Net-Lease Banks Reach Lowest Cap Rates in History

By Randy Blankstein, President, The Boulder Group: Investor demand for bank ground lease properties remains strong as banks are one of the few single-tenant, net-lease options with long-term leases and rental escalations in the primary terms.

Randy Blankstein, The Boulder Group

Cap rates within the single tenant bank ground lease sector reached their historic low after compressing by 25 basis points from the first quarter of 2013 to the first quarter of 2014. The sector is composed of both national and regional banks, regardless of credit. Overall asking cap rates for the bank ground lease sector were 4.7 percent, representing the lowest cap rate across all net lease sectors which The Boulder Group currently tracks.

Investor demand for bank ground lease properties remains strong as banks are one of the few single-tenant, net-lease options with long term leases and rental escalations in the primary terms. In addition, 95 percent of the bank ground leases in the market have an investment grade rating, further contributing to their appeal and low cap rates. The cap rate compression experienced can be primarily attributed to the lack of new construction properties available throughout the market coupled with a high demand for this asset type. Investor demand is best quantified by the closed cap rate spread of 23 basis points which decreased by 10 basis points over the past year.

The primary challenge facing buyers of bank-ground lease properties remains the scarcity of product. Bank properties constructed in the past two years only made up 16 percent of the market in the first quarter of 2014, a 6 percent decrease when compared to a year ago. A contributing factor to the lack of new construction supply is that some bank tenants prefer to own their real estate rather than engage in a long-term lease. New construction properties with long-term ground leases are in the highest demand amongst 1031 exchange investors and private buyers as they offer long-term leases to investment-grade tenants with historically low-lease default rates. Accordingly, bank ground leases with 20 or more years of lease term remaining experienced the greatest compression of 52 basis points in the past twelve months.

Investor demand for bank ground leases is expected to remain active as investors continue to seek this asset type. Primary demand will remain concentrated in properties with long-term leases; but with cap rates at historic lows expect some investors to expand their criteria to include shorter term ground leases with quality real estate and above average branch deposits. The bank ground lease sector will continue to command a premium to the net-lease retail market as individual investors seek investment grade tenanted properties. However, with a lack of new bank properties the expectation is that competition among investors for this asset type will continue to increase.