THE NNN MARKET

By: Tom Georges, Associate Director/Investment Sales, The Stan Johnson Company

Tom Georges was interviewed by Jaime Lacky of Northeast Real Estate Business regarding the state of the net lease market.

Single-tenant investment sales volumes have risen steadily since the end of the Great Recession, with 2015 posting a total of $19.3 billion in the retail sector in the U.S., $21.7 billion in office properties and $22 billion in industrial properties, according to a report by Stan Johnson Company. Northeast Real Estate Business recently spoke with Tom Georges, associate director of Investment Sales with Stan Johnson Company’s New York City office, for insight into the net lease market.

NREB: What trends are you seeing in the net lease market today?

Georges: The net lease sector is still very much a seller’s market with a shortage of quality assets.

NREB: How does transaction volume compare to last year?

Georges: We’re seeing transaction volume across the board off over last year’s pace with single-tenant industrial transactions down close to 8 percent while office and retail transactions are down close to 30 percent each over the first two quarters of 2016.

NREB: Generally speaking, who is selling?

Georges: Developers continue to be active.

NREB: We reported earlier this year that some institutional players would be taking advantage of the market conditions to divest some of their noncore properties. What are you seeing on this front and how is it impacting the market?

Georges: We are seeing some institutions selectively divest non-core assets. This has added some inventory to the market and buying opportunities for investors.

NREB: What are you seeing in terms of cap rates?

Georges: Cap rates have flattened and in some cases have slowly crept up, but the persistent motivation of 1031 exchange buyers and the continued low interest rate environment have served to keep a downward pressure on cap rates overall. Over the first two quarters of 2016, we saw retail cap rates average in the low to mid-6’s, while industrial properties traded in the mid- to upper 6’s and office properties in the low to mid-7 percent cap range.

NREB: What are you seeing in terms of institutional investment in net lease properties versus investment by high net worth investors?

Georges: The flattening and subsequent slight increase in cap rates is allowing institutions back in the market and they are becoming more active as buyers.

NREB: So high net worth individuals have a higher threshold when it comes to cap rates? Why is that? Where is the sweet spot? What factors might benefit individual investors in the coming year?

Georges: Individual investors do not have the same cap rate spread requirement that institutions often do, so they are able to absorb a lower cap into their investment strategy. Couple this with tax deferment motivation and the time pressure requirements of the 1031 exchange buyer, and often we see that 10, 20 or even more basis points of a cap rate are less of a concern for the individual investor.

NREB: How do smaller investors find and evaluate net lease opportunities and compete against institutional investors?

Georges: Generally speaking, smaller investors are more attracted to properties with longer lease term remaining, more passive management structures and possibly better credit while institutions are willing and able to take on more risk as far as these elements are concerned.

NREB: Many retirees invest in net-lease properties. How is the increasing number of retiring Baby Boomers shaping the net lease industry?

Georges: Net lease property investments are often a terrific place for Baby Boomers and retirees in general to place investment capital. In addition to receiving long-term, predictable rental income, net lease property investors can enjoy the benefit of passive real estate ownership and a perfect strategy for balancing an overall investment portfolio. Net lease properties also can be a key part of a well-planned estate planning strategy.

For so many investors who spent a lifetime building wealth in real estate, a 1031 exchange can be a very wise move. By deferring capital gains tax through IRS tax code 1031, investors have the ability to keep significantly more of their investment dollars working for them throughout their entire life. And often reinvesting exchange funds into net lease properties is a perfect way for investors to move from a labor intensive form of real estate ownership to the minimal management and income-predicable ownership that net lease assets provide.

NREB: What about sales volume by property type? Many of us still tend to think “retail” when we think net lease. How is the industry evolving in terms of office and industrial properties? Who is the primary investor when it comes to office and industrial net lease properties?

Georges: Generally speaking, industrial and office properties tend to attract more sophisticated investors, who are willing to accept slightly shorter term and assume slightly greater risk while benefitting from a higher cap rate return.

NREB: Where are the opportunities in the net lease sector in today’s market?

Georges: This really depends greatly on the investment strategy and goals of the individual investor or group. Geographically speaking, often we find ourselves directing our clients toward acquiring assets in growth markets like Austin, Dallas, Seattle and San Francisco. On the East Coast, we see opportunity in areas like Orlando and Tampa, and parts of the Carolinas, like Charleston, Raleigh and Charlotte, are very attractive.

NREB: What markets stand out in the Northeast?

Georges: In the Northeast, Washington D.C.; Philadelphia; and Boston are all strong growth markets. I’d be remiss if I did not mention the New York metropolitan area, a market in which real estate in general operates under a completely unique set of rules.

NREB: What markets stand out in the Midwest?

Georges: In the Midwest, cities like Columbus, Ohio; Indianapolis; Oklahoma City; and, of course, Chicago stand out as solid growth markets.

NREB: What factors should we watch that might impact net lease investment activity in the near or long term?

Georges: Obviously, there are many factors that might impact the future of net lease activity: continued economic and social uncertainty (both domestically and globally), the pending presidential election, or dramatic moves in interest rates. Tax reform could specifically have a tremendous impact on the future of 1031 exchange as a viable tax strategy, which could significantly decrease the buyer pool.

As we all know, tax reform has been looming for some time. With the presidential election cycle nearing a decision, it’s quite possible that tax reform could become a forefront issue. And whether we welcome in a President Clinton (cough, cough) or a President Trump (cough, cough, cough) a reconstructing of how capital gains are treated and tax code 1031 will no doubt be part of the conversation.

I recently attended the annual conference of the Federation of Exchange Accommodators (FEA), an organization comprising mostly qualified intermediaries, which (among other things) is dedicated to educating the public and policy makers about the benefits that tax code section 1031 has on the U.S. economy as a whole. For example, in 2015 the FEA led a coalition of industry associations that commissioned Ernst and Young to produce a study analyzing the effects that a repeal of tax code section 1031 would have on the general economy. In part, the study concluded that a repeal or limitation of the code would impact the overall U.S. Gross Domestic Product over $8 billion annually or an estimated overall drop in GDP between $61 billion and $131 billion over a 10-year period.

NREB: What about the anticipated slow, controlled increase of interest rates?

Georges: The uncertainty surrounding the timing, intensity and effects of pending interest rate increases are and have been one of the most speculated variables of the U.S. economy for years. While markets fear and react poorly to change in general, a slow and controlled increase of interest rates would have a far less dramatic effect on the net lease marketplace than would a sharp and drastic interest rate hike.