Net Lease Cap Rates Increase

The Boulder Group, Wilmette, Ill. said single-tenant net lease property cap rates increased slightly for all three asset classes in the third quarter as debt costs increased.

Single-tenant cap rates increased six basis points to 5.86% for retail, three basis points to 6.80% for office and one basis point to 6.61% for industrial, Boulder said in its Third Quarter Net Lease Research Report.

“For the first time in the past two years, cap rates increased for two straight consecutive quarters” said Randy Blankstein, President of The Boulder Group. “As the Federal Reserve continues to increase rates in attempt to curb inflation, debt costs have increasingly put upward pressure on cap rates for buyers of net lease properties.”

As economic pressure mounts, formerly opportunistic sellers removed properties from the market that were attempting to take advantage of the historically low cap rate environment, Boulder said. The supply of net lease properties decreased by more than 12% quarter-over-quarter.

“Net lease buyers and sellers have yet to agree on pricing levels given the current environment and a period of price discovery continues,” said Boulder Group Partner Jimmy Goodman. “The expectation from market participants is that the bid-ask spread will widen as price discovery plays out in the fourth quarter and into 2023.”

The rising rate and inflationary environment affected acquisition criteria for net lease buyers, the report said, noting investor demand for properties with rent growth or the ability to increase rents in the near term are in the greatest demand.

“Demand for properties with limited or no rental escalations is limited to properties with above market yields or strong underlying real estate,” the report said. “Investors expected cap rates to widen for non-core net lease deals with short-term leases, lesser tenants or secondary markets. This has yet to occur on a wider scale, causing a wait-and-see approach for many investors. As the quarter came to a close, institutional investors and publicly traded net lease real estate investment trusts raised the cap rate floors for future acquisitions as their cost of capital increased.”

Boulder said capital markets and the Federal Reserve’s monetary policy will continue to affect the net lease market. “Year-end transaction volume will be impacted by the capital markets and the decrease in activity driven by 1031 exchange investors” Blankstein said.