Net Lease Q&A: Sovereign Investment’ Hoppen Thinks Market Still Strong for Private Equity
- Jun 24, 2008
From the point of view of private-equity investment, times aren’t that bad in the net lease business. That’s the thinking of Jeffrey Hoppen, chief investment officer of Princeton, N.J.-based Sovereign Investment Co., a private principal equity investment firm specializing in net lease portfolio transactions. Hoppen further posits an increase of community and regional banks looking to sale-leaseback transactions as a route to diversification of funding sources. Sale-leaseback transactions, he says, are no longer viewed as a move by struggling companies in need of cash. Instead, they have become financial management tools used by stable companies to rearrange their capital structure, pay off debt and more. CPN recently asked Hoppen about the state of the net lease market. CPN:Net lease transactions are down, but do you expect them to rebound any time soon? If so, why?Hoppen: Retail investment activity is expected to gain momentum by late summer and early fall after a dramatic decline in the wake of last year’s capital markets shock. Retail cap rates compressed by more than 200 basis points between 2002 and 2006, while the yield on the 10-year Treasury crept up about 50 basis points, which reduced the risk premium. Concerns of slower retail sales growth, however, along with tighter underwriting standards and lenders’ overall re-pricing of risk are translating into higher cap rates. The single-tenant sector will experience the steepest cap rate increases, particularly for lower quality assets. Lenders are requiring significantly higher equity contributions for non-institutional-grade single-tenant properties, and spreads have widened to a degree that requires some price adjustment in many cases. CPN: What about for better-credit tenants? Hoppen: Cap rate increases for properties with top national credit tenants will be modest — 20 to 40 basis points. A slowdown in 1031-exchange capital coming out of coastal apartment markets will continue to dampen sales activity. Tighter lending standards and slower economic growth will encourage many owners to comb through their portfolios, selling underperforming assets or properties that fall outside of core business strategies. Owners may find that the financing they have in place plays a major role in the marketability and value of their properties. For example, investors who purchased assets over the past few years with high-leverage interest-only loans may need to reduce pricing expectations, particularly if their property is facing near-term lease rollovers. With supply and demand fundamentals generally well balanced, large centers are expected to stay in high demand as institutional investors, particularly pension funds, ramp up acquisitions during the rest of 2008. CPN: Why are community and regional banks now more interested in financing net lease deals? Hoppen: Community and regional banks are looking for stable areas to invest. After being burned in the residential mortgage business and losing residential business to brokers and conduits, they’re looking for ways to invest in real estate and benefit from their local knowledge and experience. Commercial net lease financing can be less risky as tenant’s credit can be quickly established and real estate intrinsic easily identified. CPN: Is any particular property type the darling of net lease right now? If so, why? Hoppen: No. Assets with strong-credit tenants, long-term leases in good locations in primary markets will always attract buyers independent of property type. Some buyers will always look for yield by taking on risk of weaker credits in tertiary markets.