Wednesday, December 15, 2010

West Virginia Market Represents High Returns and Stable Demand


An analysis of West Virginia’s most recent demographic data reveals a State that is stable and predictable. The market exhibits the following characteristics:

  • The highest rate of home ownership in the nation
  • #7 ranking for the percent of population living in the state of birth
  • Population growth of 0.6% between April 2000 and July 2009

The slow, steady growth in West Virginia should be viewed not as inhibiting investment but as a variable in one’s market assessment that can be easily quantified. As a net lease investor, this should provide confidence that with careful analysis, any fluctuations in this growth factor should not be enough to jeopardize your investment’s success.

For certain net lease tenants that target lower income households, such as Dollar General, this is especially auspicious. West Virginia’s high rate of home ownership creates a large base of Dollar General’s target demographic that is largely immobile. This strong demand will likely mean continued growth of net leased tenants like Dollar General and similar tenants in the West Virginia Market.

It is no secret there is a scarcity of high quality inventory in primary markets. This is leading to a “downward compression of cap rates across all sectors.” If this trend continues, the strength of these markets will no longer justify the inflated price tags and slim yields of the assets themselves. Opportunistic net lease investors will need to begin looking beyond these supply constrained markets to have any chance of earning a superior risk-adjusted rate of return.

West Virginia net lease investment represents the opportunity to realize property value appreciation while still delivering a secure stream of cash flows. The State benefits from the same creditworthy tenants that make up the nation’s primary markets and West Virginia banks enjoy the eighth highest ROA in the country. For the willing investor, there should be plenty of opportunities that have been overlooked in this thinly traded market.

Wednesday, December 8, 2010

Industrial Assets – A Shifting Investment Paradigm

It has been estimated that as much as $97 billion will be invested in the US commercial market by global investors in 2011. DTZ, a British-based real estate services firm, stated this represents a 54% increase from their December 2009 prediction. In short, growing confidence in real estate investment will pull investors off the bench – leaving the industrial sector poised to benefit. However, investors scrambling to find viable and profitable net lease investments are running into a short term problem. There is a lack of both current supply and new industrial construction in the pipeline.

Investors want quality, top rated tenants in the strongest urban markets. These investments are increasingly rare. However, “Mission Critical” net lease industrial assets are available - investors may just need to rethink their criteria. These properties often have existing permitted industrial uses, are located in and around quality commercial markets, and provide goods and services unique to their businesses. The real values of these investments are not only the tenant, or even the property, but the permitted use so critical to the nature of the business. Sellers are willing to sign long-term leases at higher returns than current market rates because these properties are so critical. Increasingly, investors are overlooking traditional analytics and considering these investments. With intelligent investment they can provide a highly profitable return.

Another strategy worth a long look is value-added investing. As infill land becomes scarce and land prices rise, this opportunity makes increasingly more sense. According to Marcus & Millichap, last year approximately 30 million square feet of industrial space totaling $2 billion was sold for redevelopment or demolition nationwide.

Value-added investing provides an opportunity for 3rd party or sale-leaseback owners who are able and willing to renovate or retro-fit their properties. Often these buildings are structurally sound with adequate ceiling heights but need functional changes such as more loading docks, upgrades of fire protection systems, lighting, HVAC, or internal reconfiguration. A quality rehab in the right location can command the same rates as new construction in outlying, less desirable locations. In addition, rehabbed properties in the right location can double their pre-renovation value.

Mature buildings and mature industries provide an opportunity for buyers and sellers to think creatively in making their real estate NNN play.

W. Douglas Wright | Director- Industrial
CALKAIN COMPANIES, INC.

Wednesday, December 1, 2010

Wild Wild Wawa


As a relative newcomer to the net lease market, Wawa convenient store gas stations are one of the hottest sought after triple net lease investment properties in the market today. With an implied credit rating of BBB- / outlook Stable, most investors understand the credit-worthiness of this privately owned company, which is considered one of the strongest convenient store operators in the country. In 2009, Wawa was ranked No. 55 in Forbes’ America’s Largest Private Companies list. Wawa currently operates more than 570 convenient stores throughout the mid-Atlantic, 270+ of which include gas.

Most Wawa net leases properties offer an investor long-term security and absolutely no management responsibilities in the form of a 20-year primary term nnn ground lease. These ground leases provide additional investment security given the nature of the real estate investment made by Wawa’s real estate team, including the Wawa Engineering and Construction Department which is responsible for the design, engineering and construction of all new stores and remodels. As with any ground lease investment, a landlord should be comforted by the fact that the tenant, in this case Wawa, has made a significant capital investment in the construction of the building, which at the end of the lease will become property of the ground lease owner.

Also driving the demand and value of Wawa triple net lease properties is the strong real estate fundamentals of the property sites. Wawa’s real estate team has specific site select criteria, which focus on key trade area location characteristics. Wawa net lease properties are typically located at signalized corners and out-parcel/pads of shopping centers with good visibility and ingress/egress. Ideal trade area characteristics include adequate population and minimum traffic counts of at least 25,000 vehicles per day. Sites should be located on high-volume intersections near other commercial traffic generators.

Pros

  • Implied BBB- credit; investment grade
  • Strong real estate fundamentals
  • NNN ground lease structure

Cons

  • Private company
  • Gas pumps raise environmental concerns
  • Ground lease provides no depreciation on land

Tuesday, November 23, 2010

Demand for Discount on Black Friday


Here are some recently released numbers from Nielsen on this years Black Friday:

  • 76%s said they will be shopping at department stores
  • 55% will shop at supercenters/mass merchandiser stores
  • 52% will shop at electronics stores
  • 35% at toy stores
  • 23% online
  • 22% at dollar stores

The top buys on Black Friday will include apparel (64%), electronics (60%) and toys (47%).

The most interesting thing about these numbers is the percentage of people planning on shopping at dollar stores. Nearly 1/4th of all shoppers said they plan on doing so. This lends credence to the recent expansion plans by such stores as Dollar General, Dollar Tree and Family Dollar. The demand for discount clearly remains an important feature in today’s retail market.

We asked whether Dollar General’s IPO made sense back in November ’09 in our blog “Does the Market Still Crave Inferior Goods”. A year later it clearly does.

Wednesday, November 17, 2010

Who is Interested in Zero Transactions?

Typically those interested in zero transactions fall into one of three categories: Distressed Owners, Highly Leveraged Sellers, and 1031 Buyers looking to maximize the amount of cash they refinance out shortly after closing on a transaction.

Distressed owners are entirely interested in burying their former basis into a 1031 exchange replacement property as a means to defer an otherwise crippling tax bill. Zero’s are typically priced at somewhere between 8%-10% of the debt load on the underlying property – making them a cost effective solution.

Foreclosed properties are deemed to have sold for the balance on the debt owed. This is the amount needed to be covered in a new 1031 transaction to defer your gain. In simple terms if you defaulted on a $10Mil loan, you’ll need to replace that property with a new $10Mil property. Generally speaking that would cost between $800K and $1Mil. Compared to your potential tax bill a zero transaction could produce a savings of close to 50%.

A person in the second group (highly leveraged sellers) is in a similar situation. Their property is sold, albeit in an orderly transaction, but ultimately because they borrowed so much relative to the sales price they walk away from closing with very little money. Sometimes not enough to pay the tax bill. Once again, the zero provides a low cost way to defer the tax consequences.

The third and probably smallest group consists of 1031 buyers looking to use a structure commonly found in zero’s called “Paydown-Readvance”.

