Net Lease Cap Rates vs. T Bills

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.

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

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.

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

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.

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

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.