The State of the Net Lease Market

By Rick Fernandez, Calkain Urban Investment Advisors

From cap rates to credit, let's address a few questions about today's conditions.

Let’s address a few questions and answers about today’s net lease market.

Can you quantify cap rate differences by market for the same credit tenant?

Demand for credit rated property within the MSA of the elite primary markets is strong but the lack of product means that a triple-net investor is going to pay a premium for that property. The spread for credit rated tenants can vary by up to 100 basis points if you are in New York or Washington, D.C. versus other primary market cities with another modest drop in cap as you enter the secondary and tertiary markets around the country. There is not as significant a variance in the recorded caps for credit rated tenants in secondary, tertiary and the primary markets outside of the elite group mentioned above. A review of closed transactions in 2010 shows that a Walgreens minutes from D.C. in suburban Virginia might sell for a 6.5 cap or better whereas a similar property might sell at a 7.5 cap in Philadelphia.

How do investors weigh credit tenant versus strong location and market?

The greatest disparity in cap rates between markets can be seen in the transactions recorded for non-credit rated tenants. At the height of the market, investors often looked at triple-net properties with the same overly optimistic view as their well-documented counterparts in residential real estate. Today, triple-net investors rightly focus on core real estate fundamentals, the survivability and strength of the tenant and the landlord’s ability to replace the tenant and rent should the tenant fail. Triple-net investors are buying national non-credit rated tenants and local mom and pop shops in the elite markets if the performance and prospects of the tenant is known and the underlying real estate is strong. In D.C., the seller of a triple-net retail condominium with a local tenant operating a quick-serve restaurant in the heart of a thriving urban market sold at a 7 percent cap rate. By comparison, non-credit retail properties outside of the primary markets trade from 50 to 200 basis points higher than their primary market counterparts.

Have you seen a difference in debt terms based on geography or is it just on the investor side?

Debt terms do vary by market and tenant with a local lender the only prospect for debt in some markets. National lenders continue to pull back in many cities but insurers and the big banks are financing a great variety of transactions in the primary markets.

As the supply of triple-net property remains limited, do you see investors moving towards lower credit or other markets?

In today’s market, suitable triple-net investment property is hard to find. Quality triple-net investment property is harder still. Perhaps hardest of all are the $1 million to $5 million size transactions where average investors focus their attention. For many of these investors, as with many of the REITs, the return will not be equal to the risks associated with non-credit tenants in secondary and tertiary markets and they will remain on the sideline.