Net Lease Property Supply Decreases

By Randy Blankstein, President, The Boulder Group: Cap rates for single-tenant retail and office properties experienced moderate increases for the first time in nearly two years in the third quarter of 2013.

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Cap rates for single-tenant retail and office properties experienced moderate increases for the first time in nearly two years in the third quarter of 2013. Cap rates in the industrial sector remained unchanged. The modest rise in cap rates, for retail and office sectors, is primarily due to the increase in interest rates correlated to the 10.4 percent increase in the 10 Year Treasury yield from July to August. Retail and office properties experienced a slight rise in cap rates; however cap rates for net leased properties valued below $8 million have not experienced the same cap rate impact. Properties priced below $8 million are in the highest demand amongst individual investors. Individual investors are more likely to pay lower cap rates than an institutional investor as they do not have to meet the same return hurdles and frequently utilize 1031 Exchanges. Additionally, institutional investors are typically more sensitive to interest rates and make real time adjustments to changes in the capital markets.

While the 10 Year Treasury yield continued to increase in the third quarter, the supply of net leased retail and office properties decreased by over 9 percent. Net lease participants were expecting cap rates to be impacted more than the moderate increase in the third quarter due to the uptick in interest rates. However, downward pressure applied on cap rates by limited supply in the market kept cap rates from being impacted more significantly.

Retailers plan to focus on same store growth rather than expansion, causing the development pipeline for new construction single-tenant assets continues to be limited. Additionally, the limited supply of core market assets has caused cap rates for these assets to remain at last quarter’s level or even decline slightly in some cases. Retail properties remain in the highest demand as evidenced by the premium over office and industrial properties of 68 and 98 basis points respectively. The competition amongst investors for this asset type can best be illustrated by the spread between the asking and closed cap rates, which compressed further in the third quarter for retail properties.

It is expected that there will be a limited movement in valuation in the fourth quarter of 2013 as there is a substantial investor pool seeking a limited supply of net lease assets. Transaction volume in the fourth quarter is expected to remain at similar levels to 2011 and 2012, as institutions are anxious to allocate recently raised dollars from their significant fundraising year.