After Historic Low, What’s Next for Net Lease Cap Rates?

Randy Blankstein  Image courtesy of The Boulder Group

Cap rates in the single-tenant net lease sector reached historic lows across all three main sub-sectors (retail, office and industrial). Single-tenant retail reached a previous historic low from the fourth quarter of 2017 at 6.07 percent. Net leased office and industrial properties reached new historic lows of 6.94 percent and 6.90 percent respectively. Cap rates remain at low levels due to the historically low interest rate environment combined with a robust economy.

Despite the decrease in cap rates, the spread between asking and closed cap rates for retail and office properties widened by 6 and 2 basis points respectively. Real estate investors believe we are in the late stages of the real estate cycle with fewer buying opportunities, especially those of high quality. In the fourth quarter of 2019, the net lease market experienced a decrease in property supply of approximately 10 percent. Regardless of the decrease and limited quality supply in the fourth quarter of 2019, transaction volume for 2019 is expected to surpass 2018 by a significant margin. This is driven by a fundraising environment for cash flow vehicles with returns that exceed corporate bonds. Total single tenant transaction volume for 2018 was approximately $59 billion.

There is some uncertainty looming in 2020 surrounding the economy and upcoming presidential election, which is creating differing forecasts for the net lease market. In a recent national survey conducted by The Boulder Group, 45 percent of active net lease participants expect cap rates to rise in 2020 while 33 percent expect cap rates to decrease. The minority expects cap rates to remain relatively stable. The same poll in the fourth quarter of 2018 showed less than 5 percent of participants expecting cap rates to remain the same or decrease in 2019.

Investor demand for the net lease sector should remain active throughout 2020. Following a year with voracious transaction velocity in the second half, expectations are for that pace to continue into 2020. With a diverse set of viewpoints as evidenced by the aforementioned cap rate poll, market participants will actively monitor the property and capital markets to create a viable investment strategy for 2020.

Randy Blankstein is president of net lease advisory firm The Boulder Group.