The Fed gives net lease market a boost as cap rates shift down

Asking cap rates in the single-tenant, net lease investment sector descended for the second consecutive quarter. This phenomenon—which retail, industrial and office property types all experienced—was supported by a variety of economic factors including the Federal Reserve’s lowering of the interest rate.

According to the Third Quarter 2019 Net Lease Market Report by Wilmette, Illinois-based The Boulder Group, asking cap rates for net-leased retail properties declined 2 basis points to 6.21 percent. That’s the lowest that retail cap rates have been since the second quarter of 2018.

Third quarter cap rates in the office and industrial sectors compressed by 7 and 4 basis points to 7.0 percent and 6.95 percent, respectively. Reinforced by the e-commerce juggernaut, industrial cap rates have never been lower.

The Federal Reserve reduced interest rates in early September and many believe there will be an additional cut before the year is out. Further interest rate reductions would only increase the attractiveness of single-tenant, net lease property investments, according to Blankstein.

“The decrease in cap rates is attributable to the Federal Reserve’s monetary policy objectives which have been quite positive for the net lease market,” said Randy Blankstein, president, The Boulder Group. “Today’s investors, with a favorable cost of capital and beneficial debt terms, are taking advantage of increased cash-on-cash returns.”

Though the net lease market fell to a neutral position earlier this year, Blankstein believes that the market now favors sellers. Even as many net lease participants have a “late stages of the real estate cycle” mindset, transaction volume should avoid a slowdown for the remainder of 2019.

Historically, the fourth quarter nets the bulk of a year’s transaction volume as institutional investors look to meet annual acquisition targets. With no expected changes in the near term to the low interest rate environment, investors should be able to rely on the stability and predictable cash flows that this investment class offers.

“With many net lease participants believing we may be in the late stages of the real estate cycle, some investors have begun to shift their focus, adopting somewhat atypical investment strategies,” said John Feeney, vice president, The Boulder Group. “Investors increasingly are setting themselves up for investments with stronger yields.”

Many investors were open in the past to sacrificing quality for location and lease term in the quest for higher yield. Recently, however, some investors have demonstrated comfort chasing the risk-reward of speculative credits in primary markets with strong real estate or store-level profitability. Examples of these spec credits include Applebee’s, Rite Aid, Tesla and other franchisee-leased properties.

Quarter to quarter, the number of net lease properties available on the market has remained essentially unchanged. There are currently 5,230 properties available, most of which—4,306 properties—are retail. From the second to the third quarter of 2019, the number of retail and office net lease properties saw a modest increase.