Net Lease: Cap Rates Increase, Though Sector Remains Strong
Various reports targeting the single-tenant net lease arena focused on two themes. First, cap rates did increase during the first part of 2023. And second, while transactions declined during the same period, investors still liked the sector.
Higher Cap Rates, Fewer Transactions
Boulder Group’s Q1 2023 National Net Lease Report stated that higher interest rates drove cap rates, while also leading to a “greater negative leverage situation for most net-lease assets than typical in recent years.” Marcus & Millichap 1H 2023 Single-Tenant Net Lease Retail report analysts agreed, noting that , “the increase in capital costs is requiring investors to take on less leverage.”
Adding to the situation is that there are fewer net-lease properties available for sale, “largely attributed to less-motivated sellers removing their properties from the market,” Boulder Group’s report said.
Still, Avison Young’s Q1 2023 Net Lease Cap Rate Report noted that, while transactions did decline, “cap rates on the aggregate remained relatively unchanged,” while the net-lease portion of the commercial real estate sector was “an outlier as it relates to stability.” This was the case, especially compared to the impact of volatile financial markets and overall macroeconomic uncertainty on the industry.
Outlook: STNL and Continued Buyer Interest
In terms of outlook, the CBRE U.S. Net-Lease Investment Q1 2023 Report indicated that net-lease pricing should stabilize more quickly than the broader commercial real estate market “due to the sector’s lower risk profile.” CBRE analysts believe that private buyers have been the largest group for net-lease investments.
Avison Young analysts didn’t disagree, indicating that private investors will continue to be active in the sector. The report also pointed out that institutional investors are also eyeing the sector as they “have large amounts of dry powder that they are obligated to deploy.”
Marcus & Millichap’s analysts believe that a “still-tight labor market, expectations for a pause in rate hikes and historically low single-tenant vacancy should continue to attract active buyers to net-lease assets.”
Boulder Group researchers weren’t as optimistic, however, noting that “until the spread between borrowing costs and cap rates decrease, transaction volume will continue to be impacted.” While the depth of the 1031 exchange buyer pool will be lower compared to historical standards, many STNL sales will “be driven by low leverage or all-cash 1031 buyers,” the Boulder Group said.
Avison Young analysts added that the remainder of the year could be problematic for overall CRE transactions. However, “STNL should remain a safe haven for investors,” the Avison Young report concluded.