Coming Off a Strong 2011, Net-Lease Deals Poised to Grow in '12

By Coler Yoakam, Director, Net Lease Platform, Holliday Fenoglio Fowler L.P.

The net-lease industry had a strong year in 2011, with volumes nearly 200 percent greater than 2009. Here are four reasons why 2012 could be even better.

By Coler Yoakam,
Director, Net Lease Platform, Holliday Fenoglio Fowler L.P.

The net-lease industry had a strong year in 2011. Last year can be characterized as an industry in transition where a handful of positive trends established a robust marketplace for debt and equity net lease investors. Based on data from Real Capital Analytics, which does not track deals under $2.5 million, the net-lease industry transaction volume topped $18 billion. This figure is slightly more than 2010 and nearly 200 percent greater than in 2009. Of the major themes in 2011, there are a few that should be highlighted.

First, there was no lack of capital in 2011. The acquisition environment was led by both listed and non-listed REITs. The most active investor was Cole Real Estate Investments, which acquired approximately $1.5 billion in net-lease assets. Furthermore, REITs accounted for six of the top 10 most active buyers — totaling $4.5 billion — continuing a trend that is making the industry more institutional. In addition to public and private REITs, net lease investment funds, a tapered but still active 1031 exchange market, and various discretionary commercial real estate funds continued to add demand for net-lease assets.

Second, the bid-ask gap narrowed in the second half of the year after concerns over the Euro-zone economic crisis subsided. Despite a sudden pause in the market followed by a brief period of price discovery last summer, transaction flow increased and deal execution improved.

Third, although a scarcity premium continued to plague the net-lease market, the portfolio premium began to dissipate. Investors no longer accepted a handful of mediocre assets mixed in with higher quality assets. Investors exhibited greater patience to acquire the right deal and more confidence that better assets would enter the market.

Finally, risk-tolerant investors emerged in the second half of 2011 with an appetite for private and non-investment grade credit tenants well situated in secondary markets. Much of this resulted from yield-oriented investors focusing more on unit level fundamentals of the operations rather than purely the credit backing the lease.

Looking forward to 2012, some of these themes will persist while other positive trends are beginning to emerge. As in 2011, an abundance of capital coupled with current price stability, product scarcity and higher risk tolerance should keep pricing and deal flow steady until the market is interrupted by an economic or political event. In addition to these trends, there are a handful of additional themes that may benefit the net lease market.

Although debt structures will remain rational, lenders are expressing an interest to move up the risk curve to a broader range of tenants and markets. Pricing may become more efficient for these assets as transaction volumes for riskier assets increase.

Disposition activity may increase from REITs looking to re-balance their portfolios and take advantage the two-year cap rate compression trend. Additionally, private equity activity was up significantly in 2011, which often results in sale-leaseback opportunities as business managers consider monetizing real estate assets.

The advent of the non-traded net-asset-value REITs could potentially add a significant amount of equity capital to the net-lease market. These low-load investment vehicles may appeal to institutional investors that require steady returns, thereby forging a new avenue for large volumes of capital to enter the net-lease space.  Also, institutional equity like endowments and pension funds looking for stable and predictable cash flow may increase capital allocations to the net lease space.

There is good reason to be optimistic about the net-lease industry in 2012. The overall net-lease investment environment is currently poised to start the year strong. If the current and emerging trends continue the industry will remain vibrant and deal flow will grow.