem of interrelations. It would make no sense to throw our gold at it and hope it simply goes away appeased.

According to the MIT Real Estate Center, commercial properties have dropped close to 42% over the past 2 years, leaving 55% of the outstanding $1.4 trillion worth of commercial mortgages underwater. This in turn has caused the delinquency rate to increase to 5%, up from 0.77% a year ago. These are the effects of an economy suffering from the collapse of a bubble fueled by reckless debt. There have been some positive recent developments such a $400 million offering of CMBS bonds (enhanced by TALF financing) but these properties represent the exception rather than the rule as they were conservatively underwritten. In-fact the Wall Street Journal goes as far to say “it will likely provide little solace to owners of tens of billions of dollars of office buildings, shopping centers and other commercial real estate that are now worth less than their mortgages.”

This is not the time for illusions about security, they are what got us here in the first place. The level of debt leveraging that occurred in the past is simply not a feasible business model. Furthermore, those properties and loans which are now under water due to that model should default as their positions are obviously untenable. These are not horrible abnormalities but necessary corrections dictated by the market. The bubble has collapsed. Only through intelligent investments, prudent decisions and a revived economy can commercial real estate rebound.

Net Lease Insider Pulse: Richard Ader on Commercial Real Estate

Net Lease Insider interviewed Richard Ader, Chairman and Founder of U.S. Realty Advisors, LLC, one of the largest owners and acquirers of single tenant net lease real estate transactions. We asked him five questions dealing with the present and future of commercial real estate, his answers proved both insightful and thought provoking.

(1) Will the commercial real estate market bottom out in 2010?

I do believe the first six months of 2010 will continue to show a decline in value and rents in most sectors of the real estate market. I believe the commercial real estate market will start to bottom out in late 2010 or possibly into the first quarter 2011. A key determinant will be how the growing shadow of maturing mortgage loans is handled.

(2) Is commercial real estate’s fate tied to unemployment or any other pertinent economic factors?

Commercial real estate is tied to all economic factors due to the fact that real estate is
capital intense, and supply and demand driven. Job creation and unemployment directly impact all aspects of commercial real estate: vacancies impact rents for office buildings, and we assume that retail demand will continue at lower levels which will affect both retail and distribution properties. In addition, until the real estate capital markets are re-started, new real estate development is likely to remain at the current depressed level. In the background is the potential for increased inflation, which would impact the cost of operating properties and financing properties, but may not affect rents which are more demand driven.

(3) When recovery does begin, what areas will grow first and fastest?

I think the first areas to recover in the real estate market will be retail and distribution, with office being last. I believe when the recovery comes, people first will start shopping again. This pent-up retail demand will trigger distribution to meet greater retail demand (and permanent changes in retail patterns). Office space will trail the recovery, as companies will first re-occupy large volumes of currently unused space before starting to lease new space.

(4) Are there segments of commercial real estate that you find appealing even in this economy, including the net lease market?

We find net leases to be appealing. Like most real estate assets, cap rates today have increased substantially compared to the over-heated markets of two years ago, and lease terms are longer. There also are opportunities to buy mortgage debt at good discounts with the objective of owning the real estate or achieving equity-type returns.

(5) Would you prefer to invest: Close to home or in a stronger metro market? If yes, what are your top two choices?

I think the preference today for investments in multi-tenanted office assets should be in the stronger metro markets. Distribution should also be in the stronger distribution areas, and retail should be based on prior performance. Net leases should be driven by corporate credit. How the lessee uses the asset in its business and what alternate demand for the asset would exist if the lessee were to move out.

Does the Market Still Crave Inferior Goods? Dollar General's Upcoming IPO

Kohlberg Kravis Roberts & Co (NYSE:KFN), recently set terms on a $750 million IPO for their discount retailer, Dollar General (NYSE:DG). If all goes according to plan, 34.1 million shares will sell for between $21 and $23 providing cash which KKR will use to pay down debts. How the market accepts this offering may betray its true feelings towards the economy. As a discount retailer specializing in value goods, Dollar General will only continue to see growth as long as people’s incomes continue to drop. Thus a strong showing at Dollar Generals IPO could indicate the market believes the recession will continue to impact people, in spite of recent positive GDP numbers.

While most businesses have been enduring hard times, discount retailers such as Dollar General and Wal-Mart have enjoyed an economic boon. In-fact, Dollar General has announced it will open 500 new stores and renovate 450 others in their fiscal year 2009. This expansion is bolstered by Dollar General’s strong earnings, in the half year ending July 21st; Dollar General saw net sales increase 13.3% over the same period a year earlier to $5.7 billion, raking in a profit of $176.6 million.

These numbers make sense economically, as one would expect a time of higher unemployment and lower incomes to translate into more business for discount retailers. However, many analysts are announcing the end of the recession due to a GDP increase of 3.5% in the third quarter. If this were true, Dollar General’s expansion would be somewhat unviable. How could one sustain its recent growth if the economic conditions which permitted it were abating? It seems Dollar General is betting that demand for their product will continue for the foreseeable future and thus so will our recessed conditions. If the market receives Dollar General’s IPO well, it would be saying Dollar General is on firm financial grounds, its expansion is on firm financial grounds and therefore the economy is on weak financial grounds.

