Net Lease's Biggest Competitor: Risk-Free Money

The answer is risk-free money. The question is why the U.S. net lease market took a beating in the third quarter of 2023.

Here’s how both parts fit together, starting with the latter.

According to data from Newmark, the total net lease transaction volume dropped 57% between the third quarter of 2022 and that of 2023, from $18.28 billion to $7.86 billion. The total number of net lease transactions fell from 1,407 to 743, a 47.19% drop.

In subsegments, office did the worst, with a 65.20% plummet from $4.54 billion to $1.58 billion. Industrial transactions went from $9.24 billion in 2022 Q3 to $4.12 this year, a 55.41% dip. The best performance among the submarkets, if a 52.00% drop from $4.50 billion to $2.16 billion.

Sale-leasebacks became a much bigger percentage of total net lease transactions, going from 8.49% in 2022 Q3 to 2023 Q3 18.36%. When considered in absolute numbers, though, the shift is smaller: from $1.55 billion in 2022 to $1.44 billion in 2023 — in that sense, a drop of 7.1%. There have been falling valuations and transactions everywhere in CRE with uncertainty and the inability to find strong price discovery. However, there is an additional dynamic in net leasing. “I think the topic of the day is risk-free,” Samer Khalil, a director with Newmark’s net lease capital markets group, tells GlobeSt.com.

The basis for calculating risk-adjusted returns needs a baseline of achievable safe return, usually pegged to Treasury yields. And as interest rates have grown, they’ve been high. The 10-year, even after a fall from nearly 5% levels, is still at 4.58% as of Tuesday. The 2-year is at 4.91%, with the 1-year at 5.33% and the 1-month, 2-month, and 3-month at 5.53%, 5.56%, and 5.55% respectively.

“You could go to [a bank] and get risk-free money,” Khalil added. “There are some investors that need to buy, but they’re criteria are so specific based on their return requirements that only select deals work.”

If they don’t need to buy, they can put their money elsewhere and bring in a guaranteed return without strain, only increasing the amount of dry powder waiting for a better deal.

And then there’s the inherent staying power of the properties with tenants sending those monthly payments. “A lot of net lease deals are pretty stable compared to other asset classes,” he said. Without a need to sell, like heading off an immediate requirement to refinance, owners can afford to sit and wait.

“Unless the seller’s got real motivation, if someone’s offering me a seven cap and I think it’s a five cap and I have seven years left on a loan,” the current owners can sit and wait, while the buyers can get decent returns for their cash.