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.

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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.

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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.

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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.