Conversely, should Dollar General receive good results at the IPO, its individual properties could witness cap rate compression. This would only make sense because, in essence, the company would be receiving a vote of good faith from the market which would be both substantial and measurable, translating into higher prices. The trend has already been towards discount retailers; a strong IPO would confirm this trend for the near future and lend credence to Dollar General as an investment opportunity. The question is whether this spike will renew investor demand for Dollar General real estate interests.

Big Numbers Don’t Tell the Whole Story: Cap Rate Averages

Cap rates are going up nationwide, but accepting this notion as all encompassing does disservice to a market filled with tenant disparity. If one surveyed the nation they would undoubtedly find properties which are suffering, as well as those who continue to prosper. Though the big numbers say cap rates are going up, buyers shouldn’t scoff at properties with low cap rates. They may well deserve them.

Take a case involving an Arby’s (NYSE:WEN) for example. Recent sales have had cap rates as high as 10.07% and 14.85% and Arby’s has posted an average rate of 8.40% over the past six months. So if an owner tried to market one for 7.50% to 7.75%, one would have to wonder what he was thinking, right? But go back to Rules 1-3 of real estate: it’s Location, Location, Location. If that Arby’s happens to be located in the DC metro area surrounded by affluent suburbs, the property would require a much different valuation than the overall numbers would project. A property with the right location can be worth the low cap rates; even if nationwide they are rising.

Real estate is not like an automobile. A car in Washington D.C. is going to be the same as one in Wyoming. However, a property in Washington D.C. will be radically different (value wise) than that of Wyoming. Though the lure of high cap rates may be great, their applicable properties may not be deal they appear to be. Would you rather have a high cap rate property in Wyoming or one with a lower rate in the D.C. area? Certainly it would depend on the investor but it would be prudent to keep in mind the oldest rule of real estate when making deals in this brave new world.

Washington DC: An Oasis of Prosperity for Residential and Commercial

There have been many whispers about purported hoards of capital sitting on the sidelines, waiting for the perfect opportunity to spring forth with investment frenzy. The question is when and where? For the answer, go no further than CNN.

What is growing at a never before seen rate?

Where are budgets boldly expanding in the face of economic calamity?

What may be taking over 1/6th of the economy?

Why the Federal Government of course. And its central hub and router, Washington DC, looks to prosper in light of this action.

In-fact, it already has.

As Globe St.’s Erika Morphy reported, Washington DC condo sales are “on a rise after a two year trough”. There were 686 new unit sales in Q3 alone, the highest volume in two years. This represents a greater trend, as sales in the past 12 months increased 45% over the prior 12 month period.

To put Washington DC’s growth in perspective, U.S. foreclosures just went up a record 23% from Q3 of last year and 5% from the previous month. As CNN states “this quarter was the worst 3 month period since the great depression”. To top it all off unemployment has gone up to 9.8% and is expected to hit at least 10.5%.

Washington DC’s unemployment stands at 6.2%, one of the lowest percentages of all U.S. metro areas and was recently named the top magnet city for young professionals. Combine this with its growing employment opportunities through government expansion and it is easy to see why Washington DC is a striking investment opportunity.

Companies are even observing increased sales activity in one of the most bemoaned sectors of the U.S. economy: Commercial Real Estate. The Pitango Gelato, a retail condo building located in Logans Circle, was just reported to have been sold for the highest price per square foot that the selling broker has seen to date. This would seem shocking due to the current state of affairs, but given the context of the building being located in the Washington DC area, the situation makes sense.

As President Reagan once said, “the closest thing to immortality we will ever see is a Government program”. This sentiment rings just as true today as it did all those years ago. In the midst of even the harshest economic turmoil, the one place of unending growth will remain the government and its seat of power, Washington DC.

Reversal of Fortunes: Giving Power to the Investor through the 1031 Reverse Exchange

Net Lease Insider sat down for an interview with Stan Freeman, President of Exchange Strategies Corporation, the nation’s only 1031 reverse exchange accommodator dedicated exclusively to providing a full set of reverse exchange processes for all asset categories to qualified intermediaries and sophisticated exchangers. He provided excellent insights into the reverse exchange process, ranging from cost effectiveness to asset security.

1. How do investors take advantage of reverse 1031 exchanges in today’s difficult investment real estate market?

First, it is unfortunately true that many investors’ gains have been seriously eroded over the last 18 months. 1031 exchanges have fewer benefits for these folks. If someone does have potential benefits from a 1031 (either the deferral of gains or renewed depreciation potential), then the issue with making a new acquisition in the context of an exchange will likely be finding a buyer for the old asset.

To that end, reverse exchanges have been used for years by investors to better control the outcome of their investment strategies. At no time in recent memory has this been more important. Using a reverse exchange, an investor can acquire what they really want without the pressure of the standard 45 and 180 day deadlines applied to new assets. Most investors would rather be under pressure to sell what they have and not under pressure to buy something they might really not want. Furthermore, in many situations, reverses can be structured to provide more time – up to a year or perhaps more – to a accomplish a particular strategy. In today’ market, this can make all the difference.

2. How do you use a reverse exchange to get more time?

There are various ways to combine exchanges to get up to two 180-day periods. Generally, this is done when there are multiple properties to sell or buy. As an example, suppose you have an older apartment building to sell and you want to buy two new net-lease properties. If you start a reverse with the first of the new properties, then you have up to 180 days to sell the old property. Once it gets sold, in the context of a forward exchange, you have another period of 180 days to acquire the second new property. This type of strategy can also work if you have multiple old properties and a single new property to acquire.

