Several of the Stan Johnson Company brokers had an open discussion about what they are seeing and their projections for the current single tenant net lease market. We've categorized their discussion points into categories of quality of the asset, cap rates, transaction length and looking ahead into the direction of the market. Please take a moment to read what Daniel Herrold, Jerry Hopkins, Brad Pepin, Jeff Matulis, and Craig Tomlinson have to say.

How do you define a quality asset?
A quality net lease real estate property today can be likened to the three legs of the stool: a strong location; lease term; and tenant creditworthiness. The stronger each of these are, the higher the quality of the asset. Just as with a chair, if two of the three are weak, investors will be reluctant to invest.
Brad Pepin, Director

How do you define a quality office or industrial tenant?
With fewer single tenant office and industrial assets available, quality is becoming pretty subjective. For cash or recourse borrowers, the focus is more on the real estate and current income stream verses the local market rents. Buyers are looking for profitable companies that are weathering the economic downturn and a reasonable story for why they need the facility in question.
Craig Tomlinson, Director

In 25 words or less, what are the three components of a quality asset?
It comes down to strong/financeable credit (typically investment-grade or at lease $100MM Net Worth), longer term leases (10 years plus) and appealing real estate fundamentals.
Jeff Matulis, Associate Director

Are investors still "fleeing to quality" as they did during the early recovery?
I don't think flight to quality is as prevalent as it was in 2009 & 2010. Certainly, there is higher velocity for deals that are located in major markets or desirable real estate locations, but because of limited product in the marketplace, properties in secondary and tertiary markets are trading as well.
Daniel Herrold, Executive Managing Director

Has the definition of an investment grade tenant changed?
It has evolved. An investment grade tenant today must have a business model that is not adversely affect by the Internet or other paradigm shifts to avoid a Blockbuster or Circuit City scenario.
Jerry Hopkins, Director

CAP RATES

So where are cap rates these days compared to pre-downturn levels?
Cap rate compression has been significant since the recession of 2008/2009. We're not quite at 2007 levels, but probably are within 50 to 75 basis points on quality assets. Trophy properties – those with good investment grade credit, strong locations, and leases of 15 years or more -- are trading in the 6 and 7 cap rate range. Lesser quality assets, loosely defined as those with weaker credit tenants and/or shorter-term leases, are trading in the 8s and 9s.
Brad Pepin, Director

How have cap rates increased this year for the various CRE sectors?
For good quality office and industrials, they are probably 50 basis points lower than last year and actually are approaching 2007 pre-crash levels - but that's for top quality assets. For properties with a lease of less than 10 years, or with a less-than-investment grade tenant, rates remain 100-125 basis points higher than their 'long lease', credit counterparts.
Craig Tomlinson, Director

Are cap rates continuing to compress?
It's been a continual process since the second quarter of 2010, with the exception of trophy properties. Over the past year, rates have compressed between 125 and 150 basis points; that's nearly 10 basis points per month. That decline has since slowed a bit, and rates now are remaining steady. That said, "trophy" properties may demand a 50 basis point premium.
Daniel Herrold, Executive Managing Director

What is the difference in cap rates for lesser quality properties vs. Class A assets?
There has been less Class B product trading recently, so there is less data to make a true comparison. When these assets do sell, there is as much a 200-basis-point difference among these lower quality assets. As there is a scarcity of product in the marketplace, properties in tertiary markets or with shorter term leases are beginning to pick up traction.
Jeff Matulis, Associate Director

Where are cap rates compared with pre-recession levels?
Cap rates today are approaching 2007 levels, with the trophy assets trading at a significant premium due to a shortage of quality inventory.
Jerry Hopkins, Director

TRANSACTION LENGTH

Why are deals taking longer to complete?
Underwriting today for buyers and lenders is more thorough than four years ago, and lenders are more careful and selective as they provide more traditional, less aggressive loan terms. However, the institutional buyers, as long as they are paying in cash, are much quicker today than the private investors who typically require permanent financing on the property, resulting in a delay.
Brad Pepin, Director

How dramatic is the market recovery from the downturn?
Two years ago, there was virtually no deal flow, due to the absence of any realistic financing. Today, there are more cash buyers and they are closing quickly. If a buyer is assuming existing debt, the closing can take as much as 120 days, but that's all about the lender. The buyer is ready and waiting.
Craig Tomlinson, Director

Is it easier to get a deal done now than in the recent past, given that some capital is flowing?
Transactions are not any easier to get done today. Investors are more cautious, dotting their i's and crossing their t's twice. Lenders are more thorough and scrutinizing in their underwriting. If a buyer is buying "all-cash," they want a premium for this as this can simplify the process.
Jeff Matulis, Associate Director

Is the deal volume finally picking up?
Absolutely. Buyer demand is on the rise so transactions are occurring at a much quicker velocity, despite challenges in the process.
Daniel Herrold, Executive Managing Director

Besides the obvious increase in capital flow, why are some transactions getting done more quickly this year?
Transactions in 2011 are getting done much quicker because fewer buyers are putting front-end debt on properties. Most buyers are buying properties quickly with cash or a line of credit, and then putting long-term debt on the back end.
Jerry Hopkins, Director

LOOKING AHEAD

How will the recent Federal Reserve Board decision to maintain low interest rates for the next two years affect the market?
This move will help keep cap rates and interest rates down. Inflation will continue to be a concern, but I'm expecting things to stay fairly stable in the coming year, especially with demand remaining high, and supply relatively low.
Brad Pepin, Director

What changes do you expect in the market in the near term?
With virtually no new product in the office and industrial space, we will sell shorter and shorter leases. As lease terms melt, cap rates simply can't remain at the current low levels. Another factor to contend with is the shutdown of the CMBS market, which had come back with a vengeance this year. Right now, that vehicle is foundering. Though this will slow down some current transactions and cause some re-pricing, the good news is that we are not dependent on CMBS any longer.
Craig Tomlinson, Director

Is the net-lease sector immune to the current market volatility?
Even though we are fairly insulated in a safe investment class, the turmoil does affect the psyche. Overall though, interest rates are extremely low and provide strong buying power. The current economic climate has created a barrier to new development and little to no new construction and many sectors, and forced trading to that of existing property versus new construction. Investors are still seeking a creditworthy tenant in a relatively safe industry.
Jeff Matulis, Associate Director

Can the current volatility actually be a good thing?
Believe it or not, much of the uncertainty may actually benefit the real estate market. As the stock market continues to show high volatility and with interest rates remaining low, this provides a good case for real estate investments. At the same time, any slowdown in the debt environment– with a case in point being the current decline of the CMBS market -- will have an impact on larger transactions, as those are typically leveraged.
Daniel Herrold, Executive Managing Director

How will the stock market's roller coaster ride affect your business?
Investors have been spooked by the recent volatility on Wall Street, shaking their confidence. Undoubtedly, 400-500 point swings in the Dow affect individual investors' activity, but they also can affect the institutions' ability to raise money for larger transactions. It hasn't affected our business yet, but we're keeping a close eye on the market, and how it reacts to this uncertainty and the many moving parts that make up the greater economy.
Jerry Hopkins, Director