WASHINGTON, DC-Net lease investors have been keeping a nervous eye on interest rate predictions, and understandable so—when interest rates hit a certain rate these investments will no longer make sense.
However, the current thinking is that time is not here yet, and likely won’t be for a while. “All this talk of rising interest rates has already been absorbed by the market,” says Winston Orzechowski, research director at Calkain Cos. “Cap rates are continuing to stay low and in all likelihood will fall in the future,” he tells GlobeSt.com. Right now and for the foreseeable future, net lease investors are better off staying put in the sector, he says–thanks to a spread that has remained remarkable stable.
Basically investors are realizing the same spread today—around 200 to 250 basis points — as they were in 2006 when interest rates were so much higher, Orzechowski says. “That is why it makes sense for investors to stay in net lease properties. It is simply a much better investing climate for them.”
Not that net lease investors should tune out interest rate movements all together—or for that matter take as gospel the prediction that cap rates will continue to fall. As Calkain notes in its 2013 mid-year report, a joint effort of Calkain Cos, and Chandon Economics, recovering asset prices have depended “inordinately” on low interest rates after the financial crisis. Currently rates are still low by any historic standard with inflation-protected Treasuries trading with negative yields.
That said, the interest rate movements in the second quarter presented a valuation challenge for properties not experiencing robust cash flow gains, the report notes. “For these assets, values will decline if higher rates are not absorbed into cap rate and debt yield spreads,” the report warns.
Calkain reported that cap rates in the first quarter were practically flat, increasing by less than 10 basis points to just over 7%. Up until the end of the second quarter, cap rates continued to absorb the shift in the interest rate environment, it said. “The results are consistent with strong demand for net lease assets–even as investors show a rising tolerance for risk–and a relative shortfall in the number of high quality assets available for sale.”
What’s more, it also noted that the abrupt increase in interest rates in the final weeks of the second quarter pointed to “some signs of bleeding over into cap rates and borrowing costs.”
“The lag from contract to closing means that transactions from early July offer an incomplete picture of any adjustment. Whether cap rates will edge up during the third quarter should become more apparent in the coming weeks.”