Within the single-tenant net lease space, I often get asked whether I believe there is a bubble in commercial real estate due to cap rates being below 2006 levels. The honest answer is I don't know, and neither do most people. Bubbles are generally discovered only after they pop.

I can, however, provide you macroeconomic data that highlights some critical differences between the current situation and the years leading up to the financial crisis. In my mind, these differences justify a continued optimism for the STNL market.

Below is a graph comparing three things:

1. Average cap rate by year from Calkain's STNL Comp Database (blue)
2. Average retail cap rates by year from Real Capital Analytics (green)
3. 10 Year US Nominal Treasury Rates (red)

In purple is the spread between the average of 1 and 2 and Treasury rates.

Because Treasury securities are backed by the U.S. government, they are generally considered “risk free.” This means any cap rate premium to the Treasury rate, known as the spread (purple bars), is the risk premium investors are willing to pay for an STNL property.

Looking at the graph below, we see a number of things. First, that cap rates are indeed at 2006 levels. Second, the risk premium investors are paying is decreasing. But most critically, the risk premium is not as small as it was in 2004-2006, or even earlier for that matter. For me to be convinced there is a bubble, I would need to see a reckless disregard for fundamentals, which would show up as smaller risk premiums vis-à-vis Treasuries. And I'm not seeing it. The cap rates buyers are purchasing at are aggressive, but they make sense for individual buyers (1031 exchanges, need to deploy capital, etc.)- for now at least.