No Let Up in Net Lease Momentum

NEW YORK CITY-“This is a lot more fun than two years ago,” commented moderator Jeff Hughes, senior director with the Stan Johnson Co., as he introduced the “Town Hall Meeting” panelists at this year’s RealShare Net Lease conference Wednesday morning. The daylong conference for the net lease and sale-leaseback sectors, brought back after a one-year hiatus, drew approximately 250 high-level executives to the Marriott Marquis—an impressive sum for a niche sector and a reflection of the sector’s continued momentum.

The outlook for net lease is generally positive, as investors who have grown itchy on the sidelines now find the sector literally a safe bet thanks to its reliable income stream. “We’re on the precipice of a couple of very good years” for net lease, predicted Robert Corry, VP for acquisitions at Cole Real Estate Investments, during the “Investment Outlook” panel that closed out the morning’s sessions.

He added that within the next 12 months, we’ll start seeing more deals at the other end of the spectrum from where the competition is currently the most heated: core assets in core markets. Town Hall panelists Trevor Bond, president and CEO of W.P. Carey & Co., noted a bubble already forming for high-quality assets, while keynote speaker Thomas Sittema, CEO of CNL Financial Group said that when it comes to secondary and tertiary assets, “you can’t give some of them away.”

Similarly to what’s been happening across the major property sectors, the bifurcation between the choicest net lease assets and “everything else,” as Cole put it, underpins a great deal of what’s happening in the current market. A theme frequently sounded by panelists was the compression of cap rates due to the focus on investment-grade properties. Observed “Debt Financing” panelist Stephen Olsen, managing director of GI Partners, “Cap rates have dropped awfully fast relative to the fundamentals.” He had a similar observation about the proliferation of private REITs even as underlying market fundamentals haven’t quite kept pace.

Whether public or private, “the REITs are going to drive this bus,” predicted Amy Levenson, executive managing director of special situations at NAI Global New York City, during the “Debt Financing in Today’s Market” panel. However, panelists also pointed to the resurgence of CMBS, although with underwriting that looks more like 1996 than 2006. Yet Philip Carroll, president of American Real Estate Capital, suggested that the potential for CMBS to crowd out life companies in the net lease sector is “overstated.”

With the specter of rising interest rates a concern across the spectrum of commercial real estate, Town Hall panelists offered predictions on what effect higher interest would have on cap rates. Bond said he expects both interest rates and inflation to start creeping upCEO Paul McDowell of CapLease quipped, “If you continually predict that interest rates will go up, someday you’ll be right.” He cautioned against making prognostications based on what’s happening at the moment, given the unexpected global events we’ve seen in recent months. That being said, McDowell predicted that cap rates would widen.

Whether an inflationary environment benefits commercial real estate depends on what happens with interest rates, Sittema offered in his keynote address—although he said it’s pretty much a foregone conclusion than interest rates will have to go up. Certainly, the strengthening overall economy has been a boon, with positive absorption across most sectors for the past two to four quarters. The lack of overbuilding was another plus heading into the downturn; in fact, new construction reached 30- to 50-year lows in many markets.

During the depths of the downturn, there was “de minimis” transaction volume, Sittema said. As 2010 doubled 2009’s volume, so this year will be double last year’s numbers. However, Sittema said the result would look more like 2003 than 2007, with volume still 70% off the peak.