Was 2011 the Best Year for Triple-Nets?
For our firm, 2011 was a bigger year than 2007 — which was surprising given the alleged new discipline in the debt markets. But was it a better one? Who were the winners and losers, and what conclusions are relevant for 2012?
We analyzed the heart of our Single Tenant Net Lease (STNL) closings from 2007 and from 2011 and, excluding assets over $25 million, we looked to see what was similar and what was different. The results may surprise you.
Transaction volumes were up more than 25 percent, despite the fact that our average transaction shrank by about 15 percent. The combined effect was surprising given the abundance of quality STNL supply in 2007 and lack of new product added to sale inventory since. The resulting excess demand contributed to several of our other findings. More surprising, almost all this growth occurred in tertiary markets, confounding the flight-to-quality theory, or at least implying that net-lease investors did not overly rely on geography as their primary indicator of quality.
What’s more, average remaining lease terms on purchased STNL properties shrank by 4-5 years. As an indicator, we sell numerous Walgreens retail and FedEx industrial leases every year. Comparing 2011 to 2007, our average term remaining on a Walgreens shrank to 19 years with FedEx terms shrinking to 6 years — short supply.
This largely explains our final, the otherwise counter-intuitive result, an overall rise in caps rates averaging 90 basis points, with major-market assets experiencing even higher spreads than tertiary locations.
What happened? With virtually no new construction of classic STNL assets, lease terms ticked away over the ensuing 3 years and a relative few buyers cherry-picked the longest leases with the most credit-worthy tenants, starting with major markets. In 2011, buyers who had stayed on the sidelines returned to a very different playing field.
So, who won the bid-ask standoff, if we reach back to the hot topic of 2009? Our Walgreens and FedEx transactions are a good proxy for the answer.
The typical Walgreens sold for around a 7.5 percent cap rate in 2011. In 2007, that same asset would have sold with a 24-year lease for a 6.25 cap. The 2011 seller made about $1 million less on the sale, but realized around $1,200,000 in net rent over the term. The typical FedEx sold for just under 9.0 cap in 2011. In 2007, that same asset would have sold with a 10-year lease for a 7.25 cap. That seller also made about $1 million less on the sale, but realized almost $1.5 million in net rent over the term.
While it may appear that both sellers were paid to wait, what they did with the interim cash flow really determines whether they won or lost. Many of these assets remained on construction loans under sweep arrangements, in which case at least the lender was better off.
2012 will be at least as large a transaction year as 2011, but will be marked by short supply, anxious equity and picky debt. With no meaningful resurgence in STNL program builds, the parties have adjusted to the realities of buying, selling and financing single-tenant properties that are becoming more “real estate” than “net-lease” all the time. This fact affects major and tertiary markets equally; it is just a matter of scale. Non-institutional buyers have to put more real money (their own) in deals and/or accept personal recourse on loans.
Our advice to buyers? Do your homework, stick with what you know and get good help. To owners? If you are holding a fresh 10-year lease, you may be holding gold, even more so than in 2007. But take the long view – go look at the 3-year trend line.
Craig Tomlinson is a director with Stan Johnson Co., one of the nation’s leading commercial real estate brokerage and advisory firms with a net-lease group focused exclusively on the acquisition, disposition and financing of net-leased real estate.