Cap Rates Compress for Essential-Use Properties
Retail assets occupied by essential use businesses are seeing more demand and lower cap rates than they would have pre-pandemic.
Pricing has actually gotten more competitive for essential use retail properties. Properties that are both considered an essential use and are internet resistant have been especially popular among investors looking to place capital. This includes tenants like veterinary hospitals, pharmacies and grocery stores, all of which have performed well during the pandemic. Non-essential use properties have been taken off of the market while businesses remain closed, helping to prop up overall pricing and cap rates.
“COVID-19 has exaggerated both spectrums of the market. If you have a grocery store right now that does delivery, it is worth even more than it was pre-COVID,” Matthew Mousavi, managing principal with SRS’ national net lease group, tells GlobeSt.com. “Because buyers have limited alternatives, they need a place to put their money. Properties that are COVID-resistant, ecommerce-resistant and in a great location are selling at lower cap rates than before the recession. There are deals that have gotten more attractive due to COVID. In many ways, it is all a buyer can buy now. Buyers certainly want higher cap rates. That is just the market.”
Exchange buyers are part of the reason why cap rates have compressed for essential use properties. Those buyers need to complete exchanges. “There is still 1031 money that has to transact,” says Mousavi. “So, it hasn’t gotten to the point where people are saying they will just pay the capital gains tax and not transact. That did happen in 2008 and 2009. It hasn’t gotten that bad. 1031 buyers are still buying.”
More broadly, there is still a lot of capital chasing deals and yield. The capital markets are active again, and capital is cheap. “People are hungry for yield, and they are being very picky about what they want and what they buy,” says Mousavi. “The fallout from that could be severe. For example, if we can never sell a gym property again at an efficient cap rate, then what happens to all of that property? Right now, there is no demand for a gym. People aren’t even calling at an 8% cap rate. Those properties have essentially been rendered unsalable.”
However, investors are still cautious, and they are focusing on safer assets. “All of the attention has been diverted to essential use, and everything else has been left on pause. But, those properties can only be on pause for so long,” explains Mousavi. “That gym or retailer is going to have to go back to the lender, and that is when devaluation will occur. If that lender dumps that deal at a 9% or 10% cap rate, then everything else will need to be priced.”