LOS ANGELES—The net lease market may be normalizing after a prolonged period of substantial growth. According to new research from JLL, net lease sales volumes normalized in the third quarter due to economic volatility and the trend is unlikely to change in 2017. As a result, dealmakers are beginning to look to secondary and tertiary markets where there is less cap rate compression. For the third quarter, the office market was the only net lease sector in the black, with $15.8 billion in sales volume, representing a nominal .3% gain for the quarter. Industrial saw only $8.6 billion in sales volumes, a 31.1% year-over-year decrease, while retail sales volumes were $7.1 billion, a 37.9% year-over-year decrease. To gain some more perspective, we sat down with Matthew Berres, SVP in JLL's Los Angeles office, for an interview about the net lease niche and what is in store for 2017.

GlobeSt.com: Why is the net lease market beginning to normalize after such a prolonged period of growth?

Matthew Berres: Through the third quarter of this year, we saw normalization in sales volumes as a result of economic volatility bringing limited portfolio and sale leaseback activity compared to a peak year in 2015. Single asset sales, however, reached the highest level in a 10-year history in the third quarter of this year. This was driven by large office transactions in primary markets, bringing office sales to increase year-over-year. Overall volume declines, however, remain impacted by declines in retail activity.

GlobeSt.com: What does this say about broader economic trends and real estate cycle trends?

Berres: This year saw various ebbs and flows resulting from broader economic trends, including a decline in the first quarter consistent with rockiness in the CMBS markets, cautious markets speculating rate increases, Brexit creating global uncertainty in the second quarter, then a period of moderation of volatility followed by the election of a new president. With that, year-over-year sales volumes have been down consistently each quarter, with recovery being seen thus far in the fourth quarter as the broader markets stabilize. Cap rates have fluctuated through the year consistent with the changes in supply and demand.

GlobeSt.com: Why are investors finding better opportunities now in secondary markets? And is it unusual that there is a shift to secondary markets when a sector begins to normalize?

Berres: The shift into secondary markets is characteristic of the later stages of the cycle. As yields have compressed to historical lows in primary markets, investors have searched for yield within secondary markets, sacrificing location fundamentals in exchange for quality assets with longer lease terms and creditworthy tenants. As net lease assets fit the profile of that risk mitigation strategy, we have seen a notable increase of institutional and foreign interest within the net lease sector. In fact, many foreign investors are evolving their US acquisition strategies beyond their common gateway cities and into secondary markets as a result of the security offered by net lease real estate. This trend is driving competition within second markets to reach tertiary markets in some regions.

GlobeSt.com: While the net lease market is beginning to normalize, do you think that it will remain healthy and active in 2017?

Berres: The net lease sector is unique from other sectors in that it offers a core investment through long term lease quality and credit tenancy, with limited maintenance costs. With that, we can expect to see a continued interest in institutional funds and foreign capital seeking safety in the later stages of the cycle. Net lease build-to-suit activity is also increasing year-over-year, with many office and industrial assets expecting completion in 2017 and 2018.

GlobeSt.com: Which net lease sectors have seen the most significant shift, and which sectors will continue to see growth?

Berres: The office sector continues to drive activity for net lease volumes with core product transacting in primary markets. A divergence continues to evolve with retail and industrial, however, as the shift to e-commerce drives industrial activity and new build-to-suit opportunities. The retail sector is in a position of restructuring as many flagship retailers shift into a strategy of experiential shopping with smaller store footprints, and larger big box stores are decreasing their footprint by holding fewer inventories on site. Restaurant and auto-related activity remains strong despite declines in overall retail activity. Some luxury retailers are acting as outliers, as we continue to see occupiers buying back their flagship locations in Beverly Hills and Manhattan, including purchases from Chanel, Zara and H&M.

GlobeSt.com: Why is the net lease market beginning to normalize after such a prolonged period of growth?

GlobeSt.com: What does this say about broader economic trends and real estate cycle trends?

GlobeSt.com: Why are investors finding better opportunities now in secondary markets? And is it unusual that there is a shift to secondary markets when a sector begins to normalize?

GlobeSt.com: While the net lease market is beginning to normalize, do you think that it will remain healthy and active in 2017?

GlobeSt.com: Which net lease sectors have seen the most significant shift, and which sectors will continue to see growth?

Instant Insights /

Is the Net Lease Market Slowing Down?

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