At the mid-point of 2017, net lease investments continue to be a strong sector in commercial real estate, a sector that experts say has become its own distinct investment class.
This strength is evidenced, in part, by commercial real estate conferences across the country that are devoted exclusively to issues and topics associated with the sector. Later this month, on Wednesday, July 26, Midwest Real Estate News will host a full day conference in Chicago. It will bring together many of the newsmakers in this segment of the business.
Following is a preview of some of the topics to be discussed and the storylines to follow, as presented by three net lease experts, Randy Blankstein, The Boulder Group; Bill Lenehan, FCTP; and Dan Lovitz, VEREIT.
According to Blankstein, the market is following normal volume patterns, starting out slow at the beginning of the year but continuing to build momentum to what he expects will be a feverish pace of activity by year end.
“The market likes clarity,” Blankstein said. “I think we’ll see more and more clarity through the balance of the year.”
Blankstein said retail business models and concepts that “gravitate to or establish e-commerce resistant” concepts are doing well and among the most popular net lease investment choices. He said those retailers include restaurants, fitness centers, medical and healthcare operations, and gas stations, among others.
“There are certain things e-commerce can’t replace,” he said.
In addressing some of the investments that have long been favorites, Blankstein said banks are undergoing evolution for the right ‘store’ count, predicting there will be fewer in 10 years. Restaurants, such as Panera, Dunkin Donuts, Starbucks, which are a perennial favorite, are trying to move from strip centers to free-standing locations, whenever possible.
“It’s all about the right concept at the right location where there is better parking, better visibility and drive-thru capabilities.” He added that most investors would prefer free-standing locations, but can’t always afford it.
Blankstein is optimistic about the balance of the year. “You’ll see strong volume through the end of the year. There is a window of opportunity right now, especially with a positive interest rate environment. There is more guesswork for what happens beyond that.”
Blankstein noted that while talk often moves back to the interest rate climate, in spite of any short-term increase in rates, the real trend since 2007 is downward movement of interest rates.
“There has to be an event that will move rates significantly,” he said. “That move is not on the table. Any movement is a slow movement, and that doesn’t have much impact.”
As Dan Lovitz evaluates the marketplace at the mid-point of 2017, he characterizes the market as “completely overheated”. He cites low interest rates and the ability to get cheap money, the continued availability of 1031 exchanges, a supply and demand equation that is “not really balanced, with lots of competition for few deals”.
“There was some uncertainty last November, but it hasn’t played out,” Lovitz said. “As a result, we have a pretty frothy market.”
Lovitz agrees that e-commerce has changed consumer buying habits, but adds, “I don’t believe the doom and gloom that Amazon is taking over the world.” Consumer spending, he notes, has increased, including for some retailers that aren’t solely e-commerce based.
“Some of the retailers who haven’t changed are struggling and filing for bankruptcy; and it is having an impact,” Lovitz said. “But it’s not the end of the world because it is helping to bring about an overall shift in the industry.”
Though retail is taking its fair share of lumps across the industry, Lovitz highlights a number of sectors that he believes are still strong and performing well.
Off price retailing remains strong because a large percentage of consumers always will be value hunters. Because of this, Lovitz said that retail spaces leased to retailers like WalMart, Ross, TJ Maxx, Auto Zone, Camping World will always be in demand by investors. In expanding his list of sectors, Lovitz said, “I still think pharmacy is strong, especially with the aging population.” He also pointed to grocery properties as providing strong investment opportunities.
In looking ahead to the balance of 2017 and into next year, Lovitz said, “In my opinion, cap rates have to go up; and it is inevitable that interest rates will go up too.” He suggests that the number of players in the market will continue to grow which will increase activity, but also add to the competition for prime acquisitions. Lovitz couched that a little by saying, I thought interest rates and cap rates were going up nine months ago I can’t believe it! We’re back to the Go Go days of 2006; it’s a great time to be a seller!”
Bill Lenehan’s assessment of the market at the mid-point of 2017 generally concurs with those of Blankstein and Lovitz.
“There was a pause around the election; deals that were expected to close didn’t,” Lenehan said. Then, he says, as things played out transaction activity plateaued at a high level.
Characteristics cited by Lenehan for the strong activity include the low interest rate structure, strong real estate pricing that helps sellers meet their exit strategy, and a strong 1031 exchange market that typically benefits net lease properties.
Lenehen went on to characterized pricing as exceptionally strong for high-credit assets and at pricing levels that definitely favored sellers. But he also was pointed out that there is a greater level of deteriorating credit among some retailers; a trend that makes strong-credit tenant properties that much more appealing and valuable.
He said the high values being recorded in the market “make people feel good.” But he added, “If you are looking to grow a portfolio, it can be a challenging time.”
In evaluating the strength of certain sectors versus others, Lenehan said, “The lines are being drawn. It’s experiential and service oriented versus product,” with the most successful opportunities being those that can’t be dismantled by the internet.”
He also said that banks and other financial services businesses are “important and trading well.”
Lenehan believes there are huge caveats to be considered when predicting what the balance of 2017 and 2018 will be like. “It’s difficult to understand regulatory and legislative materials, and that’s a huge caveat.”
He added, “Across the net lease space, we’re pretty insulated, but not perfectly.”
For more information on the Net Lease Summit visit the event page.