Check Out Net Lease Central

Hello Everyone,

Net Lease Insider is now publishing its content to a new website - Net Lease Central - a one stop shop for the latest news, research and analysis of the net lease market.

Beyond the weekly blog from Net Lease Insider, Net Lease Central also hosts content from Net Lease Advisor and Calkain Research.

We hope this new tool will provide the most comprehensive picture of the net lease market.

Thank you.

Net Lease Snap Shot: Convenience Stores/Gas Stations

• Cap rates for c-stores differ more greatly from premium to non premium tenants than any other sub-section. For example, ExxonMobil trades with cap rates around 5.00%, 7-Eleven around 7.00%, and single unit operators from 10-12%. A gap of almost 700 basis points.
  
  
• There was a high focus on only best in class in 2009. Today people are looking at properties with cap rates ranging from 7-8% to 10-12%.
  
  
• Larger corporate operators in 2006 and 07 did a lot of sale-leasebacks, especially Circle K. Recently they have been re-purchasing sites. In general, the same people who were selling years ago are buying again.
  
  
• Environmental regulations (many of which became active in 2010) caused many gas stations to be sold by corporations due to lack of profitability with regulations.

• Gas Stations are the most polarizing sub-section. They have accelerated depreciation and steady demand. However, environmental regulations and concerns over alternative fuels turn many away.

Read full report here.

Net Lease Profile: Starbucks

After a period of over-expansion and uncertainty, Starbucks balanced the ship delivering record-setting financial results in 2010 and entered 2011 focused on improving top line growth and international expansion. The Starbucks brand is very strong and the company continues to capture a larger market share as the premier retailer of specialty coffee. Celebrating their 40-year operating history in the Spring of 2011, Starbucks' management reaffirmed their growth plans, utilizing a global retail footprint.

From a net lease prospective, it is important to recognize that Starbucks' initial growth and market dominance can be contributed to Starbucks ability to find great real estate locations. As others have pointed out, the Starbucks concept and success is driven as much by real estate as it is by coffee and the Starbucks experience. As a result, Starbucks has not only become the premier retailer of specialty coffee, but Starbucks' retail locations have also become popular net lease investments.

Starbucks typically operates under a 10 or 20 year net lease (varies between NN and NNN) with rental increases every five years. With more than 11,000 location in the US, Starbucks locations can be found in both urban and suburban locations, and their locations take advantage of other traffic generators, typically being positioned on the commuting-side of traffic patterns. The average Starbucks store size varies depending on urban versus suburban location, but the newer free-standing locations range from 1,700 - 2,700 SF situated on 0.50 - 1.00+/- of land. The prototypical store model offers a drive-thru window and the configuration is adaptable to a variety of alternative uses.

The combination of a strong brand, stable financials, and premier locations makes Starbucks an appealing option for net lease investors.

View the full profile here.

Research Snapshot: Grocery Stores

Net lease grocery stores are a major player in the NNN market. Their focus on staple products and central locations are the definition of a stable asset. While other retailers with large foot prints couldn’t weather the recession (Circuit City) net lease grocery stores made it through relatively unscathed.

Like all real estate, location is central to a grocer’s success. However, unlike other sectors such as office or traditional retail, there it not a strong temptation to overbuild. Grocery stores inhabit a very stable area of the consumer’s basket. A recession may force customers to cut back on casual dining and weekend shopping but milk and bread will still be bought.

For these reasons cap rates for grocery stores have recently compressed at a faster rate than the rest of the net lease market. Investors are demanding stable, recession proof assets and grocery stores fit this bill perfectly.

Read the full report here.

Net Lease Profile: Chase Bank

JP Morgan Chase currently sits as the largest financial institution in the United States with over $2 Trillion in assets. Their retail banking operation features just over 5,000 locations across the U.S. with deposits of nearly $650 Billion as of June 2010.Rated A+ by Standard &Poor's and Aa1 by Moody's, Chase stands as one of the higher rated retail tenants commonly seen in the net lease world.

From a real estate perspective, Chase utilizes 7 different prototypes, depending on location and available site dimensions, with the bank branches ranging from 2,585sf to 4,766 situated on 0.65 to just over 1 acre of land. While they tend to prefer to own their locations, when a new site is opened as part of a lease agreement, they will retain ownership of the improvements through the utilization of a long term unsubordinated ground lease.

Their typical lease is for a term of 20 years with four renewal options at five years per option. Given their high credit and class A real estate requirements, their average cap rates are near the lower range found throughout the net lease world, however their leases do provide for rent growth, with 10% increases every 5 years the standard schedule. Some of the recent leases have featured a troublesome clause, allowing the lease to be assigned to any entity that meets certain financial criteria, such as minimum net worth benchmarks. While the minimum threshold set varies, they do detract from the implied safety of a lease guaranteed by the parent company.

Chase was well positioned to weather the stresses of the recent recession, seizing the opportunity to acquire the ailing Washington Mutual Bank without assuming legacy assets. As part of this assumption, Chase has been able to expand it's footprint into markets previously unable to penetrate, such as Florida. While they have been converting existing locations, look for Chase to secure a dominant presence in each of the newly entered markets within 3 to 5 years, creating numerous net leased assets along their expansion routes.

Read the full profile here.

