Bridging the Net Lease Retail Buyer-Seller Gap

Calkain Cos. Associate Director Scott Campbell delves into how factors like rising interest rates and a new political structure have made the gap between buyers and sellers a particular focus for net lease retail investment players this year.

Scott Campbell, CalkainIn my article from December, I discussed the correlation (or lack thereof) between cap rates and interest rates, but what actually happened at the start of this year?

The gap between buyers and sellers has always been focus among brokers, but it has been a particularly sensitive issue so far in 2017, due to rising interest rates and everyone settling into the new political structure, among others factors.  Although we have seen an uptick in cap rates, it is not as drastic of an increase as many buyers would like to see, which is why we have seen somewhat of a lull in first-quarter activity. Across asset classes, we have seen many buyers come 75 to 100 basis points above asking price to see if there are deals to be had. As I previously discussed, there is simply not a direct correlation between cap rates and interest rates. Cap rates will move slightly if there is a move in interest rates, but they are not going to move 50 bps if the Fed hikes rates at the same measure, contrary to popular belief.

Our job as brokers is to let parties on both sides know what similar assets have been trading for in order to come to an amicable solution for any transaction. On the buy-side transaction, the hike in rates has put some properties out of reach from a simple debt perspective. Prospective purchasers today cannot borrow money on properties in the high-4 percent cap rate range since one would be looking at a negative leverage situation. This has certainly contributed to many buyers taking a pause when looking at net lease investment while considering using debt.

On the sell side, many are just not willing to accept a lower price when many assets are trading close to where they were trading a year ago. One may ask, “why are they still trading at prices/cap rates that they were a year ago, even though debt costs have gone up?” The simple answer is 1031 exchanges. One of the main drivers of our niche industry, between the timeline crunch and enormous tax implications of a 1031, is that investors are willing to push cap rates on deals to make sure they exchange into a property that is secure from a underlying real estate and hedge against inflation perspective.

Where is pricing going now and through 2017?  We expect cap rates will start to steadily trend upward for the rest of the year and for the years to come. However, buyers are still going to combat against the aggressive exchange investor and a robust economic environment, which will keep cap rates close to recent trade activity levels. There will always be a fluctuation in the real estate market, but strong investment fundamentals (i.e., location, credit of the tenant, lease term, etc.) will always be the cornerstone of net lease retail investments.