The “paydown” part involves dedicating all equity from your old property to the transaction (this is still a 1031 fundamentally). After the deal closes you “readvance” or draw on the loan to the point where only the minimum required equity remains in the deal. This allows a 1031 buyer to walk away from the closing table with extra cash. The downside is that you are left with a 20 year investment you can’t refinance and a property that doesn’t produce cash flow.

Wednesday, November 10, 2010

A Decade of Deferrals


According to the IRS, in 2002 individuals entered into 143,184 1031 exchanges. By 2005 that number had peaked to 283,560. Everyone can guess what happened next. The market dropped - dragging investments down with it. As a result, anywhere between 59,192 and 78,923 exchanges were estimated to be performed by individuals in 2008. However, it’s likely we’ve already returned to 2002 level numbers.

Institutional investors and traditional buy-and-hold investors believe the market is improving- thus, why "sell in a soft market?". However, clients with low-basis property that have certain events (death, retirement, financial distress) trigger property sales are opting to conduct like-kind exchanges. The natural processes of the life cycle along with an improving market have forced many investors out of the trenches.

An example would be an apartment building investor retiring to Florida and swapping out of an Arlington Apartment building and buying a Walgreens NNN lease as replacement property. The client gets cashflow without the "toilets, tenants, and trash". The market may not be perfect – but time waits for no one. Many of the baby boomers who could afford to wait just a few years ago are acknowledging and accepting current realities.

Another interesting and timely example are landowners selling to energy companies drilling on their property. This low-basis acreage with no depreciation benefits is great fuel for an income-producing commercial replacement property whether it be retail, industrial, or office. These clients often do not know that their land is "like-kind" with commercial real estate, and they do not know that passive real estate investments are out there that they do not have to actively manage.

Clients should really try to plan for both capital gains events and estate events. Unfortunately too much attention is put on deductions, current income, and economics of deal. Investors now face 25-50% in capital gains taxes upon disposition and upwards of 45-55% in estate taxes. This level of taxation will erode a substantial amount of the cash you will net from an investment when attempting to build real wealth.

Wednesday, October 27, 2010

Challenges When Dealing Internationally

The United States has numerous federal guidelines concerning international in­vestment which serve as roadblocks to investment. Specifically, the Patriot Act created a host of issues. Specifically the taxation issues breakdown into three categories: taxation of operations, estate taxation and income taxation upon dis­position.

Here is an overview of each issue:

Taxation of Operations

A foreign person is subject to US income taxation on income that is connected with the conduct of a business in the US. Such income is subject to regular graduated rates of taxation on his net income and the foreign person is entitled to regular deductions in relation to the property operations, such as deductions for real property taxes, mortgage interest and maintenance expenses. The graduated rates for 2010 reach as high as 35% for both individuals and corporations and are scheduled to increase to 39.6% in 2011 for individuals. However, a for­eign corporation also is subject to a branch profits tax at a 30% rate on its after regular corporate tax profits. If the foreign person is a mere passive owner, such as with respect to triple net leased property, his activities may not be considered the conduct of a business in the US. In that case, the foreign person will be subject to a 30% withholding tax on the gross rental income and no deductions are allowed. However, the foreign person can elect to treat such rental income as connected with a business in the US, so that he can be subject to the graduated rates and receive the ben­efit of deductions.

Estate Taxation

The estate of a foreign individual is subject to US estate taxation on US assets that are held by the foreign individual at his death. US real prop­erty interests are US assets for this purpose. Although Congress allowed the US estate tax to expire in 2010, it is scheduled to return in 2011 and ap­ply at rates ranging from 18% to 55% of the fair market value of his US asset including real property.

Income Taxation Upon Disposition

When a foreign person disposes of an interest in US real property, he is subject to tax on his gain. If the US real property interest is a capital as­set (not inventory held for sale to customers in the ordinary course of business) that has been held for more than one year, an individual for­eign person will be subject to tax at a maximum rate of 15% (scheduled to increase to 20% in 2011) on his gain. A foreign corporation gets no tax rate benefit for such long term capital gain and therefore is subject to tax at a maximum rate of 35%.

In order to collect, in part, the US tax on a foreign person’s gain from the disposition of a US real property in­terest, the US requires the buyer of real property from a foreign person to withhold 10% of the foreign per­son’s amount realized from the dispo­sition of the US real property interest. The foreign person must file a US tax return declaring his full gain and may apply the withheld amount as a cred­it against his final tax liability. There is a procedure to apply to the US In­ternal Revenue Service to request a reduced withholding amount if the foreign person can demonstrate that the tax on his gain is less than the 10% of the amount realized that is required to be withheld.


The previous was excerpted from Calkain Research's recent Broker Opinion Report "International Entities". View the full text here.

Wednesday, October 13, 2010

Insiders Look at the First Net Lease Book


This text comes from the “Tenant Profiling” section in the new book, “The Little Book of Triple Net Lease Investing”.

Tenant Profiling

This is an extremely important task for the simple reason that there must be a good fit between the tenant and the building. For example, putting a pharmacy in a building originally built for, say, an industrial purpose and located away from the general public, would be a fatal mistake. That’s because pharmacies are all about health and cleanliness and easy access. Industrial sites, on the other hand, represent the exact opposite of that. Such a mismatch of tenant and property is tantamount to business suicide, both for you and the tenant.

The investment team must profile prospective tenants in depth to ensure that the final selection involves a tenant who’s likely to reach maximum potential within the building. It must obey one of the ironclad “laws” of commercial real estate: the market value of a property is measured solely by its worth to the tenant it services.

The range of tenant options spans the local tenant providing a local service and operated by a local one-unit vendor, to a national brand tenant that’s a public company and listed on a stock exchange and which has billions of dollars in revenues, and everything in between.

Most national brand tenants can easily be profiled because so much public information is available on them, plus they’re rated by respected national agencies such as Moody’s, Fitch, and Standard and Poor’s. A local tenant can be just as good an investment as a national one; however, you need to evaluate this tenant in a different way since information isn’t as readily available. Here’s what you (or your investment team) would look for:

For more, read the full text of “The Little Book of Triple Net Lease Investing”.

Thursday, October 7, 2010

A New Take on FASB Rules from Richard L. Podos

Mention the acronym “FASB” in the halls of commercial real estate and you may start a veritable shouting match. Like some impending disaster, the fear that FASB will turn the CRE world upon it head (while leaving no prisoners) is rampant and pervasive. Fortunately for us, it’s simply not true. Unfortunately, many have not got the memo.

Here are concerns that are often voiced in connection with the proposed FASB rule changes and why they will NOT have the disastrous effects envisioned:

Calkain: Two major marketplace impacts being posited are shorter-term leases and more corporate ownership. Are either or both going to become the trend?

RLP: In a word, NO (with certain exceptions at the margin). First, lease term from a tenant’s perspective is about occupancy strategy and economics. No major tenant is going to start doing large leases for 5 year terms, with all of the expense entailed in tenant improvement (TI) and moving, not to mention issues such as employee attraction and retention, customer proximity, risk of exposure to landlord leverage on renewal, etc. That said, will a low-cap ex renewal be short... yes, probably. As to corporate ownership, there has been an inexorable worldwide trend towards leasing over the last 20 years based on core competency and capital deployment drivers... accounting doesn’t change any of that.

Calkain: How will the industry build the proposed new standard into pricing?