Research Snapshot: Day Care Net Leases

Day Care centers are a popular and varied net lease tenant. Unlike other segments such as Banks and Pharmacies, the cap rates for day care centers fluctuate greatly depending on tertiary factors. Nevertheless, since the economic crisis of 2008, Day Care cap rates have stabilized and recently compressed. This is inline with the net lease market en masse and shows a direct correlation to larger market forces. Day care cap rates remain higher than the net lease average, though this is also part of their overall trend.

Key issues that affect day care centers are size of the operator and whether or not the lease is franchise or corporate. Though some net lease investors and REITS choose only to deal with large and national day care operations, more exclusive locally based operators can sometimes offer substantially lower cap rates. However, the advantage of a corporate lease is seen by many as preferable to one guaranteed by a franchisee. Another issue affecting day care centers are their specific location. Properties located as outparcels to centers or with flexible zoning to permit retail or medical office as alternative uses tend to trade for lower cap rates. Investors view this as a means to protect the income stream since a variety of replacement tenants able to match the day care’s rent are possible.

You can read the full report here.

Is the Time Right for Rite Aid?

Yes, the time is right for Rite Aid. An investor will obtain an above average yield commensurate with the market’s view of purchasing a Rite Aid pharmacy.

There is a very active market for Rite Aids with numerous transactions closing in 2010 and 2011. A number of these pharmacies are located on the East Coast. The sales, at cap rates in the 9% range, resulted from the resale of Rite Aids which were originally sold by Rite Aid in 2008. These transactions closed with relatively long periods of time (greater than 17 years) remaining on their base leases. The typical buyers have been individuals and smaller investment firms. In general, financing has been provided by local banks. Cap rates are yielding an approximate 2% premium to comparable CVS and Walgreen locations.

The supply of corporate 2008 vintage Rite Aid stores has been nearly fully absorbed. In addition, Rite Aid has announced that it will not conduct any corporate sale-leaseback transactions in the current year, so that the Company will not add to the available inventory on hand.

Location has reemerged as a critical factor in NNN retail investment analysis. Published asking cap rates for Rite Aids generally are in the 8.5% to 9.5% range, with California locations listing in the mid to high 7’s. A positive indicator that the number of distressed sellers has declined is that asking cap rates of over 10% are rare.

Due diligence for any retail product, but a Rite Aid in particular, should focus on the balance of the remaining base lease term, proximity of national and local competitors and if available, store sales. An absence of any of these factors could have a significant negative impact on the cap rate or even the salability of the property.

Rite Aid’s financial situation has stabilized. Questions about Rite Aid’s future have diminished. Same store sales have begun to rise. Debt maturities have been extended. New management is focused on boosting front-end sales and profitability. In summary, the investor will receive a strong return relative to other investments available in the market.

Rite Aid recently held their first quarter fiscal 2012 earnings conference call. You can view a full report on Rite Aid and that conference call here.

2011 Summer Cap Rate Report

Net lease cap rates averaged 7.75% for the first quarter of 2011 continuing the drop in cap rates that began in the second half of 2010. The key driver in this trend has been an increased demand for high quality net lease properties – assets which feature a strong credit tenant, good location, and favorable lease terms – and the scarce supply of those high quality assets. Investors have clearly shown a lopsided preference for these NNN investment properties and as 2011 progresses, demand will outpace supply.

High quality credit rated net leases have routinely sold for caps below 7.00% and when the combination of tenant, location and market align, Calkain’s investors have shown a willingness to close at cap rates (Calkain closed a Bank/Pharmacy deal below a 5.9% cap) that rival the peak of the market. We saw the same thing happen in the last half of 2010 and if that trend continues, it is likely that – buoyed by the improving economy –other NNN asset types will see a compression in cap rates as investors look to jump into the market rather than await the delivery of new product.

You can read the full report here.

Net Lease Credit Rating Report

Below is an excerpt from Calkain Research's new Credit Rating Report:

In commercial net leases, the investment yields are primarily based on the credit of the tenant. Other factors such as rental location and trends are also factors, but are not the significant factor in the yield. While credit of the borrower is important in the credit decision, the lender heavily weighs the credit rating of the tenant. Ratings are determined by several credit agencies. Two of the major agencies are Standard & Poors (S&P) and Moody’s. Lenders such as private investors, banks, and insurance companies use these ratings to consider who they may consider giving a secured loan too and what the terms will be.

Each lender has different criteria for who they lend too. For example, CTL lenders will only lend to investment tenants regardless of the quality of real estate. On the other hand, insurance companies such as American Fidelity assess all types of companies and measure them through H and Z scores to determine if they qualify. A company could have no or non-investment credit but have high H and Z scores and qualify for a loan. As do investors, all lenders try to diversify their portfolio assets as much as possible.

You can read the full report here.

Research Snapshot: DC, MD & VA Market

A recent theme in the net lease market has been the success of primary markets compared to their tertiary counterparts. While primary markets have been resilient and recently showed remarkable success, tertiary markets continue to struggle. The Washington DC area (D.C., Maryland and Virginia) is chief among the top tier markets and its relative success is easily measurable.

The data highlights a trend that began around the start of the recession in 2008. Although originally quite close, the spread between DC, MD & VA and average market cap rates increased exponentially over the following years. While average overall cap rates show an incremental recovery, the DC metro area has displayed a remarkable resurgence. The key factor to this markets success is the employment stability provided by the federal government, an educated workforce and growing demographics.

