Room Enough for All Net-Lease Investors?
- Feb 04, 2015
There is a growing sentiment that the net-lease industry has become more and more specialized for institutional investors, and thus crowding out the individual investors. The truth is, institutional investors are as active as ever, but overall that perception is simply not true. While large fund owners have become a larger presence in the industry, they often find that their strongest competition from a cap-rate standpoint is indeed the individual investor. In addition, large fund owners tend to focus on the large portfolio deals that attract a lot more media attention, and not the single-property deals. For individual properties under $10 million, individual investors still dominate the market and competition. The point is, there is still a lot of room in the sandbox.
Speaking of competition, there is a lot of it at all-price points. 1031 buyers have strict timelines to adhere to and large funds need to fill growing allocations, which adds more demand. On the flip side, due to the lack of supply, buyers are expanding their criteria and are now looking at properties with shorter remaining lease terms. We have seen more acceptance for 10-15-year leases, where 15-20-year leases used to be the common threshold.
However, while the market may be ever changing, the three legs of the stool (lease, credit and location) are constant. But even within those three legs, the weighting shifts depending on the situation. For instance, location has historically been the least important of the three and sometimes is even less important given the market demand. Various funds have proven this point by basing their underwriting on the operational viability and necessity of the site – not the location. (It is important to note though that location does have an increasing role to play with shorter lease terms because the investor will need to take into account any other future uses of the property).
But let’s not forget why the net-lease industry exists: it’s a safe bet for investors. This makes the final leg of the stool – credit – the feather that can tip the scales towards closing a deal. To protect their capital, individual investors sometimes face situations (e.g. 1031 investors) that require them to make sure that they are closing a deal in a timely manner instead of taking their time to look for the perfect property as long as the credit is healthy. Allocation requirements have to be fulfilled, so institutional investors have made large price concessions or expanded their criteria – but credit is still king.
So at the end of the day, what types of properties are popular with net-lease investors? We at Stan Johnson Co. get this question a lot and love to share and advise our clients given that we are the bridge between institutional and private capital. On the industrial property type, FedEx is the most common net-lease tenant and remains very popular. With the growth of e-Commerce and evolving supply chain strategies, bulk distribution centers are in high demand. The list of retailers popular with net-lease investors is long, but current in-demand tenants include Academy Sports, Hobby Lobby, LA Fitness, Mattress Firm and various QSRs. From a volume perspective, drugstores and dollar stores remain at the top of the list.
Overall, the popularity of the net lease market has been growing with more entrants coming to the deal table every day. It is a hot market, and a great time to be in net lease sales. We expect the interest level of net lease properties to be even stronger in the coming years to all types of investors, and are excited to see this continue. A rising tide lifts all boats, and creates a win-win situation for everyone involved.