Northbrook, IL—The latest data reveal that cap rates have started to rise, albeit marginally, for each of the three core property types of the net lease market. In addition, it looks as though prospective sellers have flooded the market with available properties, hoping to hop aboard the low-cap-rate train as it pulls out of the station. Cap rates are expected to continue their upward track as interest rates continue their climb and property supply outstrips demand.

Those are among the findings indicative of a real turning point in the market in Boulder Net Lease Funds LLC's Q2 Net Lease Market Report, after many quarters of largely same-old, same-old trends. "For the first time in over a year at least, there were significant changes to the market," Jeffrey Rothbart, principal of Northbrook, IL-based Boulder and author of the company's research reports, tells NET LEASE forum. "We knew these types of numbers were going to show themselves this quarter, but we think the real effects will not be seen until the numbers for Q3 are out."

The biggest increase in cap rates, according to the Boulder report, was the 23 basis point rise in the net lease industrial segment, bringing mean cap rates to 8%. Next was office with a 20 basis point increase to a mean cap rate of 7.7%, and finally retail with a 10 basis point increase to a mean 7.1% cap.

The findings seem to be in line with othere data. "Rising interest rates have started to temper sales and change the mix of buyers for retail properties, but cap rates have not yet increased materially," according to the May Retail Capital Trends Monthly report from Real Capital Analytics Inc. in New York City. Importantly, the report adds, "So far, cap rates for net-leased properties have been the most impacted." And, the Q1 Korpacz Real Estate Investor Survey from global consulting firm PricewaterhouseCoopers reports a small, 4% increase in average overall cap rates for net lease properties as compared to both the prior quarter and one year earlier.

Another significant and intertwined market development noted in the Boulder research is a staggering increase in the number of properties available for purchase: a total of 14,450 properties, representing an 86% increase over Q1. "The low cap rate period was driven by two things: low interest rates and a major imbalance between supply and demand," notes Boulder's Rothbart. "Now, because you've got this increased supply, cap rates are moving up to reflect the increase in interest rates. Cap rates are going to go up much more significantly in Q3 than they did in Q2, because the market can't sustain where it is."

Paul H. McDowell, CEO of New York City-based investor Capital Lease Funding Inc., says the increase in supply has been less apparent in the larger asset segments. He says that overall, net lease market cap rates have reached a turning point. "You've clearly seen a bottoming of where cap rates are," says McDowell. "They will start to move in the other direction."

The changing dynamics of the net lease market have become evident in other ways, particularly in terms of anecdotal reports of properties being returned to the market with pricing readjustments. With the uptick in interest rates, brokers have been finding that while they put together a book on a property in one environment, months later they were trying to broker deals with buyers in a different environment, says McDowell. "I think we're seeing the end of that process right now."

Rothbart also tells NET LEASE forum that the number of properties that Boulder tracked as being sold during the quarter was staggering--he estimates sales increased 250% to some 12,000 assets. "I think that what that shows is buyers thought the cap rates were getting better," he notes.

Rothbart relates that while it's hardly a buyers' market, it is becoming less of a sellers' market, again thanks to increased supply and rising debt costs. "You just can't sustain the low cap rates that were going on," he concludes. "It doesn't make sense from a purchaser's perspective anymore. You can't make the numbers work to get any sort of real return."

McDowell agrees, adding: "I would say that it's still a sellers' market in that buyers are very squeezed between where cap rates are and where underlying Treasuries are. But on the flip side of that, there aren't as many buyers around, and that will inevitably force sellers to readjust pricing."