Net Lease Returns Shine Amid Low Cap Rates

NEW YORK CITY-In the net lease sector, “Cap rates are effectively too low to make much economic sense,” Richard Rouse, vice chairman and CIO at the newly renamed Lexington Realty Trust, said Tuesday. Even so, said Robert Micera, CIO for office and industrial at Cole, “it's still an attractive risk-adjusted return” given the alternatives to available to investors, a point also made by Ric Russell, managing partner at Cassidy Turley.

The three CRE veterans were among an all-star lineup assembled for this year's RealShare Net Lease, held Tuesday at Convene in Midtown Manhattan. The focus on cap rates pointed up the fact that net lease has become a go-to for a wide array of investor classes, from pension funds to overseas buyers. The popularity of the sector was also reflected in this year's conference attendance: nearly 300 CRE professionals gathered to glean insights from Rouse, Micera, Russell and about three dozen other industry leaders.

What Jeff Hughes, managing director of investment sales at Stan Johnson Co., called the “elephant in the room”—the imbalance between demand and supply of desirable product—came up frequently in the discussion. Ninety percent of net lease capital is chasing “a narrow sliver” of the market, with the sought-after core assets comprising perhaps 1% of what's available, observed Peter Weisman at ARC Trust.

If this state of affairs doesn't change, the sector could become like the multifamily market, where “buyers are lining up for the privilege” of acquiring an asset with zero cash flow in the hope that it might produce income later. Nonetheless, “uninvested capital sitting on the sidelines is a wasted opportunity,” said Weisman, director of acquisitions, office and industrial investments at ARC Trust.

Part of the problem in terms of the supply/demand gap is what Cole's Robert Corry called “under-demolished” product. In both suburbs and CBDs, there's a need for new product, the kind that tenants will want to commit to long-term, said Corry, VP of acquisitions for office and industrial.

In the capital markets realm, Merrie Frankel at Moody's Investors Service noted the resurgence of CMBS. Having bottomed out following the 2008 capital markets crisis, origination of securitized CRE debt hit $50 billion in 2012 and is on pace to reach $75 billion this year, a 50% increase. Even so, Frankel, VP of CRE finance, said her Moody's colleagues on the firm's CMBS desk haven't seen very much of that going toward net lease.

Similarly, Teddy Kaplan, managing director at Angelo, Gordon & Co., said that about 10% to 15% of assets that his company is taking to CMBS wind up not closing at proposed. That may change as the market becomes more robust, he added.

Cap rates have compressed as capital has chased net lease assets; will they tighten further? In retail, there's no room for further compression, but there is in office and industrial assets, noted Gino Sabatini, co-head of global investments at W. P. Carey. Rouse foresaw little change in interest rates over the next 12 months, so accordingly he predicted there will would be little movement in cap rates.

The low-interest-rate environment came up for comment by William Kahane, co-founder of American Realty Capital. Referring to Ben Bernanke, Kahane quipped, “Uncle Ben has given us all a kiss on the cheek through 2015.”