Cap rates in the single tenant net leased big box sector compressed from the fourth quarter of 2012 to the fourth quarter of 2013 by 63 basis points. The decline in cap rates was primarily due to the limited supply of big box properties available within the net lease market. Investor demand was driven by institutional investors and real estate funds targeting higher dollar valued properties to reach acquisition goals after a record fundraising year. While institutional investors are the primary buyer of big box properties, 1031 exchange buyers with large exchange requirements are able to pay a premium for these assets due to their short deadlines. Despite the year over year cap rate decline, big box properties were still priced at a 25 basis point discount to the entire net lease retail market in the fourth quarter of 2013.
Lack of new construction remains the major supply constraint as big box retailers have limited expansion plans. Furthermore, big box retailers that are expanding are able to backfill second generation real estate at lower rents than leasing new construction freestanding locations. Typically, rents for a new construction freestanding big box property exceed second generation rents and tenants can occupy second generation space quicker. Additionally, many large format retailers such as Costco, Target and Wal-Mart tend to own their own real estate further contributing to the supply limitations.
Big box properties tenanted by investment grade companies remain at the forefront of investor demand. In the fourth quarter of 2013, big box properties with investment grade tenants were priced at a 125 basis point premium over non-investment grade tenants. The premium associated with investment grade tenants primarily exists as financing terms favor these assets. However, due to the large premium associated with investment grade properties, some investors are beginning to change their acquisition criteria to include non-investment grade properties, like Academy Sports, Best Buy and Hobby Lobby, as higher yields can be achieved. The supply of investment grade properties only made up 25 percent of the big box market in 2013, a 5 percent decrease from a year ago.
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The single tenant net leased big box sector will remain active as institutional investors seek net leased properties with higher dollar amounts. However, the property supply of new construction will remain low as big box tenant expansion plans remain limited for 2014. The low supply of new construction assets should be offset by maturing loans. Property owners with maturing debt will have the option to either refinance at low interest rates by historical standards or sell and take advantage of the low cap rates available in today’s net lease market.
Randy Blankstein is president of net lease advisory firm The Boulder Group.
This article was republished with permission from National Real Estate Investor.