"Tourist" Investors Leave Field in STNL Deal Pullback

The pendulum has swung in STNL transactions during Q1 2023 from the frothy sellers’ market of H1 2022—which drew a lot of family office players and other investing “tourists” into the sector—to a glut of assets chasing a dwindling number of buyers.

The deal velocity has slowed considerably and the competition has thinned, like a table in a Vegas poker room at 2 a.m. It’s the time when the serious players deploy their reserves to scoop up the opportunities.

At the GlobeSt. Net Lease Spring conference in NYC this week, Jimmy Goodman, partner at the Boulder Group, surveyed a panel of net-lease REIT players on the state of play in a market where buyers of all stripes, including institutional investors, family offices and 1031 players have retreated—and the dwindling number of deals are smaller and slower.

“What I would call the tourists of our industry have all pretty much washed out of the system,” Goodman said.

“There’s been a 20% decrease in volume,” said Steve Wolff, VP, acquisitions at Spirit Realty Capital. “The demand isn’t there.”

Wolff, a cash buyer who focuses on industrial properties, said there’s been a thinning of the competition for deals.

“Last year, there was an influx of players who really didn’t know industrial but [bid on deals] because it was the golden child,” he said. “We’re seeing less competition across the board, we’re seeing less bids on deals that we bid.”

“Deals are continuing to get done, but the size of the deals has gotten smaller and they’re taking longer to transact,” said Asher Wenig, senior VP at Northmarq.  “People are waiting for the debt market to come back.”

“There’s been a general pullback in demand. We’re seeing a lot of opportunities, but they’re not the kind of deals we want to be chasing right now,” said Maxwell Elliot, a partner at LCN Partners.

For Josh Zhang, director of investment, Four Corners, the canary in the coal mine of a market heading south came in the form of brokers returning his calls.

“Last year, we’d see a deal and we’d ask five questions and they wouldn’t call us with the answers. We’d call the broker back and they’d tell us it was already sold,” Zhang said.

“These days, we get shown an opportunity and we ask questions, they answer right away. If we don’t respond in a day or so, they call us back,” he said.

According to Zhang, the sea change in the STNL market dynamic can also be measured in a dearth of what he called “splashy entrances.”

“Last year, every other week you’d see a big announcement on LinkedIn or the Business Wire about a new family office, a new private equity vehicle or a new REIT,” he said. “We’re not seeing any big splashy entrances this year.”

Cash buyers like Spirit Realty and Four Corners are the belles of the ball in an environment when liquidity rules.

“It’s not just because we’re cash buyers, it’s because we’re reliable buyers. They know if we sign up with them on a deal, we’re going to close. They know we don’t sign up deals for fun,” Zhang said.

On the seller’s side, there’s a glut of NNN inventory that’s sitting on the market, most of it with no place to go. Goodman said there are more than 500 assets on the market from chains including McDonald’s, Starbucks, Walgreens, Dollar General and Chipotle’s.

“They’ve each got 50 to 100 assets on the market asking 5 caps. They’re out there, but they’re not transacting,” Goodman said. “Everyone is asking for the same cap rate.”

“What is it going to take to move them?” Goodman asked. “What is it going to take to clear up some of this volume of retail assets that are lingering there with cap rates from 2022?”

“I think interest rates are going to have to come down,” Wolff said.

“The big question is what are the merchant developers going to do to push back on the tenants to get a bigger overall development spread?” Goodman said.

Goodman predicted that merchant developers will opt for direct sales with cash buyers as a quick way to transfer their risk to a new owner.

“They’ll be calling [cash buyers] the second they get the deal permit and closing sales prior to permitting so they can hedge their bets on cap rates or interest rates going up,” Goodman said. “We’re going to see more direct deals.”

“But for these guys who are selling cap rate, they’re just going to sit there while they try to get some more equity in place for the deal because that construction loan is going to come due,” he said.

The dwindling number of buyers who are purchasing fast-food outlets are drawn to them for their liquidity—Goodman said assets like McDonald’s and Starbucks are acquired as “just another bank account” for their cash flow—or because certain locations offer development opportunities.

“I just saw a Rite Aid trade at a 10 cap because there was a lot of potential for air rights,” he said.

The REIT players are hoping for a stronger second half in 2023, but Elliot said he’s keeping an eye on two key benchmarks: forbearance and inflation.

“Between now and 2025, there’s a half-trillion dollars of leveraged bonds coming due, loans that were at 3% or 4% looking at 12% to 14% for debt service. We’re starting to see the leading edge of that come through,” Elliot said.

“This will fuel sale-leasebacks as sellers try to avoid that leverage-berg,” he said. “There are going to be bankruptcies.”

Elliott also expressed some pessimism on the inflation side of the ledger.

“We could end up in a scenario a lot of people talked about, where at the end of the year we’re at the back side and you go back into a situation where the Fed tries to build the economy up—and you get inflation that’s 5% and sticky,” Elliott said.

“That’s a real possibility,” he said.