California capital is heading to other markets for single-tenant triple-net deals. There are limited opportunities in California for triple-net deals, and in addition to the intense regulatory environment, investors would rather own triple-net assets in other markets. 1031 Exchange buyers make up a huge portion of this capital, driven by retiring owners looking less management-intensive assets.
“A lot of these investment sales are 1031 exchange money, and nearly two-thirds of private exchange money is coming from the West Coast and predominately California,” Eric Carlton, EVP at Colliers International, tells GlobeSt.com. “In the last couple of years, inventories have become low as private 1031 demand continues to grow. That has forced California money anywhere in the country to look for these types of deals.”
The dearth of single-tenant triple-net opportunities and high pricing in California isn’t the only factor driving capital into other markets. Buyers are also moving capital to softer regulatory and lower tax states. “In the last year, California buyers would actually prefer to be outside of the state because of the business climate here and the taxes and regulations. If investors can do it, they want to be out of California,” adds Carlton. “You get better pricing and they can be in a [better regulatory environment.]”
Carlton recently brokered a deal for a Walmart Neighborhood Market in Hinesville, Georgia, that is exemplary of this trend. The buyer was completing a 1031 exchange out of California and into this coupon-clipper asset, paying full asking price of $12.5 million. Tertiary markets like Hinesville, Georgia, are one example of the markets where buyers are heading to find deals. Florida is among the most popular markets, along with Utah, Idaho and Colorado. Phoenix is also a hot market for triple-net, single-tenant investment. “Phoenix is on fire. It is close, and there is supply,” adds Carlton.
The wave of demand in smaller markets has put downward pressure on cap rates over the last two years. Carlton’s Walmart deal closed at a 5.3% cap rate. “The spread between owning an investment in California versus anywhere else in the country has shrunk. You can’t pick up as good of a deal in a market like Georgia today as you could four or five years ago,” he says.
However, cap rates seem to have already bottomed out. In early 2018, cap rates increased slightly. “If you had asked me in the third quarter of last year, I would have thought we would be up another 50 basis points,” says Carlton. “So, I am predicting cap rates will be flat this year and start to slowly increase in 2020.”
Single-tenant triple net assets are a perfect fit for investors to buy far from their home base because there is no management intensity. Most of the trades have 15 to 20 year lease terms, leaving little for investors to worry about well into the future. “There is no management intensity, so there is nothing to do. The challenges come in when you have several tenants coming in and out,” says Carlton. “That is a challenge that you wouldn’t want to do from afar. Single-tenant properties run themselves, and that allows tenants to go anywhere in the county and be a buyer.”