Net Lease Insider

Check Out Net Lease Central

2011-10-07T06:44:00.000-07:00

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

2011-08-03T08:56:00.000-07:00

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

2011-07-26T13:28:00.000-07:00

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

2011-07-21T09:10:00.000-07:00

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

2011-07-13T05:23:00.000-07:00

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

2011-07-06T07:46:00.000-07:00

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?

2011-06-29T09:54:00.000-07:00

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

2011-06-22T05:55:00.001-07:00

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

2011-06-15T14:16:00.000-07:00

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

2011-06-08T10:57:00.000-07:00

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

2011-06-01T05:28:00.000-07:00

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

2011-05-25T10:17:00.000-07:00

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

2011-05-18T06:21:00.001-07:00

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

2011-05-13T13:00:00.000-07:00

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?

2011-05-04T11:43:00.001-07:00

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

2011-04-27T13:08:00.001-07:00

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

2011-04-20T11:12:00.000-07:00

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

2011-04-13T11:19:00.000-07:00

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?

2011-04-06T07:01:00.000-07:00

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

2011-03-30T11:40:00.000-07:00

...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

2011-03-23T06:26:00.000-07:00

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...

2011-03-16T12:18:00.001-07:00

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

2011-03-09T05:39:00.000-08:00

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

2011-03-02T07:18:00.000-08:00

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

2011-02-23T11:53:00.000-08:00

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

2011-02-16T07:03:00.000-08:00

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

2011-02-09T07:11:00.000-08:00

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

2011-02-02T13:52:00.000-08:00

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

2011-01-26T12:05:00.000-08:00

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

2011-01-19T08:13:00.000-08:00

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

2011-01-12T06:38:00.000-08:00

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

2011-01-05T06:11:00.000-08:00

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.

West Virginia Market Represents High Returns and Stable Demand

2010-12-15T08:40:00.000-08:00

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.

Industrial Assets – A Shifting Investment Paradigm

2010-12-08T07:59:00.000-08:00

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 3^rd 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.

Wild Wild Wawa

2010-12-01T10:36:00.000-08:00

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

Demand for Discount on Black Friday

2010-11-23T09:01:00.000-08:00

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 1/4^th 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.

Who is Interested in Zero Transactions?

2010-11-17T13:33:00.000-08:00

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.

A Decade of Deferrals

2010-11-10T10:46:00.000-08:00

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.

Challenges When Dealing Internationally

2010-10-27T07:03:00.000-07:00

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.

Insiders Look at the First Net Lease Book

2010-10-13T06:27:00.000-07:00

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”.

A New Take on FASB Rules from Richard L. Podos

2010-10-07T08:25:00.000-07:00

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.

Understanding Net Lease Investors

2010-09-23T08:50:00.000-07:00

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.

CVS Corporate Bond vs. CVS Net Lease

2010-09-15T06:24:00.000-07:00

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.

Lack of Inventory = Lower Cap Rates?

2010-09-08T11:37:00.000-07:00

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.

Seeking Shelter From New Health Care Tax

2010-09-01T14:04:00.000-07:00

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.....

A Tax Tsunami

2010-08-18T08:53:00.000-07:00

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.

Industrial Snapshot

2010-08-11T12:45:00.000-07:00

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.

Trophy Markets

2010-08-04T14:00:00.000-07:00

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”.

Looking Back: NNN Cap Rates

2010-07-21T12:45:00.000-07:00

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

2010-07-15T06:15:00.000-07:00

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

2010-07-08T06:19:00.000-07:00

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.

Should We Fuss About FASB?

2010-06-30T10:18:00.000-07:00

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....

2010 Cap Rate Report

2010-06-23T13:56:00.000-07:00

“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.

Zero Hour for Net Leases

2010-06-17T10:41:00.000-07:00

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.

Drug Store Wars

2010-06-11T07:40:00.001-07:00

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.

ICSC RECon 2010

2010-05-26T13:23:00.000-07:00

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.

Opportunities on the Cutting Floor

2010-05-19T07:30:00.000-07:00

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.

Are Cap Rates Going Down?

2010-05-12T08:21:00.000-07:00

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.

Springtime for Retail, Sale Leasebacks, and Urban Investments

2010-05-04T11:41:00.000-07:00

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.

