Northeast Real Estate Business

MAY 2018

Northeast Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Northeast United States.

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34 • May 2018 • Northeast Real Estate Business tion of e-commerce. Meanwhile, net lease tenants that have been hurt by online shopping — namely big box op- erators — are looking at creative strat- egies to simultaneously increase traffic and trim their footprints [see sidebar]. "Deals, especially in top markets, are still trading at very competitive cap rates," says Doug Aronson, a man- aging director for Herndon, Virginia- based Calkain Cos., which has brokered $12 billion in sales since 2005. "In the past five years, we have seen more and more new inves- tors come to the net lease sector, fueled in part by very low yields on other traditionally conserva- tive investments." Indeed, annual dividend yields for net lease real estate investment trusts (REITs) provide a glimpse into how much cash the properties are generat- ing for investors. Store Capital REIT (NYSE: STOR), National Retail Proper- ties (NYSE: NNN) and Realty Income (NYSE: O) ended 2017 at around 4.5 percent or higher, according to indus- try trade group NAREIT. That was more than 150 basis points above the benchmark 10-Year Treasury yield. "There are not a ton of other options out there for the typical investor or that a person with capital to deploy can feel comfortable with," states Chris Sands, founder and CEO of Charleston, South Carolina-based Sands Investment Group, which has brokered $3.3 bil- lion in sales since 2010. "There are a lot of benefits to owning a single-tenant net lease property — it creates a cer- tainty of cash flow, you derive tax ben- efits from depreciation and you own a brick-and-mortar building that pro- vides you the chance to recoup your investment if the tenant leaves." Slow Start Sales of single-tenant retail proper- ties in the United States totaled $14.6 billion in 2017, an increase of about $125 million over the prior year, ac- cording to New York-based Real Capi- tal Analytics (RCA). The most active acquirers for the year were private investors, including 1031 exchange buyers, which shelled out some $8.3 billion for single-tenant assets, reports the data researcher, which tracks deals of $2.5 million and greater. REITs and institutional investors followed, pay- ing some $4.8 billion for properties. Investment volume of more than $1.7 billion through February this year represented a year-over-year decrease of nearly 20 percent, according to RCA. Net lease experts attribute some of the slowdown to investors taking time to review changes to tax policy and interest rates amid an extended period of peak pricing in the commer- cial real estate sector. Like commercial real estate broadly, net lease proper- ties have benefitted from the Federal Re- serve Bank's accom- modative monetary policy, which has sustained historical- ly low interest rates and fueled asset appreciation, says Richard Chichester, president and CEO of Irvine, California-based Faris Lee Investments. As a result, to a large de- gree net lease real estate remains fully priced, if not over-priced, he adds. Still, he and other net lease brokers downplay the chances for a dramatic slowdown in sales this year. In fact, in February Faris Lee Investments repre- sented First and Mission Properties, a 1031 exchange buyer, in its purchase of a CVS in San Francisco for $16.8 million. The 4 percent cap rate marked the lowest ever paid for a CVS in a sale exceeding $10 million on a national basis, according to the brokerage. To prepare for occupancy by CVS, the property underwent a major renova- tion that features rooftop parking. "We're still seeing a lot of demand for single-tenant net lease properties, and I would expect that to continue regardless of what happens in the economy because these investments are really bonds wrapped in real es- tate," says Chichester, whose firm has been involved in $20 billion worth of transactions since 1996. "Interest rates are still at historical lows, and there is not quite the same sensitivity to the correlation between the 10-year Trea- sury bill and cap rates in these assets versus other real estate sectors." Other net lease brokers echo Chich- ester's sentiments, even with the benchmark 10-year Treasury yield's rapid ascent as the central bank shift- ed to a tighter monetary policy regi- men in 2017. The yield on the 10-year bond rose to around 2.8 percent in early February — up roughly 80 basis points from its 52-week low in Sep- tember 2017 — and has generally hov- ered at that level even after the Fed- eral Reserve announced in March that it would raise the federal funds rate another quarter of a percentage point. The central bank also affirmed its commitment to further rate increases this year. Cap Rates Holding So far, however, rising interest rates have failed to affect cap rates. At the end of 2017, for example, the average national net lease cap rate declined 10 basis points to 6.33 percent across 11 retail categories despite the Fed- eral Reserve's tightening, according to Calkain's Net Lease Economic Re- port issued in February. What's more, in the few cases in which cap rate in- creases occurred, they were typically miniscule: The average convenience store cap rate, for example, rose to 5.66 percent at the end of 2017 from 5.61 percent a year earlier. "There are net lease properties avail- able for all types of risk tolerance," says Aronson, who is in Calkain's Fort Lauderdale, Florida, office. "But in- vestors may need to rethink things if they believe the time has come where they can grab a brand new, 15-year 7-Eleven absolute triple net lease at a 6.35 percent cap rate. It's not happen- ing." Indeed, Calkain research indicates that the average 7-Eleven cap rate in 2017 was 5.36 percent. The healthy spread between the 10-year bond yield and cap rates also reduces the chances for a substantial rise in cap rates, suggests Will Pike, executive vice president and manag- NET LEASE STAYS STEADY NET LEASE from page 1 Last year Calkain Companies represented the seller of a newly constructed CVS in Elkridge, Maryland, which came with a 25-year lease and several five-year options. A 1031 exchange investor paid $5.25 million for the property, which equated to a capitalization rate of 4.95 percent. In 2017, Marcus & Millichap represented the seller of a 12,350-square-foot Walgreens in West Milford, New Jersey, for $10.6 million. A private investor fulfilling a 1031 exchange acquired the nine-year-old property. Doug Aronson Calkain Cos. Richard Chichester Faris Lee Investments

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