What sorts of retail properties do high-net-worth investors favor these days? Ryan Imbrie is now at work finding investments for two high-net-worth investors representing both ends of the individual-investor spectrum: One of them sold a portfolio of self-storage facilities valued at $22.5 million and is looking at a large, single-tenant net-lease deal, while the other sold an eight-unit multifamily asset and is looking for a small, single-tenant net-lease deal in a rural Oregon community. “Right now many single-tenant net-lease acquisitions are being driven by 1031 exchanges,” said Imbrie, a managing director in the Portland office of SVN Commercial Real Estate Advisors. “Investors are selling, for example, multifamily at a low 5 percent cap rate and buying a retail asset with a higher cap rate.”
The swapping of certain types of properties through so-called 1031 exchanges can defer recognition of capital gains or losses upon sale. High-net-worth individuals generally invest in strip or neighborhood shopping centers or in single-tenant net-lease properties, but the bulk of the transaction market is in the latter category. “When you are dealing with these high-net-worth individuals, they have a focus on safety,” said Imbrie. “They want something tangible to hold for a period of time. Single-tenant net-lease assets can provide them with an attractive cash flow and the safety of a corporate check arriving each month.”
More important, single-tenant net-lease assets are an easy investment. “With single-tenant net-lease, as compared to multitenant, the former provides more of a fixed return with a passive ownership structure,” said Jason Powell, a director in the Atlanta office of Tulsa, Okla.–based Stan Johnson Co. “With a net-lease property, you can have zero landlord responsibility, depending on the way the lease is structured. You also eliminate certain exposures you would have with shopping centers, such as operating expenses, capital expenses, lease risk, vacancy [or] credit risk and management responsibilities.”
Conversely, the upside is greater with owning a shopping center, sources say. “In today’s market, most single-tenant net-lease returns are in the mid-to-high-5-percent range for properties leased by investment-grade-credit tenants with 10-plus years of remaining lease term,” said Powell. “Returns on a grocery-anchored shopping center can be in the 5 to 7 percent range, while unanchored shopping centers with a mixture of national, regional and local credit can be in the 7 to 9 percent range.”
In addition, net-operating-income appreciation on multitenant properties can also help boost returns on a shopping center investment, observers say, because one typically sees more rent escalations in the shop tenant leases, with opportunities to renegotiate and reposition the rent roll coming up as leases expire.
“There are fewer buyers of quality larger assets in secondary and tertiary markets,” said Mark Bratt, senior managing director and head of U.S. retail investment sales at CBRE. Bratt says he is seeing a lot opportunity for private investors now. “The REITs and pension-fund advisers are focused on the major markets,” he said. “The nontraded REITs have not been as active. Private investors are most active in the $2 million to $10 million single-tenant net-lease deals.” Net-lease retail investments remain popular for auto-parts stores or fast-food franchises, he says. “Net-lease is easy to understand and manage,” he said. “A fair amount of apartment sellers are buying net-lease retail because they no longer want the headaches with apartments.”
Two important issues with single-tenant net-lease assets are tenant creditworthiness and the lease term. “With net-lease, buyers are focused on tenant credit, [the] remaining obligated lease term and asset location,” said Powell. “Walgreens, CVS and McDonald’s are examples of popular investment-grade tenants in this sector. The majority of net-lease investors are looking for a minimum lease term of 10 years, with a preference for lease terms of 15 to 20 years.”
Both issues are important with regard to financing. “The credit of the tenant backing the lease has become more important, especially with the commercial-mortgage-backed-securities lending market,” said Powell. “To get favorable nonrecourse lending, one typically has to have an investment-grade tenant on a long-term lease. Many of the deals in the $5 million range or higher are CMBS-financed; $1 million or $2 million deals typically get bank financing, or buyers pay cash. We’re seeing a lot of people pay cash, especially under $3 million.”
In addition, having a significant lease-term obligation is vital to this sector, as it attracts passive, risk-averse real estate investors, Powell says.
The box itself is of some importance. “I prefer the auto-parts and paint stores, with a 6,000- or 7,000-square-foot rectangular box,” said Imbrie. “Right now you might have a great credit tenant, but in 15 years Sherwin-Williams moves — that’s an easy property to reposition. I’m less excited to put my client into a Sonic [drive-in restaurant], for example, which has a specific build-out that only works for it. I would only suggest a client purchase a Sonic with a cap rate that justifies the risk.”
There is one caveat when individuals buy shopping centers, notes Imbrie. “Some investors attempt to turn multitenant shopping centers into coupon-clippers by handing the reins to a management company, which sends a monthly management report,” Imbrie said. “Too often the report is thrown directly into the circular file without being reviewed. However, it is imperative the owner review the reports in detail so they understand future capital repairs or if tenant issues need to be addressed.”
In any case, the net-lease and high-net-worth combination is a good marriage, according to Jim Costello, a senior vice president at Real Capital Analytics. “High-net-worth investors don’t have billions in their pockets to invest, but tens of millions,” said Costello. “So buying a net-lease property is a good option.”