There are also forms of reverse exchange that allow a new property to be improved prior to title being transferred to its ultimate buyer, thereby increasing its value for purposes of deferring more gain. This can also work with leaseholds. Both forms allow the investor more time to make improvements that bring a property to a full income producing condition.

In addition, there exist non-safe-harbor structures that require a great deal more care to implement. They are more complex and expensive and should be considered when the gains from the sale of an old property are substantial and there is real potential based on a either a series of new property acquisitions over a period of time or a construction project that will require a lot more than 180 days to complete. There are situations in which these structures make a great deal of sense.

3. But, I have the impression that reverse exchanges are very expensive. Isn’t that an impediment to using them as you suggest?

Investors with properties that produce healthy income will almost always find that a reverse is economically sound. The investor can earn the rents from both the old and new properties for up to 180 days if they are using a reverse exchange. So, if this income is greater than the reverse exchange fee plus the cost of funds needed to acquire the new property, the economics are significantly better than in a delayed exchange. Of course, a detailed analysis of the exchange economics for a specific situation is probably more complex than this. But it is always worth doing and we help our clients through the analysis on a regular basis.

4. These days, many investors are hesitant to use 1031 exchanges at all because of the numerous instances of theft and bankruptcy. Is there a reason to be nervous?

A reverse exchange is a title-parking arrangement. There is no cash, per se. And, there are well established methods of insulating assets from liability, bankruptcy and failure to execute. There is really no asset risk in a reverse exchange if it is structured properly.

Regarding the spate of QI failures, it is the accumulation of a large amount of cash proceeds – often following the acquisition of one QI by another – that has proved too tempting for some. The exception to this was the situation involving a large title-company-subsidiary in which securities were purchased with exchanger funds that became illiquid. The motivation was to increase the earnings on the cash it held. When selecting a QI for a delayed exchange it’s important to use one that allows you select the bank where proceeds are parked and is bonded and insured.

None of these issues pertain to reverse exchanges.

Perhaps choosing your accommodator for a reverse exchange requires some additional care in light of these cash-drive failures. If the QI you choose is heavily dependent on delayed exchanges and if their business is under stress because of the decline in exchange activity, then you should make sure that the LLC they form to hold your assets is fully protected from a decision they’d make to seek protection from a bankruptcy court. The entanglement that can occur if the LLCs are not structured right can be lengthy and difficult.

For more visit: http://www.exstra1031.com/

S&P and Moody’s Put on the Defensive: Rating Agencies to Share Liability under New Bill

From Merriam-Webster:

Conflict of Interest
Date: 1843
: A conflict between the private interests and the official responsibilities of a person in a position of trust.

To most, AAA investments are as good as gold and function as a secure reference point with which to steer portfolios. However, they recently served as a false beacon, leading thousands onto the jagged rocks of financial peril, causing billions of dollars to be lost forever. The credit ratings agencies responsible for these guiding lights are supposed to have the interests of the investor and public aligned with their own but it is widely perceived that this is not so. Now under public pressure for accountability, congress is considering a bill that will force liability onto these agencies.

It is commonly known that credit rating agencies such as Moody’s, Standard and Poor’s, and Fitch make their money not from the public who uses their ratings but from the companies who pay to have their securities rated. This would seemingly create a conflict of interest, because the agencies would naturally be more eager to appease those who pay them than those who do not. Thus their official responsibilities (putting out accurate credit ratings) are in conflict with private interests (being paid by companies to rate them). Especially if that company is say, Lehman Brothers, whose financial viability rests upon the AAA ratings of their securities which they know to be worthless. A company in that position would undoubtedly be willing to fork over lots of cash to keep their self-sustaining illusion afloat. Likewise ratings agencies, faced with the proposition of losing business if they are not conciliatory, might be persuaded (through proper monetary investment) to help in that endeavor.

The ratings agencies response to their defaulted ratings is essentially “oops” because they are not liable for the ratings they put out. It is of course natural then that the public would want to strike back at these agencies and hold them accountable for their ratings, to ensure that no future “investment grade on Friday, bankrupt on Monday” ever occurs. But a regulation such as the one proposed is a tricky measure, in need of careful analysis before implementation.

For one, if those giving financial advice are suddenly made liable, to what extent and under what conditions can they be sued? It is possible something could evolve like what currently plagues the medical profession, a multitude of frivolous lawsuits which drive costs unnecessarily upward. Any investor could theoretically have a claim against these agencies, even if the market did take an unforeseen dip. Secondly, the regulation could come out looking like the widely criticized Sarbanes Oxley Act. An act which is generally hailed as being not only a hazardous maze of red tape but essentially a useless precaution. Finally, these agencies may not be liable but they cannot falsify their reports without reproach. Already there are pending law suits alleging major fraud, which could end up securing convictions, penalties or major settlements. These suits could bring about the accountability desired, making legislation unnecessary. Regulation is always more complex than it seems in principle; prudence requires us to be cautious, skeptical and thorough with regards to any proposal.

