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What the Latest Rate Cuts Mean for the Net Lease Sector
The persistent high cost of capital, along with the fact that large amounts of corporate debt are set to mature, have been ongoing challenges for investors. The Fed’s recent rate cut – the first in over four years – leaves many speculating how investors will fare. “Impacts from these changes will take some time to see,” says Zachary Pasanen, managing director, investments, at W. P. Carey. “I don’t necessarily believe we’ll experience a rush of investment overnight. Everyone is still in the process of figuring out what the environment will look like, and there are also geopolitical situations at play.” Cap Rates and Market Sentiment Pasanen suggests a positive outlook for the net lease sector, noting that while volumes are down compared to the previous year, the sector’s resilience remains. He explains that net lease investments function similarly to bond instruments, and with rates being cut, he doesn’t believe the risk profile changes that dramatically. “I think the risk paradigm is still very much in that 7%-8% cap range,” says Pasanen, noting that while conditions may eventually spur more net lease activity, it won’t take place immediately. He also cautions that investors should not get too caught up in “rate cut mania” and risk comprising spread. Focusing on fundamentals and maintaining a disciplined investment approach remain as important as ever. Relaxed Interest Rates and the Financing Landscape Funding business growth and quickly accessing capital have left many corporates looking for alternatives to traditional financing. With the Fed’s recent rate cut, Pasanen believes that sale-leasebacks will continue to be an attractive option. He further notes that while there have been pockets of “stress” in the market, these aren’t the same as “distress.” “Many lenders were willing to accommodate borrowers and work with them,” says Pasanen. “This group made it through this past year and is saying, ‘Okay, I’ve extended the maturity of my debt and identified some dislocation among acquisition targets, and now might be a good time to raise capital and grow my business.’” However, as these businesses return to banks to raise more capital, financial institutions may have reached a limit in how much they can help, a scenario where sale-leasebacks can be beneficial. “W. P. Carey has been in business for over 50 years,” says Pasanen. “We’ve been through numerous market cycles and have a lot of capital to deploy. As the market recalibrates, we’ll continue to do what we do best – work with corporate owners to unlock the value of their real estate through sale-leasebacks.”
A Resurgence of Investor Confidence
Earlier this week, real estate professionals from over 70 countries gathered in Munich for the annual EXPO Real trade fair. After a muted year of investment volume, participants were eager to meet with peers to discuss prospective deals and the outlook for the market. The mood can be best described in two words: cautiously optimistic. After rising interest rates caused months of uncertainty and volatility, attendees finally feel stability is on the horizon. Below are three key topics discussed as delegates look ahead to 2025. Interest rates on the decline Monetary policy decisions on both sides of the Atlantic were a major topic at this year’s EXPO. The European Central Bank began cutting rates this summer, followed by the Federal Reserve in September. These rate cuts are an indicator that inflation is on track to reach its target level for price stability. As a result, we’ve seen the bid-ask spread between buyers and sellers narrowing as real estate values adjust to more realistic levels. For investors waiting on the sidelines for economic clarity, this has also served as the impetus to start deploying capital into new and existing assets. At W. P. Carey, however, we would caution that investors should not focus too much on the next interest rate decision. Instead, they should consider the more important factor – long-term borrowing costs. Real estate investors typically borrow on a long-term basis given the length of their leases, so short-term rate cuts won’t have as much of an impact as some are anticipating. New sectors growing in popularity Post-pandemic challenges in sectors including office and some segments of retail have made investors far more selective in terms of capital allocation. Industrial remains among the most popular asset classes as it continues to benefit from strong market fundamentals. The e-commerce boom and logistics sector’s key role in European supply chains remain long-term growth drivers, while the emerging trend towards nearshoring will provide manufacturing and logistics with a further boost. We’re also starting to see some newer sectors growing in popularity. Self-storage, cold storage, senior living, hospitality and data centers have emerged as attractive investments, with strong operating fundamentals and positive long-term growth potential. As investors continue the flight to safety to protect returns, we expect to see a shift in the sectors – and geographic markets – receiving the most capital. An uptick in sale-leasebacks in 2025 Despite some volatility, the overall environment for sale-leasebacks remains favorable, with high-yield debt and leveraged loans continuing to be expensive. The influx of cash from a sale-leaseback remains incredibly valuable for companies, supporting debt restructuring, strengthening balance sheets and providing capital for operating expenses and growth investments. In addition, we continue to see interest from private equity firms in sale-leasebacks as a means of financing new acquisitions or bolstering the growth of portfolio companies. Last year alone, approximately 75% of W. P. Carey’s investment volume was attributable to transactions with PE-backed companies and we anticipate a significant portion of this year’s deal volume will be as well. While it will take some time for the sale-leaseback market to recalibrate and reach its new normal, we are starting to see the green shoots of a more stable industry as we gear up for a busy fourth quarter. We remain “cautiously optimistic” heading into 2025 and look forward to continuing to find opportunities to help companies unlock capital from their real estate assets.
