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.

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.

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.