Net Lease Cap Rates Hold Steady at Historic Lows

By Randy Blankstein, President, The Boulder Group: Demand throughout the net lease market will continue, as investors remain attracted to the stable cash flows this asset class generates.
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Cap rates for the single-tenant net-leased retail sector remained unchanged in the third quarter of 2014, at a historic low rate of 6.5 percent. Cap rates for the office sector compressed by 37 basis points to 7.4 percent, while those in the industrial sector rose by a mere three basis points to 8 percent. There were no major contributing factors to the leveling of retail cap rates, as supply and demand remained near levels from the previous quarter. During the third quarter, the 10-year Treasury yield dropped to its lowest point of the year (2.55 percent) in late August. However, by the end of the quarter, Treasury rates had risen, ending near levels similar to the end of the second quarter. With little movement in the capital markets, retail cap rates have plateaued, as buyers cannot meet acceptable return thresholds at lower cap rates due to the low interest-rate environment.

During the third quarter, the supply of office and industrial properties increased significantly — by 30 and 21 percent, respectively. Owners of these assets have attempted to take advantage of the current low retail cap rates by enticing investors with higher yields offered by office and industrial properties. The supply of retail properties increased by only 3.1 percent between the second and third quarters, as new construction remains limited with the exception of the dollar-store sector.

Dollar-store retailers, inversely to other retailers, have been expanding at an aggressive rate over the course of the past two years, adding more than 2,000 locations. However, with the most recent news regarding the potential Family Dollar acquisition, many investors have decided to wait and see how the situation plays out.

Demand throughout the net lease market will continue, as investors remain attracted to the stable cash flows this asset class generates. While some investors wait on the sidelines as the changing dollar-store sector takes shape, investor demand for other new-construction properties in the $1 million to $3 million range — such as quick-service restaurants, casual-dining restaurants and auto-parts stores — will grow. With steady capital markets, market participant expectations are for cap rates to hold steady or rise slightly by the end of the year.