A New Approach to Net Lease REIT Valuation
- Jan 03, 2018
When I wrote my first book, “The Little Book of Triple Net Lease Investing”, in 2008, I was merely trying to fill in time between long periods of having nothing to do—post financial collapse. What I didn’t realize at the time was that there was little to no information on the valuation process of a single-tenant net lease property. I felt that anytime someone was new to the property type, whether an investor, an appraiser or a broker, I had to start from the beginning and go through the obligatory “Net Lease 101” with them. However, I quickly deduced that in my discussions with every person interested in the property type, I was able to break down our talk to three main variables; real estate, tenant credit and lease terms.
Each underwriting aspect has dozens of data points to identify, but it was easy to explain and subsequently document in my book, and made it easier for people to understand how to find a value of a property. But ultimately, there is a tremendous amount of subjectivity that goes into valuation process of a net lease property. The goal for most people involved in a transaction is to find a cap rate—a simplified method of getting to a price that everyone can agree on. Using comparables (comps) as the barometer of value is an industry standard, that, in my opinion, is an archaic pastime and similar to me suggesting that we go to Blockbuster to get a movie. Comps are a look into the past, not the present. Additionally, appraisers are challenged to find net lease comps in specific markets for the subject property where there aren’t that many to compare, and again, they are constantly searching for the lowest common denominator, the cap rate.
With, on average, only 10 percent of their time spent on triple-net lease appraisals, appraisers also openly admit that their increased workload and the subsequent compression of their fees translates to them trying to get as much work “out the door” as possible and have them move on to the their next assignment. The current net lease valuation process uses little math and very few variables for underwriting.
Now, I’m a decade more experienced from that first publication, a decade wiser and feel that while the text in that first book still applies to basic valuation of a net lease property, I’ve become infinitely more sophisticated on how to truly quantify the value of any one net lease property. A net lease asset, we’ve determined, can have as many as 192 different variables that go into the underwriting of that property. Its a far cry from the original three that most people use today. Therefore, with this new and more accurate method of valuation available, it begs many questions as to how we are finding the value of a net lease asset. A few that come to mind:
- What if you could put a value on whether or not a property is on a corner or mid-block?
- Can you quantify demographics from a value perspective as opposed to just the numerical indicators or thresholds that are afforded to the the general net lease investment population?
- Can you enter up to 192 different variables into an algorithm and within minutes, not weeks, have a value of a property that is much more accurate (within 6 percent margin of error as opposed to an appraisal that is in the 15 percent range) than anything an appraiser can accomplish in their prescribed time frame?
This is especially important for net lease REITs, as a large portion of the value of their entire companies is based on the value of their assets. Their share price is directly correlated to the value of those assets, and if an appraiser that admittedly doesn’t have enough time or information and doesn’t make enough money to find an accurate value of a net lease asset, then there could be a tremendous variance in the value of their portfolio that can directly impact their share price. Appraisers are starved for more accuracy and time/cost effectiveness. Investors want to make sure they are paying or selling an asset for an advantageous price. But in an investment climate where a few basis points makes a drastic difference to the perception of the performance of a company, then to solely rely on an inefficient valuation process could change the net lease investment climate by billions of dollars a year, perhaps trillions by some estimates.
Triple-net lease investments have become an industry in and of themselves. The amount of capital that is within this niche marketplace forces anyone within the industry to adopt a better, more accurate and more efficient method in which to value their assets. REITs, developers, landlords, brokers, lenders and appraisers should all take notice.
David Sobelman is the CEO of Generation Income Properties, a public net lease REIT; founder of 3 Properties, a net lease brokerage; and founder of Verum Properties, an algorithmic approach to net lease valuation.