The net lease industry, like most others, depends upon the validity of credit ratings. One of its most appealing qualities is the promise of long-term viability. Discovering a portfolio of AAA properties is actually not even investment grade would simply be disastrous. Accurate ratings are without a doubt needed but legislation must be properly vetted to ensure it is not harmful, ineffective or unnecessary.

Need Cash? Sell the Capitol Building! The New Trend of Government Sale-Leasebacks.

As reported by Globe St.’s Brian K. Miller, Arizona has approved plans to auction its “State Capitol Executive Tower” in a 20 year sale-leaseback. The tower houses the offices of the secretary of state, state treasurer and Governor and has an estimated value of $40 million. Arizona was forced into this predicament because of its current budget shortfall, which currently stands at around $3.2 billion.

However unlikely, this is just one example of a growing trend of government sale-leasebacks. California plans to sell $2 billion (or 62% of Arizona’s budget deficit) worth of government real estate, including the Attorney Generals Office, in a similar sale-leaseback. The City of Alexandria, VA, is considering the same thing with a host of its properties and Chicago has already performed sale-leasebacks with the “Skyway toll road, downtown parking garages and downtown parking meter system” for $3 billion. Sale-leasebacks make sense for governments because they allow them to get cash now to pay off their debts while retaining the option to buy back the property in 20 years or so.

Investors have shown a great deal of interest in these properties because their tenants (the government and in-effect, taxpayers) have strong credit ratings and in some cases will return twice what the investor pays. Not surprisingly, interest goes beyond political boundaries, as it is reported that international investors are heavily intrigued by these sale-leasebacks. This creates a bit of an irony, because in theory, you could have a U.S. State Capitol building owned by China.

Sale-leasebacks are generally structured as net leases, giving strength to a segment, which as Michelle Napoli pointed out, is already one of the most active in this current market.

Retailers Expecting Lean Santa: Holiday Retail Sales & Outlook

The fourth quarter is typically a time retailer’s look forward to with such glee that even a child would be hard pressed to match their level of expectancy. This is, after all, the time of presents, candy, costumes, decorations, ornaments and lavish meals. Children know Santa is coming to town and retailers know parents are. In-fact retailers are so anxious to begin this cycle of profits; they are often accused of putting out holiday items too early, the infamous “Christmas creep”. However, last year retail was hit hard by the recession; today the economy looks much the same and retail must adapt.

This will be the second holiday season celebrated under our current recession and the retail sector carries no illusions about that. According to a recent survey released by Hay Group, 72% of retailers predict sales this year will be equal to or less than sales last year and 57% are planning on reducing staff levels this holiday season. In comparison, last year 60% of retailers expected an increase in sales and only 29% decreased staffing levels. While these numbers are obviously negative, they are also prudent, reflecting a necessary change in mindset rather than an unfortunate change in the economy.

Additionally, retail is adopting new promotional strategies to better fit the current economy. 43% of respondents plan on “running more promotions and/or deeper discounts” this holiday season and another 43% plan to run promotions continuously from now till new years. This reflects a shift in focus from last year, when 45% percent of retailers ran most of their promotions on Black Friday (this year only 35% will), giving people more time to save up paychecks before making purchases.

These changes may already be having a positive impact on retails outlook. According to Fitch Ratings:

“Many companies across Fitch’s U.S. retail coverage have been managing inventory positions well. Gross margins have rebounded for those companies in the discretionary categories that were hit particularly hard during the 2008 holiday period. This, combined with strong cash flow management and the resolutions of liquidity issues for several companies, has resulted in an improved overall credit outlook”.

Though this may not be the holiday season of our dreams, it will certainly be a reality we are more equipped to cope with. Through tempering sales predictions, cutting overhead costs and altering promotional activities, retailers are becoming leaner and more efficient. Furthermore, in this current market where nearly 50% of net leases are traded as retail, should credit scores and sales improve, the only thing that may be going down are cap rates.

The Party is Over: Net Lease & the Future of Commercial Real Estate

In a very interesting article by Globe St’s Amy Wolff Sorter, the typical real estate investor of the future is predicted to be quite different from the one of our near past. Due to real estates most unfortunate bubble, the new investor will be squarely focused on pragmatic investments for the future, rather than “Real Estate Riches in 14 Days”. If true, it sounds like this “future investor” would be very interested net leases.

Specifically the article states:

“Experts tell GlobeSt.com that, in the wake of the 2008 economic crisis, the real estate owner of the future will undergo a seismic shift from the buy-and-flip investor to one that is knowledgeable about real estate and will stay with an asset for the long haul.”

This description perfectly fits that of a net lease investor. Net leases are primarily characterized by long term leases with stable tenants of investment grade credit. As such, net lease properties are generally considered to be low risk, dependable investments. For a marketplace suffering the effects of a hangover fueled by a lost weekend of high risk binging, net leases could represent that cool cup of tea and handful of Advil in the morning.

Retail Sales Signs of Life: Do Signs Point to Destinations Anymore?

The early days of September have seen a recent flood of positive news: Retail Sales are Showing Signs of Life. Examples of this include articles entitled “August Retail Sales a Pleasant Surprise” released on Sep. 4th by Globe St. and “Retailers Begin to Show Some Signs of Life, But New Leasing Deals Continue to Pose Challenges” by Retail Traffic on Sep. 1st. If readers from another planet saw these articles, they would undoubtedly think that these were the first reports of good news in a while, as we are just “beginning” to see them. But to an earthly observer, there is something odd about these “Signs”. Namely, that we have been reporting to have seen them for over half a year.