RLP: Believe it or not, it’s been happening for years. Just because the lease accounting changes haven’t been officially formalized doesn’t mean the industry is keeping its head in the sand. Again, economic drivers are paramount. We’ve all seen a move towards shorter lease terms by occupiers with greater uncertainty; on the other hand, certain tenants, especially retailers, make long-term commitments because they *know* they will remain at a given location for a long time. And again, deals involving heavy amounts of tenant improvements (TI) suggest longer terms to deal with amortization, whether funded by landlord or tenant or my firm. Renewals with minimal capital investment will tend towards short, but that’s about it.

Calkain: What (if any) unintended consequences will result from the standard?

RLP: It certainly won’t have a major impact on tenants’ financials... with certain exceptions (e.g., retail, airlines), the impact on corporate reporting and ratios will be de minimus. Most importantly, the credit ratings agencies and the equity analysts have been capitalizing leases for over 20 years, actually around 2X of what the new lease accounting will require, so no major impact. The largest unintended consequence we foresee will be the impact on sale-leasebacks. Over the next two years, we expect to see a slow-down in those transactions, simply due to uncertainty, except where there are strategic concepts driving portfolio re-positioning (a big concept for another day). However, once the new standards are better digested, that trend will level off, and transaction velocity will resume.

The key thing to remember with the proposed lease accounting is that it does not change the strategy and business drivers that underlie tenants’ real estate deals. Our motto? “Economics trumps accounting”.

Richard Podos is the CEO and President of Lance LLC, a New York-based finance and investment firm focused on TI funding and asset-intensive build-to-suits, and is a thought leader at CoreNet Global regarding lease accounting.

Thursday, September 23, 2010

Understanding Net Lease Investors

Certain types of investments appeal differently to investors and their varying needs. These needs might include offsetting tax liabilities and expanding one’s business. Another investor may be concerned with capital gains or bond-like income streams. An investor nearing retirement may be worried about hedging their money against inflation and wealth preservation.

As with any business, understanding the clientele is instrumental to mastering the trade. When it comes to net lease investments, we can roughly separate investors into three primary segments of interest:

Segment A – 1031 & 1033 Exchanges
  • Interested in cost segregation and business expansion
Segment B – Capital Gains
  • Looking for real estate exposure and capital gains
Segment C – Estate Planning
  • Concerned with hedging for inflation and wealth preservation.
We can further analyze these three groups in terms of demographics, lifestyle and usage.

You can view a chart illustrating this here.

This classification schema is helpful because it gets at the roots of an investors interest. There will be numerous situations when these interests overlap and understanding how they interact is vital.

Wednesday, September 15, 2010

CVS Corporate Bond vs. CVS Net Lease

Where to invest is a question on many people’s minds today. Many are seeking to mitigate risk and avoid the costly mistakes of the past while still owning a lucrative investment. As such, a growing debate has emerged about where best to place capital. Although some would dismiss real estate as too costly; closer inspection reveals a well of opportunity.

Let’s say you were looking to invest in either CVS bonds or real estate earlier this year (CVS rated BBB+ by Moody’s). A 10yr issuance that was done in March of 2009 has maturity date of 2019. It pays a coupon of 6.6% and is priced at $111.45; you would receive a yield to maturity of 5.04%, and an annual yield of 5.92%.

Now let’s look at an opportunity to purchase a brick and mortar store that CVS would lease from you. The lease runs through 2034, and property is for sale at $3.5Mil. Furthermore, there are .50/Sqft increases in rent every five years.

We’ll set the period of observation to 10 years and assume no increase in value (you can see the specifics here). Said differently, we’ll sell the property for what we paid for it, and the bond will just be redeemed for its face value. Also, to keep the playing field level we aren’t going to use any leverage, just cash.

In this example, the property would receive a 78% higher return over the bond. It achieves both a greater yield and cash flow for the same amount of money invested. Some of this is due to the tax benefits of depreciation expense, but even in a world without taxes the property still outperforms the bond. The risk profiles of the two investments are also virtually identical in that CVS is the guarantor of both streams of income. All things being equal if one had to make a mutually exclusive investment decision between the two choices the answer is obvious.

Wednesday, September 8, 2010

Lack of Inventory = Lower Cap Rates?


Today, the largest challenge the net lease market faces is a severe lack of inventory. Buyer demand for high quality net lease assets is high and cap rates have compressed in response to this. However, there is simply not enough high quality inventory to match demand. This is forcing cap rates down and clogging the market.

Buyers want the best assets available; risky assets are no longer popular. This means high credit tenants in major metro markets; such as Walgreens and McDonalds. These are coveted because they combine low risk with high returns and passivity. High net-worth buyers with excess cash are not satisfied with the 1% return they are receiving from banks, are leery of the turbulent stock market and worried about increased inflation. They desire to invest their cash into secure assets which produce high returns. In many ways, net lease investments are the perfect option. The problem is there are so few high quality net lease assets available.

The recession caused companies to halt construction; cutting the amount of new product in market down to a trickle. Even today, we are 6 months to 2 years away from new construction. This process has bottlenecked supply. Today we are seeing cap rates between 5.75-7.50% (they were at 6.75-8.5% six months ago). These are numbers not seen since the height of the market in 2006. This is not a long-term trend as much as the odd environment we are currently in. Lack of supply plus increases in demand has equaled lower cap rates.

Current conditions are projected to continue until construction picks up and new product beings entering the market. We can expect to see this in the next 6-24 months. Once substantial new product enters the market, we can expect to see a rise in cap rates and transactions. For now cap rates will remain low.

Wednesday, September 1, 2010

Seeking Shelter From New Health Care Tax


Many investors could be facing an unexpected extra tax. However, despite viral hoax emails to the contrary, it is not focused entirely on real estate transactions, in fact if you’re a real estate investor you’re probably in as a good a position as possible. Let’s examine:

The Health Care and Education Reconciliation Act of 2010 added IRC § 1411. Under this new regime, beginning in 2013 individuals with net investment income (interest, dividends, rental income etc...) and making over $200,000 and married couples making over $250,000 will face the specter of a 3.8% tax on the lesser of the amount their MAGI exceeds $200,000/$250,000 and their net investment income.

This new measure is an attempt to capture and subject the “unearned” income of the “wealthy” to the same Medicare payroll tax that earned income is.

If you’re a real estate investor you’re probably about as well positioned as you can be as stocks and bonds don’t provide nearly the sort of opportunities to shelter income that real estate does, mainly through depreciation expense.

Of note distributions from Pension Plans, 401K, 403B, and IRA’s are exempt from the tax. Also, for real estate investors who materially participate in their investments the ability to elect to become a Real Estate Professional and turn their passive income into earned income may present some planning opportunities.

Oh by the way, this tax is in addition to the more well known new “Hospital Insurance Tax” of 0.9% imposed on earned income in excess of the aforementioned MAGI thresholds. All in, these new taxes could amount to an almost 5% increase in taxes to the “wealthy”. I guess someone has to pay for healthcare reform though.....

Wednesday, August 18, 2010

A Tax Tsunami


As commercial real estate struggles to break through the economic quagmire, it must contend with a flurry of changes on the horizon. Specifically, changing capital gains tax rates, estate taxes, and FASB standards could heavily alter the landscape. Of course, they also may not. There is much uncertainty in the future and all we can really do is theorize.

Capital Gains Taxes

If the Bush tax cuts are allowed to expire (which all signs are pointing to) then the capital gains tax rate will increase from 15% this year to 20% in 2011. There are few things this rate change could induce. Investors may be more likely to cash out this year or consider continuing their investment via 1031 tax exchange.