Tenant Partnerships – The Road to a Sustainable Future
As Climate Week NYC approaches, the spotlight on sustainability is brighter than ever. For companies across industries, the annual event underscores the urgent need to address climate change. The real estate sector, estimated to be responsible for nearly 40% of global carbon emissions, plays a critical role in advancing this worldwide effort. At W. P. Carey, we recognize our potential to drive meaningful impact in the fight against climate change through our extensive portfolio of over 1,200 net lease properties. While the net lease model means our tenants have full operational control of their properties, we are committed to collaborating with them to achieve shared sustainability goals and enhance the quality of our properties. Here’s how: Gaining insights through data Collecting detailed energy data remains a core focus for us. Collaborating with our tenants to install IoT smart meter systems provides both us and our tenants access to high-quality utility data for their leased properties. This data can be utilized to assess energy usage for regulatory compliance as well as voluntary reporting. It also enables us to calculate the carbon footprint of our portfolio and identify opportunities to implement energy-saving measures at our properties. In 2023, we began a smart meter installation program with our European tenants, making the process more efficient for both W. P. Carey and our tenants while also reducing the risk of data errors. Renewable energy opportunities Renewable energy can reduce building operating costs and lower carbon emissions. One of the most accessible sources of renewable energy is solar power, which can be harnessed through the installation of solar panels. Particularly given the roof space that our industrial and warehouse assets provide, we believe we have a large addressable market for solar. Through W. P. Carey’s CareySolar® program, tenants have the opportunity to take advantage of rooftop and carport solar installations at their leased properties through a broad array of structures. These include: Landlord-operated Landlord-financed Tenant projects Rooftop leases W. P. Carey collaborates with each tenant to understand their current energy usage and determine the ideal solar solution for their unique property. In 2023, W. P. Carey extended the lease term with an existing tenant for their 265,000-square-foot industrial facility in Illinois. Simultaneously, we signed a 15-year power purchase agreement where we plan to build a 1,350-kilowatt roof mounted solar system that would offset 740 metric tons of CO2 annually. We will manage and fund the construction of the system and sell the power generated by the system to the tenant. Building energy retrofits Implementing sustainable features to improve energy efficiency has a huge impact on a property’s life-cycle emissions. W. P. Carey can do this through property-specific energy retrofits. An example of an energy retrofit is the installation of LED lighting. LED lights are 80% to 90% more energy efficient than other light bulbs and do not contain any environmentally hazardous materials. Additionally, LEDs last up to 25 times longer than traditional incandescent bulbs. In 2023, W. P. Carey completed a full LED retrofit at our 1.5 million-square-foot warehouse in University Park, Illinois. The LED project is expected to result in a 35% reduction in lighting electricity usage and 41% reduction in utility and maintenance bills at the property. Following the completion of the retrofit, we leased the property to Samsung for a term of 10.5 years. Green-building certifications Green-building certifications such as LEED and BREEAM can provide many benefits for both landlords and tenants. Achieving a green-building certification means that a property meets certain sustainability requirements across a variety of categories including energy, air quality and water usage. Certified buildings are typically more energy and cost efficient and create healthier work environments for employees. In addition to being more environmentally friendly, green-certified buildings can offer tax benefits. Many states offer tax incentives for green building projects, based on either energy savings or reaching a certain level of certification. Real estate studies have also shown that green buildings sell and lease faster than traditional buildings, and garner higher rents and lease rates. At W. P. Carey, we’re committed to achieving green-building certifications where we can, and our portfolio includes 6.6 million square feet of green-certified buildings as of June 30, 2024. In 2024, our state-of-the-art food research facility in the Netherlands received a BREEAM Outstanding certification, the highest level of BREEAM certification for buildings worldwide. Conclusion Reducing the carbon footprint of a net lease portfolio is an enormous challenge, but by bolstering tenant engagement and systematically identifying sustainability opportunities, progress is possible. Sustainable real estate is beneficial to the planet, attractive to tenants and improves the value of our broader portfolio, making it a win-win-win for all.
