Check Out Net Lease Central

Hello Everyone,

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

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

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

Thank you.

Net Lease Snap Shot: Convenience Stores/Gas Stations

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

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

Read full report here.

Net Lease Profile: Starbucks

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

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

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

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

View the full profile here.

Research Snapshot: Grocery Stores

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

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

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

Read the full report here.

Net Lease Profile: Chase Bank

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

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

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

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

Read the full profile here.

Research Snapshot: Day Care Net Leases

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

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

You can read the full report here.

Is the Time Right for Rite Aid?

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

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

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

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

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

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

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

2011 Summer Cap Rate Report

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

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

You can read the full report here.

Net Lease Credit Rating Report

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

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

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

You can read the full report here.

Research Snapshot: DC, MD & VA Market

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

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

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

Read the full research report here.

2011 ICSC Observations - Part Two

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

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

2011 ICSC Observations - Part One

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

Here are some key observations from the floor:

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

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

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

Net Lease Profile: Fedex

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

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

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

Pros:

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

Cons:

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

For more, read the full profile.

Keith Wentzel on Net Lease Financing

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

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

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

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

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

Read the full report here.

How Low Can Cap Rates Go?

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

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

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

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

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

How to Calculate the Value of a Zero Property

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

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

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

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

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

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

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

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

That said a few prominent issues kept appearing:

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

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

Net Lease Profile: Walmart

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

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

Pros:

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

Cons:

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

Bright Lights for Retail's Future?

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

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

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

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

Stuck Beside a Cap Rate with the Second Quarter Blues Again

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

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

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

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