Brokers say the net lease retail investment market will continue to sizzle through the fall, as buyers and sellers race to complete transactions under federal tax laws that could change in the new year.

About a year ago, investors began flocking to single-tenant retail properties net leased to essential businesses, said Barry Wolfe, Marcus & Millichap senior managing director of investments in Fort Lauderdale, Florida. Today, sustained investor demand is pressing cap rates down, which means sales prices are higher, for properties leased to popular quick-service restaurants, convenience and discount stores, automotive parts suppliers and medical service providers. "Properties leased to operators in the fast-food sector and discount retailers have been coveted by buyers and have traded at compressed cap rates," Wolfe said. "Now, we are seeing fast-food cap rates in line or even lower than pre-COVID numbers. On some Chick-fil-A, Chipotle and McDonald's, caps are as low as we have ever seen them."

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Most buyers favor properties leased for lengthy terms to operators with strong credit and financial strength, which lowers tenant default risk. Investors often pay premium prices for new properties with new leases, expecting predictable returns from rent and minimal additional costs until the lease matures. "Properties with longer lease terms tend to trade at lower cap rates, while those with short-term leases will typically trade at higher cap rates, even in favored categories like fast-food and [discount] stores," Wolfe said.

Dollar General stores, for example, are commanding exceptionally high acquisition prices or low cap rates. In transactions that Wolfe's team has brokered, competition compressed cap rates for Dollar General stores to an average 6.99% in the first quarter, down from an average 7.76% for the first quarter of 2020. Cap rates for Dollar Tree averaged 7.18% in the first quarter of 2021 and Family Dollar 7.82%. "The stronger attraction to the Dollar Generals is that they have a 15-year, triple-net lease model, versus Dollar Tree and Family Dollar, which have a 10-year, double-net lease model typically," Wolfe said. "We're seeing cap rates on some Dollar General deals at 5.4 percent."

Triple-net tenants typically pay all real estate taxes, insurance and maintenance costs, in addition to base rent. Double-net makes the landlord responsible for some property expenses, such as the roof, building maintenance, landscaping or parking. Significantly, Dollar Generals with 10 or fewer years remaining on their leases usually price on a par with other discount stores offering similar terms, Wolfe said.

Factors that will keep net lease retail investment hot

Many U.S. cities are easing restrictions as vaccinations continue and consumers return to more conventional dining and shopping habits. Will that chill investor demand for net lease?

Not likely, brokers say. Discount and convenience stores, drive-thru restaurants and other net lease investor favorites of the past year not only weathered social distancing and other pandemic conditions, but also proved their resilience during rising e-commerce sales. That puts them in good standing to maintain sales volume in a post-COVID market, in which competition with online retailers and direct-to-consumer sellers concerns many brick-and-mortar store operators. "They are seen as Amazon-safe, so a good place to be betting on the future," Wolfe said.

Camille Renshaw, an investment broker based in New York City, predicts net lease investment sales will remain brisk through the end of the year as both buyers and sellers push to close transactions before potential tax changes can become law. The Biden administration has proposed ending tax-deferred exchanges of $500,000 or more, currently allowed under Section 1031 of the tax code, which investors frequently use to sell real estate and reinvest in net lease properties.

"In my couple of decades' career, I've never seen equal pressure from the seller side and the buy side come together at once before. But now, due to Biden’s potential tax changes, there is real pressure on both groups," said Renshaw, who is CEO and co-founder of B+E, an investment brokerage specializing in 1031 exchanges and net lease real estate. "Sellers want to sell everything that they had planned to sell during Biden's administration and do it by Dec. 31. At the same time, we have exchangers and other folks [seeking acquisitions] that are terrified of what tax changes are coming in 2022."

That has Renshaw expecting an uncharacteristically busy summer for investment brokers and a year-end surge of transactions. "Summers aren't usually wild in real estate, but people need to trade, they need to buy and sell and they have to get it done this year," she said. "The impression is that changes are coming so it is a game of musical chairs right now. Everyone wants to change the chair they are in and be in another chair by the end of the year."

Wolfe echoes Renshaw's tax concerns and credits ICSC for taking a leadership role in efforts to preserve tax-free exchanges. "We're all going to have to keep a very close eye on some of the tax reforms out there," she said. "That is the wild card — what happens to 1031 exchanges and how capital gains are taxed — and it could be the land mine that has a very significant influence on our industry."