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.