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Who wins in today’s single-tenant net lease market?

The Single Tenant Net Lease (STNL) market has seen a nice evolution. Rents are rising and capitalization rates are at or near historic lows.

2021 was a record year for STNL deal volume, with $103 billion in investment sales, according to Stan Johnson Company research, and Q1 2022 has already outpaced Q1 2021 by more than 30%. At the same time, the STNL national inventory remained very constrained.

This makes it a good time to be a net lease seller.

Sell, buy the dream

“Sellers still have the opportunity to take advantage of today’s prices,” said Curtis Hodges, senior vice president of the Stan Johnson Company office in Tulsa, Okla. “We have experienced significant cap rate compression over the past two years. We are at historically high prices and valuations should not rise much more than they are today.

Enter the first speed bump. With valuations unlikely to continue rising, sellers may not want to wait too long. Hodges believes we are approaching an inflection point where price expectations may soon need to be adjusted.

“We’re not there yet – the capital for STNL is still plentiful, and there is significant capital sitting on the sidelines,” he notes. “But we’re heading into what could be a period of price adjustment, maybe by mid-year or early 2023. I think a lot of people are wondering when we’ll start to see the bids fall at a higher rate and when assets will reprice because buyers can no longer get comfortable with leveraged return metrics. »

One group of investors who may be more sensitive to these metrics are 1031 exchange investors. STNL trades are notoriously popular with this cohort, but while they would benefit from the return earned in this ultra-competitive market and at the prices of point, they should also find an asset to trade on.

It’s easier said than done right now. Yet, with the market at a high level, it is possible for the inflection point to occur after the sale, but before the new trade closes, resulting in optimal conditions.

“If the equity in the 1031 downleg product is sufficient to invest in upleg property without securing high loan-to-value (LTV) debt, you will be able to pull the trigger on transactions than those constrained Larger funding rounds will have a tougher time with it,” adds Hodges. “Those with large stakes in NTCLs who want to do a 1031 may find themselves in an optimal position and with more favorable pricing on their rising leg. than today’s peak prices.”

Naturally, this also means that cash is king again.

“Cash buyers will stay in the market,” Hodges continues. “Especially that people are selling in this market. Some investors also waited patiently for this window of opportunity.

Of course, price spikes aren’t the only trend to watch in this market. Supply chain issues. Inflation. Higher construction and material costs. Labor shortages. Political unrest. Then you have interest rates. The Fed raised its target federal funds rate by 0.5% in early May – the biggest increase in more than 20 years. With several rate hikes expected, there should be upward pressure on cap rates.

As the saying goes, however, there are opportunities – and winners – in every market. In addition to timing a 1031 trade perfectly, Hodges believes risk can pay off, well, a return.

“A lot of people are looking at other types of assets looking for a bit higher yield,” he says. “This could include net leases with shorter lease terms, less credit, or examining secondary markets with favorable demographic trends. You want to examine your appetite for investment risk and work with an experienced advisor on the marketplace that can fully underwrite deals with lease term, location, investment grade, private credit, or tracking emerging tenant concepts in mind.

Emerging winners

Hodges is particularly optimistic about emerging tenant concepts which are very convenient.

“If the business model allows for faster stops inside the store, or allows people to not have to go to a store at all by offering drive-thru or curbside pickup, that concept is usually a winner,” he says.

Other STNL winners include quick service restaurant concepts like Sonic, Chipotle, Slim Chickens and Dutch Bros. Coffee, notes Hodges. These tenants are adding more drive-thru lanes, reducing or excluding seating space, and growing rapidly.

“We are seeing high cap rates for Dutch Bros.,” adds Hodges. “In some cases, they’re selling at lower cap rates than Starbucks.”

Lanie Beck,
Stan Johnson Society

“Medtail,” the merger of healthcare and retail, is another STNL concept that has been in the spotlight, adds Lanie Beck, director of corporate research, marketing and communications at Stan Johnson. Company.

This term originated several years ago when healthcare tenants began occupying retail space, she says. “Urgent care facilities and dental practices, among others, have begun to take advantage of vacancies in malls to get closer to desired clientele, and now, in some cases, those tenants are embracing the sell-in format. single-tenant, stand-alone retail – think Aspen Dental or Clarkson Eyecare.

The next wave of retail redirection could be on the horizon, predicts Beck. “Pharmacies like Walgreens and CVS need to serve more and more customers through their drive-thru lanes, whether it’s for prescription pickups, tests, vaccines, or urgent care services. Post-pandemic, we are seeing significant delays and back-ups as most of these properties only have one drive-thru lane.

Beck thinks the answer may lie in vacant retail bank branches. “If pharmacies or other medical care providers had three, four or five channels in play at once, think about how many additional customers could be served. I could see this becoming a reality in more than ten years.

Where are the opportunities

With many investors turning to the net lease retail market for long term holdings, it is important that buyers have confidence in an area, geography and tenant or concept before pulling the trigger.

“If you can’t buy in a primary market, then look at markets where there are favorable demographic shifts,” Hodges says. “Lesser-known secondary or tertiary markets often have many strong tenants and growing concepts for investors to consider. If you study the history of the net rental market, there are opportunities today to buy properties that could go the way dollar stores did 20 years ago, for example.

So where would Hodges and Beck put their money?

“As a net rental investor, I would look for that emerging tenant that I believed in. I would look at his business model and want to be sure it’s sustainable,” says Beck.

Hodges agrees. “Some QSRs that I personally like. I would probably go with a well-located Dutch Bros. in a growing secondary market. They found fast, quality service. The market is big enough for two large, specialist concepts, so that they can compete with Starbucks. They’re also moving into markets where they can be successful.

And just like that, a new winner might be born.

— Compiled by Nellie Day. This article is published as part of Shopping Center Business’ Retail Insight series. Click here to subscribe to the Retail Insight newsletter, a four-part newsletter series, followed by video interviews delivered to your inbox in May/June.