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When interest rates are higher and less debt is available in the market, David Sobelman, CEO and President for Generation Income Properties, says net lease underwriting is disciplined and deals are heavily scrutinized. But when interest rates are low and debt is readily available, unsophisticated buyers come in and make mistakes.
"They may have never owned an expensive, asset-management-intensive commercial real estate property before," Sobelman says. "These are typically the least sophisticated investors who look less at a real estate asset's intrinsic underwriting measures than someone who is actively looking to own and manage assets as a full-time profession." Right now, rates are low, and that could lead to problems, according to Sobelman.
"I have had the privilege of being intimately involved with several market cycles, over the previous seventeen years, where investor demand has expanded and contracted synonymously with tenants' respective national and regional footprints," Sobelman says. "This hindsight has ironically provided a tremendous amount of insight into the psychology that invariably changes with investors given a specific snapshot of time in any particular cycle."
Take big box properties, for instance. Sobelman says they often have tenants that novice investors perceive as creditworthy. Also, the assets are triple net leased. "That combination of attributes is a recipe for attraction of capital from those that have been smart or lucky enough to figure out how to make a few dollars in their life and want to explore the 'passive' nature of the investment that their net lease broker has so egregiously touted," Sobelman says. "Purchasing a big box asset allows for larger allocations of dollars in one transaction and therefore justifies what the buyer is most likely trying to accomplish – immediate passive income."
Sobelman says investors forget that these assets with big-box tenants are not bonds – they are real estate. "It shocks me to see how people have worked their entire lives and when they are in the 50s, 60s and 70s, the typical age profile of a net lease property owner, they follow the 'shiny object' and not the better investment," he says. Companies, such as Earth Fare and Lucky's Market, were perceived as "safe" by investors until they weren't, according to Sobelman. "Some investors, developers and landlords incur the inherent risks of ownership based solely on the tenant's legacy market perception," he says.
If that legacy tenant does fail, landlords can face difficulty replacing them. "Vacant big box assets, or any vacant assets are no longer even close to the nature of their initial state when they were purchased by the owner," Sobelman says. "They are large footprints in contracting business models that still require taxes, insurance, and possible mortgage debt to be serviced without any income. Additionally, repositioning a big box requires a healthy amount of free cash that typically comes from the landlord/owner."
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Leslie Shaver
Les Shaver has been covering commercial and residential real estate for almost 20 years. His work has appeared in Multifamily Executive, Builder, units, Arlington Magazine in addition to GlobeSt.com and Real Estate Forum.
