Gap Between Net Lease Retail Buyers, Sellers Shrinks

The gap between buyer and seller expectations is narrowing in the single-tenant net-leased retail sector, analysts said.

Investment activity is climbing “as sellers meet market realities,” Marcus & Millichap said in its first-half 2019 Net-Leased Retail Report. “With sellers bringing down pricing to market and buyers implementing more aggressive investment strategies, the gap is beginning to close.”

Marcus & Millichap said the sector is benefiting from “moderating” growth in the U.S. economy, which has encouraged more investors to look to single-tenant assets as a conservative investment. “Though supply is beginning to ebb, most investors are still finding quality options, particularly among older, legacy properties as new construction remains tempered.”

Buyers will likely continue to take advantage of healthy debt availability to secure single-tenant net-leased retail assets, especially for properties with good locations, favorable lease terms and high-credit tenants, Marcus & Millichap said.

Marcus & Millichap Capital Corp. President David Shillington noted volatility in the broader market has started to work its way into loan underwriting, with lenders more cautious and conservative than previous years.

“Active lenders include local, regional and national banks and insurance companies, with sentiment driven by the high-profile decline of big box retail,” Shillington said. “As a result, lending on tertiary assets and locations remains tight, while net-leased assets and premier mixed-use structures are highly desired by lenders.”

Shillington said this dynamic has created a “two-tier” market structure, with loan-to-value ratios in the 55 to 75 percent range depending factors such as the borrower, the asset and its location. “Mezzanine and bridge loan structures have been more frequently used in this environment, with owners undertaking capital improvements at higher leverage ratios using short-term debt before refinancing upon completion,” he said.

Colliers International reported the market for net lease retail properties weakened moderately last year. “Demand for U.S. net lease property was adversely impacted by the relatively steep rise in longer-term interest rates, which crested at their highest levels in more than seven years in mid-2018,” Colliers Chief Economist Andrew Nelson and Research Manager Jeff Simonson said in the firm’s Single-Tenant Net-Lease Retail Report. “This pushed cap rate spreads to their lowest margins since the recession, making net lease investments relatively less attractive. But rates have since fallen back down and cap rate margins have expanded to their lowest levels in more than a year, when the Federal Reserve signaled an extended pause in additional rates hikes.”

But Colliers predicted continued vigor in U.S. property markets due to robust operating fundamentals and compelling property returns. “Moreover, the U.S. economy is outperforming every other advanced economy, making the U.S. an attractive investment for off-shore and domestic investors alike,” the report said. “Thus, market conditions overall are still favorable for net lease retail, though a return to the peak levels of 2015 appear unlikely.”