Net Lease to Remain Active in 2018

By Randy Blankstein

Cap rates in the fourth quarter of 2017 for the single-tenant net lease retail sector reached a new historic low rate of 6.07 percent. During the same time period, cap rates for the office sector increased by 2 basis points to 7.00 percent and cap rates for the industrial sector decreased by 2 basis points to 7.25 percent. Cap rates in the fourth quarter of 2017 represented the lowest point of the year for all three sectors.

Despite fourth-quarter cap rates being the lowest experienced in 2017, the majority of demand remains for higher-quality assets, as the overall sentiment is that the current real estate cycle is in the late stages. Property owners are attempting to sell assets in the current market to take advantage of the historically low cap rate environment, regardless of asset quality, but the market generally is no longer seller oriented in terms of pricing—with the exception of high quality properties. In recent years, sellers were perceived to have the upper hand, however most active net lease participants believe there has been a move to neutral.

Asset availability

Despite a slight rise in the supply of net lease properties in the market, there is a lack of new construction properties with long-term leases. Accordingly, fourth-quarter cap rates for recently constructed properties tenanted by 7-Eleven, DaVita and McDonalds compressed by an average of 13 basis points. All three of these tenants are e-commerce resistant, which has been a point of emphasis for a growing number of net lease investors.

The net lease market is expected to remain active in 2018, as investor demand for this asset class remains strong. The expectation is that there will likely be upward movement in cap rates moving forward. In a recent national survey conducted by The Boulder Group, the vast majority of active net lease participants expect cap rates to rise in 2018. The largest segment of net lease participants expect cap rates to increase between 25 and 49 basis points by the end of 2018. With more rate hikes expected by the Federal Reserve in 2018, investors will carefully monitor the capital markets and the effect on pricing.