Estate Tax

In one of the oddest strokes of lawmaking to come from Washington, the estate tax expired in 2010 but is scheduled to make a deafening resurgence in 2011. In 2009 the max rate was 45% over $3.5 million; in 2011 it will be 55% over $1 million. This will certainly cause an increase in asset planning, especially with regard to trusts. Whole swaths of people who never needed to worry about the estate tax will be searching for financial planners in order lessen this tax hit.

FASB 13

This is a tricky one. Mostly because no one really knows what the final lease accounting changes in FASB 13 will be. But there will be changes. That has been enough to worry many industry insiders, who could see these changes having serious affects. More likely than not, the concept of operating leases will go away, and no more lease classification will exist. Investors could face a shortage of financing, and tenants may demand shorter leases. However, it is too early in the game to know for sure and debate is still heavy on whether there will be any impact at all.

How these changes will affect commercial real estate (and net leases) may in the end, be an art for scryers. What will their individual impacts be? How will they affect the industry in unison? Investors undoubtedly will continue to "swap until they drop" and receive a step-up in basis for capital gains purposes, and with proper estate planning will side-step the draconian estate tax. More likely than not more money and attention will be spent on tax planning in 2011 than ever before. Lease accounting, estate tax considerations, and capital gains tax rates rising will cause most developers and investors to put their tax attorney on speed dial in front of their lender contacts.

Wednesday, August 11, 2010

Industrial Snapshot


Calkain Research has done a quick overview of the issues facing the industrial market and industrial net leases specifically. Our analysis focuses on pertinent facts, conditions and trends to glean where we are today and will be tomorrow.
Market Statistics:
  • CoStar Group reported 13 million SF of positive net absorption in 2Q 2010. This is the first positive reading since mid-2008.
  • The national vacancy rate decreased from 10.1% to 10% according to Costar, the first drop in over two years. Availability also slightly decreased from 14.8% to 14.7%.
  • Real Capital Analytics reports that single tenant industrial cap rates had a weighted average of 8.5% in 1Q 2010. 85 basis points higher than the same period last year.
Market Conditions:
  • Occupancies have leveled off.
  • Many current customers, due to their own economic uncertainty, choose to stay in their current space and negotiate more favorable terms.
  • Cost to move is very high.
  • Due to negative demand, development is down.
Current Trends:
  • Companies have shifted to leasing space rather than owning, preferring to invest their capital in their core products/ product development (Coca Cola is prominent in this).
  • Current Buildings that have been around for decades are becoming functionally obsolescent to meet modern design specifications.
  • Because rental rates are so low, demand will have to drive rents up, narrowing the gap between today’s cap rates so that developers can once again make a profit. Currently, developers are sitting on the sidelines until that happens.
Positive Indicators:
  • When demand does turn around, industrial has a short construction cycle and can therefore respond quickly.
  • Building obsolesces alone will account for a huge increase in demand over and above an economic recovery that would result in increase supply and demand.
  • Most industrial properties have NNN leases which means most cost increases are passed onto tenants.
Expert Opinions:

Gordon Whiting, founder and Senior Portfolio Manager of Angelo, Gordon's net lease real estate strategy:

The strength of the industrial market today is still market specific and varies depending on the location and type of industrial asset. In general the bid and the ask spread has compressed and sellers have much more realistic valuations. In the single tenant triple net lease market, particularly in the less than investment grade area, where we specialize, initial cap rates are still double digit with annual rental increases. Those increases are usually tied to the increase in CPI and most times have a minimum rental increase. I believe that now is a good time to buy these assets and it is also a good time for sellers to sell. Mortgage financing has loosened up and that is a helpful market dynamic.

Wednesday, August 4, 2010

Trophy Markets

MIT Center for Real Estate reported a nearly record setting jump in prices for investment grade U.S. commercial real estate in the second quarter. Though sales remained stagnant, investor demand for stable, high quality assets greatly increased; amounting to a 17.3% increase in prices for properties sold by major institutional investors.

David Geltner, director of research at the Center for Real Estate, made this statement in relation to these events:

“High investor demand for safe investments [is] pushing prices sharply up from the deep bottom for “trophy” buildings- prime properties fully leased out to solid tenants”

This coincides with a recent trend of higher price points reached by net leases. However, it has less to do with “trophy buildings” than “trophy markets” with high investment rated tenants. Net leases in populous urban areas are in the perfect position to take advantage of the demand for stability in today’s market.

For further illustration, here is some recent activity witnessed by Calkain:

TD Bank
1515 15th St. NW, DC
Sale Date: March 2010
NOI: $301, 606
Sales Price: $4,300,000
Cap Rate: 7.01%

Walgreens
3130 Lee Highway N. Arl, VA
Sale Date: July 2010
NOI: $500,000
Sales Price: $7,300,000
Cap Rate: 6.85%

Blue Cross Blue Shield
8896 SW 136th St. Miami, FL
Sale Date: On Market
NOI: $468,815
Sales Price: $6,378,435
Cap Rate: 7.35%

The areas these assets are located in (Washington DC and Miami) continue to experience prosperity today. Furthermore, the above properties are located within some of the best parts of those urban centers; ensuring stability and demand. Because of this, investors are willing to pay heavily for “trophy markets”.

Wednesday, July 21, 2010

Looking Back: NNN Cap Rates


Back in May we did a story dealing with the possibility of net lease cap rate compression based off a Wall Street Journal article.

Specifically, the article said: “in recent months, cap rates have been falling because property prices nationally are rebounding. More investors are going after fewer high-quality properties, driving prices up.”

Now that we are a few months advanced, how does this statement stand up?

Certain areas and products have certainly seen cap rate compression. Highly trafficked urban areas such as the Washington DC metro area and popular tenants like Walgreens and CVS are exemplars of this. However, on average the trend has been more towards stabilization.

Our own cap rate report, released in late June, has net lease retail cap rates at 8.10%; a slight increase from 8.00% in the fall of 2009. Real Capital Analytics confirmed our current estimates in their 1Q Single Tenant Retail report by also citing a current average of 8.10%. They differed slightly in their 4Q 2009 averages, highlighting a rate of 7.7%. Nonetheless, a similar trend is projected. Cap rates have increased slightly but at a much reduced pace from what was seen earlier.

Though we are not experiencing overall cap rate compression the areas and products which are succeeding represent great investment opportunities. Furthermore, cap rate stabilization points to a secure market that is more attractive to investors.

Thursday, July 15, 2010

Gordon Whiting on the Industrial Market


Gordon Whiting, founder and Senior Portfolio Manager of Angelo, Gordon's net lease real estate strategy, gave us his input on the industrial market:

1. What is your opinion of the industrial market today?

The strength of the industrial market today is still market specific and varies depending on the location and type of industrial asset. In general the bid and the ask spread has compressed and sellers have much more realistic valuations. In the single tenant triple net lease market, particularly in the less than investment grade area, where we specialize, initial cap rates are still double digit with annual rental increases. Those increases are usually tied to the increase in CPI and most times have a minimum rental increase. I believe that now is a good time to buy these assets and it is also a good time for sellers to sell. Mortgage financing has loosened up and that is a helpful market dynamic.

2. What are some current developments that should be watched?

I would watch how companies try and refinance the $360 billion of bank debt and high yield bond maturities that come due between now and 2012. It may be difficult for many non-investment grade companies which are highly levered to refinance this debt and that could cause them to sell their corporate owned real estate and lease it back in order to pay off their debt. This has caused the negotiating power to shift back to the buyers. I see this possibly continuing through 2014 as there is over $1.1 trillion of leveraged loans and high yield bonds that mature between now and 2014.*

3. Where do you see the market in 6 months? A year?

I see the market in the same place in 6 months or a year. I see it as a good time to buy real estate and a good time for sellers to sell in order to generate capital to pay off debt that is maturing, if they don’t have access to the capital markets. Many middle market companies still don’t have access to the capital markets and this is a good way for them to monetize the capital that they have trapped in bricks and mortar.