All one has to do is Google “Retail Signs of Life” and they will come upon articles such as Wall Street Journal’s “Retail Sales Show Signs of Life” dated March 6th, Internet Retailer’s eerily similar “Retail Sales Show Signs of Life” dated April 7th and “Signs of Life: Slower Decline May Signal Recessions End” by RIS Media on August 4th.

So how can we be purportedly “Beginning to See Signs of Life” for this long and not yet see the actual Life? The answer may lie in what we are using for signs these days.

Take the opening sentence from the Globe St. article cited above:

“Summer is ending with a pleasant surprise for retail observers, with August US comparable-store store sales declining by a better-than-expected 2% from the same month of 2008, according to the International Council of Shopping Centers Chain Store Sales Index.”

Does this not represent a weird prognostication of good health? We are doing better by doing worse; it is a “pleasant surprise” that comparable-store sales declined by 2%? This is close in resemblance to Orwell’s infamous “Doublethink”, having two contradictory thoughts at the same time. Like, “things are worse but better”. In essence, becoming our own devils advocate.

We can see “signs of life” for as long as we want if we simply make the predictions worse than what actually happens. An actual show of improvement will be a trend in which sales do not decline, or even perhaps go up. Those will be the real signs and hopefully we’ll see them soon.

It’s the Loans, Not the Land: The CMBS Refinancing Crisis

It seems to be a generally accepted fact that Commercial Real Estate is about to hit the ground like a ripe watermelon thrown off a ten story building. Stories abound about how its impending collapse will send systemic shocks rattling through our weakened economy, delivering a rude kick to the face just as it is trying to get up. Investors stand quivering on the sidelines and banks are trying to find out how they can hire Jimmy Stewart (aka It’s a Wonderful Life) to perform some crowd control once their money evaporates with the popping of this last bubble.

And you know what? These predictions, dire as they are, may not be totally off base. If recent reports are to be believed, things are not all well with the world. The delinquency rate for CMBS rose to 3.14% in July, which is more than six times as high as the level last year and by 2012, $100 billion of the $153 billion worth of CMBS loans (65%) will face difficulties being refinanced. With this kind of information, it’s easy to see why so many are pessimistic.

The thing to be remembered, however, is that this is all the result of massive artificial inflation. There is nothing inherently wrong with the land; there is nothing inherently wrong with commercial real estate. There was something horribly wrong with the way people behaved between 2004 and 2007. Essentially, taking a Louisville Slugger to the figurative credit piñata and declaring “come get it!” resulting in drastic overpricing and horrible loans. The land itself was the innocent victim of this all and today faces the repercussions of our malfeasance.

In-fact, the cash flow from most of those properties whose loans expire in 2012 is enough to “pay interest and principal on their debt”. Even in the midst of this deep recession, commercial real estate is still producing wealth. The problem is that its values have inevitably fallen from their inflated highs, making it almost impossible for borrowers to extend their existing mortgages or refinance with more debt. But is this necessarily a bad thing? Clearly the market was flooded with bad credit, so is it wise to take out more debt, or in the case of government action, tax payer funded debt, to refinance bad loans? Perhaps it is best just to let the market clear itself of its toxic waste.

We collectively went on a binge of epic proportions and today have to face the consequences. But we never destroyed or devalued assets, we overvalued them. When the dust settles it will be found that commercial real estate is still a great investment, still capable of building wealth and in reality, still is today. If the economy does get hit by a wave of CMBS foreclosures, it’s not because of the land, it’s because of us.

Land Investment, Present and Future, a Discussion with Rich Samit.

Net Lease Insider sat down with Rich Samit, Founder and CEO of Fraser Forbes Real Estate Services, the leading firm in the Mid- Atlantic region handling land sales, financing, management and advisory services. Net Lease insider sought to discuss the outlook of land and its implications on the net lease market.

The discussion centered around five questions and produced some very interesting results:

Q1. Why do so many land owners consider a net lease asset as a replacement property?

A1. Like land, a net lease investment is “passive”, requiring no action on the owner’s part to maintain. For owners of land, who are not accustomed to taking an active role in property management, a net lease ensures their management responsibilities remain the same. This also translates into greater flexibility relating to location. As management never comes into play with a passive investment, proximity is of no consequence, allowing for wide range of geographical possibilities.

Furthermore, a transfer from land to a net lease is also a transfer from a non-depreciable asset with no income (land) to a depreciable asset with income (net lease). The advantages here are clear; the net lease allows for use of the depreciation tax shield while collecting income for the owner, making it an attractive option.

Q2. As a follow-up question, do most investors selling land consider doing a 1031 exchange?

A2. Normally a 1031 exchange would come into play because owners of land generally see appreciation in their asset and would rather defer it than pay taxes on it. However, land purchases in the last few years were subject to the bubble of price inflation and today are not faring well. If you bought land from 2004-07, you are most likely flat or underwater. Because no gain is observed, today most investors have no need of the 1031.

Q3. Have you started to see an increased number of 1033/eminent domain transactions due to increased government infrastructure appropriation?

