Net Lease Forum: Momentum Heads Into Overdrive

For years the Miami-based Popeyes Louisiana Kitchen lagged as a brand. Its menu was perceived to be ho hum and its restaurants dreary. Then the company made a mighty push to revitalize, to great success. It changed its menu to emphasize its New Orleans roots and began focusing on expanding its footprint. By the time the multinational fast food conglomerate Restaurant Brands picked up Popeyes for $1.8 billion in 2018, the chain’s course was set. It was steadily opening new locations both in the US and globally—a trajectory that continues to this day. The number of Popeyes restaurants worldwide grew 7.6% over the 12-month period ending Sept. 30, 2018.

At least some of those restaurants were self-developed, says Brenna Wadleigh, CEO of N3 Real Estate, a net lease developer based in Southlake, TX. It is not the only retail chain to be building out its own assets either, according to Wadleigh. She also counts Panda Express, Chick-Fil-A, Quicktrip and Bridgestone, as well as a number of franchises in this group.

The driver behind this trend is telling for the net lease space. Because the market is typically a reliable sector with strong returns, in recent years restaurants and retailers have come to realize the gains they can reap from developing their own outlets, she says. Some hold the assets on their balance sheets, but many others are structuring deals as sale leasebacks. “They build it and three months later put it on the market just like a developer would, and then keep the gain,” Wadleigh says.

This tactic of self-development is an interesting aspect of the current net lease arena, serving to deliver more assets to a market that is hungry for acquisitions.

“There is not much quality product out there, so when a property that’s occupied with a good tenant that is adapting well to the Internet, we see strong demand for it,” Wadleigh says.

Buyers seeking deals range from high-net worth individuals that want to reseed their 1031s to institutional investors such as net lease REITs and private equity shops. Public companies such as Realty Income, Spirit Realty, Store Capital and W. P. Carey all reported more acquisitions than dispositions for 2018. Even conservative pension funds are gravitating to these income-producing assets. As one example, Pennsylvania State Employees’ Retirement System, as part of a mandate to boost its exposure to net lease, made a $300-million commitment to Oak Street Real Estate Capital Net Lease Property Fund last year—one of the largest ever by a US public pension fund to the sector, according to IPE Real Assets, which reported the transaction.

The sellers of these assets range from developers like N3, which find the current pricing hard to resist, to institutional investors that are making select dispositions. Individual investors, mainly through 1031 exchanges, are also looking to exit their holdings after having held onto them for decades. Aging baby boomers also actively selling, explains David Gorenberg, qualified intermediary product leader at Wilmington Trust. “The economy is reasonably strong right now and interest rates are low, which makes it the right time to sell,” he says. “If you’ve owned property since the beginning of the downturn 10 years ago, that property has likely not only recovered but also increased significantly in value.”

As these buyers and sellers converge on the market, deals are starting to pick up. “Trends like this tend to gain momentum, so this could continue into the second and third quarter of this year,” reports Jonathan Hipp, CEO of Calkain Cos.

Not only has the number of one off deals been rising, but more importantly, so have portfolio sales. At the end of last year, for example, Dallas-based Landes Group acquired 27 net-leased retail properties located in 12 states in an $86-million transaction. The 563,000-square-foot portfolio consisted of five Wawa locations, eight CVS Pharmacy stores, four Service King Collision Repair shops and 10 Walgreens. Each property was occupied under long-term triple-net leases.

Competition was tight for this portfolio, according to Justin Grissen, Landes Group’s chief investment officer, and there were a handful of buyers vying for the deal on the best and final offer round. In general, 2018 was an active year for the company, which closed 65 net lease transactions. In this year’s first quarter alone, it expects to close on 35 assets.

Also last year Broomfield Hills, MI-based Agree Realty closed on a fairly significant transaction: a $142-million sale-leaseback with Sherwin Williams. In one swoop the net lease REIT picked up a high-quality portfolio of more than 100 retail properties. Agree Realty is also looking forward to a bountiful 2019, according to comments president and CEO Joey Agree made during a year-end earnings call. Its current pipeline, he said, “contains several unique opportunities that are anticipated to close in the upcoming months” including urban condos in core city center locations, smaller sale-leaseback transactions with its retail partners as well as early extensions, or what the industry calls blend-and-extends.

This activity is, not surprisingly, starting to affect pricing. Hipp reports private equity investors are buying more opportunistic real estate while REITs prefer assets with primary lease terms of 10 years or more. On the other end of the spectrum, private equity is buying assets that trade at cap rates with 100 to 100-plus premiums over what a REIT would buy. That’s because private equity buyers need to achieve a higher return to justify a purchase. “They are more opportunistic buyers looking for value add, blend-and-extend or five-year leases,” he says.

In some cases, sellers are willing to offer discounts for portfolio sales in exchange for certainty of execution, Hipp continues. Many sellers are, in fact, bundling several assets into a portfolio with this sort of play in mind. “They want to trade to a buyer—typically an institutional investor—that has a high probability of closing.”

For her part, N3’s Wadleigh doesn’t see many sellers agreeing to a discount. “We’re just not seeing the premiums,” she says. “This year, people expected net lease cap rates to jump because of expected interest rate hikes but we’ve seen only a marginal increase. Demand is still very strong, especially for assets priced $5 million and under.”

N3, she added, is selling into the 1031 market “because that’s where the pricing is.” As well as deals—or at least, some of them.

Indeed, as acquisition demand continues to build, net-leased assets are making their way to market via all sorts of scenarios, including from the balance sheets of tenants such as Popeyes.