4. What role are net leases playing in the market?

Net leases or really sale leasebacks play an important role in the market and I believe that role will continue to grow as companies turn to the real estate that they own in order to generate capital. It is also a good time to be an investor in net leased real estate as prices are lower than they have been in many years, cap rates are up and they provide steady current income with the possibility for long term capital gains.

5. Where would you invest in the industrial market today?

Definitely in the less than investment grade single tenant triple net lease market. If you do your real estate and credit underwriting properly and have a long term lease given the double digit cap rates and rental increases today you will have a very attractive investment. It has high current cash flow, tax shield from depreciation for individuals, positive option value from either credit or market improvement and a built in hedge against inflation, particularly if your rental increases are tied to the increase in CPI. Now is the time to invest!

*Morgan Stanley, “How the Tight Credit market is Augmenting the Investment Opportunity for Private Debt Capital”, May 2009


Gordon J. Whiting joined Angelo, Gordon in 2004 and is the founder and Senior Portfolio Manager of the firm's net lease real estate strategy.

Thursday, July 8, 2010

Industrial Sector Life Signs


The industrial sector, which has been dormant as manufacturing plummeted, may be showing signs of vitality. A recent CIRE article pointed out many positive developments and industry insiders consider this a hot topic. With net leases becoming ever more popular within the industrial sector; NNN investors could have access to a land of opportunity.

Here are some highlights from the CIRE piece:

• Investment activity and user sales increased approximately 35 percent and 50 percent respectively from 1Q09 to 1Q10.

• Capitalization rates climbed from 8.8 percent to 8.9 percent during this period but are expected to tighten as demand picks up.

• Though institutional investors ramped up in the first quarter, private investors and regional owner-users, motivated by the narrowing bid/ask gap, still accounted for the majority of transactions.

• In smaller markets, owner-users are grabbing up vacant 25,000- to 300,000-square-foot industrial properties to accommodate the 45,000 manufacturing positions that employers added in the first quarter.

• In markets where institutional investors are active, there’s a flight to quality.

• Distressed industrial properties remain rare due to the unique nature of the asset. As of 4Q09, industrial properties represented only 3 percent of the $172 billion in total troubled assets, according to Real Capital Analytics.

These signs point to an industry ready to shake off the coils of inactivity. Investors who want to diversify or simply take advantage of a positive trend should find this an attractive refuge. The current in all areas seems to point to higher quality and this often correlates to net lease properties. As more demand enters the industrial sector, net leases could see a corresponding rise.

Numerous meetings, with various net lease institutional buyers, have conveyed that the industrial sector is high on the list of where investors are looking to place capital. It would be of no surprise if there were a number of larger net lease industrial transactions announced during the summer months.

Wednesday, June 30, 2010

Should We Fuss About FASB?

Recently, there has been some gnashing of teeth about the possible impact on sale-leasebacks by a proposed change in the manner in which leases are accounted for under GAAP. FASB has put forward some changes which, if enacted, will effectively eliminate the distinction between operating and capital leases. For companies such as Walgreens and CVS, who heavily utilize sale-leasebacks, and typically structure the resulting leases as operating leases, this would means billions of dollars of lease liabilities would move from the footnotes to the balance sheet.

While it's true that this change will be a headache for the accounting departments of both lessors and lesses (not the least of which due to its retroactive nature) it's impact onoverall sale-leaseback activity should be zero.

Here's why:

Sale-Leaseback Economics Don't Change Because of How You Account for Them.

The underlying economics of a sale leaseback need to work independent of how the transaction is accounted for. If the cost of doing the sale lease back isn't exceeded by the return obtained on the proceeds of the transaction than it makes no sense. How we record the debits and credits of such a thing is largely irrelevant.

It’s also not like operating leases are a secret on Wall Street. Analysts and those who follow these companies closely have already baked the operating leases into the debt loads of the companies. It’s common practice to take as much as 2/3 of the operating leases listed in the footnotes into consideration when conducting ratio analysis and comparing companies.

That being said, moving the obligations from the footnotes to the balance sheet is essentially a smoke and mirrors exercise although one would have to admit it does enhance transparency. Particularly so for companies who use the practice as a matter of course. It’s amazing how often you hear that Walgreens has no debt. Apparently, those who think so don’t read the footnotes.

While rationally, this change should be a non-issue to the investors in and conductors of sale-leasebacks, no one ever said people were required to act rationally....

Wednesday, June 23, 2010

2010 Cap Rate Report


“Are we there yet? Are we there yet? Are we there yet?”

- Bart Simpson

Are we there yet? No, but the steady rise of cap rates in 2009, born of the recession, bail-outs, defaults, and fall in consumer confidence has given way to a modest stabilization as financial indicators have subtly improved in the first quarter of 2010. Across the country, decreased transaction volume brought on by a still conservative lending environment and the impact of the recession in all but a few standout markets has prevented a true return to normalcy. Those factors have also turned investors towards key primary markets where real estate fundamentals remain strong, the impact of the recession is less severe and debt placement more readily available. Cap rates in these select primary markets have stabilized and even dropped to an extent as the influx of investors from across the country has led to a scarcity of quality inventory. The net result of the transaction volume in these primary markets is a modest downward compression of cap rates across all sectors.

Net lease investments continue to represent a large portion of the transactions taking place, proving that there is a significant flight to quality as buyers seek out properties with strong credit tenants. Single-tenant net lease retail properties, priced between $1M and $10M, have become the sweet spot for many investors and 1031 buyers. A quick analysis of these types of transactions points to the possibility of 2010 being a plateau year with potential cap rate compression coming in 2011. Today, most net lease properties have been trading at cap rates between 6.50% – 8.75%.

For more, check out our full report.

Thursday, June 17, 2010

Zero Hour for Net Leases

It is not a secret that many commercial real estate loans stand on shaky foundations. In-fact it has been recently estimated that a “sizable amount of the additional $700 billion in commercial real estate loans coming due during that time frame are loans that could not get refinanced at existing levels in the current lending environment”. This of course will lead to many foreclosures and create an investment opportunity for CRE buyers. However, for the unfortunate holder of the original asset there may be a potentially huge tax consequence. There may also be a glimmer of hope in the form of a Zero-transaction.

Simply speaking a zero transaction is the acquisition of a property using a highly leveraged loan (loan to value usually 88% plus) with all rental income dedicated towards debt service, thus producing “zero income” for the property owner. One of the vehicle’s applications is to defer tax liabilities incurred in a commercial foreclosure.

The Problem

Though it is not widely known, the foreclosure of a commercial property is often a taxable event. How the IRS computes the tax depends on whether the property was financed with a recourse or non-recourse loan. In the case of a recourse loan, tax liability is calculated by taking the difference between a property’s fair market value and its adjusted basis. The tax liability of a non-recourse loan (which the remainder of this piece will be dealing with) is calculated by taking the difference between a property’s outstanding mortgage balance and the property’s adjusted tax basis.

The “outstanding mortgage balance” is the key element which catches investors off guard.

For example:

Let’s say you bought a property for $5M (your cost basis) which subsequently has been depreciated to an adjusted tax basis of $3M. Let’s also say you refinanced this property during an upsurge in the market and pulled out $8M of equity. If this transaction was foreclosed upon (without any action to defer tax liabilities), you would face a taxable gain of $5M, i.e. the $8M in outstanding mortgage amount minus the $3M in adjusted tax basis.