A3. In the last 12 + months there has been a 20%-30% increase in the number of 1033’s seen. There are many government projects underway such as Metro’s expansion to Dulles Airport, the hot lanes in Maryland and Virginia, the ICC and purple line in Maryland, and other various state needs on both sides of the Potomac river. As a result, the construction of such facilities has forced people into 1033’s through eminent domain. Deals involved cover a wide range, going from $1 million to as much as $50 million in some cases and net lease investments have been one of the favored asset classes for reinvestment.

Q4. At what point in this cycle will investors start to recognize land as a very undervalued asset opportunity?

A4. The bottom seems behind us in terms of residential real estate. Many developers who haven’t been active in 3+ years are building up their land assets as that market begins to recover. The picture is less positive on the commercial real estate side. Prices continue to fall and until they hit bottom, investors are holding back.

Q5. What is the current state of land as an investment opportunity?

A5. The best opportunities today are large raw residential or mixed use land investments in the urban and suburban core. Though they require a large amount of capital to purchase and maintain, many deals can be purchased at discounted prices and will definitely see a high level of appreciation in the future. Also, any investment near new infrastructure developments such as mass transit systems and power life style centers has a lot of growth potential.

Medical Office Real Estate: A Net Lease on Life

While many real estate investments are loosing value, the medical office sector has shown remarkable resilience. According to a report from Marcus & Millichap Real Estate Investment Services, the segment is holding up much better than other property types and this trend projects to continue.

Currently the nation spends $2 trillion on health care annually, by 2013 that number is projected to grow to $3 trillion. In-fact, medical expenses have increased by an average of 7.7% over the past 10 years and now make up 17% of GDP. This exponential growth has been fueled by the large amount of baby-boomers who are steadily increasing in age and by 2013 the number of people over 55 will have increased by 20%. As more people advance in age, their medical expenses will rise correspondingly, fueling demand for the medical office segment.

Another driver of demand has been the shift from “an impatient to outpatient focus”. This has been caused by the steep rise in costs associated with hospital construction. A single hospital bed is now estimated to cost $1 million, driving many new hospitals to house around only 100 beds compared to older hospitals featuring close to 800. This decrease in supply, coupled with an increase in demand from an aging populace, has created a large need for medical office space.

These trends are reflected in the industry’s employment numbers. While the rate of job growth has decreased, job growth itself is still positive. 50,000 jobs have been added this year and another 200,000 are projected to be added by years end. By 2013, 2.4 millions jobs are projected to be added to the sector.

Despite these positive indicators, vacancy is projected to rise. This is due to the economic climate which is forcing many to abstain from health care expenditures they previously would have made. All told, vacancy is projected to increase by 100 bps this year, reaching 12.4% and rents will decrease by roughly 2.7%.

This increase in vacancy should be seen as a possible opportunity for those considering investment. Unlike other sectors, medical office real estate is virtually guaranteed to see a future rise in value as our population ages and health costs increase. Furthermore, if you couple a medical office investment with a net lease structure, you can create a passive investment that will see real growth in the future. This is perfect for someone who wishes to take a less active role in property management but still see his property value escalate. The combination of higher demand, less space and higher employment make medical office real estate an attractive net lease investment for the future.

Is Net Lease Back?

Last Thursday, Globe Street’s very own Michelle Napoli reported that Realty Income Corp, one of the larger players in the REIT market with a focus on net lease investments, has begun looking at acquisitions. Specifically, CEO Tom Lewis said:

“I know there will be some modest acquisitions in the third quarter, and I’ll define that as a trickle, and we’ll see where it goes from there.” He adds, “We are looking at transactions and buying again.”

This is highly significant information because, as Lewis states himself, “it’s been about 20 months since we put out an LOI on a property.”

The fact that Realty Income’s previously muted presence is coming to an end amongst a series of acquisitions could point to the long elusive light at the end of this recession wrought tunnel. At least, as far as the net lease market goes.

And who is the culprit for this recent spat of good news?

Why it’s those two eternal forces of capitalism, who until recently were not on speaking terms: Buyers and Sellers. The gap between them seems to be closing, especially in terms of seller expectations. Which are becoming, as Lewis notes, “more realistic.” This means that for those who have prudently stored capital, the time may be now to start buying. And in a market as tumultuous as this, net lease investments with their incumbent safety, may be the place to start investing.

Bolstering this perception is a recent upgrade by Friedman & Billings Ramsey Capital of Cap Lease Funding’s target, elevating it to $6.00 from the previous $4.00. This positive development for Cap Lease Funding, which specializes in Net Leases, could very well be indicative of the entire market. Taken together with Realty Income Corp’s new dalliances, we may be seeing the beginnings of a positive trend. So look out world, there may be sunny weather ahead.

How Much Longer Will The Recession Last? The Results Are In

Posted below are the results from our poll given two weeks ago concerning the length of our present recession. The numbers leave us with two important things to take away:

1. Most respondents, 78%, trended towards the middle. In this case I’m defining the middle as “Less Than One Year”, “One Year” and “More Than One Year”. In other, less scientific words, 78% of respondents believe the recession will end in a year, give or take a few months.

2. In terms of the extremes “Its Already Over” and “More Than Two Years”, we see large disparity trending towards the latter. 17% of people answered “More than Two Years” compared to only 5% for “It’s Already Over”. This leaves one with the impression that more people tend to think extremely negative of our situation than positive.

