Why Buy Now Instead of Later?
- Dec 07, 2016
What do the numbers really look like if you were to buy a 5 cap rate today instead of a 5.5 cap rate one year from now? This is a typical conversation I have with most of my buyer clients when looking at the net lease sector in today’s market. Whether they are considering the potential of rising interest rates from the Fed or the impact of the presidential election results, these factors have been a component that most investors overdramatize. Calkain provides up-to-date information to our clients by performing various studies addressing this scenario.
If you were to wait to buy a net lease asset that today is a 5 cap, with the hope that this same asset would be a 5.5 cap a year from now, then the investment dollars gained would not be what you might expect. Take the pharmacy market, for example. At this time last year, most pharmacies were trading 53 basis points (bps) lower for various reasons (such as the coming Walgreens-Rite-Aid merger). Let’s assume you were an all-cash investor with a purchase price of $5 million, and you made the decision not to purchase a year ago because of an aggressive cap rate inflation of 50 bps, with lost income numbers of $275,000 (NOI assumption). In the rare event that you did see an increase of 50 bps in the net lease sector and bought one year from now, your overall effective “gain” would be quite minimal. When you figure that you are most likely going to put your non-working dollars into a bank with around a 1 percent return, you are only positive $37,000 over a 10-year term under the example given.
If the Fed raises interest rates 25 points in December, which is most likely the case, many investors feel there will be a comparable rise in cap rates. In all actuality, there is little correlation between interest rates and cap rates from a historical standpoint. Even deep into 2008, one of our biggest recessions in United States history, we only saw an average cap rate increase of 85 bps across the country with credit tenants, so a 50 bps increase is very unlikely in the next few years. While we expect only a minimal fluctuation in cap rates in 2017, this extreme cap rate example of 50 bps would significantly reduce one’s 10-year gain, if not put it into a negative category.
There are many aspects that an investor must look at when deciding on the best net lease asset, but waiting for an extreme uptick in cap rates is not as lucrative as buyers currently sitting on the sidelines widely believe. The true impact is that you’re not putting your dollars to work.