Cap Rates Fell by 25 Basis Points in 2011

Overall, net lease cap rates fell by 25 basis points in 2011. The primary drivers of this trend are lack of product (especially high quality product) and an ease in lending conditions. 


Construction of new net lease product continues to flow at a trickle while financing has become more available – with local and regional banks competing with insurance companies for credit tenant deals. Investors have shown the willingness and ability to invest but are hindered by lack of product to satiate their demand. This lack of supply and increase in demand has forced prices up and cap rates down – many would argue that 2012 promises to be a seller’s market in 2012. It is worth noting that these numbers illustrate the average trend in net lease cap rates and the net lease market itself is highly diverse depending upon tenant, lease terms and location. 

Though these factors have always been significant, their effects have recently compounded. Investors have shown a preference for high quality tenants in prime – urban and suburban – locations and are willing to pay some of the highest prices in recent years to obtain them. Cap rates in prime markets can be up 125bps lower than the charted averages of many segments. However, investors are increasingly showing interest in properties containing lower credited tenants or located in secondary locations – exchanging risk for higher returns. Net lease investments continue to gain traction as an alternative investment instrument for cash flow and yield investors.








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Boston Net Lease Market Heating Up

Invesco Real Estates Institutional Client has Paid $75 Million for 179 Lincoln St. in Boston.

Building owners are seeing their offices fill up, leading to higher rents, which makes their properties more attractive to potential buyers. Many buildings have been the objects of bidding wars in recent months, with pension funds, insurance companies, and overseas investors competing to own a piece of the skyline.

“Boston holds a very desirable spot in global capital markets,’’ said Michael Smith, a managing director at Jones Lang LaSalle. “Many investors believe the city has weathered the recession better than other markets.’’

The volume of sales is still far from 2007, when 34 buildings changed hands for total sales of $4.9 billion. But the improvement is unmistakable after a period between 2008 and 2010 in which only 14 office buildings were sold in Boston, the kind of cold streak that causes nightmares for commercial brokers.

Just this past week, CBRE | New England closed on the sale of a five-story office building that drew more than 50 bidders, including several large financial institutions that typically focus on high-rises. The building, at 179 Lincoln St., was sold to Invesco Real Estate for $75 million.

“179 Lincoln St. is a great example of how people are viewing Boston today as one of the most attractive markets in the US,’’ said Chris Angelone, an executive vice president at CBRE | New England. “Five years ago, it might not have been an institutional buyer, but today it is.’’

http://articles.boston.com

Investors have Shown a Willingness to Close at Cap Rates

NNN Lease Market News

By Winston Orzechowski,
Research Director, Calkain Cos.
Calkain’s investors have shown a willingness to close at cap rates ....

Net lease cap rates averaged 7.75 percent for the first quarter of 2011, continuing the rate drop that began in the second half of 2010. The key driver in this trend has been an increased demand for high-quality net lease properties — assets which feature a strong credit tenant, good location and favorable lease terms – and the scarce supply of those high quality assets. Investors have clearly shown a lopsided preference for these triple-net-lease investment properties and, as 2011 progresses, demand will outpace supply.
High quality credit rated net leases have routinely sold for caps below 7 percent and when the combination of tenant, location and market align, Calkain’s investors have shown a willingness to close at cap rates (Calkain closed a bank/pharmacy deal below a 5.9 percent cap) that rival the peak of the market. We saw the same thing happen in the last half of 2010 and if that trend continues, it is likely that – buoyed by the improving economy – other triple-net-lease asset types will see a compression in cap rates as investors look to jump into the market rather than await the delivery of new product.
Pharmacies
High-quality pharmacies such as Walgreens have long been the poster boy for net-lease properties. As a result, pharmacies continued to outperform the overall net lease average — 7.56 percent to 7.75 percent. However, it should be noted that the highest-quality pharmacies enter the market in the mid 6 cap range while the weaker performers in the pharmacy segment round out the cap rate average with significantly higher closing cap rates.
Banks
Not surprisingly, banks continue to have the lowest cap rate. Their average is far lower than the overall net-lease average, moving between 6.47 percent and 7.75 percent. The sector tends to have the strongest credit tenants overall and are most commonly traded as ground leases with regular rental increases over both the initial and renewal terms.
Quick-Service Restaurants
QSR cap rates declined from 2010 to 2011, moving from 7.65 percent to 7.42 percent, and are lower than the overall average, which moved from 7.42 percent to 7.75 percent. However, the average cap rate of 7.42 percent is not totally illustrative of credit tenant transactions with the corporate guarantee of McDonalds, Chik-Fil-A, or Yum Brands-tenanted properties – many of which trade in the low 6s. Furthermore, it should be noted that much of the QSR’s that are trading garner a higher cap rate because the tenant is a local or regional franchisee whose lack of strength as a guarantor is reflected in the higher closing cap rate.
Dollar Stores
Though higher than the net lease average – 8.63 percent to 7.75 percent – dollar-store cap rates have witnessed a precipitous decline. Between 2010 and 2011, they fell from 9.29 percent to 8.63 percent. This is not a surprise. Dollar stores continue to gain market share coming out of the recession. Look for lower executions of dollar stores as the summer progresses. Furthermore, Dollar General has moved to a more favorable triple-net-lease, driving cap rates down. Dollar General is also expanding in markets that are less rural, with better real estate fundamentals. There are also rumors that Dollar Generals credit is improving.
Causal Dining
Casual Dining observed a slight increase from 2010 to 2011, raising from 8.24 percent to 8.39 percent. This could be caused by a variety of factors. Most restaurant leases are franchisee not corporate guaranteed, increasing the cap rate. This segment is also not recovering from the recession as well as others with consumers showing a preference for the lower priced menus offered by the QSR segment. Shopping center vacancies have also had an impact on the sector due to decreased traffic at the center.
Big Boxes
Big boxes observed a definite cap rate decrease from 2010 to 2011 — 8.52 percent to 7.97 percent — with transactions in strong key markets closing significantly lower. While the tenants have strong appeal and often carry a solid credit rating, the transaction size, acreage and square footage of the investment (larger on all fronts than the typical net-lease investment) means that there is a more select pool of eligible investors for properties in this sector. The sector has displayed exceptional growth in the past decade and the performance of the retailers in this segment has found a new strength driven by an improving economy and consumer spending.