When compared with results returned by other polls, such as “The Harris Poll” released on July 15th, we can see a correlation. 63% of their respondents answered between “Less than 6 months” and “Between 1 and 2 years”, which is roughly comparable to our middle range of 78% answering between “Less Than One Year” and “More Than One Year”. Though our results show a higher skew in that data range, both polls returned a majority in that area.

Of higher significance is the number of people whose predictions ranged beyond two years. In our poll that number was 17% but in the Harris poll, if their latter two categories of “In more than 2 years” and “I do not expect the recession to end in the foreseeable future” are coupled together, that number is 38%, more than twice as large. So while both polls show a skew to the extreme negative over positive, theirs is certainly higher pronounced.

Harris Poll: When Do You Expect The Recession to End?




All in all, both polls have more similarities than differences, with the clear results being most people think the recession will end in roughly a year and of those remaining, that the recession will last more than two years. The one difference is a more pronounced trend to the positive in our poll, implications being that GlobeSt readers are of the more upbeat variety.

Real Estate: What is it Good For? Absolutely Nothing…

Yes nothing. Actually, Zero. When was the last time an investment involving a “zero cash flow” sounded appealing? For most of us, that time would be never. However, there are times when “Zero Cash Flow” property can be of the most instrumental use. The benefits lay in the tax implications for those performing 1031 transactions, if used properly, they can allow someone to leverage a property with (if you can believe it) 90% debt. Of course that debt comes at a cost, namely all those rent checks that would normally be going to you, instead go to your lender (hence zero cash flow). However, after you are done paying off the debt, you would be left with a property completely paid off, most likely highly appreciated in value, and a deferment of the impending capital gains taxes.

Here’s how it works:

Say someone, Mr. Fornit for example, needs to sell a property worth $7 million, with only $1 million in equity and the rest in debt. The property was originally bought in 2000 for $2 million and if sold today, faces a $5 million capital gains tax liability. To avoid the impending capital gains tax, Mr. Fornit needs to enter into a 1031 but that means the new property must be of equal or more value. After satisfying the $6 million debt obligation, Fornit only has $1 million of cash to reinvest in a property that must be worth at least $7 million to comply with the 1031 rules. To buy a property you need to provide at least 30% of its price in equity. In this situation, Mr. Fornit’s equity would only equal 14% of the total cost.

By entering into a zero cash flow transaction, he can avoid these problems. A zero cash flow transaction is structured almost like a bond, so a bank will invest the $6 million needed into Mr. Fornit’s property and in return will receive the properties rent checks to pay off the debt. In this way the bank recoups its investment and Mr. Fornit ends up with a wholly owned property that satisfies his 1031 and defers his pesky IOU to Uncle Sam.

Note: This kind of transaction only works with investment grade properties to ensure payment stability.

So you may ask: what do zero cash flows from properties have in common with anti-hawkish music by Edwin Starr? One common theme: the best interests of the common man may not be directly aligned with the interests of Uncle Sam. So avoid your unnecessary taxes and stick it to the man!

Will the sun come out tomorrow?

What is the state of the economy? Today this question seems more existential and philosophical than reality based. Over and over we hear things like “signs indicate a possible recovery” or “X number could be a sign things are leveling off”. It almost reminds one of ancient shaman looking at the stars, studying the flight patterns of birds, or sifting through bones to predict the future. It seems each day brings us a new set of “signs”, and a new set of prognosticators telling us how close, far, or indeterminate our situation is from recovery.
Take for example two reports, one from the Wall Street Journal and one from CapLease, both published only days apart in July. CapLease cites employment data and states:

“After 18 months of economic decline, we are seeing signs that the deepest recession in a century may be close to hitting bottom and the economy gradually recovering. The Labor Department reported that 345, 000 jobs were lost in May – well below the 650,000 average monthly job loss in the first quarter and the 504,000 loss in April.”

Now compare this to the Wall Street Journal story, subtlety titled “The Economy is Even Worse than You Think”

“The Bureau of Labor Statistics preliminary estimate for job losses for June is 467,000, which means 7.2 million people have lost their jobs since the start of the recession. The cumulative job losses over the last six months have been greater than for any other half year period since World War II, including the military demobilization after the war. The job losses are also now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all job growth from the previous expansion.”

Here we have two reports using relatively the same numbers, with both coming to wildly different outlooks of both the present and future (in the case of the Wall Street Journal a near apocryphal vision). One side claims to see the light at the end of the tunnel, while the other maintains we make Alice look like Sir Francis Drake. This is not to fault the process (it is really the only thing we can do) it just demonstrates how differently the filtering mechanisms of disparate brains can sort things out. So in the spirit of “and now for something completely different”, Net Lease Insider will illustrate a set of trends and facts and let you be the judge.

Note: All information was gathered from CapLease inc. You can read their full report by clicking on "July 2009 Newsletter" at this page.
Of Homes:

• Home prices dropped 7% in the first quarter of 2009, while home sales saw an increase in March and April.


• 45% of home sales this year were distressed properties sold in foreclosure auctions.


• Since their peak in 2006, home prices have fallen 32% and now match their 2002 levels.


• It is estimated that housing is 18-20% below fair value at today’s prices; three years ago it was estimated to be overvalued by 35%.