Navigating Economic Tides: Interest Rates & Commercial Real Estate
Last month, the European Central Bank (ECB) announced it would cut interest rates for the first time since 2019, bringing the deposit rate down to 3.75%. This decision came following Eurozone inflation declining from its 10.6% peak in 2022 to 2.5% in June. But what does this mean for the European commercial real estate market? Inflation is cooling The rate cut is an indicator that inflation is on track to reach the ECB’s target of 2%, which is its desired level for price stability. Investors are hopeful that more stability in the market will further narrow the bid-ask spread between buyers and sellers, helping boost transaction volume. The rate cut will also lower borrowing costs for some investors and encourage more bank lending, increasing liquidity in the market and encouraging those on the sidelines to start deploying capital into new and existing assets. Still a muted impact Despite the positive implications, most real estate professionals expect the impact of the cut will be muted. While it’s a first step in reducing borrowing costs, there is not a universal consensus as to how the ECB will view future rate decisions. In its July meeting, the ECB decided to keep rates stable. A key issue remaining for the commercial real estate industry is the refinancing risk for maturing loans. While the cut will likely help some borrowers at the margin, it is not expected to have a significant impact on the pressures facing those needing to refinance. Additionally, cutting rates too quickly may not be ideal for some European economies. If inflation climbs back up, the ECB may have to reverse course and increase rates again, causing further volatility in the market. It is also important to consider the divergence between the ECB and the U.S. Federal Reserve’s own decision to hold rates steady for now. This could impact the Euro-U.S. Dollar exchange rate, which feeds into inflation via the prices for imported goods and services. Final thoughts While the ECB’s decision has garnered a lot of attention, we believe the more important factor is long-term borrowing costs. Real estate investors typically do not borrow on a short-term basis, but rather on a 5- or 7-year fixed rate basis. In this context, SWAP rates often matter more than the ECB’s (short term) deposit rate. As a result, we do not see this decision having a significant impact on the real estate investment market at this point in time. Investors should remain focused on their long-term strategy and direct their attention to factors within their control like quality underwriting, timely execution and capitalizing on opportunities when they arise.
Keeping Up with Industrial in a ‘Wildcard’ Year
Uncertainty around interest rates, slowed transactional volumes, and a future of unknowns has left investors in the industrial sector watching trends closely. “This year has been a bit of a wildcard,” says Jason Patterson, senior vice president of investments at W. P. Carey. “People constantly speculate about what the future holds regarding interest rates, and we also saw a bit of softening on the lease demand side at the end of 2023.” As uncertainty persists, understanding a few key trends can help the industrial sector track what’s next as it moves closer to a new normal. Cost of Capital Challenges Persist As 2024 began, forecasts predicted multiple interest rate cuts; however, the Fed has held rates unchanged to date. Recently, it adjusted the previous forecast from three expected rate cuts in 2024 to one, against the backdrop of persistent inflationary concerns. Volatility around rates has also led to investor hesitancy in making long-term commitments, further impacting transaction volumes. “There is also a long and continuous trend toward e-commerce,” says Patterson. “In the near term, there has been a bit of volatility due to overbuilding in certain markets, and there is a bit more vacancy that needs to be absorbed. These shorter blips are relative to what seems to be a long-term trend toward higher value in industrial real estate.” Despite ongoing challenges, opportunities still exist for the industrial market, and understanding some existing tailwinds can help investors capitalize on these. Shift to Onshoring Onshoring is a continued tailwind for the industrial sector, especially on the manufacturing side according to Patterson. “It seems there is bipartisan agreement around a movement to onshore, as sentiments trend toward increased American manufacturing.” Upticks in high-tech chip manufacturing and transitioning the auto fleet to electric are also drivers of long-term industrial demand, says Patterson. While electric cars accounted for only 2% of vehicles in 2018, that number jumped to roughly 18% of all vehicles sold in 2023. A push toward more sustainable vehicle technologies could further drive long-term industrial demand, but Patterson cautions that continued growth could depend on the outcome of the election. Strategic Positioning and Access to Capital When operating in a market with many unknowns, a good place to start is focusing on what’s within your control, suggests Patterson. “Factors such as interest rates are out of the hands of most folks,” says Patterson. “We focus on sticking to our competitive advantage, which is underwriting sub-investment-grade long-term lease opportunities.” Agility is also key, as is working with partners who can support the market’s need for increased flexibility. According to Patterson, “This is a time when having a reputation for strong performance and access to capital is very valuable. At W. P. Carey, we are well positioned to execute with significant liquidity and capital, enabling us to be nimble in the current environment.”
