At mid-year 2024, the overall single-tenant net lease market continued to struggle with reduced investment sales activity.
Office volume was down approximately 43% from last quarter, and retail property transactions fell 56% in the last three months. The 17% boost in quarterly industrial activity was only enough to push the combined volume to $8.8 billion, making it the second slowest quarter of sales activity in over ten years. At this time, and without an uptick in volume during the second half of 2024, it’s likely the market will fall short of matching last year’s stunted totals.
Even with one or two interest rate cuts this year, which are still far from guaranteed, the market will need time to react and adjust. Activity is not expected to balloon overnight, although transaction volume will almost certainly increase somewhat in response to more affordable debt. Rather, investment sales between now and year-end will primarily be driven by upcoming loan maturities, opportunistic acquisitions of distressed assets, 1031 exchange activity and other tax-motivated investment decisions. Elevated interest rates, coupled with the upcoming U.S. presidential election, have created a muddy, uncertain environment that many investors are simply waiting out if they have that luxury.
With today’s shifting market conditions, property values have dropped. Average cap rates for the overall net lease market have been on an upward trajectory since bottoming out in third quarter 2022. In the last seven quarters, cap rates have increased 93 basis points to the current average of 6.57%. While the last three months saw a decline in average cap rates for the single-tenant office and industrial sectors, further reductions are not expected. Instead, cap rates across all net lease sectors may experience some fluctuation quarter to quarter, especially if transaction volume remains slow.
Q2 2024 Single-Tenant Office
Following first quarter 2024’s impressive performance, the single-tenant office sector saw transaction volume return to levels more in line with recent quarters. With $2.02 billion logged during second quarter, the market is set to outpace last year’s activity, even if second half office volume remains muted, which is expected.
With very few high-priced trades, the majority of investment activity over the last three months occurred in sub-$10 million assets. Healthcare properties, including dialysis facilities, imaging centers and physicians’ offices, were among the more frequently sold asset types. Several portfolios were also traded. Among the higher profile transactions were Novant Health’s 16-property medical office sale-leaseback and the $60.7 million sale of the Class A headquarters campus of Blue Cross Blue Shield of Minnesota.
After a 12-basis point jump in first quarter, the average cap rate for single-tenant office receded slightly, ending mid-year at 6.75%. This is still elevated from the 2023 year-end average and further reductions are not anticipated. What’s more likely is that the market will see additional small upticks in the final months of 2024 to continue the general upward trend seen since mid-2022.
Buyer distribution for the first half of the year remains deviated from recent years. While institutional investors continue to represent roughly one quarter of the active buyers, REIT activity has become more prominent. With 27% market share, REITs were the most active buyer type for single-tenant office in the last six months. Private buyers, which have captured up to half of the market in the last two years, now only represent 25%. In the second half of 2024, watch for net lease healthcare transactions to continue buoying the market, which could result in a greater number of private investors becoming active in the sector.
Q2 2024 Single-Tenant Industrial
The single-tenant industrial market was the only sector to report an increase in sales volume from first to second quarter 2024. Despite the 17% uptick, transaction activity is still comparatively low to totals seen in the last few years. With $4.95 billion closed in the last three months, the sector still isn’t on pace to match last year’s performance, and a significant rebound in activity by year-end is not likely given that interest rates remain elevated. Still, investors continue to seek out industrial properties, especially in markets with extremely low vacancy and slow levels of new construction. Tenant demand in these areas that lack supply is helping to drive rents up, which is attractive for investors seeking yield.
Similar to the single-tenant office market, the industrial sector reported a jump in average cap rates at the beginning of the year, with a 16-basis-point jump from year-end 2023. Rates then declined in second quarter by five basis points to the current average of 6.46%. Given the large increase in such a short period of time, it’s possible industrial cap rates could fluctuate in the remaining months of 2024. Any declines, however, are likely to be insignificant and short-lived, as the general trend has been increasing since cap rates bottomed two years ago.
Buyer activity for single-tenant industrial product has been extremely consistent in the last several years. In the first six months of 2024, private investors continue to be the most active buyer group with 37% of the market. They are followed by institutional investors at 24% and REITs at 12%. International investors have been more active this year than historically, but the breakdown is extremely similar to overall ratios witnessed this decade. This suggests investors remain committed to their strategies of including industrial assets in their portfolios.
Q2 2024 Single-Tenant Retail
With $1.82 billion in transactions reported during second quarter 2024, the single-tenant net lease retail sector posted its slowest quarter since 2011. This is only the third time in 13 years that quarterly activity has failed to exceed the $2.0-billion mark, but with rapidly rising cap rates, it’s been challenging to get buyers and sellers to agree on pricing. High interest rates have exerted pressure on transaction activity as well, and portfolio volume – which has historically contributed significantly to retail sale volume totals – is down more than 49% year-over-year. The market has relied on smaller priced individual asset sales to drive activity levels, which simply don’t add up to impressive totals. With fewer than 300 transactions in second quarter, the net lease retail market is certainly facing its challenges.
Despite the seemingly dismal outlook, expectations call for increased activity in the second half of the year. We regularly see fourth quarter as the strongest and most active for the retail sector, especially as many year-end transactions are motivated by tax savings strategies. Furthermore, if interest rate cuts occur at any time this calendar year, the retail market is positioned to benefit.
International capital remains absent from the net lease retail market, but buyer distribution metrics reflect other noteworthy trends. In the last six months, REIT activity has been noticeably stronger than in recent years. With 38% market share, compared to 19% in 2023 and 15% the prior year, REITs have used current market conditions to their advantage. Conversely, private investors, which comprised 60% to 70% of the retail buyer pool in the last two years, represent less than half the active buyers. Watch for these ratios to adjust as the year progresses, however. With a meaningful uptick in transactions, especially during fourth quarter, it’s likely those tax-motivated private and individual investors will recapture some of today’s market share from the REITs.
Lanie Beck is Senior Director, Content & Marketing Research for Northmarq.