Until we witness a full economic recovery, primary markets, especially DC, MD, & VA, will significantly outperform the national average in cap rates. The high demand and scarcity of high performance markets will continue drive their cap rates lower.

Read the full research report here.

2011 ICSC Observations - Part Two

To follow up on last weeks post, here is some more feedback from the 2011 ICSC conference:

• Everyone from individual investors to large capital groups were hinting at looking at some second tier credit assets that they previously would not have reviewed. There were lots of comments on lack of prime asset inventory and plenty of capital and competition for it.
  
  
• There seemed to be a higher number of professionals with a long tenure in the business vs. the looks good “leasing eye candy” and a shiny outside. Substance was key and it felt as though the firms sent their best and brightest. Everyone was there to work.
  
  
• There were some fantastic conversations with accompanying call backs and leads.

2011 ICSC Observations - Part One

We’ve come a long way since 2008-09 and this years ICSC conference is a poignant reflection. The attitude is the most positive in years. Last years notions of “nearing the light at the end of the tunnel” have progressed to reality.

Here are some key observations from the floor:

• The industry is the most bullish it has been since the Great Recession. Investors have renewed optimism and construction progresses.

• Attendance is up. As one attendee observed, “The reason they allowed people to use the overpass to walk between exhibit halls was because no one wanted to jump off into traffic this year.”
• People are talking about real deals; tenants actively pursuing new sites and development opportunities (as opposed to last year, where there was cautious optimism).

• Net lease buyers are very active, they want to see everything and can't put out their capital fast enough given limited inventory.

Net Lease Profile: Fedex

Fedex can write the textbook on global logistics – pioneering the just-in-time supply chain. Its unparalleled tracking systems allow customers around the world to see every detail of a package's movement from the moment the label is prepared until it is delivered to its final destination – anywhere in the world. It's $38 billion in annual revenues generated by over 290,000 employees.

With the help of its innovative information technology and its continued network expansion and accelerated transit times, they have opened new hubs, relocated more than 500 local facilities and are now delivering 50% of their packages in two days or less and 80% in three days or less. Their average daily package volume is now 3.5 million in FY10.

Investing in a Fedex distribution and staging facility means an investment in a Credit Tenant Lease, investment grade quality, which is the core to the Fedex ground business. Leases are typically long term and the locations are strategically located near important air and ground hubs.

Pros:

• Strong Credit Tenant
• Strong Real Estate fundamentals in hub selection
• Continued focus on network expansion and accelerated transit times
• Proven business model and management team

Cons:

• Most locations have Landlord responsibilities, such as roof and structure limits
• Impact of higher fuel costs on cash flow and margins
• Real estate is designed for their specific use, which could impact the releasing to other tenants

For more, read the full profile.

Keith Wentzel on Net Lease Financing

We aked Keith K. Wentzel, Managing Director of Fantini & Gorga, his opinions regarding net lease financing and the future of the market.

What types of NNN properties are the easiest to finance? The hardest?

To a great extent, three criteria impact the feasibility of net lease financing: Credit quality, location and lease term. Assets with investment grade (or equivalent) tenants, good locations, and long term leases (20-25 years) are easiest to finance. Without one or two of these criteria, financing becomes increasingly difficult. Below investment grade tenants, tertiary markets, and short term leases are major concerns and can negatively impact the ability to obtain financing for a property..

Over the last 12 months high quality assets have been in strong demand; drug stores such as “Walgreens” being the perfect example. As a result of this strong demand, cap rates for high quality assetshave been driven down to the low/mid 6 percent range. Investors are now looking for higher returns and have started focusing on properties that may not have all 3 of the criteria mentioned above. Around the end of 2010, an increasing number of investors became willing to sacrifice one or two of those criteria for better yields.

Washington D.C., New York, Boston, Chicago, Dallas, L.AandSanFrancisco are all popular locations for acquiring net leased assetsandurban infill locations with good demographics are highly sought after.

Read the full report here.

How Low Can Cap Rates Go?

Credit, location and lease term have always been integral to lower cap rates. Today, however, the floor for properties possessing such qualities is steadily dropping. Quality net lease investments are in high demand, creating some of the lowest cap rates seen in years.

It is no secret that investment activity surrounding high quality net lease assets has been increasing. The economy is perceived as improving, retail has survived and all that “money on the sidelines” is back in the mix. Safe, reliable assets are receiving the most attention. In real estate, it is hard to find a safer investment than top tier net lease properties.

Due to lack of construction during the recession, the pool of “grade A” net lease assets available is relatively small and continuously shrinking. Assets possessing the valuable triumvirate of credit, location and lease term are short in supply and high in demand. The result is plummeting cap rates.

A good example of this is a PNC/Walgreens multi-tenant transaction we recently completed. It featured a very favorable location in a core market - Fairfax, VA - which has a top 10 national ranking for median household income, strong credit ratings (PNC and Walgreens both rated A+ by S&P) and attractive lease terms (ground leases with 20 years for Walgreens, 15 years for PNC). As a result this property sold at a 5.90% cap rate. This example is very illustrative of the demand for high quality NNN properties and the dropping cap rate floor.

It is very likely this trend will continue for the rest year – when new development and higher interest rates may force cap rates back up.

