Net Lease Profile: Starbucks

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

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

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

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

View the full profile here.

Research Snapshot: Grocery Stores

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

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

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

Read the full report here.

Net Lease Profile: Chase Bank

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

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

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

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

Read the full profile here.

Research Snapshot: Day Care Net Leases

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

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

You can read the full report here.

Is the Time Right for Rite Aid?

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

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

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

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

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

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

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

2011 Summer Cap Rate Report

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

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

You can read the full report here.

Net Lease Credit Rating Report

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

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

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

You can read the full report here.