Net-Leased Retail, Office Cap Rates Reach New Low

Cap rates for the single-tenant net lease retail and office sectors continue to fall to new lows, reported the Boulder Group, Northbrook, Ill. 

Following several quarters without significant changes, cap rates for net lease retail properties declined by 15 basis points to 6.25 percent in the third quarter, the largest decline since early 2014. Single-tenant net lease office cap rates fell 5 basis points to 7.25 percent. Industrial sector cap rates fell three points but remain at 7.59 percent. 

“Properties in the greatest demand continue to be new construction with long-term leases with investment-grade tenants,” said Boulder Group Vice President John Feeney. “Despite a slight rise in the supply of net-lease retail properties, there is a lack of new construction properties with long-term leases as the development pipeline has slowed compared to the first half of 2015.” 

Retail assets show greater investor demand than office or industrial properties, Boulder Group reported. Cap rates for retail properties were 100 and 134 basis points lower than office and industrial assets respectively in the third quarter. Feeney said private and Section 1031 like-kind exchange investors prefer to purchase retail assets “as they have a familiarity with the tenants and have a preference for lower-priced properties when compared to office and industrial investors.” This means that private and 1031 investors will pay lower cap rates than institutional investors, he noted.

Because of demand for new construction with long leases and strong tenants, Feeney said that cap rates for recently constructed properties tenanted by 7-Eleven, Bank of America and Family Dollar compressed by 32, 25 and 65 basis points respectively in the third quarter, accounting for the greatest retail tenant compression.

The Boulder Group said the net lease market will remain active at least through the end of the year. “The expectation is that net lease transactions will surpass last year’s historic levels based on sales velocity through the first three quarters,” Feeney said. “1031 investors will continue to acquire assets at the lowest cap rates due to their tax consequences; however institutional investors will generate the majority of transactions over $15 million.”

Feeney said single-tenant net lease cap rates will likely remain favorable to sellers as investors continue to seek this asset class due to the relative ease of ownership–the tenant pays property taxes, insurance and maintenance in addition to rent.