Realty Income’s Lewis Sees Slow Recovery for Retail Net Lease Market

Current tepid deal volume in the net lease market should continue, though the impact on his company would be relatively small, Realty Income Corp.’s CEO Tom Lewis advised during his latest company conference call. This assessment comes not long after he struck an agreement with the bankrupt Buffets Holdings Inc. regarding 104 net leased retail properties (as reported by CPN in July). Realty Income ended its second fiscal quarter with occupancies of 96.8 percent among the 2,367 properties that it already owns, or about 60 basis points lower than at the end of the first quarter, he noted. “I think as everybody knows, the retail environment is weak overall,” Lewis noted. “And it’s obviously a very difficult environment, particularly in the last six to eight weeks for the consumer… while we can see some stress in some very small positions we have with some retailers, we would really be surprised by some substantial additional vacancies in the next quarter, though.” The company’s top 20 tenants, he reported, are still in fairly good shape. “And quite frankly, when you get down to below the top 20 tenants, you are looking at about 2 percent of rents.” == On the other hand, growth in terms of acquisitions of net lease properties has nearly ground to a halt for the company, owning to macroeconomic forces. “If you look at the acquisition environment today, you start with a 1031 tax-deferred exchange side of the business,” he said. “The number of those type of [sellers], which [had] been very big, has declined quite a bit, as you see sales in other property categories declining, which means there are less gains that need to be sheltered through a 1031.” He estimated that 1031 transaction volume is down about 50 percent overall during the last 18 months. Moreover, he added, “relative to the segment that we primarily play in, which is the larger portfolio buyers, I think that’s slowed down a bit too. Most of the people who bought in bulk to then flip have exited the market, usually through having trouble accessing capital. There are a lot less other institutions out trying to buy today, and a few like us are on the sidelines, waiting for cap rates to move higher.” On the supply side, Lewis noted that “the bid/ask spread out in the net lease market between buyers and sellers is [still] pretty large. Unless owners today are compelled to do a transaction, they are trying to hold out for an improvement in the market at some point, and hope cap rates will fall from where they are today.” For net lease retail properties, however, cap rates haven’t been falling lately. Just the opposite. “On the larger transactions we’ve looked at, my sense is that they’re moving up into the high 8s, and maybe the low 9s, and continue to move up,” Lewis said. Moreover, he predicted a continued sluggishness in retail net lease transaction volume through the rest of 2008 at least, though that will eventually change — perhaps by early next year. “There are a lot of people out there that don’t have access to other forms of financing, [but] they do have real estate on their books,” he said. “At some point, they are going to have to enter the market. I think they are hoping that the credit markets will open up and allow them to access other forms of capital, [but] our sense is that it will be difficult to do that.”