Single-tenant net lease update: retail is in high demand

Real Estate Indicators from Managing Director Marc Mandel and Director Steve Schrenk, who lead HFF's triple-net-lease (NNN) team inHFF's Philadelphia office. For a listing of current NNN properties available for sale, please click here

The net-lease retail market has become very segmented over the past year. While overall cap rates may have increased slightly over the past 12 to 18 months, certain property types have remained in high demand. These property types are not limited to, but include:

• Gas and Convenience Stores
• Grocery Stores
• Quick-Service Restaurants (QSR)
• Medical-Related Tenants

While these certainly aren’t the only net-lease deals that have been in high demand, they have been some of the most highly sought-after in today’s market.

Traditionally, pricing movement and overall deal volume in the single-tenant market tends to lag the other major property types (multi-family, office and multi-tenant retail). While transaction volumes may fluctuate heavily in these product types, a strong flow of capital has remained to pour into the net-lease space, especially through 1031 exchanges. There are a variety of reasons this influx of capital continues, most specifically the fact that net-lease properties offer limited owner responsibilities, long-term leases, strong credit and attractive rental increases.

Most recently, there has been a strong push for shopping center owners to unlock hidden value by the monetization of outparcels. This is possible by subdividing outparcels on existing shopping centers, which tend to be net lease and trade at a premium. Additionally, this can take place by the creation of signing new outparcels leases in larger parking lots where parking ratios are still compliant with existing tenant leases and municipal codes. This has also been taking place on mall redevelopment sites and has become a major component in both office and multi-family development/redevelopment space. 

One of the specific property types within net lease that has seen incredible demand is gas and convenience stores. These properties are appealing to many as they typically offer strong corner locations, large parcel sizes and an “Amazon/internet” proof type of business. This holds true with other property types such as coffee, quick-service restaurants and medical users, all of which offer a hedge on the internet business.

Net-lease grocery stores are another category that are in high demand. We have had recent success trading a couple of single-tenant Safeway properties over the past few months and were thrilled with the high level of activity for these assets. Additionally, we are presently marketing a short-term, net-lease Kroger, on which we have received multiple offers from opportunistic/value add buyers who are chasing yield while feeling confident in this market segment.

As always, the gold standard and most demanded segment of the net-lease space remains to be low-priced, single-tenant QSRs. These restaurants continue to be in high demand whether they offer a short-term lease at market or below market rent or a longer-term lease with more than 10 years of term. With an average price point of between $2 million to $3 million, it seems a strong market will always exist for these deals as there are many buyers in this price range. The buyer pool runs the gamut from high-net-worth individuals, private and public REITS, institutions and various 1031 clients looking to place money or fill their 1031 exchange needs.

Lastly, we have been tracking the trend in the pharmacy sector – specifically CVS, Walgreens and Rite-Aid – closely over the past several months. In July 2018, we found 450 pharmacies on market. We completed the same study prior to the completion of this articles and found over 550 single-tenant pharmacies on the market. Interestingly, the average asking cap rate for these properties fell 18 BPS from 6.48 to 6.3 percent; however these properties are averaging more than 180 days on market and counting. The increase in inventory is a result of a few reasons. Prior to the completion of the Walgreens/Rite-Aid acquisition, investors were hesitant to purchase and sell due to the uncertainty of what they would eventually own. Also, build-to-suit development in the pharmacy space brings higher rents, typically limited rent growth and unreplaceable rent should the tenant ever vacate. Additionally, Walgreens took on an increased level of debt with the acquisition of 1,932 Rite Aid stores, and the uncertainty of store closures proved to be a detriment. Meanwhile, during this same period, CVS took advantage of the situation and extended many of their leases while reducing their rent obligations. The uncertainty continues to mount within the pharmacy space with continued pressure from Amazon and other internet retailers who are taking market share and have spent significant amounts of capital to compete in this space. Investors have become more focused on buying properties at market rents with rental increases in well-located areas, all of which have become increasingly important. Nonetheless, these assets offer long-term leases from investment grade, credit tenants so there will remain to be interest.