What Do Midterm Elections Mean for the Single-Tenant Sector?

Despite the unlikelihood of sweeping changes, investors in the segment have expressed caution about tax reform's future, noted NetCMG's Jonathan Hipp.
Jonathan Hipp

With our apologies to the city of Oakland, Calif., novelist Gertrude Stein once famously observed that “There is no there there.” She could also have been talking about the coming midterm elections and their possible impact on commercial real estate and the net-lease sector.

Historically, when the industry has been faced with major sea changes in the greater marketplace, a wait-and-see period descends on the investment side. We saw it in the run-up to the 2016 presidential elections and earlier that same year when the global marketplace watched with anticipation the outcome of the UK’s parliamentary vote on leaving the European Union.

No such drama looms as November 6 draws near. There is some talk about the possibility of repealing tax reform, the law enacted late last year, but that contingency may occur only if the Democrats win the House.

Cautious optimism

For the meantime, Calkain is tracking a cautiously optimistic approach to the net-lease market on the part of investors of all stripes, and they are putting to great use the gains made by that very tax reform act.

Let’s discuss the caution first, and then we can explore the optimism. Some degree of caution is typical to this time of year as we wait for Fed movement on interest rates. And at this advanced stage of the economic cycle, some concern in understandable over the possibility of a 2019 correction.

But research we have seen indicates that a slowdown is not likely until 2020 at the very least and, to the extent anyone can predict, it is likely to be short and shallow. As for interest rates, we do expect an increase. In fact, we are tracking an acceleration in that trajectory, which means that cap rates will rise to keep up.

Despite its accelerated pace, that rise is not anticipated to be severe or to hinder investment activity. (We additionally expect the gap between the two-year and 10-year Treasury to widen a bit, a condition that favors pricing and investment.)

As we stated in our third-quarter Cap Rate Report, rates rose by eight basis points (bps) quarter over quarter, with the largest expansions showing in the categories of dollar stores (45 bps), medical (26 bps) and quick-service retail (20.5 bps). This was in addition to an aggregate gain of 24.4 bps for retail that doesn’t fit into any of the traditional net-lease categories, such as grocery or cellular phone stores. On the flip side, we saw the greatest cap rate compressions in the pharmacy sector at -25.8 bps; casual dining (-11.4 bps); and automotive retail at -11.0 bps.

Overall, the net lease market is behaving at a moderate and controlled pace; there is an overall equilibrium between the buy and sell side (with some unsurprising exceptions such as an oversupply of dollar stores).

But in all, capital is being raised and deals are getting done, a prognosis that we are confident will continue well into the coming year, long after the guesswork over the midterm elections is over.

Jonathan Hipp leads the efforts of NetCMG, the capital markets division of Calkain Cos., of which he is the founder, president & CEO. Since 2005, Calkain has transacted more than $12 billion in net-lease deal volume since 2005.