Rate Hikes Did Not Impact Net Lease Activity In Q1: Here Are 3 Things To Note
Although the market is strong, net lease asset investors are cautious about the effect of rising interest rates on cap rate volatility.
The Federal Reserve raised short-term interest rates for the fourth time in six months in June, boosting its benchmark rate to between 1% and 1.25%. That movement could impact deal volume and asset valuations, though the 10-year Treasury remains at historic lows.
“We’re still in a low interest and cap rate environment [and] pricing is still near historic lows," Boulder Group Vice President John Feeney said. “A lot of sellers are taking advantage.”
Coming out of Q1, here are three things to note:
Uptick In Office, Industrial Cap Rates
Though cap rates remain at historic lows, the office and industrial sector did see subtle movement, inching up a mere 4 and 7 basis points to 7.12% and 7.27%, according to data compiled by the Boulder Group. But that move had little to no effect on deals.
“Sellers who maybe purchased an asset four or five years ago now [have an] opportunity to make a profit,” Feeney said.
Investment activity remained robust and deals fluid in Q1. Last year talks of interest rate moves caused some uncertainty in the market, which resulted in a pullback in transactions. Net lease sales totaled $58B in 2015, according to CoStar, but transaction volume fell 7% to $54B in 2016. But that is not happening now.
Retail Deals Still Dominate
Retail remains a favorite among investors, Feeney said, particularly because investors are often more comfortable with retail prices, which range from $1M to $7M while industrial and office properties often start at $10M.
“We typically see more activity in retail because of the nature of the lease,” Feeney said. “It’s very stable, predictable terms. Most net leases start off with long leases. It’s very easy to understand returns and [they tend to] have very creditworthy tenants who you can depend on to pay that cash flow stream. It’s as close to fixed income of an asset that you can get.”
New supply rose in the first quarter, up 20% compared to the previous quarter, with the majority of that supply coming from the retail sector.
“It is easier for an individual who sold an apartment building and wants to buy a net lease to understand a Walmart or a Starbucks, because it’s something they use in their everyday life,” Feeney said.
No One’s Worried About 1031 Tax Reform
Private investors and 1031 exchanges still dominated net lease asset transactions in Q1. Though foreign investors may enter the net lease game through a REIT or large institutional investor, they do not typically acquire small, $1M Dollar Generals, Feeney said.
Although Congress is talking about axing the 1031 program during tax reform, Feeney said investors are not concerned.
"It’s one of those things that's been on the table for a long time, but nothing’s ever happened,” he said. “Until something is passed or on the table, people aren’t paying attention to it,” he said.