Is Retail Development Picking Up?

2010-04-28T10:58:00.000-07:00

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.

$55 Million Net Lease Leaves Harbor

2010-04-21T13:24:00.000-07:00

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.

Walgreens Goes Urban With Duane Reade

2010-04-14T06:41:00.000-07:00

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.

US Apartment Uptick = Net Lease Impact

2010-04-07T06:00:00.000-07:00

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.

An End to Our Long Winter?

2010-03-31T06:05:00.000-07:00

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:

The pace of layoffs is abating, instead of accelerating.
Production is on the rise, albeit from anemic levels.
Home sales are surprisingly on the upside.
Profits are surprisingly on the upside.
Financial markets are rallying, to some extent.
Core consumer spending, driven by pent-up demand, appears to be regaining some momentum.
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.

Net Lease Cap Rates vs. T Bills

2010-03-23T08:25:00.000-07:00

Cap rates are an important economic indicator for the net lease market as they effectively reveal supply and demand of NNN investment property and the return investors expect for their NNN investments. Furthermore, when compared with Treasury Bills, NNN investment property and the Net leases behind them offer an interesting picture of the ebb and flow of credit and risk and a window into the behavior of lenders and investors alike.

If we think of Net Leases as a bond like asset backed by real estate and the credit strength of the tenant, we see that cap rates and T-bills move in opposite directions in response to the rise and fall of interest rates. The returns offered by T-Bills rise when interest rates fall. For NNN properties, a fall in interest rates has an opposite effect driving cap rates lower as the drop in the cost of debt makes a lower return tolerable to NNN investors. Said another way, T-bill rates typically rise during periods of business expansion and fall during recessions. The economic engine that drives up the return for T-bills typically drives down the return offered by Net lease investments. This effect is compounded as the competition amongst investors pursuing Net lease properties drives cap rates down even further.

So where are we today? It is still too early to tell but preliminary data for 2010 suggests that the steady rise in cap rates that began in 2008/2009 may be leveling off. Lack of quality product, low interest rates and a very modest thaw of the frozen debt market may be responsible. Warren Buffet and others have pointed out that it is a fool’s game to try and time the market but the day of bargains in Net lease investments may be coming to an end.

Is Walgreens Leading Us Down the Yellow Brick Road?

2010-03-17T07:19:00.000-07:00

Walgreens has been considered the bellwether for net lease properties, its high credit ratings (A2 for Moody’s and A+ for S&P) ensuring stability relative to the market. For the past year its cap rates have been climbing and many forecasted they would continue to rise till years end, however, recent developments may indicate that are cap rates leveling off. If Walgreens can be considered a bellwether for the market, this could point to wider implications.

Starting in late 2008 fears began to mount about the inflationary effects of governmental spending. The 25 year flat lease, customary on most Walgreens net lease properties, became increasing unattractive as a long term hold asset. Furthermore, the glut of properties on the market, 200-250 in 2008-09 compared to around 100 in 2007, placed upward pressure on cap rates. As a result Walgreens witnessed cap rates go from an average of 6.3% in Q4 2008 to 7.9% in Q3 2009. Some predicted average cap rates would exceed 8% by the end of 2009. However, as the year ended and we entered 2010, it became clear the upward motion of cap rates had ceased.

There is now a sense of stabilization in regards to Walgreens cap rates. It has been reported they averaged out at 7.5% for 2009, a far cry from the 8% some predicted. This could be because fears over future inflation have subsided and/or supply has decreased. Certainly there is a perception that the economy has taken a few steps back from the precipice of disaster encountered in 2008. Such developments could downplay the risk of inflation in people’s minds. It is also known that the supply of Walgreens has dropped substantially; there are now much less than the 200 or so properties previously on the market. This could mean that the market has already achieved stabilization through our current cap rate increases and now stands at a rough equilibrium.

Though it seems Walgreens has reached some cap rate stability, it is still unclear whether or not this applies to the rest of the market. There are still reports of large bid-ask spreads between buyers and sellers, so the net lease market has certainly not leveled out just yet. However, judging from Walgreens history as an indicator, it may not be far behind.