How to Calculate the Value of a Zero Property

How do I calculate the possible market value of a zero cash flow property?

Values for zero cash flow properties are usually expressed as a percentage over the debt. That is to say, some percentage in excess of the debt. As an example, a brand new CVS zero with 25 years left on the lease/loan that fully amortizes would price in today's market at probably between 9% and 10% over the debt, such that if the loan balance were say $10Mil, then the total value be about $11Mil, meaning you could buy it with approx. $1Mil in equity. Further, the more seasoned that zeros become (older) the more valuable they tend to get, as you are closer to the day that you own it free and clear.

Another way to approach the problem would be to value the store as you would any other NNN property by applying a cap rate to the NOI. However, by applying a cap rate to the NOI, you would probably need to add at least 150 basis points premium to the cap rate. This helps account for the constraints of the zero deal (i.e. inability to refinance etc.). Said differently, If you have a deal that would otherwise trade at a 7.00%, as a zero it would probably value closer to an 8.5%.

It should be noted that both of these methods determine “gross” values and not a “net” value. That is to say that the net value (Gross Value minus the Debt) is the actual out of pocket cost to you to do the deal.

Lastly, as should be obvious, the real estate itself should play a role in it's valuation in that, location, possible reuse, and building condition may drive whether or not their is any residual value to the building at all in the absence of the tenant exercising their renewal options. A critical mistake that many people make when looking at zeros is to discount the real estate and simply view them as a security or abstract financial instrument. This is not the case, real estate fundamentals still apply.

Net Lease Conference 2011 – What a Difference a Few Years Makes

The 2011 net lease conference displayed the most positive atmosphere since the economic pitfall. It was easily the best attended net lease conference in years. We are continually told that things are getting better, but to see that attitude on the ground is a different story.

The most noticeable thing besides its attendance was the high level of interest participants showcased. In previous years, a sizeable number walked around in almost a trance –trying to figure out how to be active in a non-active market. 2011 saw the return of the players. This energy revitalized the event and gave it a positive attitude. People were optimistic about the future.

That said a few prominent issues kept appearing:

• Interest rate fears.
• Overall lack of supply continues to plague the market.
• Development probably won’t begin again till 2012 (and that's pending interest rates)
• Sale Leasebacks are currently popular ways to raise capital (more so than usual anyway).

Overall, the 2011 net lease conference showed lots of promise for the future.

Net Lease Profile: Walmart

Wal-Mart discount department stores vary in size from 51,000 square feet to 224,000 square feet, with an average store covering about 102,000 square feet. Wal-Mart Supercenters stock everything a Wal-Mart discount store does, and includes a full-service supermarket. Wal-Mart Supercenters vary in size from 98,000 to 261,000 square feet, with an average of about 197,000 square feet. Wal-Mart has displayed exceptional growth over the past decade and its AA S&P investment grade credit rating carries strong appeal for real estate investors.

Wal-Mart stores are rare investments on the net lease market with the transaction size, acreage and square footage of the investment (much larger on all counts than the typical netlease property) appealing to a more select group of investors. Big annual rents and relatively low selling cap rates means the typical net lease Wal-Mart transaction is over $10mm. The selling cap rate is often in the low 6's to high 7's depending on lease structure and remaining term.

Pros:

• Corporate guaranteed, investment credit.
• High visibility virtually creating a new downtown wherever it opens.
• Typically low rent per square foot.
• Low recourse and low interest rates often available.

Cons:

• Flat rental rate, minimal escalations
• Large footprint poses re-lease problems should the tenant relocate.

Bright Lights for Retail's Future?

Closure announcements for this quarter GAFO (general merchandise, apparel, furniture and other goods) fell by 53% compared to last year. Blockbuster and Talbots made up 41% of those closings. This suggests retailers are rebounding from their severe contraction.

According to ISCS, a total of 700 U.S. stores and restaurants – 10.4 million square feet and .07% of retail space – closed this quarter. A 53% decreased from the year before. This has been connected to a 3.3% increase in shopping center sales last year. 2010 did witness a 7.5% increase in GAFO closures over 2009. However, the latter half of 2010 experienced significant improvement. This improvement has trended into 2011.

High quality net lease properties in select markets have already experiences noticeable cap rate compression. Whether or not this trend spreads throughout the greater retail market is uncertain.

Note: Credit ratings have taken on increasing importance in our shaky economic landscape. S&P provides an insightful guide betweencorporate credit rating and default rate:

Stuck Beside a Cap Rate with the Second Quarter Blues Again

...Or is it Deja Vu all over again? Whether it is Dylan or Yogi there are striking parallels between first quarter activity in 2010 and 2011. Both years began with a flurry of activity, cap rate compression and a more open lending environment. Deals were transacted and the outlook was positive. Then we hit the brakes. In early 2010, the collapse of the Greek economy set off a fear of European default with repercussions that were felt across the globe – an enlightening testament to the power and perils of a truly global economy. The good news of course is that by early summer, the net lease world was right again and deal making and cap rates responded to an improving economy and a lack of quality net lease product.

