Bankruptcies and store closures agitate the big box, net lease market Matt Baker February 5, 2019 Share on Facebook Share on Twitter Share on LinkedIn Share via email The wave after wave of retail tenant bankruptcies and store closures continues to have reverberations among active investors. However, though cap rates are on the rise, according to the Net Lease Big Box Sector Report released by Wilmette, Illinois-based The Boulder Group, the forecast is not all bad for this sector. Big box asking cap rates, according to the report, were 7.04 percent in the fourth quarter of 2018. This is a 29-basis-point increase from the 6.75 percent at the end of 2017. Big box properties are the standout as the year-over-year differential for the overall retail net lease market was slightly less stark, rising from 6.07 to 6.25 percent between Q4 2017 and Q4 2018, an 18-basis-point rise. “The year-over-year change, and the pricing discount between the overall net lease and the big box sectors are attributable to ongoing investor concerns about the evolving retail environment,” said Randy Blankstein, president and founder of The Boulder Group. “Additionally, store footprints for big box retailers, along with the cost associated with backfilling big box properties, are the primary risks being underwritten by investors.” Vacancy in the sector widened in 2018 after the tenant bankruptcies and store closures of many notable retailers including Toys R Us, Orchard Supply (Lowe’s), Sears/Kmart and Shopko. The Boulder Group report also noted the increasing spread or discount between the overall net lease and big box retail sectors; following an 11-basis-point increase from 2017 to 2018, the disparity between the two sectors increased to 79 basis points. But all is not lost. The issues facing non-credit, big box retailers cannot be ignored, but large properties with desirable locations and fundamentals are still in demand among investors. Some retailers are even expanding, such as Burlington, TJ Maxx/HomeGoods and Hobby Lobby. These retailers and the real estate investor community were quick to acquire or lease the more coveted real estate vacancies left behind by retailer bankruptcies last year, leading to a transaction volume in 2018 that was on pace with 2017. “Big box properties with strong real estate fundamentals in primary retail corridors remain in demand among institutional investors and large 1031 exchange buyers in spite of the issues facing non-credit tenants within the big box retail space,” Blankstein said. “When investment cycles evolve, as they are now, tenant quality and financial health become increasingly more important for income investors in the net lease big box sector. Accordingly, investment-grade tenants including Walmart, Costco, Whole Foods and others are garnering a significant premium over non-investment grade users.” According to the report, in the fourth quarter of 2018, investment grade tenants in the big box sector were commanding a 68-basis-point premium, more than double the premium associated with this category one year earlier. The asking price for investment-grade big box properties was $10,510,612 last quarter, or $176 per square foot. Non-investment-grade properties were asking nearly half that at $5,496,774, or $141 per square foot. According to Blankstein, for as many hurdles that big box retailing faces, the news and the forecast is not all bad for the sector. “The single-tenant, net lease, big box sector will remain active as both individual and institutional investors seek net-leased properties to fulfill larger acquisition targets and 1031 exchanges,” said Blankstein. “With higher yields than the overall net lease retail sector, many investors will be targeting assets with strong real estate fundamentals after careful underwriting and understanding of local retail markets.” That said, big box properties with issues related to tenant health and financial strength, as well as properties with irreplaceable rents or tertiary locations, will be less in demand. And the Midwest, which averages a 7.40 percent asking cap rate, faces more challenges than other parts of the country, according to The Boulder Group’s report. The West Coast saw the lowest average asking cap rate at 6.29 percent. Representative single-tenant, big box transactions in Illinois last quarter include the sales of a Mariano’s in Crystal Lake for $25.2 million, an Art Van Furniture in Downers Grove for $20.2 million, a Jewel-Osco in Oak Lawn for $16 million and a Target in Skokie for $13.8 million. The Art Van transaction had the lowest price per square foot and highest cap rate ($165 and 7.25 percent, respectively); the Target transaction was at the other end of the spectrum with a $419-per-square-foot price and a 5.29 percent cap rate.