The Power of REITs
Inflation, interest rate volatility and market dynamics have shaken the foundations of standard investment models. As a result, investors are looking for avenues that promise long-term growth and security. Investing in Real Estate Investment Trusts (REITs) has gained considerable attention, particularly because REITs have a unique blend of income generation, diversification and stability. So, what exactly are REITs, and why should investors consider them? What is a REIT? A REIT is a specialized company that owns, operates or finances income-producing real estate assets, including commercial and residential properties, hotels, healthcare facilities, industrial spaces and more. REITs were created by the U.S. Congress in 1960 to allow individual investors to access the benefits of real estate investment once reserved for institutions and wealthy individuals. One of the key distinguishing features of a REIT is its tax structure. A REIT must meet the following IRS requirements: Income Distribution: Distribute at least 90% of taxable income to shareholders as dividends. Asset Composition: At least 75% of assets must be invested in real estate, cash or U.S. Treasuries. Shareholder Requirements: Must have a minimum of 100 shareholders and no more than 50% of its shares can be held by five or fewer individuals during the last half of the taxable year. Types of REITs There are three main REIT types, each with different specializations: Equity REITs: Own, manage and develop income-generating properties (e.g., industrial, retail or warehouse facilities). Mortgage REITs: Invest in or originate mortgage loans and mortgage-backed securities, often borrowing money at lower short-term rates and investing in higher-yielding mortgage assets. Hybrid REITs: Combine features of both equity and mortgage REITs. Benefits of Investing in a REIT REITs have gained significant popularity among investors in recent years, and for good reason. They offer a range of potential advantages, including: Accessibility: Offer access to the real estate market with a lower initial investment. Diversification: Enable investors to diversify investments across different properties in various real estate sectors and geographic locations. Steady Income Stream: Can provide reliable income due to requirement to distribute 90% of their taxable income to shareholders as dividends. Liquidity: Publicly traded REITs offer more flexibility as investors can quickly buy or sell shares on the stock exchange. Professional Management: Typically have a management team of experienced real estate professionals who leverage their expertise in portfolio management to optimize property performance. Portfolio Growth Potential: Offer portfolio growth potential from property appreciation and higher rental income. Tax Advantages: Provide a tax-efficient investment option, with dividends often taxed at lower rates than ordinary income, allowing investors to grow their wealth more efficiently. Why Should Individuals Invest Now? REITs offer investors a unique opportunity to gain exposure to the real estate market without the burden of property ownership and can provide steady income streams and the potential for long-term capital appreciation. Their comparatively low correlation with other assets also makes them an excellent portfolio diversifier, which can help reduce overall portfolio risk. As a result, REITs may be a valuable addition to an investment portfolio for individuals seeking steady income, diversification or a combination of both.
‘We’re Bullish On Net Lease Retail’
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.
Countdown to ICSC Las Vegas
ICSC Las Vegas, one of the largest tradeshows for the retail industry, is on the horizon with an expected 30,000 attendees eager to network and reconnect face-to-face with industry leaders and peers. After a somewhat sluggish 2023, attendees will be looking to the conference to shed some light on the retail landscape and offer insights on new trends and opportunities within the sector. Consumer spending, retail vacancies and sale-leaseback activity will be among the most pressing topics discussed at the show. Here's an overview of each: Consumer spending remains steady Despite inflationary concerns, consumer spending has remained steady over the past year, as core retail sales, excluding gasoline, food service and auto vehicle purchases, increased by 3.3% at the end of 2023. As a result, demand for retail space has remained strong and the market is starting to see in uptick in new developer-built retail locations coming online. W. P. Carey has completed several deals that align with this trend – for example, the acquisition of 22 recently built and to-be-completed car wash facilities across the U.S., leased to Tidal Wave Auto Spa, a prominent car wash operator. With interest rates projected to decrease in late 2024, the market will likely continue to see a ramp up in new development over the coming months. Retail vacancies at record lows Strong demand for retail space has resulted in record-low vacancy rates, with total retail vacancy reaching 4.2% at the end of 2023. Low vacancy rates are a positive sign for investors like W. P. Carey as it provides greater confidence in long-term leases and the ability to re-lease vacant buildings if the need arises. However, it also means more competition for less space which is pushing retail rents significantly higher. This makes it more expensive for retailers looking to expand and acquire new space, which in turn increases operational costs. Sale-leaseback activity picks up With rents rising significantly, retailers – particularly those looking to grow their real estate footprints – will be seeking new ways to access capital. This will likely contribute to greater demand for sale-leasebacks, where a retailer sells its real estate to an investor (like W. P. Carey) for cash and simultaneously enters into a long-term lease. This is a valuable business decision for most retail companies because owning real estate can serve as a drag on their balance sheet. By unlocking the value of their real estate through a sale-leaseback, retailers can reinvest proceeds into their core competencies, leading to better overall returns and long-term growth.
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.