Following a solid close to the fourth quarter, 2011 got off to a roaring start with further cap rate compression and transactions closed at rates that rivaled those of the peak years of net lease investing. As the second quarter of 2011 approaches, we potentially find ourselves in a place that looks an awful lot like the second quarter of last year. Will news from across the globe cast a shadow on domestic trade? Will revolution, heightened U.S. involvement in the Middle East and a historic disaster in Japan stall the US economy and net lease investing in particular? Alternatively, just as in 2010, will the volatility in the bond and securities market drive investors to net lease assets that provide bond like, secure, stable returns with solid real estate fundamentals as a backstop to their investment?

Whitey Ford was pitching for the Yankees at Yankee stadium. Luis Aparicio led off for the White Sox with a first pitch base hit. Nellie Fox batted second fouled off a couple pitches and then got a base hit. The next batter hit a home run and Yankee manager Casey Stengel went out to the mound and asked Yogi "Has Whitey got anything?" to which Yogi replied, "What the hell do I know? I haven't caught one yet!"

Like Yogi we don’t have enough information yet but let us know what you think and how global events influence your investment strategy.

Shelby Pruett on $625M Net Lease Deal

Shelby Pruett is Managing Partner at Equity Capital Management - a self administered real estate company focused on investing in institutional quality, single-tenant office, industrial, and retail properties that are net leased to investment grade and other high credit quality tenants on a long-term basis.

HIPP: What is driving your sale of up to $625 million in net lease assets?

PRUETT: ECM’s primary objective has always been to provide its investors with attractive risk adjusted returns through multiple time periods and economic conditions. We are a private equity real estate firm and in 2010 filed to take part of our platform public through ECM Realty Trust.

During the IPO process we were approached by a number of private and public companies, including public REITS, interested in entering into joint ventures, merging, and or acquiring our assets. Through conversations with these companies, we came to a global solution that met all of the constituents needs. As a fiduciary to our investor we made the decision to enter into contracts to sell our assets to some of these parties, one of which was a public REIT.

HIPP: What are your thoughts on the IPO market as it relates to your business?

PRUETT: We still believe public platforms and markets hold merit. We had positive feedback from the public markets as one of the only large scale investors aggregating institutional quality net lease and sale leaseback assets. These net leases were backed by investment grade credit tenants, at significant discounts to the assets underlying values. The platform, team, strategy, board, and structure were well received in the market.

We carefully studied the reception other firms received in the IPO market and believe that while public markets in general are attractive, a company’s timing of entry is critical. At the time we made the decision to sell, we had not launched our road show. The global solution that materialized through the sale provided certainty and was beneficial to all parties. With that said, we believe the sale supported the viability of the platform ECM was bringing to the public market and we are continuing to review an execution in this area with alternative assets.

Read Full Interview

UPREIT Follow Up...

Well, it appears that last week’s blog post on UPREITs struck a nerve because it generated a huge response. Not just in terms of viewership and comments but also in terms of questions. Below are a few of the more common questions that got raised:

What is tax treatment of my gain when I do convert my units?

Obviously you would want to consult your tax advisor to confirm what the treatment for your specific situation might be. That said, the treatment of your gain for tax purposes should be nearly identical to that of the gain you would have recognized had you simply just sold your property in a normal sale transaction. That means that un-recaptured section 1250 gain taxed at a 25% tax rate, as well as capital gains tax at the 15% rate will be considerations. Also, any appreciation in the stock will constitute additional 15% gain, and any depreciation expense you get allocated during your holding period will generally increase your un-recaptured section 1250 gain.

Are there any other quirks associated with a property contribution?

One other consideration is that during your holding period the rental income you will be allocated from the OP will have less depreciation expense from your contributed property than you would have otherwise expected. The rules are highly complex but essentially the built in gain you had on the day you contributed your property to the REIT (the difference between your tax basis and it’s FMV) is burned off by allocating you less depreciation expense, and consequently more income. As a practical matter, this means if you held your units for 39 years (or whatever the remaining depreciable life of the property is) you would have fully recognized your built in gain, albeit as ordinary income as opposed to capital gain. At that point, upon conversion you’d only have to recognize a gain from stock appreciation. Again, you’ll want to consult your tax advisor to make sure you understand the tax ramifications of such a transaction, as it can get tricky.

What are the transaction costs associated with such a transaction? Do I need to bring money to my own closing?

Transaction costs on the seller side are remarkably low, although it could result in needing to bring a nominal amount of money to the closing table. Often times such contributions are done by conveying the LLC, which owns the property, and in many cases can thus avoid transfer taxes that might otherwise apply. Also, most of the costs associated with the deal like legal fees, etc. are borne by the REIT. One thing to note however is any cash you receive from the REIT reimbursing your legal fees would be considered income to you.

Read the White Paper

UPREITs: An Old Idea is New Again

Net Lease investments have long been a haven for those looking to invest in real estate without the headaches associated with management. Owners can rely on a predictable cash flow stream and a risk profile that’s essentially a function of their tenant’s credit.

Still though, there is an inherent lack of liquidity in real estate investments, triple-net or otherwise. Also, the notion of management and diversification takes on new meaning depending upon whether you own one property or twenty. Once you eclipse ten or twenty properties in a portfolio, even triple-net ones, management can become an issue. A tenant will always be rolling, and issues will present themselves regularly that need to be dealt with whether we want to or not.

At the other end of the spectrum, perhaps you own just one large property. An industrial warehouse, or a big box store, perhaps it was inherited. Now, all your eggs are in one basket from a diversification standpoint.