Warren Buffet's Logic Applied to Net Leases

2010-03-10T06:47:00.000-08:00

Recently, Warren Buffet sent a letter to his stock holders in which he outlined six key points to his success. They are rather simple and based upon sound common sense; the trick is not in knowing them, but in applying them. As they are quite general in nature, they can also be applied to the net lease market, which after all, is just another form of investment.

Stay Liquid. Warren Buffet wrote:

"We will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses."

There are two simple lessons to be gleaned from this advice, 1.) Have cash, and, 2.) Ensure investments produce cash. While seemingly easy to follow, it is clear from the recent real estate and financial crisis that these principles are quickly lost. Overleveraging and risky investments can too easily entice people from the shores of sanity. When investing in net leases, ensure you are not overleveraged and that your investment is a sound, income producing property.

Buy When Everyone Else Is Selling.

"We've put a lot of money to work during the chaos of the last two years. It's been an ideal period for investors: A climate of fear is their best friend. . . . Big opportunities come infrequently. When it's raining gold, reach for a bucket, not a thimble."

This is pretty easy to understand but hard to follow. First of all its takes a considerable amount of bravery and foresight to run in the opposite direction as everyone else, secondly, it takes well planned fundamentals to ensure one has the cash to take advantage of the situation. However, for investors who do have the resources, allowing fear to inhibit investment opportunities defeats the entire purpose of investing.

Today’s commercial real estate market is obviously at a low point but those who insist on “waiting for the bottom” are in reality waiting for someone else to start investing first. In order to capitalize one must first mobilize and do so before the mob.

Don't Buy When Everyone Else Is Buying.

"Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance,"

Nothing is free. That includes “reassurance”, with which one buys off the cognitive dissonance of a decision. The most utilized source of this are the opinions of other people; we all care deeply about “what others think”. The price for this can be easily assessed in terms of cash, as demand increases price. Thus, the more people it takes to lend support to your investment, the more money you will pay for it.

Value, Value, Value.

"In the end, what counts in investing is what you pay for a business -- through the purchase of a small piece of it in the stock market-- and what that business earns in the succeeding decade or two."

When investing in commercial real estate it is very important to obtain an asset which produces value. There are many ways of assessing this, but stability over time is usually the most reliable. A few years ago, many would have rather owned an artificial island off the coast of Dubai instead of a less luxurious grocery store in a high traffic area; it is easy now to see which one time has judged the better.

Understand What You Own.

"Investors who buy and sell based upon media or analyst commentary are not for us,"

It is important to study the fundamentals of what you wish to acquire, with net leases this is especially important. Location, credit tenant rating, past returns, and lease agreements can all impact an investment tremendously. Before making an investment it is vital to understand its attributes.

Defense Beats Offense.

"Though we have lagged the S&P in some years that were positive for the market, we have consistently done better than the S&P in the 11 years during which it delivered negative results. In other words, our defense has been better than our offense, and that's likely to continue."

Aggressiveness can be a value but it must be paired with a secure end. There is no gain in being aggressive in a market which bottoms out. As Napoleon said “Take time to deliberate, but when the time for action has arrived, stop thinking and go in.” It is important to create a strategy which will provide in both high and low tides. Take the necessary time to pick the proper asset and then proceed forth with vigor.

How Will Retail Fare in 2010?

2010-03-03T11:01:00.000-08:00

As 2010 gets underway it is inevitable the same questions which many had in ’08 and ’09 will be asked again. Concerns about the health of our economy, specifically retail, have not been resolved. Outright recovery is not forecasted and many are now predicting an extended economic quagmire. Since it appears likely the climate will be similar to last years, the companies that do well in 2010 will likely be the same that succeeded in the previous two years.

As reported by Shopping Center Business, the top three expanding U.S. Retailers in 2009 were: McDonald’s with 1000 stores, Walgreens with 554 and Dollar General with 500. These three companies perfectly illustrate that “value” is the biggest seller in today’s market. This trend has continued into 2010. In February Walgreens agreed to buy Duane Reade (257 drug stores) and the operator of T.J. Maxx and Marshalls announced “plans to nearly double its overall store count from just above 2,700 units to 4,200 locations”, with 130 new stores planned for this year. Dollar General not only plans to open 600 new stores this year, but will feature investor friendly lease terms as it moves away from its traditional modified double-net lease to a more favorable triple net lease. This will definitely be a crowd pleaser for net lease investors, who seek no landlord responsibilities and wish only to receive a monthly check.