NNN Investment Properties one of the most Passive Forms of Real Estate

NNN Lease Market News

Experienced, savvy and sophisticated real estate investors typically are inundated with decisions of what to do with their existing assets as they plan their estates.  In many cases, individuals holding various types of real property may want to simplify their portfolios for the next generation for ease of administration and enjoyment. (NNN) investments (“NLIs”) are one of the most passive forms of real estate (NNN )investment.  Under an NLI arrangement, the investor purchases the real property subject to a (NNN) investmets.  In such case, the tenant is responsible for paying all of the taxes, insurance, and most importantly, the maintenance of the real property.  By divesting of current real estate holdings and purchasing an NLI, the investor can ultimately simplify the investor’s real estate portfolio and have the ability to transfer assets to the investor’s beneficiaries with the comfort of understanding that little to no real estate experience will be required in order to manage the NLI. Additionally, depending on the type of asset purchased, the investor can assist in providing the investor’s heirs with (a) an income stream that extends into the future; and (b) an appreciating capital asset.

Investors concerned with the potential tax burdens associated with the sale of their existing real estate (NNN )investments may consider taking advantage of the tax-deferred exchange provisions of Internal Revenue Code Section 1031 in order to effectuate their diversification into NLIs.  Through the implementation of a properly structured tax-deferred exchange, investors can sell maintenance-intensive real property (NNN) investments, defer the taxable gains on such sales and reinvest the proceeds in an NLI.  Throughout the remainder of the investors’ lives, they can continue to enjoy the income stream and appreciation afforded by an NLI.  Should a particular investor continue to maintain their (NNN) investment in the NLI until death, the investor’s estate will receive a step-up in basis in the NLI to its fair market value as of the date of the investor’s death, thereby eliminating all of the deferred income tax on such real estate (NNN )investment.  Thereafter, the investor’s beneficiaries receive the following benefits: (a) a real estate (NNN)  investment; (b) an income stream subject to the terms of the NLI; and (c) an asset in which they possess a relatively high basis such that if they sell the NLI in the future, they can minimize the taxes paid in connection with such sale (or, if properly structured, such taxes can be deferred through a subsequent 1031 exchange).

Case Study:

Situation

For over 40 years a private investor had amassed a portfolio of New York real estate encompassing over 3,800 multifamily units.  Over the four decades, the investor had personally managed and operated the portfolio with a small team of staff and advisors.  Now in his late 60’s and with no heirs willing to undertake the management-intensive nature of the holdings, the investor was looking to gradually simplify his assets while maintaining a level of passive income that could be easier to pass on to heirs.

Problem

The size of the investor’s portfolio made it more challenging to find one single buyer since the assets are valued at approximately $420 million.  Additionally, the sale of the assets, if not properly timed, would have triggered a substantial capital gain that would have drastically affected the net proceeds for the investor.

Solution

Staggering the sale of the assets within the portfolio to allow for much smaller dispositions and encourage an ultimately higher sale price, due to increased competition, would allow the investor the opportunity to use the 1031 tax deferred exchange code in order to find like-kind assets to purchase.  The assets found for the exchange were real property occupied by tenants who signed long-term(NNN) triple net leases, were priced in the $2 – 10 million range and had a large scope of geographic diversification.  Therefore, the passive income attained from the newly acquired assets coupled with the use of the 1031 tax code allowed the investor the comfort to plan for future generations’ passive income as well as eliminated the immediate capital gains taxes he would have realized.

Authors’ Biographical Information

Benjamin R. Hanan is a Shareholder in the Business & Corporate Counseling, Personal Services & Planning and Employment Law Practice Groups at Abel, Band, Russell, Collier, Pitchford & Gordon, Chartered. Also a Certified Public Accountant, Mr. Hanan focuses his law practice on corporate law and business transactions involving individuals, physician practices, and other entities, including entity formation, operation, business sales, mergers and acquisitions, employment arrangements, buy-sell arrangements, and equity owner agreements. Mr. Hanan also devotes a substantial portion of his practice to estate planning and family wealth transfers.

Mr. Hanan earned his Juris Doctorate degree, with highest honors, from The George Washington University Law School in Washington, D.C. Mr. Hanan attended the University of Texas at Austin, where he earned an undergraduate degree in accounting, with highest honors, and a Masters degree in professional accounting.

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