April 5, 2022

Single-Tenant Net Lease Cap Rates Drop to Record Low

Cap rates in the single tenant net lease sector reached historic lows for all three asset classes in the first quarter of 2022, according to a report issued by The Boulder Group.

Single tenant cap rates compressed by 13, 10, and 17 basis points for the retail, office and industrial categories respectively. Cap rate compression continues to be derived from the significant demand for net lease properties across all investor classes.

“Following record transaction volume in 2021, net lease sales velocity continued in the first quarter of 2022,” Randy Blankstein, President, The Boulder Group, said in prepared remarks.

Transaction volume in the first quarter of 2022 exceeded the first quarter of 2021 by more than 10% for the net lease sector, according to the report.

Where Cap Rates Compressed Cap By 20, 15 and 10 BPS

Despite the record transaction volume in 2021, the overall net lease property supply declined by more than 5% in Q1 2022.

“Supply chain issues and delayed expansion plans for retailers related to COVID-19 limited new construction supply,” Jimmy Goodman, Partner, The Boulder Group, added. “Only 15% of net lease retail properties on the market were constructed in 2021 or 2022.”

New construction properties with credit tenants including AutoZone, CVS and Dollar General experienced greater compression. Cap rates for these tenants compressed by 20, 15 and 10 basis points respectively, in the first quarter.

Competition amongst investors for high quality net lease product can be evidenced by the bid-ask spread in the first quarter of 2022. The spread between asking and closed cap rates compressed by 2, 5 and 7 basis points respectively for retail, office and industrial sectors.

“Toward the end of the first quarter, interest rates and inflation posed concerns to investors,” John Feeney, Senior Vice President, The Boulder Group, said. “Accordingly, net lease investors are targeting properties with fixed rental escalations during the term of their leases.”

Transaction activity in the net lease sector will remain active through 2022. Property supply will be a constraint for transaction volume as current demand for net lease assets outpaces supply.

“Net lease investors will be carefully monitoring the capital markets following the uptick in the 10-year Treasury toward the end of the quarter,” Blankstein said. “Cap rates will face upward pressure as the Fed has forecast multiple rate hikes in 2022.”

Momentum Remains

Senior Managing Director Alex Sharrin, JLL Capital Markets, tells GlobeSt.com that despite broader market volatility and rising interest rates, the net-lease sector remains a preferred investment vehicle for private capital and institutions alike.

“While pricing may adjust in certain product types and regions, the general narrative remains: single-tenant real estate outperforms in inflationary environments,” Sharrin said.

Newmark’s executive managing director Ken Hedrick does expect to see rising interest rates have an impact on demand and market velocity. However the firm did not see an impact on demand for net leased real estate in the first quarter, he tells GlobeSt.com.

“Historically, cap rates have followed interest rates after a lag period. However, if demand remains high, it could cause cap rates to hold steady for a period of time but we expect these trends to become more apparent as we get into the second quarter,” he said.

Retail Likely to See Most Cap Compression

Lanie Beck, Director of Corporate Research, Marketing & Communications, Northmarq, tells GlobeSt.com that although it will be several weeks before Q1 2022 is truly finalized, her preliminary findings also point to cap rate compression for the net lease market.

“Office and industrial sectors aren’t projected to vary more than a few basis points, so quarterly adjustments should be negligible,” Beck said. “The retail sector, on the other hand, is the most likely asset class to see more substantial compression, as preliminary research indicates we could be looking at approximately a 10-basis-point drop from year-end.”

If that holds true, the single-tenant net lease market will post two consecutive quarters with average cap rates below the 6-percent mark for the first time in history.

“For sales volume, it’s much too early to know where first quarter 2022 will stack up,” Beck said. “However, we’ve seen strong activity in recent months and excellent momentum that’s carried over from last year, despite the continued shortage of supply. The single-tenant market has already exceeded the $16.6 billion reported in first quarter 2021, and conservative predictions for first quarter 2022 put final figures somewhere in the $20 billion to $25 billion range, although we could certainly exceed this.”

2022: Continuation 2021 Pricing and Buyer Activity

The activity level of one individual company is very telling. SRS National Net Lease has closed, year to date this year, 180 properties, up approximately 17% from this time in 2021, with over 230 properties under contract, also 14% higher than this time last year, Matthew Mousavi, Managing Principal, SRS National Net Lease Group, tells GlobeSt.com.

“There is a continuation of demand and capital flows we saw in 2021, with continued robust demand from 1031 investors,” he said. “Funds, REITs, DSTs and other institutional groups have substantial capital allocation requirements this year as well.

“Lastly, income-producing real estate is viewed as a hedge and safe haven for capital in periods of higher inflation. This demand will also temper cap rate movements. We expect this year to be quite active with a focus on how debt for these assets is priced as we move through the balance of the year.”

Indeed, the net lease product type continues to be one of the highest sought after ‘food groups,’” Adam Friedlander, Senior Vice President of Beta, tells GlobeSt.com . “Buyers are attracted to the passive nature of the investments, corporate guarantees and long-term leases with scheduled rent increases.

“The most active buyer pool has been private capital, 1031-exchange buyers,” he continued. “The 1031-exchange market was extremely robust in the second half of 2021 and first quarter of 2022. Investors selling land, multi-family buildings, multi-tenant office and retail were exchanging into long term NNN leases for ease of management and passive income stream from credit rated tenants.”

He said that NNN buyers today are focused on tenants deemed as “essential retail services” such as convenience stores, grocery stores, drugstores, dollar stores, auto parts, dialysis clinics, fast casual and quick service restaurants

QSR’s Command Most Aggressive Cap Rates

Commanding the most aggressive cap rates are QSR’s such as Chick-fil-A, In-N-Out, McDonald’s, Starbucks, Raising Cane’s and Chipotle. Opportunities where higher yield exist include gym tenants, big box retail, casual dining restaurants, banks, drugstores and Dollar stores with short term leases in secondary and tertiary markets.

“There are no signs that the NNN environment will slow down in 2022,” Friedlander said. “Even with interest rates on the rise and inflationary pressure, the NNN product type will continue to be in high demand especially for new product with corporate leases in major MSAs.”

Chester P. Lee, co-chair of Duane Morris’ Real Estate Practice Group, disagrees, noting that there are some headwinds that may slow the cap rate compression of these assets. “Rising interest rates and inflation negatively impacts the returns of long-term triple net leases which do not typically have frequent rent bumps,” he tells GlobeSt.com.