Participants in the single-tenant net lease space seem to think that bigger is better. With this space evolving and growing as an industry, there has been a recent spate of merger and acquisition activity in the single-tenant net lease niche. It appears that at least part of the motivation for these deals is to develop bigger portfolios that can derive the benefits of large-scale operations.
Nicholas Schorsch, chairman and CEO of American Realty Capital Properties, which is acquiring Cole Real Estate Investments in a recent $11.2-billion deal, agrees that becoming bigger was a good part of the attraction. The combined company will manage a $20-billion, 100-million-square-foot portfolio of net-leased assets.
Schorsh says, “It’s not just being bigger for the sake of being bigger. It’s one of those transactions where you have both size and scale, which allows us to participate in the S&P index, but also allows us to have a better balance sheet. The individual assets are very homogenous and this means that the portfolios fit beautifully together.”
Another single-tenant net lease player, W. P. Carey, which prides itself on being a 40-year veteran in this space, is also focused on the benefits of large-scale portfolios, but looks to get to this outcome by building up a portfolio of “bespoke” assets. W. P. Carey’s $6.5-billion-plus global portfolio encompasses about 38 million square feet. According to Jason Fox, co-head of global investments, “We are not a commodity buyer of real estate. Our focus is to put together a big, diversified portfolio across many components.”
Large Portfolio Benefits
Whatever be the means to achieve their objectives, single-tenant net lease players concur that there are certain benefits to owning a large-scale portfolio.
Gordon DuGan, CEO of Gramercy Property Trust in New York City, notes, “The business is very scalable. As you add assets, you don’t necessarily need to add people. If one public company buys another public company, all the things you need to do to be a public company—insurance, infrastructure, Sarbanes-Oxley testing—you only need to do for one company.” Thus, by building a bigger portfolio, companies can grow their revenues faster than they add to their expenses.
Shelby Pruett, chairman and CEO of Equity Global Management in Chicago, also sees economies of scale as a benefit of owning a bigger net-lease portfolio. “Large-scale portfolios enable firms to take advantage of administrative and management economies of scale, as well as obtain local market efficiencies though regional focus and use of regional managers,” he explains. Moreover, “a larger portfolio does not necessarily translate into a larger front and back office,” given that tenants take on maintenance and other responsibilities in a single-tenant net-leased property.
Another benefit that could result with strategically acquired large-scale portfolios is diversification. Acquiring properties that have tenants in different industries, properties in different locations and different types of properties helps make for diversification so that the portfolios are not exposed too much to any particular tenant, industry or location.
A larger, diversified portfolio could also help to lower a firm’s cost of capital, considering that ratings agencies tend to view this favorably, which could improve a firm’s credit rating and help it access funding at a lower cost.
As a net-lease company builds up a large portfolio, certain management skills have to come into play. Managing a large-scale portfolio calls for a proactive, analytical approach. As well, managers should be able to understand their tenant’s businesses to better manage the real estate.
W. P. Carey, for instance, prides itself on exiting in 2011 a portfolio leased to Best Buy, that was acquired in 1993, before the retailer had to retrench and close a number of stores, negatively impacting its credit rating. In this case, the credit analysis was not just reactive, but proactive.
Tom Zacharias, W. P. Carey’s head of asset management, says that an asset management team has to be able to understand and analyze the value of the real estate, the market risk for an asset in a particular location, see if there is an opportunity to re-lease an asset, and process information from relationships with others participating in a market, such as brokers. All this input helps the asset management team “execute a business plan for an asset” which is part of a portfolio. Also key is the ability to negotiate with tenants and others, and to gather as much information as possible to get the best outcomes.
By acquiring assets that tend to be critical to the tenants, such as a corporate headquarters or a core manufacturing plant, managers hope that they can protect themselves from downturns in the tenant’s business better, because the tenant will prioritize the asset. “I would have to say prudent underwriting of your tenants can provide longevity for your company and excellent execution at a low cost of capital for your tenants,” says Fred Berliner, senior vice president at United Trust Fund, the oldest firm specializing in corporate sale-leasebacks.
Another important piece of portfolio management is managing lease terms to make sure that there is no concentration of leases expiring at the same time, say in 10 years or 15 years. Richard Ader, chairman of New York City-based US Realty Advisors, says, “When you are buying, you want to make sure that every single asset you buy doesn’t mature in 10 years. You want some to mature in 10 years, some in 12 or 15 years, a variety of maturities, so that you are not hit all at one time with expiring leases.”
As well, it could help if the asset management team works together with the investment team as they source assets, an approach that W. P. Carey prefers. That way, the asset management team is in from the beginning of the investment process and understands the risks involved and the potential opportunities to add value for the tenant. They could also share any information they have about a market or property type with the investment team. Brooks Gordon, executive director of W. P. Carey’s asset management group, says, “We very much take a similar view of the world and we view our job as to achieve the goals that the investment team laid out to start, and then seek opportunities to beat those goals while protecting the downside as much as possible.”
And at Gramercy Property Trust, the asset management team and investment team will see properties together and tour the properties with lenders. “The moment we close on an investment, we are thinking about how to maximize the value of the investment,” says DuGan. That involves working with the tenant to take care of its needs, which is an important aspect of portfolio management.