What Does the Fed's Breather Mean for Net Lease Investors?

Midyear is a good time to reflect on the six months past and those upcoming. If two words define the first half, it would be speculation and uncertainty, these in the midst of the ongoing economic upheaval and the Federal Reserve’s movement to curb inflation. 

But after 10 consecutive interest rate hikes over the course of 15 months, the Fed in June took a breather, the reported response to an ailing economy at last responding to treatment. It is too much to assume yet that the Fed’s action–or happy lack of it this month–means that inflation has peaked and not just plateaued and that our months of market uncertainty are a thing of the past.

The market has endured a cap rate expansion of 60 basis points (bps) in recent months, the result mostly of the Fed’s actions, and at least two more rate hikes, another 25 bps, have been forecast. The expectation now is that cap rates will continue to expand for the short term (a totally subjective measure), peak later this year and normalize in 2024. And with a path to normalization comes hope.

Of course, like a battleship, it takes a while for the market to respond to any movement by the Fed. And we as net lease professionals must move on more than hope alone. Times such as these call for strategies rooted in a careful balance of risk and reward, expert guidance and the know-how that comes with experience. No, these times are not for the faint of heart.

Prior to the long-awaited, still-hoped-for normalization, net lease investors with cash on hand and an eye for smaller deals, in the range of $5 million, can avoid knocking on lenders’ doors and proceed with investment plans. Larger players with more significant targets will have to weigh their appetite for risk against the still-tight debt markets and judge, almost on a weekly basis, when and if it is time to pull the trigger on a deal. Here, of course, established relationships with lending institutions and the solid advice of broker advisors can go far toward achieving those investment goals. That is, if you proceed with caution and remain open to contributing more equity. Your lender, after all, is working with higher interest rates and more stringent underwriting parameters

But the following remains true, whether we are in good times or inflationary, and no matter if it is an institutional player or a high net-worth fund: Successful deals hinge on long-term leases with creditworthy tenants, parameters that speak not only to safety but even possible value enhancement. Due diligence is a game everyone can, and must, play.

Clearly, we are not yet through our post-pandemic era of speculation and uncertainty. But economic conditions seem to be leveling off enough to set into motion the beginnings of market confidence. At least for those who entertain dealmaking with the full knowledge of the risks they face and the full price of the rewards they seek.

Hope is a good thing. Especially when it is partnered with common sense.

Jonathan W. Hipp is head of Avison Young’s US Net Lease Group.