Los Angeles-based Sentinel Net Lease has never overlooked the Midwest, regularly investing its dollars in properties throughout the center of the country even before the COVID-19 pandemic hit. And now that the commercial real estate market has been working through the pandemic for more than a year? Sentinel still likes the affordable prices and profit potential of Midwest-based assets.
Just look at February. That’s when Sentinel acquired the Tesla Store & Service Center in the Chicago suburb of Schaumburg for $10.5 million. The 27,032-square-foot property is completely occupied by Tesla under a long-term lease.
Dennis Cisterna, chief investment officer with Sentinel, referred to the property as an example of pandemic-proof real estate. That, of course, is key today for net lease investors. What net lease properties are most likely to perform well even as the country continues to fight back against the COVID-19 pandemic?
The good news for the Midwest? Plenty of those pandemic-proof properties are right here.
Midwest Real Estate News recently spoke with Cisterna about investing during the pandemic and which net lease assets are the most attractive today. Here is what he had to say.
Let’s start with the broad question: Which net lease assets have performed the best during the last 12-plus months?
Dennis Cisterna: The obvious answer is that anything that has been open for business has performed better. Start with essential services and look from there. Drug stores, wholesale clubs, grocery stores, all have done great during the pandemic. Anything with a distribution or manufacturing capacity has done OK, too. By and large, any net lease asset that wasn’t shut down because of safety concerns has done well.
At the bottom of the pack right now are office buildings that were shut down as soon as COVID hit. I don’t’ think any of these employers were ready with a return-to-work type of plan. That makes office buildings a challenge for investors today. It’s difficult when you don’t know what the long-term utility of an office building is. That puts the screws onto a lot of people who were trying to sell these assets. A lot of the liquidity that is normally in the market for these buildings just hasn’t been there because of the pandemic.
That does bring up an interesting question: What do you see in the near future for the office market? Do you think companies will bring their employees back or will some settle on a hybrid arrangement where some people work from home and some in the office?
Cisterna: We own a few office buildings that we did buy during the pandemic. We were able to buy them at a great price and they came with great tenants. The executives we have spoken to at large companies are eager to have their workforce back in the office. They have seen a marked decline in productivity across different busines units. There are some office employees that can more efficiently work remotely. For instance, companies’ sales staffers can probably work efficiently even if they are mostly working remote. But there are other employees that just can’t work as productively when they’re not in the office.
We own call centers. The executives for the companies that occupy our call centers say that their customer-service ratings and their net promoter scores have fallen off a cliff. Providing that oversight and infrastructure necessary to have a well-functioning customer service center can’t be done from a work-from-home environment.
Do you think, then, that most employees will return to the office?
Cisterna: For some businesses, there is a lot of merit to a potential hybrid approach where employees work part of the time in the office and part of the time remotely. At end of day, though, it’s all about dollars and cents. If there is not any kind of immediate health risk, most executives want those employees close by and being efficient as possible.
Grocery stores have long been a favored asset class for investors. Have grocery stores become even more attractive during the pandemic?
Cisterna: I think investors have seen just how resilient grocery stores are. It’s easy with grocery stores and any brick-and-mortar retailer to think that digital sales or online sales will make the physical stores useless. The pandemic showed, though, that this was definitely not the case. For a lot of grocers, the pandemic gave them an ability to embrace online ordering and increase their revenues in stores by taking advantage of some of the tech that is out there.
if you look at online or digitally enabled sales as a percentage of revenue for these grocery stores, you see that it is starting to increase. That’s a good thing for grocery stores. It’s not as if your Kroger or Piggly Wiggly is just going to be totally defunct and all grocery products will be shipped from a warehouse in the middle of nowhere. There has to be a hub-and-spoke mentality to how the distribution of food works. These grocery store buildings are more essential now, not less.
Online food delivery and pick-up has been a success story for a lot of retailers. BJ’s Wholesale Club is a good example. It has seen a huge surge in its BOPIS — buy online, pickup in store – business. Grocery store brick-and-mortar locations, then, not only have their inherent value but they also now add the benefits of digital sales and online ordering.
What about quick-service restaurants with drive-thrus? I’ve noticed long lines at several of these places, like Portillo’s and Chick-fil-A.
Cisterna: Quick-service restaurants are always appealing to investors. Number one, it’s very easy to track the growth of that industry in terms of the total number of quick-service restaurants. Investors like that you can see decades-long growth in the quick-service market. For investors, that’s a very easy narrative to digest. Equally as important, these are not expensive pieces of real estate to buy. These are good options for 1031 exchange buyers, high-net-worth individuals, small real estate funds or anyone looking to buy a long-term legacy asset. They are not sold at high cap rates. There is such a certainty around the business and the assets are bite-sized. There is always a very robust acquisition and disposition market around quick-service restaurants.
Personally, though, I don’t like that space. It’s wildly inefficient. The risk-and-return profile of a ton of assets in that space are out of whack constantly. That’s why I love being an investor in this space. I feel I know how to locate mispriced assets. I don’t think quick-service restaurants are ever mispriced. I think they are overpriced. That’s because of the small nature of these investments and because in the universe of real estate investors, there are a whole lot of people who can buy a $1 million, $2 million or $3 million quick-service restaurant.
What net lease assets do you prefer?
Cisterna: I’m agnostic to the property type. I am very comfortable in retail, office and industrial. It’s about understanding this combination of the quality of the real estate, the quality of the tenant and the duration of the lease. Those are the three pillars that help us make good investment decisions. Sometimes you will see two assets side by side at the same price despite one having much more risk than the other one. My goal is to flesh out where I can get the best risk-adjusted return. I like to work in the middle market, the $10 million to $20 million space. I don’t have a ton of competition in that space.
I should ask about industrial, too. That sector has been booming since the pandemic.
Cisterna: There is no doubt that industrial, light industrial, warehouse and distribution centers are very attractive investments now. That whole universe is exploding. If you look at the new industrial paradigm today, the most in demand are buildings that are 100,000 square feet to more than 1 million square feet.
Is there any part of the country that you most prefer for investments?
Cisterna: Not in particular. You want to be where there is population density and significant demand going forward. How I look at all our deals is that there needs to be a narrative about why that real estate is important to someone. The Midwest gets the cold shoulder from a lot of institutional investors. Some investors are more focused on growth than stability and necessity. There is a lot of opportunity in the Midwest and Southeast. In the Northeast, you have to be more selective. The West Coast is challenging. It is too competitive. The prices are too high. You can’t get the returns you are looking for.
What do you see for the CRE market during the rest of 2021?
Cisterna: I am a firm believer that the worst is very far behind us when it comes to the pandemic. I think that we have reached the tipping point with vaccinations and that cases will continue to decline. Normalcy will be restored. Any time you go back into a normalized market from the doldrums of a previous year, you will see a strong surge back. The government has pumped a ton of money into the economy. Interest rates are extremely low still. There is very much a risk of inflation with certain elements of the economy. It’s going to be interesting to see what happens. I think right now with CRE, the next nine months of the year is going to be more about stabilization than hitting the gas again. But given where we are already in March, I think the rest of 2021 is going to be significantly better.