‘We’re Bullish On Net Lease Retail’
Why W. P. Carey Is Doubling Down On The Asset Class
Investors are flocking to the net lease sector anew as the Fed pauses its rate actions and cap rates stabilize, W. P. Carey’s Michael Fitzgerald told GlobeSt. GlobeSt's Holly Amaya spoke with Fitzgerald at ICSC Las Vegas about the state of retail net lease and what has changed in the sector from last year.
In this video, you’ll learn:
- Why he continues to be bullish on net lease retail,
- What an increase in cap rates has meant for investment, and
- How the sector will fare in 2024 and beyond.
Watch now
An interview with Michael Fitzgerald, W. P. Carey, and Holly Amaya, GlobeSt.com.
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Why Net Lease Continues to Draw Investors
The net lease retail sector continues to outperform despite changing interest rates, with a growing number of retailers expanding their footprints or developing new properties against a “compelling” cap rate environment. That’s according to Michael Fitzgerald, executive director, head of US Retail, W. P. Carey, who told GlobeSt at ICSC Las Vegas that many retailers are “aggressively expanding” in their markets. “We’ve seen a lot of activity in sale-leaseback and we are bullish on net lease retail,” Fitzgerald says. “The retail sector is enormous – and we’re chasing deals.” Fitzgerald also discusses: The state of retail fundamentals How investors are responding to changing interest rates and economic uncertainty What makes W. P. Carey stand out from its competitors in terms of investment opportunities Watch now An interview with Michael Fitzgerald, W. P. Carey, and Holly Amaya, GlobeSt.com.
Navigating Net Lease Retail
Rising interest rates, increased cap rates, and sluggish deal activity created changes in the retail market over the past couple of years. Indeed, the bid-ask spread left many retail net lease deals stuck in negotiations. “There was a time when buyers and sellers found themselves pretty far apart, trying to find a way to meet in the middle,” says Michael Fitzgerald, executive director and head of US retail at W. P. Carey. “During 2023, we saw volume slowdowns of traditionally marketed sale-leaseback deals, as some sectors experienced 50, 75, or even 80 basis point increases in cap rates.” However, at the start of 2024, Fitzgerald notes that he’s seen a stable flow of developer-fueled deals and a higher demand for liquidity. As the market progresses into 2024 and beyond, understanding its direction can help investors make more strategic decisions. Low vacancy rates, creating new opportunities A recent report found that retail vacancy rates are at their lowest level in two decades, as rents continue to rise. The report compared 390 retail marketers across the United States and found that the national retail vacancy rate sat at just 4%. According to Fitzgerald, low vacancy rates are a positive sign that provides confidence in long-term leases and the ability to quickly replace tenants. “Let’s say a fitness operator signs a 20-year lease,” says Fitzgerald. “If retail vacancies are low, that’s a positive for us if we need to re-tenant, as we can likely replace them with a new tenant at or above the original price without compromising our income stream.” He explains that W. P. Carey typically focuses on finding deals in markets with growing rents, such as Phoenix, versus smaller and less vibrant markets. “When you get into underwriting situations where vacancy rates are low, it often allows us to get more aggressive with the cap rate and other deal terms,” says Fitzgerald. Looking into 2025 and beyond Another factor that could contribute to an uptick in activity is merger and acquisition deals. An increase in M&A typically corresponds to an uptick in sale-leaseback activity, as firms leverage proceeds as part of the capital stack for new acquisitions. Overall, Fitzgerald remains optimistic about the coming months. “I think the retail market will continue to be strong because there’s always compelling fundamental reasons why retailers want to sell their real estate rather than hold it,” says Fitzgerald. He explains that it comes down to retailers not being real estate companies. Businesses can generate better returns for investors by investing in their core competencies, ie. running retail operations, and often find holding onto real estate is a drag on their cash and liquidity. As a result, he predicts continued demand from retailers for creative ways to access that liquidity – such as sale-leasebacks.
Retail Revitalization: Key Takeaways from ICSC Las Vegas
After a two-year hiatus, ICSC Las Vegas – one of the largest conventions for the retail industry – made its big comeback with over 22,000 attendees getting together to discuss the opportunities and trends in the sector. Retailers, brokers and real estate investors were among the exhibitors on the conference floor, where a number of topics dominated the discussion. Rising rates and inflation, the retail recovery and resurgence of brick-and-mortar were among the biggest themes at the conference. Here’s an overview of each: Financing amid rising interest rates and inflation Inflation continues to rise at its fastest pace in 40 years, with the consumer price index reaching 8.6% for the 12 months ending in May. Interest rates have also been surging, with the Fed raising benchmark rates in its most aggressive hike since 1994. This challenging and volatile economic environment has made it difficult for retailers to secure traditional debt financing at attractive rates. However, one method of financing that has been gaining traction in the retail sector is the sale-leaseback – where a company sells its real estate to an investor for cash and simultaneously enters into a long-term lease. Big names such as 7-Eleven, Sherwin Williams and Mister Car Wash have made sale-leasebacks a core part of their growth strategies due to the ability to quickly unlock otherwise illiquid capital and reinvest those proceeds into their business. Retailers can also lock in a long-term rental rate which is especially advantageous in the current economic landscape while not having to worry about short-term refinancing or restrictive debt covenants. Retail revival Despite the challenging market environment, there was a lot of optimism for the retail sector at ICSC Las Vegas. Virtually all retail property types from grocery to c-stores experienced an increase in leasing activity over the past year – with retail tenants absorbing 91 million square feet of space nationally over the past 12 months. Furthermore, the retail sector is now seeing the lowest levels of bankruptcy filings in the past five years in addition to a steady uptick in foot traffic in physical stores. This is indicative of a larger retail recovery, leaving the sector in its best position since the pandemic began. Resurgence of brick-and-mortar Perhaps the biggest topic of discussion at the conference was the resurgence of brick-and-mortar retail. While many had predicted that e-commerce would be the way of the future, consumers have proved them wrong by returning to physical stores en masse. In 2021, retail sales totaled $5 trillion – with only about 13% of that stemming from e-commerce. Online shopping actually decreased year-over-year, demonstrating that consumers were eager to return to physical stores as the pandemic subsided. This increased demand also spurred many existing retailers to expand their store footprints and some online-only retailers to open physical stores. However, not all segments within retail are created equal, with some property types like movie theaters continuing to struggle while others like restaurants have thrived. Regardless, retailers have continued to adapt to meet the evolving demands of consumers, with omnichannel – a combination of e-commerce and brick-and-mortar – emerging as the prevailing strategy for success. Conclusion Despite a challenging few years for the retail sector, fundamentals continue to improve in 2022 as demand for high-quality retail assets returns and retailers look to cash in on owned real estate to improve balance sheet health and fund future growth. Interest rates, inflation and a rumored recession lingered in the air at this year's ICSC Las Vegas, but attendees were confident that the retail revival is underway.