For the family, portfolio, or large single asset owner another ownership option is the REIT. Specifically, the UPREIT. These types of REITs are the perfect fit for the investor who doesn’t want any management responsibilities or the large single asset owner looking to diversify.

The way it works is the property owner contributes their property to the UPREIT in return for units in a partnership, which are transferable into shares in the REIT. The contribution of the property doesn’t trigger any tax gain. It’s not until the units are swapped for REIT shares that any tax is incurred. In this way it’s similar to a 1031 exchange. Additionally, like a 1031 exchange, it’s basically a cashless transaction from the perspective of the seller/contributor.

The difference is you are trading into something which is very liquid (assuming it’s a public REIT), as opposed to another piece of real estate. There is also potential upside in that the value of the stock can increase. Additionally, if you contribute one property into the REIT you’re now effectively diversified -- owning part of all the REIT’s properties. This is in contrast to exchanging one property for another. Furthermore, by not recognizing gain until you convert your units, you can choose the timing of your gain recognition.

Lastly, during your holding period you’re still receiving regular distributions. You still have a solid income producing investment.

None of this is new. This structure has existed for years. Recently, the startup of several new Net-Lease REITs (some public) has shined a new light on this opportunity. We’ve actually just put together a new whitepaper, which illustrates the process; its pros and cons.

Click Here to get it.

Many of the new funds and REITs that have started up recently have been having the same problem that every net lease investor has been having; the utter lack of quality inventory. It will be interesting to see if UPREIT contributions free up some of the quality product that has thus far been on the sidelines.

ICSC Observations

Andrew Fallon, Calkain Companies Associate, provides his obervations on the 2011 Mid-Atlantic ICSC.

• What differences did you see between this and last year’s conference?

This year’s ICSC Mid-Atlantic Conference had a very positive vibe. Attendance was up and there was a general buzz that was not there in 2010. I think that in February 2010, there was still a lot of uncertainly and concern about the economy and how the market would recover from the depressed conditions. In place of that uncertainty and concern was anticipation and optimism.

While there is always deal making at an ICSC conference, this year’s show seemed to have more velocity and urgency. There was a strong developer and third party presence, indicating that once stalled projects are back online and moving forward. Retailers and tenant reps were actively seeking new opportunities for expansion. On the heels of 2010, brokers, developers, lenders, and retailers are excited about continued growth and recovery in 2011.

• What was the outlook at this year’s conference?

The consensus is that the commercial real estate market bottomed out in 2008/2009 and significantly recovered in 2010. We are now accelerating from recovery to expansion. The capital markets discussion revealed not only that many lenders are active again, but also that they are willing to be flexible on terms. Of course, the flexibility is on core, class A assets, which are trading at pre-crash values -- meaning sub 7% and in some cases sub 6% cap rates. The obvious concern is when and how quickly interest rates will rise.

The bottom line: consumers are spending again, leasing activity is up, rental rates are increasing, and investment sales volume should exceed 2010. The outlook is positive, and next year, we might be discussing the successes of those who capitalized on spec development opportunities.

Andrew M. Fallon | Associate
CALKAIN COMPANIES, INC.

Read the Full Report

NNN Industrial Investment One-Liners

Don’t lose sight of the fundamentals:

• The length remaining on the lease term may not be as important as the location and the use of the property. An opportunity to renew or release could be a benefit to investors, especially if the underlying real estate meets the long term requirements of the tenant or use group.

• All things being equal, should the investment value of a property with a stable, high quality industrial tenant, who is operating with a short lease term, be overlooked or discounted? If the business model of the tenant shows creditable future growth and the site and location are critical to their operation, the investment has value beyond the initial lease term.

• Should the real estate be as equally important to the equation, as lease term and financial strength? All attributes of a NNN investment play a critical role in determining the true value if the asset and in some special cases, the value of the real estate may be as important as the strength of the tenant and the uniqueness of the location.

• The location, zoning and uniqueness of the property will always add to the real estate value. The tenant’s use of the real estate and their special requirements can make a case for a much higher value of the intrinsic real estate.

• Spending the time to quantify the real estate value with special consideration put on permitted use requirements and necessary equipment in place, can make or break a NNN deal even if the financial fundamentals say differently.

• Should savvy NNN industrial investors consider the real estate as just one factor of a NNN investment or the most critical component of the equation? In a NNN transaction, real estate having necessary site specific requirements to the Tenant’s business operation, it should disproportionately add value to unattractive real estate.

2010 4th Quarter Cap Rate Report

The story of cap rate movement in 2010 is a tale of two trends. Beginning with promise and an increase in NNN deal making, the year quickly faded in the wake of poor global economic news – only to rebound and rally around mid-year in select markets (headlined by New York and Washington D.C.). Overall, cap rates in the second half of the year were lower than the first. In fact, sellers of credit rated NNN properties in core markets closed at cap rates rivaling the 2007 peak of the market. Numerous reasons have been offered as the cause but chief among these were a lack of quality supply, a more positive lending environment and improving market fundamentals.

It is no secret that there was dramatic contraction in development over the past two years. The pause in expansion by national retailers coupled with stagnant retail sales and the tight debt market all but encouraged already wary developers to halt or slow projects slated for development. Those eager to invest quickly discovered that NNN properties were in short supply and properties of real quality in strong primary markets were even rarer still. In early summer, these factors created a dwindling pool of quality investment grade NNN assets.

