Retail Net Lease Cap Rates Increase 10 Basis Points in Q2

The COVID-19 pandemic hit the net lease transaction market hard in the second quarter.

In Q2, asking cap rates in the net lease retail sector increased by ten basis points to 6.25%, according to The Boulder Group’s 2nd Quarter Net Lease Research Report.

“For the average retail tenant, whether it be in casual dining or fitness or movie theaters or soft goods, saw that their balance sheet and business didn’t get better in the last three months,” says Randy Blankstein, president of The Boulder Group. “This was not a great quarter for retail in general. Most stores weren’t open for the majority of the quarter.”

It’s common knowledge that the COVID-19 shutdown has hit some CRE sectors much harder than others. As The Boulder Group’s report shows, that trend has resonated through the net lease transaction market. Industrial properties, which benefited from the boom in e-commerce, saw cap rates fall six basis points to 6.99%.

Part of this increase in cap rates was the product of a limited number of properties selling in the quarter. Those industrial assets that did transact were at low cap rates. The strength of the sector also played a significant role.

“E-commerce is up, and it needs storage, warehousing and distribution,” Blankstein says. “That’s why that sector has been doing well.”

While COVID-19 walloped high-rise office buildings, Blankstein says the single tenant net lease buildings haven’t struggled as much. The cap rates for these properties remained unchanged at 7%.

“There are some concerns with suburban office buildings regarding spacing and floor plates and other things of that nature,” Blankstein says. “COVID will minimally impact a lot of these. Downtown high rises are a completely different situation.”

Overall, transaction volume declined more than 20% in the first half of 2020 compared to 2019. Investors backed away from non-essential businesses, while owners seemed resistant to selling.

“People understood that it was a bad time to put something on the market,” Blankstein says. “If you own a fitness center, a health club or soft goods business that was closed, you probably don’t want to put those on the market until they’re open and paying rent.” 

Still, there was competition for the highest-quality assets among investors who were looking to avoid the volatility of alternative investment vehicles and the stock market. In the second quarter, long-term leases to 7-Eleven, CVS and McDonald’s posted some of the lowest cap rates in the sector.

The spread between asking and closed cap rates compressed by eight and nine basis points respectively for retail and industrial sectors.

“Net lease transaction volume for 2020 is expected to be significantly lower than in 2019 as a result of the impact of Covid-19,” Blankstein says. “However, the stabilization of the 10-Year Treasury Yield in the second quarter will provide investors with an enticing yield spread for the net lease sector.”