While the 0.3% and 0.5% increases in retail sales respectively for December and January encourage the possibility that sales will significantly increase this year, it seems likely they will generally remain flat. With an average unemployment rate of 9.8% forecasted for 2010, many families will continue to place a preference on savings and value. This plays to the advantage of companies such as McDonald’s, Dollar General and Walgreens, ensuring their expansions will continue. Furthermore, a recovery may not necessitate a return to 2005 spending practices. Many consumers were badly burned through the over-leveraging which allowed for the high level of purchases seen in the “boom years”; this could encourage a long term preference for value.

In the past two years the most successful net lease tenants have been value tenants such as McDonalds, Dollar General and Walgreens. Their focus on affordable products has not only ensured survival, but allowed for great amounts of store expansion. With no indicator to say otherwise, it is likely this trend will hold for the duration of 2010.

Sweetgreen: A Fresh Dining Experience

2010-02-24T06:16:00.000-08:00

Unbeknownst to many, an interesting new dining concept is springing forth in the Washington DC area. Sweetgreen is a modernly styled salad/yogurt restaurant, which caters to the ever-growing demand for healthier foods and is quickly spreading in popularity. It is headquartered in Washington DC and just opened its newest location in Logans Circle (DC) on the ground floor of the luxury Metropole residential condominium, across from the 15th and P Street Whole Foods. Currently it has four retail locations but its immediate success has encouraged plans for further store expansion.

The idea behind Sweetgreen is simple: a sustainable salad and yogurt bar with a chic atmosphere and unique dining experience. In the Washington DC area, this approach has established Sweetgreen as a leader in fast-casual dining by combining the convenience of fast food with healthy, high-quality menu options. Due to its favorable position, the owners think the new Logan location will be their best store yet.

The last twelve months have seen a surge in popularity of retail condominiums located in dense urban markets. Properties located in these areas, especially in the Washington DC urban core, are experiencing increased demand as they have prospered even in the face of the recession. Sweetgreen stands at the forefront of this trend, taking advantage of the current opportunities in the urban market to expand its presence. As highlighted by RE Business, many individual investors are drawn to urban retail because the size and price points often allows them entry to prime urban markets previously beyond their reach.

Retail condominiums are also a popular choice among many 1031 investors who are seeking suitable replacement property. The retail condo units are typically NNN meaning the tenant is responsible for all expenses associated with the property. The properties are actually easier for both the landlord and tenant to manage because the services required to maintain the property are already contracted by the condominium at large. The tenant simply pays the retail unit’s portion of the condo, management and maintenance fees.

Another potential benefit to investors lies in the assessed value of the property and the weight given to improvements and land. Since the improvements are a greater part of the overall value in a condominium it is possible to depreciate a significant portion of those improvements on a 15 year schedule through a detailed cost segregation study. That means a stronger return and more cash in your pocket at the end of the year. All of these factors make retail condominiums and some of their prime tenants such as Sweetgreen very attractive investments.

Net Leases Grow on Chains

2010-02-17T06:38:00.000-08:00

It’s no secret that most net lease properties belong to nationally established retail chains. Among the more popular are McDonalds, Walgreens and 7-Eleven. Recently two more restaurant chains, Chipotle and Chick-fil-A, have shown they are poised for expansion. This should signify possible buying opportunities for net lease investors.

In the year ending on December 31, 2009, Chipotle experienced very positive results:

Its revenue increased 14.0% to $1.518 billion

Comparable restaurant sales rose 2.2%

Net income increased 62% to $126.8 million

Diluted earnings per share rose 67% to $3.95

For 2010, Chipotle expects its sales to remain steady and plans on opening 120-130 new stores. This expansion creates new investing opportunities with a highly successful tenant.

Chick-fil-A also had a successful year in 2009:

Overall sales increased 8.6% to $3.217 billion.

Same-store sales increase of 2.52%.

Opened 83 new restaurants.

In 2010, Chick-fil-A plans on opening 78 new locations, also creating more investment opportunities.

