If there is graffiti or a roof leak, the tenant is not calling you, according to Andrew Bogardus, executive director in the net lease group at Cushman & Wakefield. You still receive a check each month while they take care of it themselves.
These assets are especially enticing in low interest rate circumstances when investors find it challenging to obtain meaningful income through other safe investment options, such as government bonds, due to their simplicity.
But what happens to the market for NNN retail properties when interest rates increase and suddenly a Dollar General in rural Louisiana’s 5% cap rate is in direct competition with a similar yield on a six-month Treasury note? And what should investors search for while examining the wide variety of NNN-leased properties on the market?
Bogardus gave LoopNet a brief overview of NNN retail assets’ fundamentals and the present competitive landscape.
What to Look for in a Retail Property with NNN Leases
Bogardus claims that smaller investors interested in NNN retail properties frequently search for a 1031 exchange possibility. They may be selling a property that requires more work, such as “a single-family home they rent out or a four-unit apartment building that they’ve been managing themselves,” and they are seeking to buy a property where they can simply “collect a check” each month.
or “mailbox money,” as Bogardus put it.
There is a NNN retail property for practically every type of investor, from banks to auto chains. Bank branches, quick service (or fast food) restaurants, automotive supply businesses, drug store chains, supermarkets, and discount retailers are some of the most typical types of retail tenants occupying these locations.
Investors that are interested in purchasing one of these assets should consider the property’s general location. Ideally, it should be near retailers that complement it in a high-traffic, high-visibility area. Even among those tenants, there is a hierarchy. Big-name, national shops often attract the most investor interest and are provided at the lowest cap rates. According to Bogardus, trendier and more well-liked customers, like Chick-fil-A or In-N-Out Burger, will command more attention and higher pricing than their less well-liked siblings (like Arby’s or Sonic Drive-In).
The normal length of a lease for a NNN retail property is between 10 and 20 years, with yearly increments. However, investors should be aware of how much time is remaining on the lease because, according to Bogardus, the more time left on the lease, the more desirable the property will typically be.
Who signs the lease is another issue that needs to be addressed., Bogardus asked rhetorically. Investors should be aware of whether their potential property is leased to a corporately owned store or a franchisee, according to Bogardus. Corporate-owned properties are seen as preferred due to their good credit standing.
For NNN retail investors, it is crucial to comprehend the stability of the current tenant because the only obligation building owners have is to lease the property once more in the event that the current tenant vacates the premises.
The Present Retail NNN Lease Property Market
As one might anticipate, the market for NNN lease properties has been significantly impacted by the rise in interest rates, which has increased the yield on a variety of safe investment options.
Since early September [2022], “we’ve seen demand fall off significantly,” Bogardus added. It has moved much more slowly.
According to Bogardus, investors might anticipate getting a loan for a NNN retail property in the region of 3%–3.5% prior to the increase in interest rates. However, the cost of debt has increased significantly and quickly in the current environment, and investors are now looking at interest rates between 5.75% and 6.25%.
Bogardus emphasized that in order to maintain the same cash-on-cash return, the cap rate must increase.
But strangely, cap rates on NNN retail assets have remained unchanged. According to Bogardus, the majority of institutional investors are currently looking for cap rates on these properties between 6% and 6.5%, although sellers are still committed to obtaining cap rates of approximately 5%.
“We have a big disconnect,” Bogardus remarked.
This discrepancy is typical of a situation that has been occurring in the real estate market across asset classes and regions, where sellers have been hesitant to give in to the current interest rate environment and recognize the effect it has had on cap rates.
The effects of that difference may be felt even more sharply in the NNN market because most NNN buyers are more focused on attaining a stable, consistent return than they are on long-term appreciation or potential future upside. The largest threat to profitse an unexpected vacancye still exists, so why incur the risk when a similar return can be obtained through other means? NNN retail buildings unquestionably present owners with fewer hazards than many other real estate investments.
Nevertheless, Bogardus thinks that cap rates will eventually catch up to interest rates. Sellers can determine where they need to be with the cap rate once interest rates stabilize.
Until then, Bogardus emphasized that the 1031 exchange market for buyers of NNN investments is still highly active. They are attempting to purchase a property with a long-term lease and a national tenant in order to delay paying taxes.
Additionally, he noted that the sites inhabited by the more well-known and reliable retailers listed earlier continue to have robust business. The cap rates must increase if the shop, though, “doesn’t have as good of a reputation, or perhaps it’s a franchisee instead of a corporate-owned store.”