Thus, investors who think returning the keys to the bank absolves them of all monetary concern involved in a commercial foreclosure are gravely mistaken. The IRS views any money previously pulled from a property via loan refinancing to be taxable gain, even though the property is foreclosed upon.

The Solution

With proper scheduling and use of the 1031 exchange, the situation above can be avoided through the purchase of a “zero income” property. The reason a zero income property can be so beneficial is due to its highly leveraged nature and its ability to defer a taxable gain through a 1031 transaction. A portion of the money an investor would have otherwise paid to the IRS can be used instead to acquire the zero income property through the 1031 exchange.

Here is how our previous example would be impacted by a zero transaction:

Assuming a tax rate of 25% (Federal capital gains rates, Federal recapture rates and state taxes), the $5M in gain would cost $1.25M in taxes. If instead, a zero transaction was pursued, the investor would need to replace the balance of the debt, $8M. By exchanging into a zero income property for approximately 10% of the $8M debt amount replaced ($800,000), there would be a $450,000 savings ($1.25M-$800,000) and the investor would own NNN property with a very high credit tenant.

In order for the transaction to flow smoothly, it will have to be properly organized and scheduled on an individual basis. It should be noted that a zero transaction is not possible without outside assistance of at least a Qualified Intermediary and qualified professional tax and accounting advice. If done properly, this strategy can be an invaluable tool for investors caught in a foreclosure situation.

Friday, June 11, 2010

Drug Store Wars


Recent developments concerning Walgreens and CVS point to changes in their stores and company interactions. These range from alterations in store layout and product offerings to new rules concerning prescriptions. Both of these tenants are huge players in the net lease market and these shifts could change the way investors view them.

CVS to Expand Grocery Aisles

CVS plans to expand grocery aisles in 3,000 of their stores during 2010. They will be doubled in size, giving the company more exposure to the trillion dollar U.S. food market. Many see this as continuation of “channel blurring”, a trend which has been embraced by many retailers. As reported by the Patriot Ledger “Just as supermarkets have expanded pharmacy and health and beauty sections in the past decade, drugstores are retaliating by putting food products in the forefront.” Cleary CVS is jumping in head first by modifying 43% of their 7,000 nationwide stores.

Walgreens to Sell Beer and Wine Again

Walgreens is breaking a nearly 15 year self-imposed ban on the sale of alcohol in their stores by reintroducing beer and wine. So far 3,100 (41.3%) of their stores have already been stocked, with plans to increase that number to 5,000 by years end. Previously the sale of alcohol and other spirits made up 10% of Walgreens total sales, indicating a likely increase in sales this year. Other drugstores such as CVS and Rite Aid have continually sold alcohol. It is available in 4,300 (61.4%) of CVS stores and 28 of the 31 states Rite Aid operates.

CVS to Exclude Walgreens from Retail Pharmacy Network

CVS Caremark has stated it will end their retail pharmacy partnership with Walgreens in roughly 30 days. This occurred in response to Walgreens announcement that it will no longer participate in new CVS managed prescription drug plans. Thus, the pharmacy networks of the two will become mutually exclusive forcing customers to one or the other. This certainly heightens the competition for customers between the two and could increase marketing to that effect.

Looking at the situation from an investor’s standpoint, the first two changes are certainly positive. CVS expanding their food section is in line with a nascent trend of frugality and “back to basics” purchase behavior. Walgreens on the other hand is opening itself up to the conclusively popular trade in alcohol which should only benefit their store revenues. The only trend which could be perceived as worrisome is the segregation of prescription customers. Forcing an exclusive choice could lead to higher costs to maintain and attract new customers. However, such fears maybe overblown. A little competition never hurt anyone.

Wednesday, May 26, 2010

ICSC RECon 2010


Net Lease Insider asked Patrick Nutt to contribute his analysis of the 2010 ICSC convention.

It is as follows:

In the weeks and months leading up to this years ICSC convention in Las Vegas, everyone I spoke with had uncertainty about the overall turnout and value in attending the conference this year. Well, as I sit in my office fresh off a 72 hour session of networking, deal making, and walking (lots and lots of walking), I can emphatically say that once again it was a great event and well worth attending. While we can all work effectively through the use of emails and phone calls, the opportunity to sit down face to face with clients and discuss existing business and future plans is always time well spent. I am still revisiting all the conversations I had and observations I made, but here’s a glimpse of what I took away from the show.

Attendance:

I heard various numbers mentioned from a variety of sources, but I would say that attendance was about even with last year, however activity was up. It seemed as though most attendees this year had pretty busy schedules and were discussing real activity that will occur over the next 12 months, rather than casually discussing hopes and plans like the 2009 version of RECon.

Prettiest girl at prom award goes to: Dollar General.

All aspects of the net lease world were feverishly talking about Dollar General and their aggressive expansion to include 600 new stores a year. We’ve seen merchant developers that formerly focused on power center and grocery anchored locations now shifting their resources toward building 20-60 new dollar general stores in the coming months. REITs and private funds alike are looking to this retailer to fill their need to place capital. This is purely a numbers game for all parties, as Dollar General needs to open these stores to keep Wall Street happy, merchant developers need volume to create efficiencies to make this a profitable program, and the institutions need this same volume and a pretty yield to make sense of acquiring assets generally priced in the $850k to $1.5M range. This could be a winning combination for all, but we’ll be keeping a watchful eye on this program to see if everyone can execute on these plans.

Biggest Question: What do I do with all this money?

That was basically the continuing theme from the institutional groups. With the rebound in the REIT sector, they are all flush with capital and need to put that money to work. They are paying their investors a return from the day they receive it, so money not spent is worse than accepting a slightly lower cap rate. With the lack of product on the market, acquisitions are in short supply and has everyone searching for quality assets. With the dead pipeline from the past few years, very little new development is coming out of the ground, forcing buyers to chase existing properties, but owners are repeating the same question…..if I sell today, what do I then do with the money??

Retailer Activity:

If you are a net lease player, the next 12-24 months should be exciting as the typical single tenant retailers were discussing new stores, relocating old locations, reasonable growth in strong markets, etc. For those in the shopping center, power center, or regional mall world, recovery is still a long ways off. The big box tenants are still waiting patiently for more signs of recovery in the global economy before moving forward with new locations. 2010 and 2011 will see the smaller retailers continue their slow growth plans, while big boxes will begin to move forward in 2012-2013…..that is if the economy and job markets continue to stabilize and improve.

Phrase least heard: “Distressed Properties”

What seemed like the mantra of the 2009 RECon was almost never brought up this year. Much of the capital raised over the past two years has yet to be deployed, and would-be vultures have accepted the reality that lenders and servicers simply don’t have the need or ability to flood the market with distressed assets. They have proven that they would prefer to work with existing borrowers and renegotiate the debt terms or extend maturities rather than take a greater loss by selling into a market filled with bottom feeders.

Overall, it was a good show with great activity from all participants. While we are still a long way from being out of the commercial real estate mess of the past several years, people in every aspect of the industry have learned a new reality for deal flow and real estate fundamentals. The industry is very different today than in previous years, the reckless have wrecked themselves, while the experienced and diligent have found a way to stay alive and do another deal.

