Investor Demand For Net Lease Properties Spiking to Record Levels
Institutional Buyers Scooping Up Newly Built Triple-Net Office, Retail Projects Faster Than Developers Can Bring Them On Line
Investor demand for net-lease properties, those single-tenant assets often perceived as boring but safe alternatives to riskier real estate investments, is spiking to record levels as more confident investors continue to snap up convenience and drug stores, restaurants and other single-tenant retail establishments.
“The net lease market has been on fire,” says JLL Managing Director Guy Ponticiello. “Net lease sales activity is expected to be north of $55 billion this year compared with $40 billion in 2007. There’s a tremendous amount of capital earmarked for the sector.”
Reports pointed to strong sales volume in both the office and retail net lease office and retail categories in the third quarter.
In the most recent example of the frothy market, particularly for dining portfolios, Rochester, NY-based Broadstone Net Lease (BNL), a private REIT managed by Broadstone Real Estate, LLC, announced recent closings of $123.4 million in triple-net properties, bringing its year-to-date total to about $350 million.
In its largest acquisition to date, Broadstone this month acquired a portfolio of 36 Jack’s Family Restaurants in Alabama, Georgia, and Tennessee.for $83 million. Other third-quarter transactions included the purchase of Kinston, NC property tenanted by Pactiv, LLC, the world’s largest manufacturer and distributor of food service packaging; the purchase of four Buffalo Wild Wings properties in Alabama, Mississippi and Arkansas; and the purchase of two properties in Texas tenanted by Federal Heath Sign Co., a producer of digital, illuminated and non-illuminated signs.
Both NNN Office, Retail See Solid Demand
Demand is spread across all types of single-tenant assets. Asking capitalization rates fell to historic lows for both net-leased office (7.25%) and retail (6.25%) in the third quarter, according to a new report by The Boulder Group. Tightening supply caused cap rates for newly delivered property occupied by 7-Eleven, Bank of America and Family Dollar compressed by between 25 and 65 basis points, compared to 15 basis points on sales of all net-lease assets, noted Boulder Group President Randy Blankstein.
“Properties in the greatest demand continue to be new construction with long term leases with investment grade tenants,” Blankstein said. “Despite a slight rise, there is a lack of new construction properties with long-term leases as the development pipeline has slowed compared to the first half of 2015.”
Despite investor demand, some retailers have remained cautious in their expansion plans, especially in jurisdictions taking steps to raise the minimum wage, which can dramatically drive up tenant labor costs.
While the potential effect of the wage hikes on the bottom lines of retailers’ bottom line is still unknown, as a whole, retailer demand is expected to remain well ahead of supply increases this year. Net absorption will nearly double planned completions, causing asking rents to climb in the low single digits.
While there’s a huge spread between cap rates of high- and lower-quality properties, institutional investors, pension funds and both publicly traded and Nontraded REITs have moved into the space with a vengeance, Ponticiello said.
“Where you do have assets with longevity of lease terms, cash flow security and rent escalation to comfortably hedge against future interest rate movements or inflation, those deals are experiencing unbelievably low cap rates,” he said. “We still see 15-year deals with decent bone structures, with newer buildings in prime markets trading in the low 5% range.”
The possibility of substantial tax increases to pay for the city’s and state’s unfunded pension obligations hasn’t prevented real estate investors from plunking down big sums—even record-breaking ones—to snap up property in the area.
“I think it’s an issue, but I don’t think it’s stopping anyone from investing in Chicago,” says Mark Stern, senior vice president of acquisitions at Waterton Associates LLC, a Chicago-based hotel and apartment investor whose local properties include Presidential Towers in the West Loop.
In February, for example, a New York financial services firm snapped up a small retail building on Oak Street for about $19 million, or nearly $3,000 per square foot. In May, a California company announced it would pay a record $850 million for a River North office tower. And last month, a Los Angeles apartment firm dropped $78 million for an apartment complex in Arlington Heights, the highest price for a multifamily property in suburban Chicago since February 2013.
“We’re anticipating some sort of tax increase, but we don’t think it will push us away from Chicago in the near term,” says Joshua Behar, acquisitions analyst at Florida real estate firm Accesso Partners LLC, which has purchased five office buildings in the city and suburbs since October.
Mr. Behar declines to specify how much the firm believes taxes will rise but says it is building such figures into its calculations for expenses and projected revenue growth. “Everybody, everybody, everybody is underwriting taxes going up,” he says.
The appetite for Chicago-area real estate is driven in part by a lack of yield-generating alternatives. In addition, interest rates are hovering near historic lows, and modest economic growth is allowing landlords to boost rents and occupancies. That all adds up to a robust market—despite the poor condition of state and city finances.
Since bottoming out after the crash in 2009 with a paltry 244 sales representing $2.4 billion, commercial property sales in the Chicago area have risen each year through 2013, when 902 properties representing $15 billion changed hands, according to New York-based data firm Real Capital Analytics Inc. Through the first half of 2014, investors paid more than $6 billion to buy 405 properties.
Acadia Realty Trust, a White Plains, New York-based real estate investment trust, has built a significant presence in neighborhoods like the Gold Coast, paying eye-popping figures to acquire buildings, including $20.7 million, or $7,065 per square foot, for a structure at Rush and Walton streets in 2012. The company wants to buy more.
“Most, if not all, of our national retailers want to be here,” CEO Kenneth Bernstein says. “Chicago is one of the great cities, and our retailers, whether they’re local, national or international, recognize that.”
Nevertheless, the uncertainty about taxes is forcing some investors to tap the brakes. Milton Pinsky, CEO of Northbrook-based Banner Apartments LLC, hasn’t given up on looking for development opportunities and acquisitions here but says the firm wants to earn a first-year return that’s about a half-point higher than in Texas, for example, in part because of the tax risk. “Because our investment hurdle here is higher, more of our activity is driven to other locations,” he says. “We have a difficult road forward.”
Earlier this year, the Emanuel administration called for boosting property taxes by $750 millionover five years as part of a pension deal it struck with city workers outside of the police and fire departments. In addition to a $590 million payment due to the public safety pension funds, the city needs to find $683 million for teachers’ pensions for 2015.
Investors and landlords either can pay the higher taxes directly or pass them along to tenants by negotiating so-called net leases. Higher taxes boost operating costs for tenants, potentially pushing them away or limiting their expansion plans.
According to a Crain’s analysis from January, the increase in property taxes necessary to cover a $590 million pension payment for the public safety unions alone would raise Chicago’s commercial property tax rate to the highest among the 50 largest cities in the country. Already, the rate is the second-highest, after Detroit.
That could be bad news for renters. Chicago developer Steve Fifield, who of late has developed downtown apartment buildings, expects higher taxes to tack on as much as 8 cents per square foot for monthly rental rates. Assuming that tax-fueled increase but no others, a 790-square-foot unit in Fifield Co.’s K2 building in the West Loop that costs $2,291 per month today would rise to $2,354.
“A significant increase in real estate taxes to help fix the pension-funding shortfall would put pressure to increase rents,” he says in an email.
Retail tenants facing higher tax bills will push for lower rents, says Andy Bulson, a principal at Oakbrook Terrace-based retail brokerage Mid-American Real Estate Corp.
Even if the prospect of higher taxes hasn’t kept investors from buying properties here, some executives believe it’s keeping companies that employ people from moving to the region. “Businesses aren’t coming to Chicago, and they’re not coming to Illinois,” says J. Paul Beitler, a Chicago developer who wants to build an office tower downtown but has not found an anchor tenant to launch it.
Source: Chicago Real Estate Daily Alby Gallun August 18, 2014