TULSA, OKLAHOMA (January 17, 2023) - Jeff Cox, executive managing director of Northmarq, answered a set of five questions posed by Shopping Center Business in the January 2023 edition of the publication.
What has been the most remarkable change in the single-tenant net lease sector over the past 12 months?
The interest rate environment is in the forefront of everyone's mind. Considering the inflationary pressure we experienced in 2022, interest rate increases came as no suprise to industry participants. The pace and magnitude of the rate increases, however, have been remarkable. Time will reveal the impact of this year's rate increases. Historically, interest rates go up quickly, but come back down slowly. One can say the same for cap rates. The fact that debt markets are up as much as 250 basis points for certain products has forced many sellers/buyers to pause, and this pause has had a slowing effect upon transactional volume.
Has supply and demand shifted? Is it a buyer's market or sellers?
Yes. The pandemic slowed and, in many cases, halted new development activity. Thus 2022 provided very little in the way of new inventory supply, leading to record low cap rates in the first two quarters. As interest rates adjusted in Q3, demand significantly outpaced supply for core NNN investment-grade product but began showing signs of weakness for the lower credit, shorter lease term assets.
It is no one's market yet. This is what people mean when they describe the market being in "discovery mode." Today's buyer is being required to stomach a cap rate lower than that same product may carry in just a few short months. Sellers holding out for yesterday's pricing are being met with disappointment and are being required to temper expectations to transact in an exploratory market.
What properties are most in demand? What factors create the ability for properties to transact in this environment?
The pandemic gave birth to a new category of net lease assets referred to as "essential business." Grocery, home improvement, gas and convenience, and quick-service restaurants with drive-through capabilities became the most favored net lease assets. Currently, anything with close to positive leverage is in demand. Long-term leases with investment-grade credit that can be financed remain highly attractive with investors. Medical, industrial, retail, and self-storage remain at the top of investors' lists. Office is in a period of transition as employers continue to shift some portion of their workforce to partial or total work-from-home.
For multi-tenant retail, open-air shopping centers in growth markets are in demand. Investors primarily prefer smaller deals due to the amount of equity required by lenders. Properties with assumable debt or all-cash buyers can more easily transact in this market.
Has supply been impacted by interest rates? What do you forsee for 2023 with regard to new supply?
Yes, as mentioned earlier, the supply or properties currently on the market has been significantly reduced due to slower development during the pandemic. Following the pandemic, interest rate increases caused a reduction in the supply of net lease assets on the market. Assuming rate hikes taper or end in the first half of 2023, we anticipate more properties will be on the market. But more properties on the market may not translate to an actual increase in total supply. It is more of a reset of the supply side. We do not expect 2023 to resemble the post-Great Recession market, as leverage is not comparable.
What positives are there for the STNL sector at present?
Real estate has long been a desired asset class for many reasons. One of the primary reasons is how easy it is to access and understand to the average investor. Currently, there is quite a bit of turbulence in the world. Economic and geopolitical headwinds cause uncertainty for investors, specifically where and how to direct capital. By comparison, triple net lease has been and remains a flight to quality and safety. In bull and bear markets, investors demand stable, reliable returns and upside. Net lease has historically delivered.