• 5.4 million out of 45 million homes in the U.S. (12%) are either delinquent or in foreclosure, with the number continuing to rise.


• By February 2009 the number of prime mortgages delinquent for at least 90 days, in foreclosure, or turned over to a lender was at 1.5 million, totaling over $224 billion in loans.

Of Consumerism:

• The Consumer Confidence Index hit 54 in May, it’s highest point since last September and up from 40.9 in April. This constituted the greatest gain since April 2003. A Reading of 90 is considered “normal”.


• Between March and April, personal after tax income rose by $131.5 billion (1.1%). $121.8 billion of the increase resulted from reduced taxes and increased unemployment benefits. $44 billion could be traced back to stimulus programs.


• Consumer spending declined 0.01% in April, as consumers saved 5.7% of their after tax income. In March they saved 4.5% and one year ago they saved 0%. Consumer Spending is estimated to make up nearly 70% of GDP.


• Mortgage debt now accounts for 70% of GDP, in the 1990’s it averaged about 46%. Household debt is at 96% of GDP, it was less than 50% in the 1980’s.

Of Other Factors:

• Total industrial production saw an annualized decrease of 20% in the first quarter of 2009. This continues a trend of four periods of harsh declines.


• Commercial paper volume is at $1.5 trillion. Companies sold $55 billion of stock between January and May, making that the busiest period since 2000.


• It is estimated that 60% of CMBS loans made between 2005 and 2007 will not qualify for refinancing at maturity.


• Unemployment is at 9.4%.

Now, it should be noted that the report contained a whole host of information which was not reprinted here, so if you really want to engross yourself with numbers and analysis, be sure to check it out. Nevertheless, the numbers provided, combined with a persons own intuition, should be enough to induce valuable insight. So pick a circle and vote, even if the only thing that knows when the recession will end for sure is the dastardly thing itself, and maybe Bernie Madoff.

15 Year Depreciation, “I’m Lovin’ It”

Amid the hundreds of pages contained within the Emergency Economic Stabilization Act of 2008, there potentially exists an extremely valuable tool for those interested in real estate investment. A new law enables restaurant buildings and improvements to be depreciated on a 15 year basis if they are placed in service within the calendar year of 2009 and more than 50% of their square footage is dedicated to “the preparation of, and seating for on-site consumption of, prepared meals”. What does this mean for the investor? Well, restaurant real estate generally has to be depreciated on a 39 year basis, which means one could increase their depreciation tax shield by close to 40% if they act within 2009. That translates into large dollar sign increases on after tax income.

Below is an illustration of just how much a depreciation shield increase of close to 40% could affect one’s cash flow. For purposes of the comparison, we will be using a McDonald’s and a Burger King, both with solid credit ratings, placed in service in 2009 and 2007 respectively. Since the McDonald’s was placed in service in 2009 it can take advantage of the accelerated depreciation schedule, unlike the Burger King.


What is evident from this example is that restaurant real estate is the place to invest in 2009. In this case we saw an after tax cash flow difference of $55,671 in favor of McDonalds for one year. If all else holds equal, over 15 years that becomes an $835,065 difference. This could make a huge difference to all who are thinking of investing in 2009 and goes to show that change on Capital Hill can turn into cash in your pockets.

“This analysis is not provided as legal or tax advice. We simply intend to illustrate the benefits of a new beneficial tax-rulemaking. Any literal interpretation of this analysis on your specific situation should be discussed with your own tax advisor”

Where is the Market Today?

There is no doubt that we have seen drastic adjustments in the net lease market. Not only from the financial and economic perspectives, but from a psychological perspective as well. Of course there have been quantifiable increases in cap rates, interest rates and internal rates of return, but the perception of today's market is probably the most interesting intangible investment factor.

As the President and CEO of a net lease brokerage firm, I have the privilege of working with professionals from a multitude of disciplines within commercial real estate. We hear market perspective from attorneys to engineers, developers to sellers, REITs to investors and everything in between. What we are hearing is everyone wants more for less. That doesn’t mean that they are getting it, but at least they are saying that they want it.

Investors want better credit, longer leases, the best real estate and an absolute triple net lease. What may be forgotten is that net lease investments offer something that other real estate doesn’t; the opportunity to underwrite the known investment potential from day one. There is no other type of commercial real estate that will allow an investor to know exactly what their income will be from the day they buy the asset until the day they sell the asset. The perception is that they should be getting a much better return than they are being offered. In some cases, that is highly warranted. But in others, it may not be.

We have to remember that net lease investments are still a long term income stream backed by real estate. When an investor and I discuss the current market statistics, I always remind them that yes, they will be getting a better return than what was offered in the last 3-4 years, but they may not be getting the deal of a lifetime. Net lease investments are still garnering single digit cap rates for long term, credit tenant investments. There was a day when today's investments were pricing out at 10%+ CAP rates, but not today.

Today, we see genuine interest in the net lease investment asset class because of its passive nature and higher returns than money markets, cd's, US treasuries, and the like. So while the perception of the market is "buy now, because it may not be this good again," I offer the following advice. The net lease market will ebb and flow with the rest of the market, but stability of the assets will typically remain somewhat constant. Net leases are almost an anomaly in that respect. Perception is reality, but net lease investments are real.