Wednesday, May 19, 2010

Opportunities on the Cutting Floor


A Landlords primary responsibility is to ensure the presence of a paying tenant. Unfortunately for many “big box” owners, the recession has left plenty of space empty; with slim chances of new tenants filling it. There is simply little interest in the cavernous lots so many feared would dominate the landscape. Retailers are demanding tighter, more economic space and landlords are responding by cutting up their “big boxes”, meeting the needs of retailers and creating new opportunities for net lease investors.

It is no secret that retail has suffered heavily since the recession. In its wake, a movement has emerged known as “right-sizing” which places a focus on frugality and sustainability. This trend has traditionally been popular with smaller retailers such as Dollar General but is now even catching on with retail giants such as Wal-Mart and Target. Both are testing smaller floor plans as they move into more urban locations and cater to scaled back consumer demands. Such developments slim the chances that vacant big-box space will fill quickly and has forced landlords to “de-box”.

Net lease investors should be intrigued by this trend because many of the tenants positioned to make use of these smaller lots are usually triple net leased. Dollar stores, such as Dollar General, Family Dollar and Dollar Tree, all have plans for expansion this year and are prime candidates to occupy the de-boxed space. Other possibilities include auto-part stores such as Advance Auto and AutoZone and certain restaurant tenants. Though not the ideal of full market recovery, this development highlights market movement and movement is a good thing.

Wednesday, May 12, 2010

Are Cap Rates Going Down?

A recent article by M.P. McQueen in the Wall Street Journal stated that cap rates for investment grade triple net lease properties were falling. Specifically it said “in recent months, cap rates have been falling because property prices nationally are rebounding. More investors are going after fewer high-quality properties, driving prices up.” In order to gain a wider perspective on this topic, we asked two industry experts, who have capital available and are active in the market, their opinions on cap rate trends today and by years end.

Here are their responses:

Jon Adamo, National Retail Properties.


I would agree that over the last few months we’ve seen a decrease in cap rates of higher quality net lease investments in the range of 25 to 50bps from pricing we experienced in 2009. There’s definitely a supply and demand issue at the root of the adjustment along with an improvement in the ability of buyers to get the better tenants/deals financed. The scarcity of new deals hitting the market will continue to keep cap rates low for the remainder of the year and may cause them to go even a little lower but not significantly.
The cost of financing is still very much a factor for many deals and although banks are doing very safe deals at very safe rates and terms they have certainly not opened their doors all the way.

If you look out past the next 6 months and into the next year I think caps will be moving up with rising interest rates. I also see more product reaching the market as developers begin to reemerge and M&A activity picks up thus producing some sale-leaseback opportunities for buyers that might look to dispose of some assets. For now it seems there’s a glut of capital for good Walgreens and McDonald’s-type NNN investments and not enough to go around putting stress on cap rates but higher rates and lower ltv’s of the new financing “norm” will cause the cap rates to rise eventually.


George Rerat, Senior Vice President of Acquisitions, AEI Fund Management, Inc.


We’ve seen cap rates for high quality NNN properties decrease from around 9.5% to 9.0% today. This drop is a reflection of the dwindling supply of high quality NNN properties on the market. Construction has been at a relative standstill and as such the pool of these assets has been shrinking, forcing cap rates down. By years end we could possibly see cap rates drop by another 50 basis points. Furthermore, it may take a while for construction to pick up again, prolonging the supply imbalance for the next 1-2 years.

So the question becomes whether or not the window is still open, as supply continues to constrict and the laws of economics take hold.

Tuesday, May 4, 2010

Springtime for Retail, Sale Leasebacks, and Urban Investments


As spring unfolds, key areas of the net lease market such as retail, sale leasebacks and urban investments seem set to grow. Numbers and analysis from the first quarter of 2010 point to better days and more opportunities ahead.

Retail

As of March 2010 consumer spending has increased over the past five months and retail sales have risen the past four. Retail sales in the first quarter 2010 are up 1.9% over the previous quarter and up 5% compared to the same period last year. Retail transaction volume totaled $3.1 billion for the 1Q 2010, which is a steady improvement from $2.2 billion in the same period last year. Furthermore, according to a major commercial real estate magazine “investors are showing strong interest in well-stabilized retail properties that generate consistent cash flows”. This description fits perfectly with net lease investments, which are defined by their stability.

Sale Leasebacks

It has been estimated that there is at least $1 billion in corporate owned essential real estate and according to RW Baird “strong corporate demand for sale-leaseback transactions”. If only a fraction of this $1 trillion were to enter the market, it would be a huge boon for net leases. Sale-leasebacks, which are almost always structured as net leases, offer corporations a chance to pull vital equity out of their real estate and enhance current operations. The real estate is sold and a long term lease is signed which leases back the property. Sale leasebacks have already provided the basis for many net lease transactions in the last two years and that trend looks to continue to pick up steam.

Urban Investments

There has been a lot of talk about the upward trend in urban investments. Walgreens purchased Duane Reade and their 258 New York metro area locations for $1 billion and those leases have been recently valued at $74 million. The German group, GLL Real Estate Partners also entered the urban market by purchasing 14,000 sq. ft. of New York retail condominiums from Hines. The urban market is one the most attractive today because it ensures a properties close proximity to large populations. As a result, net lease urban properties have increasingly been in demand.

Wednesday, April 28, 2010

Is Retail Development Picking Up?



In a retail climate often described as a veritable desert for new developments, there have been recent signs of life. David Sobelman, Executive Vice President of Calkain Companies, has observed that in high credit tenants, there has been a relatively unnoticed trend in developments.

Below he answers five questions relating to this trend:

1. What, if any, developments are you seeing in the net lease or retail markets?

High credit tenants, those with investment grade credit ratings, seem to be the only tenants currently seeking expansion opportunities. These include Walgreens, CVS, TD Bank, Chase Bank, Blue Cross Blue Shield.

2. Do you see any trends developing which may indicate our future?

It seems that there is more “chatter” about looking for new sites; either ground up development or retrofitting existing locations for new tenancy.

3. Have you seen any tenant development lately? If so, how much and concerning which tenants or sectors?

Short answer, yes. Walgreens is active, as is CVS. Drug stores, c-stores, some banks are taking over vacant bank sites through mergers mostly though.

4. Why do you think there is a preference to develop new properties when vacancies are very high?

Cheap land. Lower construction costs, developers being able to negotiate better contracts with contractors to build sites and increase their overall returns.

5. Are these developments related to certain areas, such as the urban market?

There is a definite trend towards proven markets, urban real estate falls into that category. Less speculative areas are sought out more than “in the path of growth” areas that were popular 3-5 years ago.

Wednesday, April 21, 2010

$55 Million Net Lease Leaves Harbor


On March 17th CNL Lifestyle Properties, an Orlando based REIT, acquired four California triple net lease marinas (the Anacapa Isle Marina is pictured above) through sale-leaseback deals worth a total of $55 million. The marinas are strategically located next to California’s three largest cities of Los Angeles, San Francisco and San Jose and add 1,984 boat slips to CNL Lifestyle properties marina portfolio (19 in all). Almar Management, the current operator, will continue to run the marinas and according to Almar’s CEO Randy Short, the deal will enable them to “focus on property enhancements that improve the experience for our boaters and their families”. These deals represent an interesting upsurge in non-traditional net lease activity.

CNL Lifestyle Properties focuses on “lifestyle” assets, such as golf courses, ski resorts, marinas and various other attractions. Their portfolio contains properties which are almost always structured as triple net leases and provides an intriguing investment angle. According to Byron Carlock, President of CNL Lifestyle Properties, these assets are “supply constrained”, ensuring a low threat of new entrants and stable demand. He also noted that though spending had decreased during the recession, attendance actually remained consistent, demonstrating stability in demand. Furthermore, CNL did not encounter a bankruptcy or default in any of its assets.

