Investors Are Flocking to Essential Use Retailers

Properties occupied by essential use tenants have quickly become coveted investment opportunities during the pandemic. Not only have these assets held value, some have actually seen cap rate compression. SRS Real Estate Partners’ recent VCA Animal Hospital deal in Fountain Valley is a prime example. The property traded hands for $9.2 million and a 4.75% cap rate, the lowest cap rate in the nation for a VCA-occupied property.

“Demand has remained robust for essential uses and corporate-credit tenants in quality locations,” Matthew Mousavi, managing director of the national net lease group at SRS, tells GlobeSt.com. “The single-tenant VCA that we sold had stellar real estate on the 405 and VCA is owned by the Mars family of companies, so it had good credit. COVID or not, you are going to have demand for that type of real estate. We continue to see activity for those types of deals. That is where the demand is.”

While the VCA deal recorded a record cap rate, most essential-use cap rates have been flat compared to pre-pandemic pricing. “Cap rates really haven’t moved for essential use-type properties,” says Mousavi. “We are still transacting these properties at the same cap rate, if not lower than where we were last year. So, it really hasn’t changed yet. What we don’t know is what is going to happen when we are out of this COVID crisis and assess the damage.”

The lack of available product has also helped to stabilize pricing. Essential-use product is doing well, but non-essential use product has largely been pulled from the market as sellers wait out the storm,” says Mousavi. “That has positively impacted average cap rates. “A lot of properties are unsellable. If you have a theater-anchored center or a fitness-anchored center, for example, well, you can sell a property that has a bankrupt tenant. You can’t transact that; you can’t finance that without taking a heavy loss on valuation. So, a lot of those properties are not on the market at all. There is less supply, which has helped to prop-up prices as well.”

However, those pricing trends could change. Mousavi says that it is too early to tell, and the market needs to see more distress if pricing is going to change. “We need REO product to really change our valuations,” he says. “We need bank-owned product; we need foreclosures. That is where devaluation occurs: when you get product coming to market that is distressed or that is bank owned. We aren’t seeing that yet. It is a very interesting time because cap rates are still low, but there is also a lot of risk in the market. It just hasn’t been priced in.”

For now, Mousavi and his team are focusing on essential uses. “We are focusing on properties that are open and operating and paying rent. It is hard to underwrite, price, finance and sell a property where the income stream is down by 50%,” he says. “For properties where some tenants are on rent relief, we are providing seller credits to cover the questionable tenants for a year or two years. There are ways around it and to get buyers and sellers comfortable.”