The Markets Developers Are Avoiding as Net Lease Deal Structures Change

Ben Hidalgo, CEO of Net Lease Development, said that the firm avoids states like Alabama and Louisiana because the product simply doesn't trade well there.

Oversupply and Rising Construction Costs Causing Issues

Two problems exist nationally for net lease, according to William Wamble, executive vice president & principal at SRS Real Estate Partners. One of them is the fact that there are too many options for net lease buyers today.

"I would say, [there's an] oversupply of listings that we need to work through to get back to the board of [the] seller-buyer, equilibrium specific to network retail [with that] probably trickling into industrial as well," he said.

As things are trending now, Wamble notes that buyers are gravitating toward properties with low replaceable rents due to the "higher prospects of backfilling it."

Another problem is rising construction costs, which most of the panelists agreed on. Warren goes as far as saying the construction and land expenses are growing more rapidly than rents.

"It's harder and harder to have them sign long leases, so you actually have to do more and more build-to-suits," Warren explained, but yet warned that build-to-suit structures aren't the easiest to complete in this environment.

"I'd say the total cost increase is 50% between land and construction coming out of Covid, and that's just been a big headwind for continued development growth," Hidalgo said.

Deals Structuring Changes but not Worse Off

The panelists also discussed how deals are being structured currently in the environment with high interest rate volatility and economic headwinds.

From Hidalgo's perspective, deals are "thinner, with more ground leases seen — yet he emphasizes that "returns are still great."

"We're doing more lease structures with tenants, where we're capping our exposure," he noted.

"So we, if we're building ability for the cost $2 million, we might say, 'hey, we're funding the first million. You're funding the next million.' That can keep those rents in an affordable price range that will trade on the market, will sell and also work on the tenants' financials."

In other words, this isn't necessarily a bad thing — deals just come to fruition differently to navigate around the rise in costs.

Interestingly, Iacono notes that a volatile market can actually be favorable at times because clients look for security, which could increase CBRE's deal volume elsewhere.

She recalled: "Sometimes that's great for us, because we get a lot of calls saying, 'I really need to diversify out of the stock market. What can you put me in that's safe and stable and long term?'

"So more volatility. I think we're going to see increased focus on gas, convenience, corporate [and] QSR]."

Skilled Negotiation a Necessity Now

Something Iacono has been noticing with lease structures is that tenants are doing more diligence and are pushing for more favorable terms due to rising costs. One of them is cam caps, which she sees developers conceding too often on when they should hold their ground.

"I think keeping the leases as clean as possible and just taking a little extra time to fight with the tenant over getting those caps out, roof and structuring [and] all the big things that they try to push back on landlords," Iacono explained.

"Pushing those back on the tenant is making a huge difference in what's moving and what's not."

Overall, the panelists agree that net lease buyers are getting wiser as costs rise. Skilled negotiation is becoming more critical in this environment, as deal structures change.