There is a lot of discussion in a range of national publications, right now, to acknowledge that we may be in a new era for Investors. The 10-Year Treasury Rates have moved past 3.0% for the first time since 2013. The yield curve of 2 Year and 10 Year has rarely been this close.
So, we ask, “What are the implications for the net lease niche?”
I confess that I am one of the observers who can remember how ‘the music stopped’ in 2008-2009, when Lehman Brothers, Bear Stearns, AIG and other august financial institutions stopped trusting each other and the overnight lending mechanisms of the Repo Market which had come to a halt. Scary times that required the triage of QE by the Federal Reserve and forced mergers of a number of banks and financial institutions to attempt to salvage our economy. As seasoned Net Lease Advisors we not only witnessed this, but were in the middle of it.
We have just completed a decade of historically low interest rates. The impact on the net lease sector has been profound. Immediately after the great recession, many retailers due to lack of credit access, had to restrain whatever may have been their prior expansion plans. So, in the net lease sector, there was a real-life “Supply Issue” with a more limited availability versus demand for net lease product.
But, slowly, gradually, a modest recovery began to take shape.
While many complained about the governmental monetary policies, in fact, the Federal Reserve had, effectively, subsidized the real estate industry with this extended period of low debt rates. Lenders were chastened, to a degree, in their underwriting. As access to debt began to take shape, a new era of ‘shadow banking’ debt sources began to fill some of the void.
A new generation of ‘Build-to-Suit’ developers appeared. In many cases, historical “For profit” developers and builders were reduced to functioning as ‘Merchant Builders’, working for mere fees, rather than a risk adjusted profit of old; but they were able to keep their construction crews working again.
With a deleveraging of outstanding credit by consumers and corporations, alike, we saw the dramatic expansion of the Dollar Stores and other retailers with funding by private equity and hedge fund players.
So, this set of market conditions, made net lease assets, closer to a ‘Bond-equivalent” investment. There was a time when we would suggest that an acceptable net lease return was 10 Year T-Bill + 3.0%+/- as a risk-adjusted return.
As the economy began to limp back, limited supply was met with increased Capital Sources “chasing yields” and corresponding deals. This conspired with the IRC 1031 Tax-motivated investors, willing to swallow hard with these compressed cap rates to defer (avoid) their capital gain liability; in addition, US-based hard assets were increasingly viewed as a safe haven by Cross Border Investors who accepted modest returns for their invested capital…all of these factors have allowed the compressed cap rates to be sustained for almost 10 full years.
There was a recent interview with legendary investor, Jack Bogle of Vanguard, who was acknowledging the historic return cycle in the Equity Markets, during this same period, approaching 10% on average returns; but he cautioned it unlikely that these returns can be sustained in the next ten year period with increased interest rates and huge deficits on the horizon. His suggestion, tempered by the wisdom of his decades of experience in both good and more challenging times, was to expect returns closer to 3+ % going forward.
This might suggest that with the threat of exogenous events, whether generated from China Trade concerns; Middle East madness and conflict; Korean Peninsula challenges. U.S. mounting deficits will have a new importance as the euphoria and actual impact of the Tax and Jobs Act fades in our memory, NNN assets will serve as they always have, to produce predictable, stable income streams.
As we have stated in prior blogs, “Not all Net Lease are the same”,so reviewing investment goals of acceptable income streams, Lease structure and terms, tenant credit and Location must all be evaluated to produce a fixed income alternative for high net worth investors in 2018 and beyond.
Sean O’Shea, Managing Director
The O’Shea Net Lease Advisory
700 S. Flower St. #2650
Los Angeles, CA 90017
(213) 226-8719 – Direct
(213) 226-8750 – Fax
(310) 433-8851 – Mobile