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Articles

WMRE 2022 Midyear Outlook:

B+E > B+E INSIGHTS > Articles > WMRE 2022 Midyear Outlook:
WMRE Midyear Outlook
07/29/2022 By Camille Renshaw in WMRE Publication

Surge in net lease inventory creates more buying opportunities

by Camille Renshaw, CEO and Co-Founder of B+E

Net lease investors on both ends of the spectrum, institutions and individuals, have capital to spend and plenty of buying options.

B+E research shows that the volume of on-market net lease assets has surged across almost every category in recent weeks. QSR listings have experienced the biggest jump, increasing from 436 in 1st quarter to 646 at the end of 2nd quarter. Dollar stores have risen from 326 to 468 and convenience stores from 179 to 237 listed properties. 

It’s no surprise that inventory has soared along with rising interest rates. Some owners believe the music is stopping, and they want to take advantage of historically low cap rates and high sale prices. Despite Fed interest rate hikes that began in March, net lease asking cap rates moved very little in 2nd quarter. In fact, the movement that did occur was further cap rate compression. For example, the average asking cap rates on net lease dollar stores tightened from 6.0% in 1st quarter to 5.78% in the 2nd quarter, according to B+E’s Q2 2022 Net Lease Cap Rate Report. 

That cap rate stability is partly because there is no formal relationship between mortgage debt constants – the true mortgage rate – and cap rates. If mortgage rates go up 100 basis points, it doesn’t necessarily mean that cap rates go up 100 basis points. One impact from higher debt costs that’s noticeable in the net lease market is that buyers are bringing more equity to deals and using less leverage. Previously, the average buyer was using debt for an estimated 65-70% of the capital stack, and in the 2nd quarter that dropped back to 55-60%.

Cap rates have also been buffered by the fact that a large number of deals were under contract in 2nd quarter when mortgage rates moved, and those sellers now have 1031 exchanges they must complete this summer. Continued demand created by these exchangers is keeping pressure on pricing. This demand may dissipate after Labor Day.

The outlook for cap rates in the second half of the year is likely to be more bifurcated. The volume of institutional capital targeting larger assets priced above $5.5 million will keep pressure on corresponding cap rates. The top 10 institutions active in net lease have raised between $1 billion and $2 billion each, and they will be under the gun to deploy that capital before the end of the year. In contrast, demand may decrease slightly among individual buyers, which could result in an uptick in cap rates for deals priced below $5.5 million. 

One unique aspect of the net lease market is that a significant percentage of the market is driven by 1031 exchangers. As evidenced by the rise in inventory, some individual investors are positioning to take advantage of a pricing shift. The typical transaction at B+E takes 125 days to complete. In this market, a lot can change in those 125 days. 

Potentially, a seller could sell at the top of the market this summer and then buy in an environment this fall, when pricing is likely more favorable. Continued increases in inventory could also weaken pricing in some categories, which could enhance buying opportunities in the fall.  Sellers want high pricing, but they don’t want to exchange back into the same frothy market. When can they sell and get really great pricing, and yet still find opportunities? It’s often when the market turns, like it is now. 

Click here to view the full WMRE 2022 Midyear Outlook Publication.

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