This year, CNL plans to invest $300-400 million in new lifestyle assets. Their conservative financial strategy has created a portfolio that is 28% leveraged by debt, though their long term target is 50%. Mr. Carlock noted their properties receive a high level of return due to their portfolio being acquired at around an 11% cap rate. He also interprets an increased interest in the market as more private equity firms look to enter the lifestyle area.

Though for many, the term “net lease” conjures up images of mundane grocery stores, Walgreens, and McDonalds, there is actually a diverse array of triple net properties in existence. This is no better highlighted than by the “lifestyle” assets which CNL Lifestyle Properties specializes in. Though the recession may have hit people hard, many still find ways to enjoy themselves and take part in their hobbies. As Mr. Carlock observed, “pursuing ones passions does not involve extravagance”.

This article was contributed to by Mr. Byron Carlock, Jr. president and CEO of CNL Lifestyle Properties,Inc., an unlisted real estate investment trust that owns a portfolio of 119 lifestyle properties in the United States and Canada. Headquartered in Orlando, Florida, CNL Lifestyle Properties specializes in the acquisition of ski and mountain lifestyle, attraction, golf and other lifestyle assets.

Wednesday, April 14, 2010

Walgreens Goes Urban With Duane Reade


Walgreens recently closed the purchase of Duane Reade, a deal which included “all 258 Duane Reade stores in the New York City metropolitan area, as well as Duane Reade’s corporate office at 440 Ninth Ave. and two distribution centers”. The transaction was all-cash and involved the absorption of $457 million in debt. This bolsters Walgreens already impressive presence in the drugstore/pharmacy market, adding a prominent urban chain and presenting new opportunities for net lease investors.

Duane Reed, which had struggled under debt and in July 2009 was downgraded to CCC+ by S&P, will certainly become more appealing now that it’s helmed by A+ rated Walgreens. In addition Walgreens has “agreed to repay or redeem Duane Reade’s outstanding debt related to the local chain’s July 2003 credit agreement, its 9.75% senior subordinated notes due 2011, its 11.75% senior secured notes due 2015, and its senior convertible notes due 2022.” The looming question is whether Walgreens will back Duane Reade leases or if they will be allowed to stand alone. If Walgreens does agree to back the leases, a high investment grade product would be added to the net lease market, if not, the asset will at lease become more attractive under the Walgreens flag.

This transaction also represents a great expansion into one the largest urban areas in the country by Walgreens. Duane Reade is centered in the New York metropolitan area and this purchase shows Walgreen’s desire to enter the urban market with force. This situation deserves close monitoring by those who are considering a net lease asset or have interest in investing in the surging urban market.

Wednesday, April 7, 2010

US Apartment Uptick = Net Lease Impact


It has been recently reported that the US apartment market may have reached bottom and be poised for a rebound. Apartment vacancy rates have stopped rising and rents even showed a modest increase in the first quarter. As life is pumped back into this market, 1031 exchanges could subsequently rise. Apartment investors heavily utilized 1031 exchanges to move from active to passive assets (such as net leases) in the past. Will this trend repeat?

To gain insight, we have solicited the help of James Brennan Esq., LL.M., Managing Director and Corporate Counsel of Exchange Solutions Group, one of the foremost experts of 1031 exchanges.

1. With the possible return to health of the U.S. apartment market, do you expect to see increased 1031 tax exchange action?

The Baby Boom generation flocked to real estate as an investment class, particularly multifamily. With Baby Boom private investors aging and looking to make life decisions regarding retirement, relocation, and estate planning, and all of those activities are distinguishable from the active process of “adding value” to apartment complexes through sweat equity and property management. Many of those B and C investors are looking to get out of active management. After living through this cycle, they want out more now than ever.

2. What makes apartment owners keen to move from an active to passive asset?

Passive triple net leases are net insurance, net utilities, and net taxes to the tenant. Apartment owners that have built a net worth over $5 million are looking to create annuity-like income for their heirs who often are not in the real estate business. These family patriarchs and matriarchs are not looking to burden their heirs who often are busy professionals in metropolitan areas with decisions regarding leasing up property or fixing the roof. Triple net leases provide credit-rated tenants with predictable cashflow.

3. How popular are net leases for those exchanging out of apartments?

Net leases are not only used by multifamily baby-boomers but also multifamily “financial engineers”. While multifamily financing is often favorable from agencies like Fannie and Freddie many borrowers are in troubled financial shape with distressed assets. These assets often don’t pass muster to be financed or refinanced with agency debt. These investors can 1031 exchange either with low equity or after conducting a deed-in-lieu 1031 into a net lease. Once in the net lease asset, the equity can be unlocked fairly easily through either credit-tenant-lease paydown readvance or through a standard refinance. These strategies allow multifamily borrowers to get an asset banks trust more with a credit rating.

4. What is the psychographic profile of a typical investor who executes this strategy?

Apartment developers are often drivers or family stewards. These decision-makers have built wealth from the ground up often not in a traditional white-collar methodology. These hard-driving decision-makers have provided for their family, and also probably have setup life insurance trusts to allow for estate planning liquidity. Triple net leases go well with this concept of transitioning wealth to the next generation without many opportunities for losing value by the heirs. The family stewards have built wealth and are now simply trying to preserve it.

5. Are there any aspects of this strategy conducive to estate planning techniques?

In an effort to defer capital gains while family stewards are still living the patriarch or matriarch often engages in a like-kind exchange to transition between apartment assets and net lease assets. In a like-kind exchange you can trade into multiple replacement properties. Therefore, if you have three children and you sold your apartment complex for $15 million, you can buy three $5 million dollar net lease assets that produce income that can be divided up amongst the heirs. This avoids management by the one heir that may be more real estate savvy.

Equally as important, the credit-rated aspect of net leases allows trust officers and advisors to sleep at night knowing that they made defendable decisions on behalf of the trust. Therefore, if a real estate trust officer is transitioning from apartment assets, net lease income streams are fiduciary friendly.

Wednesday, March 31, 2010

An End to Our Long Winter?


Recently Diane Swonk, Economist and Federal Reserve Board advisor, highlighted seven factors which indicate our recession is coming to an end. She is quick to note that the gains are not definite; stating “whether those gains can be sustained long enough to bring down unemployment remains an unknown” and characterized any potential recovery as “rocky”. Nevertheless, her points can be taken as a glimmer of hope.

Here are the points as she outlined them:
  1. The pace of layoffs is abating, instead of accelerating.
  2. Production is on the rise, albeit from anemic levels.
  3. Home sales are surprisingly on the upside.
  4. Profits are surprisingly on the upside.
  5. Financial markets are rallying, to some extent.
  6. Core consumer spending, driven by pent-up demand, appears to be regaining some momentum.
  7. Factory orders could be picking up from rock-bottom levels.
A common thread in many of these is the sign of some gain from heavily recessed conditions. None of these marks a return to levels we would hope to consider “normal” but they do represent small, perhaps significant, changes. Taken together they lend credence to the notion that the bottom of the crisis has been felt and we are now on the road to recovery, albeit “rocky” recovery.

Ms. Swonk also mentions that “Consumers are going to have to remain more defensive than offensive in 2010”. But what about investors? If these signs really point to recovery, this could be one of the last chances to invest in a recessed market. Net lease assets have fared better than most commercial real estate and continue to be a safe bet for the future. Financing still remains tough but for those with the resources, getting a net lease asset before the market enters full recovery could be a good move.