The Next Big Thing for Net Lease is Urban Retail

There has been a heightened level of investor interest and activity surrounding suburban, single-tenant QSR assets over recent months. With their drive-thrus, delivery apps and online ordering, sales have been strong, and they are a favorite with net lease retail property investors. Cap rates on assets for many national brands have dropped 25 to 50 basis points in the past 16 months. With that said, inventory is tight, competition is high, and money is on the sidelines waiting for the next wave of cash-flowing net lease retail opportunities. 

We see potential for that capital to be deployed into urban retail and food service concepts for investors willing to consider something other than a typical suburban NNN pad site.

While suburban pad sites are usually anchored by a big box retailer or a sprawling shopping mall, in the urban realm, high foot traffic, dense residential options, public transportation, and employment hubs – all within walking distance – have proven to be the drivers for businesses operating in this environment. Forward-looking investors appreciate the fact that urban property is highly adaptable to various uses without being pigeon-holed by the architecture of a typical pad site. From a lease structure perspective, these assets are often NNN and feature annual rent increases rather than every 5 or 10 years as is typical for a suburban QSRs.

In addition to the traditional concepts, urban net lease food and beverage category properties are occupied by a highly creative and expanding variety of tenants including coffee, bakery, dessert, shakes, vegan, and other specialties. As urban streets fill up again and people go back to work, the demand for this category has only one way to go, and that is up!

Overall, urban food service concepts that made it through the pandemic adapted, creating new income streams. Led by QSR’s example, in order to survive, they expanded tech-based customer purchasing options to include take-out and delivery.

In addition to using ordering apps and delivery services, urban food concepts have also needed to address the expansion of outdoor dining. The challenge has been met for many urban users that had limited exterior real estate by adding tables to the sidewalk, converting parking in front of the restaurant for use as sheltered space for dining, and in some cases, closing off roads for use as communal seating for customers. This has actually added seating for many tenants and some of these streets have plans to continue to offer these supplementary seating options post-pandemic as well.

Regardless of the economic cycle, investors always want to know: Will the rent be paid? Can I replace the rent if the tenant leaves? Is the guaranty on the lease meaningful? Most investors buy NNN real estate because they are looking for a predictable and reliable income stream. They want to walk out to the mailbox and have long-term confidence that the rent check will be there. Urban deals are often leased to local tenants and the sale of that urban net lease property often rivals that of nationally known brands. In essence, the urban streetscape provides the assurance that rent can be replaced, and the real estate will be a generational investment for the buyer.

As a recent transaction example, SRS completed the sale of single-tenant, property leased to Levain Bakery in the urban Georgetown submarket of Washington, DC. At just over $2,538 per sf, this transaction marked the highest price per sf for an urban retail-occupied property in DC over the past 10 years per CoStar. Not only is the cookie a delicious draw for business, but the location of the bakery with a prime, urban street-level storefront in the heart of a vibrant market is a perfect example of the urban version of a suburban QSR with a sidewalk full of pedestrians standing in lieu of a line of cars in the drive-thru.

As inventory remains tight for passive retail investment, urban net lease assets offer investors a favorable opportunity for rent growth beyond typical structured rent increases, and potential for dramatic appreciation in value on re-sale of the asset. As life approaches a return to normal, the adaptability, strength and resiliency of the urban economy offers an opportunity for investors to capitalize on the resurgent urban market.

Rick Fernandez is senior managing director of SRS Real Estate Partners – National Net Lease Group