Though many lament the current market, the steady expansion of many successful quick service restaurants has provided fuel for the net lease market. Chains like McDonalds, whose global same store sales rose 2.6% for January and Buffalo Wild Wings, who has experienced rapid growth, represent enticing opportunities for investment. Tenant growth and that of their applicable brands ensures products are widely dispersed and potentially adds the to staying power of those tenants. Those who have demonstrated steady, durable demand and will only attract more attention as they expand.

Urban Might

2010-02-09T12:52:00.000-08:00

Wal-Mart and Target plan on developing smaller stores in order to penetrate the urban market. By decreasing square footage, entrance will be easier, allowing companies to take advantage of low prices in high traffic areas. This continues the recent trend of urban expansion, demonstrating the strong attractiveness of that market.

Typically, urban areas are associated with higher “real estate and fixed costs”, rendering big box stores somewhat ill-suited and clumsy. For retailers like Wal-Mart and Target, it was easier to move to locations more suitable for their gargantuan constructions. However, the wave of foreclosures which has washed over commercial real estate has forced prices down and tenants out, leaving many attractive properties in its wake. In order to take advantage of these opportunities, the traditional big box model has to be scaled down, with a focus on smaller, streamlined stores which will be able to enter the urban market.

This urban move would seem somewhat risky; can a model based on large stores and inventories really be shrunk? But the high traffic provided by these areas along with an increase in demand for value products, should ensure success. Furthermore, these developments lend credence to the notion that urban investments are at present some of the best and most secure. The net lease market has observed continued success in regard to its urban properties and expects the trend to continue.

Franchisee or Franchisor?

2010-02-03T00:30:00.000-08:00

Currently there are around 1 million franchise outlets in the United States and over 40,000 international ones operated by U.S. based franchisors. Ownership and operation of these outlets can differ greatly depending upon their parent corporation. For instance Burger King franchises around 90% of their restaurants, McDonalds 80%, Wendy’s 79%, and Arby’s 69%. Conversely, large investor groups, such as Bain Capital, can also decide whether to license out the business model and make money off royalties or operate the franchises themselves, earning revenue directly. This decision is highly dependent upon the market in question and impacts future management of the property.

Typically, franchisors have three main sources of income, (1) retail sales at Company-operated restaurants; (2) franchise revenues, consisting of royalties; and (3) property income from restaurants that the parent company leases or subleases to franchisees. If a company were to engage in the first, it would necessarily negate the latter two and vice versa. In order for the first option to make sense, the specific franchise would need to operate with larger margins. For example, Bain Capital, which owns a 93% controlling economic interest in Dominos Pizza, chooses to sell the franchise rights of most of their stores (including U.S. based ones) but operates outlets based in Japan. This is because pizza delivery is considered a luxury item there, with people willing to pay up to $43.00 dollars for a single delivered pizza. Thus in Japan, it is more economical to operate rather than sell the franchise rights. Conversely, in the U.S., where pizza delivery is assuredly not a luxury item, it makes more sense to sell the franchises as margins are lower.

Should a parent company choose to own and operate a store, it can receive benefits related to its applicable real estate. A location operated by a parent company with investment grade credit, will instantly increase in value. This is because the locations returns are no longer guaranteed by an individual franchisee who has no credit rating but by a company which does. Furthermore, that company can still pull money out of the property through a sale-leaseback. This allows the company to take advantage of the properties increase in value and pull capital out for other uses. These factors are highly evident in net lease properties, where credit ratings are of high importance and sale leasebacks have always been very popular. A property which is corporate owned and guaranteed will typically fetch a much higher price than an individual franchisee due to the flight to quality in the current market.

The decision between owning/operating and franchising a property greatly impacts how it is valued. It also impacts the level of commitment and funds a franchisor dedicates to it. The applicable margins of the specific locale and the opportunity for greater profitability will then be the decisive factor.

An Urban Trend or an Urban Legend?

2010-01-27T07:55:00.000-08:00

A new trend could be emerging across our nation’s urban areas. With commercial real estate prices down and many locations vacant, the opportunity has arrived for well positioned investors to grab prime space in urban markets. Though many postulate commercial real estate has not yet bottomed out (Moody’s recently forecast another year of declining prices), there may simply be offers that can’t be refused in today’s cities.

