Why Net Lease Cap Rates Are on the Rise

All-time high-interest rates and a decline in 1031 exchanges are doing away with “would-be” sale transactions.
According to a recent analysis from a leading commercial real estate firm, cap rates in the single-tenant net lease sector rose for a third straight quarter at the end of 2022. In the third quarter, single tenant cap rates for retail climbed by 5.95%  (a 9 basis points increase), office rose to 6.95% (a 15 basis points increase), and industrial by 4 basis points to 6.65%.

The cap rates for net-leased properties are under increasing pressure, according to Randy Blankstein, president of The Boulder Group. Over the course of 2022, borrowing costs for institutional and individual investors will both increase. For context, the 10-year Treasury yield started the year at 1.53% and concluded at 3.87%.

Analysts say that in spite of deal flow slowing and properties remaining on the market for longer periods of time, the market supply of net lease assets increased in the fourth quarter. In the first quarter of 2022, cap rates for retail, office, and industrial properties were all close to historic lows. However, when borrowing costs rose throughout the year, retail and office cap rates soared. Office cap rates increased by 25 basis points from Q1 to Q4, while single-tenant retail cap rates increased by 20 basis points. According to industry analyst findings, the spread between industrial cap rates only increased by 5 basis points.In the fourth quarter, the supply of net-leased properties grew by over 10%. Cap rates on recently built facilities leased to Dollar General increased by 40 basis points over the previous quarter. Additionally, 7-Eleven (+25 bps), DaVita Dialysis (+25 bps), and Starbucks (+15 bps) also saw cap rate growth.

According to analysts, based on 2022 Q4 results, transaction volume for the net lease sector will continue to lag behind the robust transaction levels of 2021 as increased borrowing costs and a diminishing number of 1031 exchange investors limits transactions. Net lease investors will closely follow the Federal Reserve’s future meetings since its monetary policies will continue to affect the market.

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