Certain Net Lease Sectors Remain Strong Despite COVID-19 Uncertainty

Despite market volatility and uncertainty created by the COVID-19 pandemic, investor activity within the net lease space for specific uses and credits continues to remain relatively strong, albeit at levels lower than pre-COVID. The industry is anxious and unsure about the long and short term effects of this crisis, and no one can provide any clear answer as to what the near term holds. This crisis didn’t begin as one with deteriorating financial conditions or a collapse of credit. It’s a health care crisis that will, in turn, have an impact on virtually every corner of the economy. 

In SRS National Net Lease Group’s second quarter 2020 Net Lease Market Overview, we found that investor activity in the net lease space has remained strong for necessity-based uses, publicly-traded companies with strong financial positions, and uses such as quick-service restaurants (QSR) with drive-thrus.

The continued interest we are seeing in net lease and what makes it a strong investment option now are due to some of the same fundamentals exhibited during the Great Recession. Being that single-tenant assets have lower price points compared to large, multi-tenant centers, the majority of net lease buyers and owners consist of small private investors or groups seeking yield and are attracted to owning a tangible asset. Since the COVID-19 crisis began, SRS’ National Net Lease Group has closed 140 transactions valued at $502 million. Additionally, the group has nearly $800 million of assets under LOI or in escrow and $2 billion in assets currently listed for sale.

For the report, SRS reviewed first and second quarter 2020 sales for the following sectors: Automotive, Bank, Big Box, Casual Dining, C-Store/Gas, Dollar Stores, Educational, Fast Casual, Grocery, General Retail, Medical STNL, Pharmacy, and QSR. It’s especially important to understand the impact the ongoing pandemic has had on the relationship between length of lease term and capitalization rates across all product types, as well as how the pandemic has affected buyer bias toward certain sectors.

Sectors proving their resilience include:

Grocery: Investors continue to look at this sector for stable cash flows. The average cap rate has dropped by 48 basis points, which perhaps can be explained by a combination of 1) increased demand for these safe assets and 2) a majority of grocery stores are comprised of strong, high credit grocers.

Pharmacy: Average cap rates for pharmacy net lease compressed by 25 basis points. This was attributed in part to the longer average lease term, as well as the broad “flight to quality” due to the pandemic.

Convenience: The C-Store/Gas Station space remained a very active sector of net lease as it exemplifies internet resistance, as well as being labeled essential. Cap rates expanded by just 8 basis points due largely to the geographic location of the properties transacting during Q2 vs Q1.

Sectors of concern include:

Big Box: the big box sector within net lease has seen diminished activity for numerous quarters, pressured by online competition.

Casual Dining: Casual dining net lease was heavily affected by COVID-19 with most transactions occurring early in Q2 likely originating pre-COVID. While cap rates compressed Q2 vs Q1, this is due to transactions occurring in primary markets only, with higher quality tenants.

Right now, investors are reacting out of concern in the short term, but the fundamental characteristics of net lease and investment real estate in general, are based on a long-term investment approach, particularly the fundamentals of an investor’s basis, tenant credit, and location. Based on those attributes the phrase “survival of the fittest” will likely hold true post COVID-19 recovery.

Matthew Mousavi is Managing Principal at SRS National Net Lease Group.