Where Have All the Good Single-Tenant Deals Gone?

By Craig Tomlinson, Director, Stan Johnson Co.: One of the most frequent questions we get from our buyers is “Where have all the good properties gone?”

Tomlinson

Public real estate investors are scrambling to perform on the promises they’ve made their investors.  Private buyers look to beat corporate bond yields or just stay ahead of the tax man.  Both groups are searching for the least unpalatable way to ‘bend’ their investment models and meet their objectives.

Transaction volumes in the net-lease sector have risen steadily since 2009 as both public and private equity funnels into our sector.  Consumer and U.S. corporate spending has failed to keep pace with this influx and so has new supply of net-leased assets to the market.  At Stan Johnson Co., we track 66 retailers with an estimated combined 100,000 single-tenant units around the U.S.  In 2012, their cumulative expansion was a modest 3,500 units.  Last year it was down 15 percent to about 2,950 new leases. Total single tenant property sales as tracked by RCA Data grew over the same period, but the number of assets sold actually declined in 2013, again by about 15 percent to 3,250 trades.

The immutable law of supply and demand is like a dome of high pressure over buyers’ most hopeful outcomes. As a result, one of the most frequent questions we get from our buyers is “Where have all the good properties gone?”

It’s not their imagination.  Our firm works exclusively in single-tenant investment sales and average lease term at close of sale is shrinking, recently about ‘a year’ in fact.

Of our 300 closings in 2013, the average lease term remaining was just under 13 years; the year before it was more than 14.  Bear in mind, that half of those are retail properties which typically begin as 15-20 year leases.  That means the average office and industrial net lease is 11 years and shrinking.

I was at a conference last week in New York and heard the CEO of a publicly traded REIT say that ’12 [years] is the new 15’ – and they buy single-tenant offices.  What he meant was ‘10 is the new 15’.  Public buyers can get away with those purchases as long as they stay in larger metros and don’t buy a rent contract that is clearly above market.  They also have to have some rent growth built into the lease – or their bent model will break.

The same panel of experts confessed that they are putting more emphasis on the real estate fundamentals today than ever before.  When you have a 20-year lease with an “AA” rated tenant, you can finance a concrete silo in South Dakota.  But when you only have eight or nine years, single tenant underwriting starts to look like the rest of the commercial real estate world.

For the balance of 2014, we believe cap rates will continue to compress for credit, single –tenant retail assets for two reasons: the smaller average deal size of retail attracts more bidders, and, the basket of retail assets on the market have more remaining lease term on them than their office and industrial counterparts.

Are they ‘better’ properties than single-tenant office and industrial?  The market is very efficient and the risk of buying short leases is priced into today’s cap rates regardless of sector.  What’s not known is how well a given retail asset will re-let when the tenant’s concept changes or for whatever reason, they choose not to renew.  No one likes to think about this stuff, but the reality is that single-tenant real estate is ultimately real estate.

At Stan Johnson Co., we are selling a significant number of assets with six-10 years remaining lease term.  Each is carefully underwritten on its real estate merits as well as the legacy of the particular tenant in the property.  Buyers are required to put more equity in these assets and to assume more risk in general. Most of these, however, reward the buyer with a 150-300 basis points cap rate premium as compared to commodity, single tenant retail properties.  These assets will become an ever increasing part of the net-lease arena for the foreseeable future.