Private buyers have been stepping into the net-lease space, a signal that a rush of new players into commercial real estate markets isn’t showing any signs of letting up.
Private investors making a first-time real estate purchase tend to land on the net-lease space because it is relatively straightforward and low risk. Net lease properties are rented to a single tenant that agrees to pay the taxes, insurance and other costs that a landlord is typically obligated to pick up.
Private capital captured a record 37.9 percent of the net-lease market in the first half of 2018, up by 9.4 percentage points since 2015, according to JLL. In 2017, private investors accounted for 36.4 percent of all net lease acquisition volume.
An expanding U.S. economy has boosted investment allocations to the broader commercial real estate market in recent years. Returns on real estate are typically higher than other assets that pay consistent income, like bonds.
“Compared to lower risk-reward yield investments in bond markets, private investors are finding stable, long-term income with net-leased real estate investments in strong locations with good credit tenants in place,” says Eric Suffoletto of JLL Capital Markets.
One big shift that has opened up the opportunity for private investors: REITS have gradually dropped back. REITs focused on net lease, deterred by cap rate compression and rising interest rates, accounted for just 14.5 percent of net lease deal volume in the first half of 2018, down from 33 percent in 2015.
Private investors, who do not have to adhere to rigid underwriting guidelines or acquisition criteria, have been nimble enough to fill those gaps. Net lease is a rare sector where REITs invest in small deal sizes, such as a US$5 million fast food outpost, which makes this possible. Meanwhile, more sophisticated, cash-rich private investors looking to put their money to work have filled in larger deal size gaps.
As the market evolves and the net lease sector undergoes both cyclical and fundamental shifts, Suffoletto expects private capital will continue to play a major role, especially at price points below US$20 million.
Retail and industrial focus
Most net-lease deals targeted by private buyers are in the retail or industrial markets. In the first half of 2018, retail captured 42 percent of private buyers’ transaction volume in deals under US$20 million, about the same as industrial, which took 41 percent.
“Private investors’ willingness to pursue investment in all markets has a double benefit,” says Suffoletto. “More properties fall into the sweet spot of their typical deal range, roughly US$1 million to US$20 million, providing more buying opportunities and less competition from institutional buyers.”
“Despite shifts in the retail landscape due to e-commerce, the net lease market will remain steady and accessible to private investors looking for strong wealth creation and wealth preservation options,” says Suffoletto.
Increased appetite for 1031 exchanges
Favorable market conditions are fueling investor appetite for 1031 tax deferred exchanges – across all sectors of real estate, according to Anna Barsky, vice president at IPX1031, a provider of qualified intermediary services.
1031 exchanges allow sellers of investment real estate to defer paying capital gains tax by reinvesting proceeds in a “like-kind” asset within a specific time period.
Net-lease properties are particularly popular for private investors seeking 1031 exchanges because they tend to be steady, creditworthy, income-generating assets that require little hands-on management.
Barsky’s firm, which advises clients on exchange transactions, has seen 1031 exchange volume increase by nearly 20 percent from 2017 to 2018. She expects investor interest to remain high through the end of the year.
“In a truly national marketplace, and at pricing levels where liquidity is widespread, this asset class will remain a viable alternative for private investors seeking simple and secure options to further diversify their portfolios, or to those looking to take advantage of 1031 exchanges,” Suffoletto adds.
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