Net Lease Properties Offer Real Estate Investors Stability in Uncertain Times
Originally published by Los Angeles Business Journal With Covid-related uncertainty top of mind for many investors, net lease properties have become one of the most in-demand real estate asset types in Los Angeles. Offering a combination of steady income and hands-off management, net lease properties accounted for 20.2% of total commercial sales in the second quarter, compared with 13.3% the previous quarter, according to research from CBRE Group Inc. The L.A. market ranked No. 3 in the nation for total net lease investment volume during the second quarter, CBRE said. Driving that gain was the industrial sector, which saw net lease investment increase to 48% while activity in the office and retail areas decreased. Peter Belisle, market leader for Jones Lang LaSalle Inc., said single-tenant lease properties are “always desirable during a recession.” In net lease assets, tenants still sign a lease. But unlike with traditional leases where owners still handle associated costs and property issues, tenants cover costs and maintenance. There can be some variation in how these agreements are structured, but the tenant can be responsible for everything from replacement roofs to property taxes. “We are seeing quite a bit of demand for those assets,” said Pat Weibel, a Director at the Stan Johnson Co. “Going into the shutdown we were unsure of how things would play out but have been pleasantly surprised with the continued demand for the net leased assets.” Other brokers have had similar experiences. “When you’re looking at overall all the asset classes for the investor pool to select from — whether it’s hospitality, retail, office, industrial — the net lease sector … has been the investment class of choice. The reason for that is you have the security of an income stream with a tenant that is offering a daily need or a Covid-compliant-type essential business,” said Chris Maling, a principal with Avison Young Inc. Newmark Knight Frank Executive Managing Director Matt Berres added that “single-tenant properties with triple-net leases have increased in popularity due to the risk-adjusted returns compared with other asset types.” Weibel said net lease assets can also be attractive to investors because they have been more reliable at a time when bond market yields are low and the stock market has been unpredictable. “Investors for net leased product are looking for a safe haven,” Weibel said. Single-tenant net lease assets represent a hands-off opportunity for owners, who can sit back and wait on rent checks. Maling said many investors start with multifamily, then move to multitenant centers before seeking something less management heavy, such as a net lease property. Some are even willing to take a reduced yield in return for fewer management obligations. Maling added that some individuals take this route as a form of estate planning, to avoid leaving their beneficiaries with lots of management work. Stephen Stein, managing partner at Tauro Capital Advisors Inc., said the company, which sources debt and equity, has seen a lot of interest in net lease assets. Matt Bucaro, a senior director at Tauro Capital Advisors, added that “single-tenant triple-net properties this year are on fire.” People are especially interested in buildings housing essential businesses, Bucaro said, although he added that office properties have not done as well. But single-tenant net lease properties may be difficult to purchase. CBRE Executive Vice President Anthony DeLorenzo called it the most “in demand” product, adding that it has been really hard to find properties as buyer appetite has increased. DeLorenzo said many net lease property buyers were 1031 exchange investors, which allow sellers to avoid paying capital gains taxes by reinvesting sale proceeds in a specific time period, or by doing a reverse change where a property is purchased and another is sold. Industrial attractions There are several reasons industrial is setting the pace with net lease properties. “People have chased single tenants and product types that are more resilient. Industrial is the benefit of both,” DeLorenzo said. Berres added that industrial properties have “been the clear beneficiary of the pandemic, and that should continue for the foreseeable future.” Weibel said the big reason industrial real estate was doing so well was stability. “The warehouse industrial distribution space is as hot as it gets,” he said, adding that investors can lock in quality tenants like Amazon.com Inc. for long-term leases with no management obligations. “Investors are clamoring and scooping up the distribution properties, especially when they are leased to tenants like Amazon or FedEx or Walmart,” Weibel said. A Torrance building under renovation that will be used by Amazon recently sold for $81 million, one year after it was sold for $41.3 million. The site was formerly a Costco Wholesale Corp. store. Maling added that Amazon often does “absolute triple net” deals where it even pays taxes making net lease assets to a tenant of their caliber very desirable. These leases allow tenants to get into desirable locations and not have to put a lot of money up right off the bat. Retail targets While shopping centers may be struggling, some types of retail real estate assets are in high demand, especially grocery stores, drug stores and properties with drive-through capabilities. “Those assets have fared very well,” DeLorenzo said. “If anything, their numbers are up because there’s been a rush on the grocery stores.” Tom Lagos, executive director with Institutional Property Advisors under Marcus & Millichap Inc., agreed that single-tenant net lease retail properties were doing well. “The single-tenant triple-net market has not slowed down at all,” he said. “That’s a sector in retail that still has velocity of transaction. You’re talking about essential tenants that are trading. When it comes to trading or moving to safety, the private investor really loves this sector because of the acquisition price as well.” Many of these buildings can sell for less than $5 million, Lagos added, which makes them accessible for many budgets. Lagos said he is seeing some apartment owners trading into these types of properties, in addition to people who already own retail properties. Maling said that not all retail assets are doing well, though, and buyers should be concerned about sit-down restaurants, bank branches and places with large footprints. “The darling investments are the quick sale retail, the McDonalds, the KFC, the Taco Bell,” Maling said. Buyers, he added, are looking for properties with long lease terms to have a bit more security when purchasing a building. Continued demand Most experts think interest in net lease properties will continue. NKF’s Berres said the fourth quarter could be the strongest of the year. “It’s a very strong outlook for net leased in general,” he said. Weibel said he expects that the asset class will remain active, especially if the Federal Reserve keeps interest rates low and there is a lack of alternative high-yield investments. “The lack of yields in the bond market and some other asset classes will continue to bring investors to the net leased market,” he said. “We continue to see it going in 2020 and beyond until there is a viable alternative yield asset class out there.” Tauro Capital’s Stein agreed. “I think it’s going to continue or accelerate,” he said. “Acceleration will be enhanced by how collections go with multifamily.” Multifamily, he said, has seen stronger rent collections than anticipated, but if that changes as the Covid-19 pandemic continues, he could see some owners wanting to offload those properties and park their money in net lease assets instead. There could be some complications, though. IPA’s Lagos said the presidential election and the possibility of 1031 exchange rules being eliminated or changed could have a negative impact on the properties. “These two combined could have a very injurious impact on single tenant triple-net values. Demand for this product could be throttled back. I’m sensing that if (former Vice President Joe) Biden wins, there may be a speed up in this sector where more buyers may want to come and rush into it until legislation comes into place clarifying what will and won’t happen in that sector,” he said. And some single-tenant net lease investors, he added, are looking outside of California because of the high taxes here.
October 19, 2020