Where to place your net lease investment emphasis.
David Sobelman was invited to write the following article for the January 18th issue of Commercial Property Executive.
“I’m looking for a low-yielding property.” This is most likely a phrase that has never been spoken. But when discussing the options of where to place the most underwriting emphasis for your net lease investment, most investors—institutional entities or individuals using their own money—frequently use the credit of the tenant and terms of the lease to determine the majority of the value of the asset. When a linearly focused valuation of an asset is used, there may be a tremendous amount of data that is overlooked when considering the real estate investment.
It should be noted that the most conservative way to invest in a single-tenant net lease investment is to start your underwriting knowing that the parcel of land and the four walls of the building actually matter. A tenant, no matter what its credit may be, may occupy a property for 50 years and provide a nice long-term income. However, when they decide to leave, whether its in five decades or in five months, you are left with real estate to either re-tenant, re-purpose or sell. Fundamental real estate investment variables become paramount when you have a vacant building or land. An investor, and subsequent future users, are not going to look at your asset the same way you did so many years ago: solely as an income producing asset that was purchased by paying a market cap rate. New tenants will now focus on geography, specific location within that geography, traffic patterns, access to the location, permitted uses, among other factors. In essence, tenants will need to deduce whether the site fits their business model, whatever that may be in their operational life-cycle. Therefore, buying a real estate asset, whether its income producing from a net lease tenant or completely vacant, will determine how many options you have going forward.
While moderating a panel discussion on the state of the net lease market in New York last September, the panelists were asked if they would purchase a net lease investment in the then-current market and if so, what would they purchase. Each panelist framed their answer as to what they would purchase with their own money except for one member, Will Pike of CBRE. Will mentioned that he was not a buyer of any net lease asset type in the market due to the compressed cap rates that are being offered for the assets he regularly sells to others. However, it was interesting that he, nor the other panelists, put any value on the real estate underwriting that could actually make the investor more money over the ownership of the asset. This phenomenon of valuing a net lease property as an actual real estate asset is readily discussed but rarely practiced. Data from multiple sources, including Real Capital Analytics, Moody’s, Morgan Stanley and Case Schiller, all point to the fact that densely populated areas typically have the highest rate of real estate value appreciation as well as rent growth. The panelists linearly and directly considered only the credit and initial cap rate of the investment and there was no consideration of that asset appreciating in value from a real estate perspective.
Even though the data shows that better real estate typically equals higher long-term returns, an investor should decide whether a net lease investment is either a core real estate asset or a financially engineered mechanism that provides a stable return. Whatever the motivation of the investor, deciding on what is more important from the outset is of paramount importance.
David Sobelman is the founder & CEO of Generation Income Properties (a public net lease REIT)