General
What’s Next for Net Lease?
The effect of rising interest rates registers in many ways around the real estate world, but perhaps the starkest impact can be seen in the investment volume differential in one of CRE’s most popular sectors. Net lease investment volume decreased roughly 35% year over year in the third quarter, according to Jason Patterson of W. P. Carey. The VP of investments at one of the largest diversified net lease REITs notes the Fed’s impact on market players has been far-reaching. “Net lease volume prior to the Fed moves had been near or at record levels so the run-up in rates certainly impacted people getting on the same page with the value of real estate or what they were willing to commit to on a cap rate basis,” Patterson said. “A high level of volatility in a space where people are making long-term investments is not the ideal environment.” A Debt Market in Disarray Call it a pause, a disconnect, or total debt market disarray, 2022 has brought major headwinds to a CRE industry and net lease sector that have gotten accustomed to cheap capital. Yet, Patterson reports still seeing a lot of attractive opportunities in the market. “Private equity-backed sellers or tenants continue to use sale-leasebacks as an attractive form of unlocking tied-up capital in their acquisitions, a counter-inflationary move that in some cases has been beneficial to us,” he said. “They’re viewing it more and more as a regular, very attractive component of the capital stack, which I think is good from a broad industry perspective.” Unencumbered by rising capital costs, equity investors have certainly found more room to work within the net lease market “The current environment favors people in a high certainty or all-cash type of capital structure like W. P. Carey,” Patterson said. “We’ve seen increased focus on certainty of close as levered buyers signed up for deals maybe in the early part of the summer and then with rising debt costs their assumptions didn’t pan out. You see deals come back to market as more investors have to reevaluate pricing in this period of volatility.” 2023 Outlook Citing the first half 2022 industrial deal volume exceeding more than 50% of the STNL market, Patterson forecasts that industrial product will continue to be a very attractive investment target. He added though that not all industrial product types are created or viewed equally. “Rather than just lump everything into broad industrial, we’re looking for real estate that is extremely critical to operations for our tenants,” he said. “Maybe we’re willing to give up a little bit in terms of fungibility for increased certainty that tenants are going to renew and keep paying rent for the long term. Asset classes such as cold storage and food production are extremely important to users and they don’t have a ton of alternative options available.” A $75 million sale-leaseback W. P. Carey completed in the second quarter embodies the above trends. The 25-year net lease for six mission-critical specialty manufacturing facilities totaling approximately 1.1 million square feet in three countries is backed by private equity. “There continue to be more and more deals getting done with private equity sponsorship, and we’d expect that to largely continue in 2023,” Patterson said. “The trend, a positive one for the industry, really is private equity ownership looking toward sale-leasebacks.”
Sail Through Inflationary Headwinds with Net Lease REITs
Experts are sounding the alarm bells regarding an impending recession due to sustained inflation, rising interest rates and conflict in Europe. As a result, some investors are questioning whether their portfolios are resilient enough to weather an economic downturn. For investors seeking a reliable dividend stock to add to their portfolio, one worth considering is a net lease real estate investment trust (REIT). REITs are companies that own or finance different types of properties and net lease specifically refers to the triple-net lease structure, whereby tenants are responsible for paying expenses related to property taxes, insurance and maintenance. Net lease REITs generally own single-tenant properties leased to creditworthy tenants and operate like corporate bonds due to their long-term leases. However, unlike bonds, net lease REITs can grow substantially through a combination of rent increases and external acquisitions, offering both stability and the potential for long-term growth. In today’s volatile market, here are three reasons why investors should consider adding net lease REITs to their portfolio. Stable dividend yields provide long-term income REITs have high and reliable dividend payouts compared to other stocks due to the REIT structure which requires at least 90 percent of taxable income to be distributed to shareholders as dividends. Several REITs have also increased their dividend over time, which has historically outpaced the rate of inflation and provided investors with steadily growing income. Furthermore, REITs can offer long-term capital appreciation through stock price increases, providing investors with total returns comparable, and often higher, than those of other stocks and fixed income investments. This demonstrates that REITs can be an attractive investment option for both income- and growth- focused investors. Contractual rent increases offer hedge against inflation Some net lease REITs provide natural protection against inflation due to contractual rent increases imbedded in their leases. These can be fixed or linked to an inflationary index such as the consumer price index (CPI). CPI-linked rental increases enable REITs, in particular net lease REITs that are not responsible for property management expenses, to directly offset inflation and pass on rising costs to the tenant. Inflation also tends to increase property prices which increases the overall value of a REIT’s portfolio; however, this growth is tempered by a REIT’s increased cost of debt due to rising interest rates. Regardless, these characteristics help protect investor returns against inflationary pressures, adding resiliency to a portfolio. Diversification protects against certain market risks Some net lease REITs offer diversified portfolios of real estate, meaning they invest across a range of property types, geographies and tenant industries. This ensures that no individual tenant, asset type or industry will have an outsized impact on overall performance, insulating investors from individual market risks and offering stability in economic downturns. Net lease REITs also offer diversification compared to other stocks and bonds an investor may own in their portfolio, as real estate is a distinct asset class that has demonstrated low correlation with other sectors of the stock market. In other words, net lease REITs tend to outperform when other assets in a portfolio are struggling, offsetting market volatility. Conclusion When investors are choosing a net lease REIT for their portfolio, it’s important to consider that not all are created equal. Selecting a REIT with an established history and experience performing in all market cycles will ensure investors are protected from adverse impacts, while reaping the benefits of stability and growth over the long term.