Net Lease News

Net Lease News

January 17 – January 23, 2023

MARKET

THE FED’S NEW CHALLENGE: STAY ON THE GAS OR TAP THE BRAKES?

• The Federal Reserve spent most of last year in emergency mode, scrambling to catch up to inflation. Now central bankers agree that phase of their work is wrapping up. What they’re still trying to figure out is what comes next.
• Fed officials will convene for their first policy meeting of the year on Jan. 31 and Feb. 1, when they’ll raise interest rates for the eighth time in a row to combat pandemic-era inflation. Exactly how much isn’t clear yet. Financial markets and analysts increasingly expect a quarter-point hike — down from a half-point in December — thanks in part to encouraging data showing that inflation continues to fall.
• A slower pace, Fed watchers say, would make clear that the central bank is no longer in a desperate game of catch-up. Instead, it could now be paying closer attention to the risks of overdoing it, especially since policymakers still have to wait and see how drastically what they did last year might hamper the economy in 2023.

PRICE DISCOVERY LIKELY TO CONTINUE AS RATE HIKES PERSIST

• Price discovery battles between buyers and sellers of commercial real estate are likely to continue amid interest rate uncertainty — but hope is on the horizon.
• Digging into the structural changes at play in the leasing market since the pandemic, suggests a “bifurcation” of the market in which Class A and trophy projects remain in high demand while outdated assets struggle to find tenants and ultimately are repurposed.
• There is a trend already that tenants are trying to sign up for shorter leases because it’s very hard to predict how much space you’ll need in 10 to 12 years from now. That trend has been accelerated during the pandemic…Many of the outdated buildings will be obsolete going forward, especially in environments where there are many dated office buildings.

EXPIRING INTEREST RATE CAPS TO FUEL DISTRESSED PROPERTY SALES

• An exponential increase in the cost of interest-rate caps—insurance that CRE borrowers with floating rates purchase to hedge against rate increases—may soon spawn a wave of property sales in an increasingly distressed market.
• When interest rates were low, derivative contracts offering hedges on multimillion-dollar mortgages could be purchased for as low as $10K. Now—as the lion’s share of these insurance contracts are expiring—the cost of rate-cap hedges is as much as 10 times higher than it was a year ago.
• Many property owners may not have the liquidity to pay the increased insurance costs. A surge in property sales is expected this year from owners who chose to unload their assets rather than spend millions on a new rate cap.
• A wave of property sales spawned by spiraling rate-cap costs would magnify an already intensifying credit crisis in commercial real estate. According to a new report from Bloomberg, almost $175B of global real estate debt is already distressed, four times more than any other sector in the global economy.

INDUSTRIAL

GROCERY GIANT KROGER EMBRACES ENTERING NEW MARKETS – WITHOUT OPENING ANY STORES

• Kroger, the largest U.S. supermarket chain, has done what was once deemed impossible: expanding its business into its 36th state without opening any stores.
• Instead of setting up a traditional brick-and-mortar store, the Cincinnati-based grocery chain with more than 2,700 U.S. stores opened up an industrial hub in Oklahoma City that will deliver groceries directly to customer’s homes through online and app orders and delivery.
• The hub — Kroger’s first in Oklahoma — serves as a last-mile delivery facility that gets its goods from an advanced robotics warehouse in Dallas about 200 miles away.
• The future of the grocery business is found in technology, Williams said, even as Kroger seeks to pair the ease of e-commerce for its customers with the experience of browsing for groceries and goods in the store. Kroger is also testing other innovations, including autonomous delivery of groceries in Phoenix and the possibility of drone delivery. 

RETAIL

FIVE BELOW TO OPEN 200 STORES IN 2023

• Citing “momentum” from its holiday sales, retail chain Five Below has announced the most aggressive expansion plan in its history, opening new stores in 200 locations this year.
• The company announced its latest expansion blueprint in a release detailing Five Below’s sales for the holiday season stretching from Oct. 30 to Jan.7. Five Below said its sales rose 11.2% during this period, topping $1B for the first time; this compared with $902M in 2021, when the chain broke even. Five Below expects its net sales to come in (its fiscal year ends Jan. 28) above $3B for 2022.
• The expansion of dollar stores has been turbocharged by their ability to do well in sparsely populated areas of the country, bringing the economies of scale of a national chain with national buying power to locations that have a lower cost of labor and operations than urban and suburban areas.

BRICK-AND-MORTAR RETAIL AND ITS 2023 ‘EVOLUTION’

• Shifts in the size, number, and type of retail stores are among the trends to watch for in 2023.
• Smaller stores. A smaller store can offer a more curated selection of items and not be as overwhelming to its shoppers – not to mention a cost-saver for the merchant when it comes to overhead. Target has made this work with its smaller locations in college towns that stock campus and dorm essentials.
• Fewer stores. Reducing the portfolio can help retailers avoid “cannibalization of visits” and increase the most out of every location. For CVS, fewer, but strategically placed locations, support its new healthcare-focused initiatives while increasing efficiency and foot traffic allocation.
• Store inside a store. The shop-in-shop retail format – where specialty brands open a branded “shop” in a larger department or big-box store – helps the bigger retailer broaden its product selection, differentiate itself from competitors, and increase engagement. The Kohl’s and Sephora shop-in-shop partnership launched in 2021 continues to demonstrate the retail format’s ability to drive foot traffic.

CONVENIENCE STORES ARE BOOMING IN MOST STATES

• The number of convenience stores across the US is on a steady uptick, according to new research, with 39 states and Washington D.C. all posting increases in 2022.  The increase was fueled by an upswing in the number of single-store operators, which increased by 1087 to 90.423 stores.
• Convenience stores have emerged as a net lease darling as of late, with an average on-market cap rate of 5% as of late November 2022, according to B+E Net Lease, and a 2022 year-to-date sale cap of 5.26%.  
• “C-stores are garnering a positive perception from both private and institutional investors due to their strong tenant credits, strong profit margins, and large variety of concepts,” B+E analysts note in a recent report. “This variety encourages customers to spend more time at the location and, in turn, spend more money.”

OFFICE

MICROSOFT TO LAY OF 10,000, SPEND $1.2B CONSOLIDATING OF

• Microsoft has announced it will lay off 10,000 employees by the end of the third quarter, the latest sign of tech giants shrinking in the face of economic challenges.
• The Redmond, Washington-based tech giant, in a memo to employees filed Wednesday with the Securities and Exchange Commission, said it would incur a $1.2B charge due to consolidation on its next earnings report. It cited lease consolidation and severance costs among the reasons for the loss, but didn’t reveal how much real estate it would cut. 
• The changes follow news of Microsoft’s shrinking footprint in multiple U.S. cities. The tech giant is exiting hundreds of thousands of square feet of office space in Washington, including a 585K SF space in East Bellevue and a 396K SF space in Issaquah.
• The new layoffs are the latest for a tech industry that has been in a state of contraction for months. Salesforce, Meta, Twitter and Amazon have all embarked on layoffs of their own, fueling the office sublease market in the process.