The single tenant net lease (STNL) market can be a godsend for investors who get in at the right time, but this market is not evenly distributed. While opportunities still exist in some regions, others have cooled off.
Low cap rates, cheap debt and a bevy of creditworthy tenants seeking spaces are just a few of the reasons the single tenant net lease market has heated up throughout the nation. The market has gotten so hot, in fact, that many now consider it a seller’s market.
“It’s a seller’s market nationwide,” says Dan Hoogesteger, a net lease advisor in Sands Investment Group’s Santa Monica, Calif., office. “Many owners of investment properties believe we have hit the peak of the market and are at a point where prices will soften in the near future. For this reason, a number of owners who were waiting on the sidelines now recognize this is their time to sell, rather than risk prices beginning to drop.”
Many STNL investors remember the burst from the last market run and are making a concerted effort not to repeat the past. These cautionary sentiments are made all the more meaningful by the fact that many believe the Fed will raise interest rates in the next six months. Then, there are those who need to free up capital for the next big venture or who want to unload a troubled property while they still can. “We are seeing more owners enter the market now simply because they are sensing that the market is hitting a peak and they don’t want to miss the window of opportunity to maximize value,” Hoogesteger continues. “The current activity we are experiencing has created a great marketplace for both brokers and sellers.”
Mountain State Momentum
The Mountain states of Colorado, Utah and Idaho is one region out West where STNL activity has been particu- larly favorable for sellers.
“The Mountain states all favor sellers right now — they have for the past few years,” notes Chris Hatch, a principal broker with Mountain West Retail and Investment Commercial Real Estate in Salt Lake City. “Without a doubt, investors are gravitating toward the Mountain states, particularly investors from California and Texas. We’re seeing a lot of people coming out of apartments and into net lease retail deals.”
Hatch attributes this extra attention to the grocery boom the region is currently experiencing. He notes that Smith’s Food and Drug, Kroger’s local grocery arm, is well into its plan of claiming 65 percent of the Utah market over the next few years. Meanwhile WalMart, Sprouts and Whole Foods have also expanded in the area.
“Grocers are booming right now,” Hatch says. “The vast majority of investors in the grocery boom are institutional. This anchor activity is driving new development in a market that has been stagnant since the recession, with a high pent-up demand for retail shop space and pads.”
Excel Trust is one REIT that took notice of the boom. The San Diego-based entity purchased a three-property shopping center portfolio in Utah from DDR Corp. for $223 million in late 2014. The transaction included Family Center at Fort Union in Midvale; the Family Center at Taylorsville in Taylorsville; and the Family Center at Orem in Orem. The Fort Union property is anchored by a 236,370-square- foot WalMart and a 65,755-square-foot Smith’s, which account for 70 percent of the center’s occupancy. Excel (now owned by Blackstone) held this property, along with the Orem asset. It sold the Family Center at Taylorsville, which was 25 percent vacant at the time, to TriGate Capital for an undisclosed sum as soon as the transaction closed.
“We see this acquisition as an opportunity to enhance our portfolio by securing a foothold in a strong market where Excel Trust already has a management presence,” said Gary Sabin, Excel’s CEO, at the time of the sale. “Utah is a business-friendly state and boasts some of the best employment and economic data in the nation.”
California, Here We…Go
Hoogesteger agrees with Sabin that investors must gauge the business-friendly climate of a particular geographic area. This is one of the reasons he believes California-based entities have begun looking outside the state for the next great deal.
“There are different drivers for companies in the Western U.S.,” Hoogesteger explains. “More developers are selling. There are also many frms that now have external reasons to sell — where they may not have typically considered it — because they now have an opportunity to lower their debt position or exchange out of one state into higher-yielding property in another state. This is especially true for California. It’s hard to resist selling at such low cap rates on the West. Many sellers will exchange out of California into a more pro-business state.”
He notes there are markets where real estate fundamentals are stronger, and where tax incentives and business-friendly attitudes reign supreme. While location may be part of the equation in the STNL game, it also boils down to the tenant and its ability to operate successfully within that community that will decide the fate of a property in the short term.
“I think buyers are looking closely at other markets because they are more favorable for the tenant, where the cost of living and rents may be lower than in California,” he says. “With cap rates so low and rents so high in this state, investors believe retailers can do better in other markets where there is simply more discretionary income available.”
Investors know that discretionary income can easily trickle down to not just the grocery anchors, but the co-tenants as well. This is especially true for salons and quick-service restaurants (QSR), as Hatch notes.
“High-end beauty services, fast-casual and fast-food dining spaces, dental chains, banks and mattress companies are tenanting the grocery-anchored centers,” he says. “For example, Bronco Burgers — a 13-store franchisee for Wendy’s in Boise, Idaho — recently put a Wendy’s out to the market for a sale-leaseback opportunity. There were 37 offers in the first 48 hours of marketing. When you have the right type of asset like that at the right time, it brings an infux of buyers.”
DJM Capital Partners is one firm that sees opportunities beyond the Golden State. Though the private equity real estate and development firm is based in San Jose, Calif., and maintains assets throughout the state, its latest STNL fund hopes to capitalize on opportunities throughout the West Coast, Texas, Sunbelt and New England.
DJM recently closed its initial round of funding for the $200 million Single Tenant Net Lease Fund, which will focus on the acquisition of underperforming or improperly capitalized assets. This will include multiple-property portfolios in premier, high-barrier-to-entry markets that can be transformed from value-add to core and core-plus holdings.
“Some sellers are looking for new, longer-term STNL assets,” says Robert Brown, senior vice president of acquisitions for DJM Capital Partners. “But with cap rates so low in the West, many are electing to pay their taxes and not trade…or they are looking for deals in less competitive markets. Some of the private, non-traded REITs will also be sellers going forward, as they look to focus their holdings on their core investment category.”
Brown notes that he, too, is bullish on the QSR industry as he’s watched new burger concepts like Five Guys and Smashburger expand, while Chipotle, Buffalo Wild Wings and Panera Bread have remained active. Brown is also monitoring higher-end and specialty retailers, including Ulta Cosmetics, Tesla Motors, Mattress Firm, and Midwest-based consumer electronics and home appliances company HH Gregg, which he says are all on the move. He is cautious to point out, however, that a company in expansion mode alone does not a good deal make.
“It’s a seller’s market across just about every asset class, with the availability of low interest debt and plenty of liquidity seeking yield,” he points out. “That said, the pricing of the net lease properties we buy is not about that at all. We look for a disconnect between value, lease term and seller sophistication as our primary drivers in this particular segment of the commercial real estate market.”
Opening a fund to acquire STNL assets while others — even REITs, by his own admission — are selling to take advantage of the favorable environment, does not worry Brown. Nor does the talk surrounding interest rate hikes or a bubble burst that some would argue is fueling this sell-off, both in and out of California.
“The ‘bubble’ conversation is certainly relevant in valuations around fortress assets like core office, retail and residential,” he says. “Are we back to 2007 with CMBS debt and overleverage dominating the market? The U.S. economy has not fully recovered, and interest rates will remain low for at least a year. I don’t think we are close to a big sell-off and recession.”