Reverse Build-to-Suit Sale Leasebacks Are a Hot STNL Commodity

NNN Pro Group, which separated from Marcus & Millichap earlier this year, entered 2023 on the heels of a banner year that netted $5.6B in net lease investment sales, including $1.5B in car wash sales and $1B in quick-service and casual dining restaurants.

The newly independent firm also amassed $3B in transactions involving a spectrum of assets including automotive repair outlets, pharmacies, convenience stores and a kaleidoscopic array of specialty use product types—everything from veterinary clinics and bowling alleys to amusement parks and funeral homes.

The dramatic slowdown in STNL transactions in the first quarter as the rising cost of debt pushed cap rates up towards 8%—STNL investment sales plunged 42% in Q1 compared to Q4 2022—is being caused by a “disconnect” between sellers and buyers on deal pricing, NNN Pro Group CEO Glen Kunofsky told GlobeSt.

“There’s a disconnect between what sellers are willing to sell for vs. what a buyer’s willing to pay and what a bank is willing to do,” Kunofsky told us. “The developers want last year’s cap rate. That’s why inventory is building up. A lot of them just aren’t priced to where they’ll sell.”

While many merchant developers aren’t transacting on the glut of properties they’ve listed—until they’re forced to do so by looming construction loan due dates—owner/operator tenants of net lease properties are flocking to sale-leaseback deals to improve their balance sheets and finance continued growth of their businesses, Kunofsky said.

“It is a very good alternative for a tenant to get these assets off their books at an accretive rate alternative to corporate debt,” he said. “It’s permanent capital that they never have to pay back—and they can control the asset for between 20 and 100 years with options.”

“What most tenants care about is what their occupancy cost is long-term and how much cash flow they’re going to make in their operating business. They want to pour their cash back into their existing business,” he added.

NNN Pro Group won’t have to adjust its strategy to meet the demand for STNL sale leasebacks—the company is the industry leader, with $4B in sale-leaseback transactions in 2022—but challenging market conditions are requiring maximum creativity in the structuring of new deals, Kunofsky told us.

“A tenant has the opportunity to change the lease structure. If there are tiers of inflation and they want to keep their cap rate lower, we can put bigger bumps in the lease that we’re marketing so they can print the lower cap rate but have bigger escalators in the lease,” he said.

“Some tenants are comfortable with bigger bumps because of their business growth, some are doing a split on CPI, it just depends how low they want the initial cap rate to be,” he said. “The bigger the escalators in the lease, the lower the initial cap rate will be.”

“If you have 3% annual bumps, you might be 60 bps better in the initial cap rate, while 10% bumps every five years might sell at a 7 cap,” Kunofsky said.

NNN Pro Group is doing a brisk business in one its most creative offerings, he said: reverse build-to-suit sale-leaseback deals with tenants who have land—but have yet to build anything on it.

“A traditional sale-leaseback is where a tenant finds the land, they build the property themselves and then we sell it subject to a lease being completed,” Kunofsky explained.

“In a reverse sale-leaseback, we’re selling the land and the tenant is putting up the money for the building. The tenant is still entering into the lease but the building isn’t built yet. The investor is getting a higher yield because they’re putting up the money to get the construction done,” he said.

“It’s attractive to both the buyer and the seller. The tenant/seller doesn’t have to bridge the timeline to go and put up the money to build it and the new investor is getting a higher rate for doing it beforehand, so it’s been very popular,” Kunofsky said. “We’ve gotten a lot of these done in this quarter, both in the institutional and private markets.”

In one recent build-to-suit transaction involving a Bay Area tenant planning to build a 100K SF K-12 school, NNN Pro structured the deal with a total cost (including the price of the land and the cost of the project) of $65M, a 7.5% cap rate and a 20-year triple net lease with 2% annual escalators.

Reverse sale leasebacks also have been popular with car wash owners and operators.

Car washes were a red-hot commodity in 2022 due to the tax breaks for car wash development that were included in the 2017 tax reform bill enacted by Congress. Although the bonus depreciation dropped this year, Kunofsky told us NNN Pro is on track to sell another $1.5B in car washes this year.

“Car washes are still a hot commodity. The only thing that’s changed is that it went from 100% bonus depreciation to 80%,” the NNN Pro Group CEO said. “They’re still a very desired property from a cap standpoint and a bonus depreciation standpoint, and they can still get the bonus depreciation from a reverse build-to-suit.”