This possible trend is highlighted in a recent story by Retailing Today, concerning J.C. Penny’s move into Manhattan. For most of its history, J.C. Penny purposely avoided Manhattan because of the number of competitors and their store space needs. However, recent times have seriously cut down the level of competition, while also providing new vacant space to occupy. The result was a two-level, 153,000 square foot store, which opened on July 31st. In its first month, the new store surpassed sales expectations by “double digits”. The location, which sits above a subway station and commuter rail line terminus, relays 250,000 people past the stores gates each day.

Another development has been the rising popularity of retail condominiums. As highlighted by RE Business, many individual investors favor this real estate type because it often allows them to own space in prime locations they couldn’t previously afford. They are also a popular choice among many 1031 investors who are seeking suitable replacement property. Furthermore, the economic downturn has caused a glut of vacant properties to fill the market; meaning retailers who are looking to buy or lease have great negotiating leverage. Retail condominiums are not only located in prime space but can often be bought by investors seeking to acquire real estate for their own use. These advantages make retail condominiums very popular today.

Net Lease properties are experiencing similar effects concerning urban locations. Properties located in these areas are experiencing increased demand as they have remained successful despite the recession. This coincides with the changing tastes of many investors from high risk/reward properties to ones with more stability. Taking into account the slump in property values, not only investors but retailers alike are jumping for the chance to own real estate in high density urban areas they previously would not have thought possible.

D.C. Has Global Appeal

2010-01-20T08:58:00.000-08:00

According to a new study from the Association of Foreign Investors in Real Estate, Washington D.C. is the top U.S. city for investment. A major reason cited is the “government activism we have now”, which is spurring job growth and attracting residents. The survey also revealed other positive indicators, such as two-thirds of respondents planning on boosting their investment in U.S. real estate this year as compared to last and half expecting U.S. commercial real estate to recover by or before the fourth quarter 2010.

For the D.C. net lease sector, this survey can be seen as a portent of good things ahead. Should the some of predictions of the survey pan out and both investment in the D.C. area rise and commercial real estate see a recovery by the end of the year, it would certainly be a better turnout than many would have predicted. While it has been widely reported that D.C. is doing better than nearly all other U.S. metropolitan areas, it is refreshing to see this fact backed up by those with foreign perspectives.

Net lease properties have already been on many peoples watch lists due to their bond like structure and relative security & stability. When the economy picks up and money starts to flow again, there is a reasonable school of thought saying it will first flow into secure investments rather than the riskier types seen in years past. Net leases fit this bill perfectly.

What the Association of Foreign Investors in Real Estate Survey is essentially saying is that commercial real estate recovery has a reasonable chance to be around the corner and one of the main centers of growth will be Washington D.C. Though this is by no means certain (note the survey itself is split 50-50 on recovery in 2010), if it does prove to be true, it will be quite the year for our nations capitol. However, whether widespread commercial real estate recovery does or does not arrive in 2010, net leases in the D.C. area should see a positive year regardless of the encircling climate, due to their inherent demand and the city’s growth.

Forbes Uses Net Lease Sale Leaseback to Sell HQ

2010-01-13T09:06:00.000-08:00

The net lease industry has inked a number of high-profile deals lately. One of the first deals of 2010 is the announced sale-leaseback of Forbes Media’s 144,000 sq. ft. headquarters in New York’s West Village to New York University. According to the Wall Street Journal, the deal was structured with Forbes agreeing to a 5-year lease deal.

If reported sales figures are correct, NYU probably got a heck of a deal. The building originally listed for $140 million in 2007, and according to the New York Post it ultimately sold for $55 million or about $380 per square foot.

Perhaps Forbes was taking a page from the New York Times, which sold its headquarters in a sale-leaseback for $225 million with a 15-year lease commitment. Yet, Forbes’ 5-year lease agreement definitely raises eyebrows in a net lease industry where 15- and 20-year deals are far more the norm. So, unless NYU has taken on the risky role of real estate speculator, there may be a bigger strategy at play here.

Will Forbes give up all or part of its space when its lease is up in 2015? The safe bet would say yes. The bigger question may be whether we can expect to see more of these large net lease sales in the coming months. Not only are cash-strapped companies such as Forbes using sale-leasebacks to raise capital, but it appears that net lease deals also are providing an alternative for companies that are in transition in this volatile economy.