Read the Full Report Here

Separate Trends Benefit Net Leases

Two recent developments should push investors towards net lease properties. A new rule from the Small Business Jobs Act demands rental properties be treated as other businesses – requiring 1099 forms to be submitted to all service providers for costs $600.00 or over in one year. Furthermore, municipal bonds are on thin ice and many cities are posting billions in debt. These developments make both active real estate management and passive municipal bonds less attractive. Those who have invested in either should see net leases as a safe harbor.

The Small Business Jobs Act, like all bills, naturally contains things many would think anti-productive to its intended nature. Its provision requiring 1099’s lives up to this by issuing heavy amounts of busywork where none was required. Specifically:

The act subjects recipients of rental income from real estate to the same information-reporting requirements as taxpayers engaged in a trade or business. Thus, rental income recipients making payments of $600 or more to a service provider in the course of earning rental income are required to provide an information return (typically, Form 1099-MISC, Miscellaneous Income) to the IRS and to the service provider. This provision will apply to payments made after Dec. 31, 2010, and will cover, for example, payments made to plumbers, painters or accountants in the course of earning the rental income.

Thus, private real estate owner/operators will be saddled with new paperwork. As owners grow older – which the advancing baby boomer population assures – the time and effort required to actively manage a property will simply not be worth it. For this reason, net lease properties become very attractive. They offer a passive asset which real estate owners can trade into via a 1031 tax free exchange.

Municipal bonds, long seen as a stable investment, are looking less secure everyday. Just to name a few, Chicago as $7.4 billion in debt, Detroit has $billion and New York has $60 billion. These are major metropolises in major debt. Though the idea of a bankruptcy or default may seem impossible – these cities cannot print their own money and many have guaranteed millions in lifelong pensions. At the very least – municipal bond owners should be wary. Those heavily invested should also look for a more stable source of income. The credit ratings of top-notch net lease tenant such as McDonalds and Walgreens would put many cities to shame and still deliver guaranteed passive returns.

The market is constantly changing and as it has proven recently – can be treacherous. Many so called “safe” investments were shown to be completely unsound. Net leases offer a secure asset with dependable returns. Of all the real estate segments – few to none offered more staying power during the recession. With actively managed real estate encumbered by paperwork and municipal bonds looking shaky – the migration to net lease assets should be natural.

State of Medical Office Market

Calkain interviewed Michael Abrams - President of Foulger Pratt Rockledge Medical Properties - concerning the medical office market.

Calkain: As a developer, what is your prediction of demand for new medical condominiums in the Washington Metro area for the next year or two?

Michael Abrams: There are several conflicting forces impacting the medical condo market over the immediate and near term. On the positive front, certain financing markets are becoming very attractive with practices able to borrow funds at about 5% and up to 90% of the project cost. This compares favorably with the cost to lease. Physician practices have also experienced generally good conditions compared to other aspects of the economy which have suffered worse over the past few years. For example you don’t hear about large layoffs by hospitals or physician groups. However, healthcare uncertainty - while better since the passage of the 2010 healthcare bill - still permeates the decision making process for individual practitioners.

Calkain: As you know, there are significant shifts impacting medical delivery systems: outsourced medical services from hospitals, the advancing age of the baby boomer generation, the recent healthcare legislation. Can you comment on the impact of these trends on developing medical buildings?

Michael Abrams: We see a trend toward consolidating practice groups into larger sizes and toward greater hospital employment of physicians. Both of these trends point away from the condo model as a vehicle for physician occupancy. Larger groups tend not to own in this manner and hospitals tend to own entire buildings or lease space. We anticipate a greater orientation by health care systems to delivering services off campus in integrated settings where a variety of medical services are provided in a more unified way rather than a building with a collection of unrelated physicians who may or may not be part of an integrated approach to care.

Read the Full Story Here

Michael Abrams is President of Foulger Pratt Rockledge Medical Properties, LLC, Rockville MD

Net Lease Cap Rates – All Markets Are Not Equal

What happened to cap rates in 2010?

Rick Fernandez: The year started strong with investors returning to the market as interest rates fell and debt became available to a larger pool of investors. Unfortunately, the financial crisis in Greece and the potential for instability within the European Union quickly cooled the New Year’s optimism. The net lease market changed again in early July in part due to another drop in lending rates and a lack of quality supply of NNN properties. A more positive lending environment and improving market fundamentals along with the volatility of the stock market drove investors to look for more predictable and stable returns. In a few markets, cap rates began to compress dramatically. Sellers in these markets suddenly saw offers 50-100bps below the caps recorded at the beginning of the year.

What markets were particularly strong?

Rick Fernandez: Professionals in the net lease community agree that, from an investor’s perspective, first there is New York and Washington DC with Chicago and San Francisco trailing behind and then everywhere else. Those eager to invest quickly discovered that NNN properties in these markets were in short supply and properties of real quality were rarer still. The DC metropolitan region in particular is an extremely stable economy and investors from around the world have turned to the area for net lease investments. These investors viewed the DC metro area as one of the most stable markets in the world. International investors closed on bank and pharmacy deals in the DC metro area in 2010. The lease structure provided long initial terms with regular rent increases that, along with the investment grade credit rating of the tenants, offered a secure, stable and solid return on investment for the investors. The forecast remains strong and ULI in Emerging Trends In Real Estate 2011 predicts the DC area to be the top market for investing in 2011.

