We believe it is, in fact, helpful to have some historical sense of the evolution of the Net Lease Niche of the Real Estate Industry to have a better sense as to how these asset fit into the investment objectives of investors small and large in today’s maturing marketplace.
If you think about it, real estate, as an investment asset class, is a relatively recent development. It was always an entrepreneurial endeavor and was fueled as a worthy investment vehicle going back to the ‘mid-70’s and ERISA provisions, in those days total assets of private pension funds amounted to something like $164 billion dollars; today, of course, its in the “Trillions.”
Corporations utilized the financing option of Sale-leaseback opportunities, when rates were comparably favorable to the corporate bond market and other higher costs of capital as they planned and revised their capital structures. Subject to market conditions, investment grade real estate, while a hard, ill-liquid asset, proved it could be a source of capital for tenant and an investment hedge and accreting asset for the investment community.
Net leased assets can fulfill a range of investment objectives. When I represented a ‘mineral-based high net worth’ family in Fort Worth, I actually rejected a series of NNN offerings since I viewed them, as being priced at a premium. I was trained in the ‘How to create more value school of real estate development” and didn’t want to pay any third party a premium for creating the value that I could do myself.
Then, the Client sat me down and explained that, I had to understand, that acquiring these NNN assets, as a finished products with a credit worthy tenant, in place, with a predictable, stable income stream, in place with appropriate security and Corporate Guarantees, was a risk-averse investment. They were legendary seasoned land deal investors, they were not interested in assuming the risk of a development and ‘creating value’ (my background, prior)… This was a diversification from their Bond Portfolio; not just another real estate deal. These NNN properties were a “Bond-equivalent investment affording a risk-adjusted return.
With a background as a regional development partner in a firm, back East, I realized that assuming the higher level of risk, was a life that I had accustomed myself, assuming such risk was ‘A-Way-of-Life’ for us, as active hands on investors; not passive investors.
So I began to realize there is a risk-premium that was worth paying…but then the question became, “How to you determine the relative valuations and what risk-premium is worth paying?” Important questions. A lot more than comparing cap rates.
Now, you begin to see how the underwriting and understanding of this NNN niche impacts your decision-making and your investment returns.
In recent years, since the Great Recession, what issues have played a critical role?
- Supply and demand played a role, when credit dried up and expansion plans mandated a reevaluation by space users;
- The role off the Federal Reserve in their triage efforts of the economy with interest rates almost to zero, served as a subsidy of sorts to the real estate industry, since it produced historical lower debt rates and the corresponding compressed cap rates (out of a disaster due to cheap money, a real estate renaissance has unfolded in the last decade);
- With tighter credit, initially, corporations, then saw sale-leasebacks as timely solution to the capital markets;
- The tighter economy did not fuel new ‘Gucci/Pucci/Fiorucci’ locations (not an ethnic slur); but the various Dollar stores became the rage;
- With the increase in valuation due to compressed cap rates, valuations went through the roof. Sellers took their money and ran; but it fueled the IRC 1031 Exchange business to defer those substantial gains;
- At the same time, since the US had take more effective steps to respond to the crisis than European countries, US real estate was viewed as a safe haven for cross border investors;
- Institutional investors, REITS and Pension funds, all seeking yield saw this as an investment vehicle, too.
- Tax law provisions always help.
It is believable that we find ourselves at the mature end of this cycle; but, barring an exogenous event, real estate assets, with/without Amazon-impact, will continue to provide one of the safest investment outcomes. We readily acknowledge that the Equities have produced terrific 10%+/- returns in the last ten years; but most thoughtful, credible commentators suggest that returns for the next 10 years will be closer to 3-4%. So Net lease assets have earned their position as a safer investment vehicles with limited risk; but “Not all net leased assets are the same”. Having acute market intel to inform your decisions has never been more important to assist best results. That has not changed.
Contributing Article provided by:
Sean O’Shea, Managing Director