Retailers Better Prepared for 2010

2010-01-06T06:26:00.001-08:00

With 2009 safely behind us, many retailers are showing greater strength and preparedness for 2010. Last years lessons have been learned well, lower overhead, better planning and a focus on value are the keys to success in this environment. Thus, whether 2010 marks the beginning of retails resurgence or simply an improvement in strategy, it looks to be a better year than 2009.

As highlighted by ICSC, discount retailers such as Target, Costco, Kohl’s and Wal-Mart all have plans to expand with new locations. The quick service restaurant industry is also set to expand with companies such as Burger King, Sonic and Panera Bread planning new store openings. Clearly the environment is conducive to the growth of value based stores. It is also forcing higher-end stores to rethink their positions; Neman Marcus and Nordstrom are now considering adding value focused offerings.

Retailers who are planning expansion are also looking at redevelopment rather than construction. With retail space experiencing heightened vacancies and lower rents, it is more economical to take advantage of existing space rather than starting new construction projects. There are exceptions to this trend, such as certain quick service restaurants like Buffalo Wild Wings, who continue to expand through construction rather than redevelopment.

Though retailers have cut their teeth on the hard times of 2009 and surely step into 2010 better prepared, in the end their fate is inexorably tied to that of the consumer. Unemployment continues to hover at 10% and many do not see significant change in the future. 2010 will most likely witness a greater quantity of deals than 2009 but will not see a return to the levels of earlier years. However, in today’s brave new world, a positive trend should be taken positively.

Some Thoughts on the New Year

2009-12-30T06:14:00.000-08:00

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

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

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

The Ghost of Christmas Past

2009-12-22T09:16:00.000-08:00

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

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

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

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

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

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

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

2009-12-16T10:15:00.000-08:00

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

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

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

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

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

2009-12-09T12:56:00.000-08:00

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

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

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

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

Net Lease Insider Pulse: Jay Bastian of National Retail Properties

2009-12-02T12:09:00.000-08:00

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

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

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

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

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

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

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

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

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

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

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

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

Buffalo Wild Wings Has Keys to Success

2009-11-25T07:56:00.000-08:00

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

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

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

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

Can Commercial Real Estate Have a “Debtless” Recovery?

2009-11-18T11:17:00.000-08:00

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

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

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

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

Net Lease Insider Pulse: Richard Ader on Commercial Real Estate

2009-11-11T11:57:00.000-08:00

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

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

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

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

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

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

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

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

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

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

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

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

2009-11-04T07:56:00.000-08:00

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

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

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

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

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

2009-10-28T09:59:00.000-07:00

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

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

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

Washington DC: An Oasis of Prosperity for Residential and Commercial

2009-10-21T07:10:00.000-07:00

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

What is growing at a never before seen rate?

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

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

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

In-fact, it already has.

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

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

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

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

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

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

2009-10-14T08:42:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

None of these issues pertain to reverse exchanges.

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

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

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

2009-10-07T07:13:00.000-07:00

From Merriam-Webster:

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

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

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

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

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

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

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

2009-09-30T07:03:00.000-07:00

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

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

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

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

Retailers Expecting Lean Santa: Holiday Retail Sales & Outlook

2009-09-23T09:34:00.000-07:00

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

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

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

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

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

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

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

2009-09-16T07:21:00.000-07:00

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

Specifically the article states:

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

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

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

2009-09-09T07:23:00.000-07:00

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

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

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

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

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

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

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

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

2009-09-02T06:26:00.000-07:00

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

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

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

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

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

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

2009-08-26T06:33:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

Medical Office Real Estate: A Net Lease on Life

2009-08-19T07:52:00.000-07:00

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

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

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

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

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

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

Is Net Lease Back?

2009-08-12T06:27:00.001-07:00

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

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

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

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

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

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

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

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

2009-08-04T10:14:00.000-07:00

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

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

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

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

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

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

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

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

2009-07-29T13:39:00.000-07:00

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

Here’s how it works:

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

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

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

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

Will the sun come out tomorrow?

2009-07-22T06:59:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

Of Consumerism:

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

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

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

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

Of Other Factors:

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

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

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

Unemployment is at 9.4%.

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