Rick Fernandez is Managing Director of Calkain Urban Investment Advisors.

You can read the full report here.

Chick-fil-A: Private Company Trades like Investment Grade

Although Chick-fil-A is a private company, there is great demand for their free-standing stores as net lease investments. The properties are well located near major shopping centers, university and college campuses, and business centers. More than half of Chick-fil-A’s 1,500+ locations are stand-alone restaurants, which meet customer demand for convenience and access in high-traffic areas.

Chick-fil-A is notorious for have strong franchised restaurant operators, proven by the fact that Chick-fil-A maintains a franchisee turnover rate of less than 5% per year. For net lease investors, it is reassuring to know that the Chick-fil-A triple net leases have a corporate guaranteed by Chick-fil-A, Inc. Many investors are becoming more comfortable with this top QSR brand and recognize that they carry a certain implied credit-worthiness. Chick-fil-A net leases properties provide a long-term investment with no property management responsibilities in the form of a 15 to 20-year primary term nnn ground lease. Also, it should be noted that the contracted rent typically increases 10% every 5-years throughout the lease and option periods.

When purchasing a Chick-fil-A ground-leased property, investors are buying the real estate upon which the Chick-fil-A restaurant sits. These ground-leased properties provide additional investment security given the nature of the real estate investment made by Chick-fil-A’s real estate team, which generally pays for the design, construction, and equipment for all new stores. Finally, from a real estate fundamentals perspective, knowing that store locations and developments are chosen based on corporate goals for target markets; it is not surprising that new stores are typically located in high-traffic areas and are often found as out-parcel/pad sites at major shopping centers.

Pros

• Excellent operators and exceptional, growing sales and market presence
• Strong real estate fundamentals
• NNN ground lease structure with rent increases

Cons

• Private company
• Franchised Operators
• Ground lease provides no depreciation on land

Read the full profile and many others here.

Part 2: A Chat with Cole's Micera on Office and Industrial

Cole Real Estate Investments (“Cole”) is a commercial real estate investment management firm founded in 1979 by Chris Cole. Cole’s investment programs are built on a strategy of acquiring income-producing, singletenant properties that are net leased to creditworthy tenants.

Robert J. Micera is the Chief Investment Officer of Office and Industrial for Cole Real Estate Investments.

HIPP: What (if any) regions are you focusing your investment activity in?

MICERA: Cole pursues acquisitions throughout the United States. Currently we own properties in 46 states. Our acquisition criteria focuses efforts on long-term, single-tenant assets (office, industrial and retail) net-leased to high-quality, creditworthy tenants. We look at assets in major markets, as well as secondary and tertiary markets, especially if the asset is strategically important to the growth and operation of a company. For smaller markets, we typically require 15 to 20 year triple net leases with annual rental increases.

HIPP: What types of property are you focusing on?

MICERA: Cole focuses primarily on acquiring single-tenant office, industrial and retail assets that are leased to creditworthy tenants under long-term net leases. Cole also acquires multitenant retail, such as power centers and grocery anchored centers, where the majority of space is leased to one or more creditworthy anchor tenants. Our current portfolio of properties maintains approximately 20% allocation to the office and industrial sector, and the remaining properties are retail assets. Our typical deal size ranges from as low as $5 million to as large as
several hundred million dollars.

Read the full interview here.

A Chat With Cole's Micera on Office and Industrial

Cole Real Estate Investments (“Cole”) is a commercial real estate investment management firm founded in 1979 by Chris Cole. Cole’s investment programs are built on a strategy of acquiring income-producing, singletenant properties that are net leased to creditworthy tenants.

Robert J. Micera is the Chief Investment Officer of Office and Industrial for Cole Real Estate Investments.

HIPP: How do you view the current climate in relation to office and industrial investing today? One year?

MICERA: Current valuations, combined with improving market fundamentals, create a solid buying opportunity that we believe will continue well into 2011. More office and industrial product came to market the last six months of 2010 and we expect volume levels will increase in 2011 based on the following key factors:

»» Sellers, who had been holding off bringing product to market, are now encouraged by the current “compressed cap rate environment” and by the brokerage community to bring their assets to market;

»» The low interest rate environment is facilitating buyers’ ability to acquire quality assets at lower cap rates;

»» More readily available debt, particularly CMBS, is allowing more buyers to return to the market; and

»» A slowly improving economy will allow corporations to grow which should result in increased build-to-suits, saleleasebacks, corporate acquisitions and refinancings, mergers, and expansions – all of which contributes to increased commercial real estate sale activity.

As more commercial product comes to market and diminishes the “2010 scarcity premium,” it would not be surprising to see cap rates stabilize, or even increase, especially if mortgage interest rates continue to increase or remain somewhat volatile. While the overall economy continues to improve and we see more evidence of consistent job growth, companies will consider expansion opportunities. This will lead to an increase in build-to-suits and sale-leasebacks. We have already started to see evidence of this increased build-to-suit activity in 2010. Also, manufacturing production has been increasing which means companies are building inventories again to address increased demand.

Read the full interview here.