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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SOUTHE AST Northeast Real Estate Business • May 2018 • 35 We're here to help. C O M M E R C I A L R E A L E S T A T E D E B T , E Q U I T Y & S E R V I C I N G Refinance options? Defeasance? Partner buyout? Loan maturity? Supplementals? Disposition? Reserve draws? Prepayment? Ownership change? Lease approval? Property damage? Billing questions? RECON 2018 ATTENDEES VISIT US AT BOOTH FP15 IN THE FINANCE PAVILION Connect with a local expert @ N O R T H E A S T R E G I O N BOSTON | LONG ISLAND | NEW JERSEY | NEW YORK CITY PHILADELPHIA | UPSTATE NY | WESTCHESTER NY ing director of the net lease property group in the Atlanta office of CBRE. During the last peak, for instance, that spread was around 200 basis points, according to NAREIT. At the end of 2017, when the 10-year Treasury yield was also around 2.8 percent, the spread was closer to 400 basis points. "In the grand scheme of things, a 10-year Treasury rate of 2.8 percent isn't that high," de- clares Pike, who with his partner brokered some $2 billion in net lease transactions last year. "We have a long way to go be- fore it gets to histori- cally normal levels, so I'm not in the camp thinking that cap rates are going to rise much at all, if any." Balance between the demand for net lease assets and their supply should help to keep a lid on cap rates, too, re- marks Scott Holmes, senior vice presi- dent and national director of the retail division for Marcus & Millichap. "A lot of buyers of single-tenant net lease assets are peo- ple who made their money in multifam- ily properties and are now transferring over to something that's less manage- ment intensive," he says. "But I would also say that we shouldn't expect the trend of cap rate compression that we've seen since 2009 to continue." Recipe For Increases Other brokers, however, say that cap rate moves traditionally have lagged interest rate increases by three to six months and make the case that the market should see price adjustments this fall, if not sooner. The best price of debt for the best net lease properties with investment grade tenants al- ready has increased some 25 basis points to around 4.25 per- cent from last year, says Jeffrey Thomas, founder of Seattle- based Thomas Co. And they're only going to rise from there, he predicts. "The speed at which those changes can occur can slow things down be- cause there's going to be a disconnect between buyer and seller expecta- tions," he cautions. "We know people that have a real need to transact, but they're taking time to digest some of these investments, especially the larg- er deals." While sellers over the past several months have largely refused to budge on price, Thomas says that some are beginning to quietly re-engage previ- ously interested buyers with sweet- ened deals. That typically marks the start of a broader re-pricing process, he adds. In some cases, sellers prepar- ing to go to market are nudging up cap rates by a quarter of a percentage point in anticipation of more central bank tight- ening, says Sean O'Shea, a manag- ing director for the O'Shea Net Lease Advisory group of Los Angeles-based BRC Advisors. O'Shea and other experts contend that seller and buyer motivations as well as investor types are influenc- ing the market, too. Climbing interest rates have a negligible effect on 1031 exchange buyers and other investors that use all or mostly cash, for ex- ample. In fact, 1031 exchange buyers looking to defer capital gains taxes on sale proceeds face a 45-day deadline to identify a new investment property. That pressure makes them more will- ing to pay a premium for net lease as- sets, which has also helped to keep a lid on cap rates, brokers say. But higher interest rates directly impact private equity funds and in- stitutional buyers that typically use leverage to finance deals. Even REITs, which generally try to keep their debt loads at around 50 percent or less of net asset value, are "very sensitive" to interest rate changes because of share- holder yield expectations, Chichester says. "Therefore, those expectations are going to influence pricing, and you're seeing a gap building between differ- ent buyers as to what they'll pay for single-tenant net lease properties," he explains. "A private buyer can still be aggressive while the REITs are more disciplined and expecting cap rates to move up a bit." Buyers that need to use only 50 percent debt are finding it difficult to make deals work on properties with a cap rate of 6 percent or below in today's interest rate environment, O'Shea points out. In some cases, in- vestors are taking out cheaper short- term loans, but they then run the risk that interest rates will be substantially higher when it's time to refinance. "While short-term debt may im- prove yields by 30 to 40 basis points, where are you going to be in the next three to four years?" he asks. "If you have no requirement to buy anything right now, keep your powder dry and see where the market is at the end of the year." n Faris Lee Investments completed the $16.8 million sale of a recently renovated CVS in San Francisco in February. The transaction marked the highest price paid for a single-tenant CVS, and the 4 percent capitalization rate was the lowest in a CVS deal of more than $10 million. Scott Holmes Marcus & Millichap Will Pike CBRE Jeffrey Thomas Thomas Co. Sean O'Shea BRC Advisors

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