Cap rates in the first quarter of 2016 for the single tenant net lease retail and industrial sectors reached a new historic low rate of 6.18% and 7.10% respectively.
During the same timeframe, cap rates for the office sector increased by 20 basis points to a cap rate of 7.20%. Cap rates for retail assets continue to decline and trade at much lower cap rates than that of net lease office and industrial properties due to their preference amongst private and 1031 buyers. Private and 1031 investors typically pay lower cap rates than institutional investors, especially for retail assets. Private and 1031 buyers are more familiar with retail tenants, prefer the lower price points and understand the general business practices of these tenants when compared to industrial or office tenants.
As demand continues for the net lease sector, supply has continued to remain constrained. Overall supply of the net lease sector compressed by approximately 3% in the first quarter of 2016 when compared to the previous quarter. New construction properties remain in lower supply as the construction pipeline remains limited when compared to previous years. New construction properties are in the highest demand amongst 1031 and private buyers as they typically have the longest lease term.
Accordingly, cap rates for recently constructed properties tenanted by AutoZone, DaVita and Fresenius compressed by 40, 50 and 25 basis points respectively in the first quarter. The limited supply has kept cap rates low for all three sectors despite the volatility in the 10 year treasury over the past year.
After the decision was made in the December Federal Reserve meeting to raise key interest rates, the 10 Year Treasury plummeted to its lowest point since February of 2015. Since that time, the 10 Year Treasury has trended upward, however remained lower than its sudden increase prior to the Federal Reserve’s decision to increase rates in December 2015.
The net lease market is expected to remain active in 2016 as investor demand and allocated capital for this asset class remains strong. With the volatility of the 10 Year Treasury effecting capital markets, investors will be monitoring the capital markets and adjusting their bids accordingly. 1031 and private investors will be less effected by the volatility of the financing markets than institutional investors. This can be attributed to their acceptance of lower returns when financing or all cash closings due to their 1031 timing and tax consequences.
About the author: Randy Blankstein is President of net lease advisory firm The Boulder Group.