Here's an Old but Useful Cliche to Think of STNL — as a Bond

There’s currently growing single-tenant net-least (STNL) inventory. An analogy to bonds can help someone new to net lease model behavior and strategy to make better decisions.

Chris Lomuto, an associate vice president in Northmarq’s San Francisco office, brought up this old suggestion to think about bonds. “Bonds make a pretty good metaphor for single tenant net lease,” he told GlobeSt.com. It’s not a perfect analogy, but a useful one.

Back to financial basics for a moment. Bonds are fixed-interest financial instruments often associated with fixed-income investing. There are government bonds (Treasurys being the standard for “safe” investments but not the only type of government bond) and corporate. The principle is always the same. The investor buys a bond for a set amount. The seller then owes interest payments and an ultimate payment of the original principal to the investor.

An important aspect of bonds is secondary markets and liquidity. Investors buy and sell bonds all the time. If in general interest rates go up above the bond’s yield, then the bond is typically worth less in trading because a buyer could invest elsewhere with a greater return. If the bond sells for less, that raises the yield. Yield and bond prices move inversely in relationship to one another.

The return an investor wants on a net-lease property is a combination of a risk-free return and whatever additional amount the investor wants as a risk premium. This is generally true for all investments, including net-lease properties.

To Lomuto and many others who have long been in the industry, that is the appeal of the simplified bond analogy. “It’s a kind of shortcut to understanding how net-lease market pricing tends to behave,” he says. “If you’re talking to someone experienced in other areas of investing and they’re trying to understand net-lease, you can explain that it’s similar to a bond market logic.”

If interest rates go up, there are competitive investment alternatives to buying a net-lease property, and you would expect the price to go down to be attractive. If interest rates drop, then the competitive position of the property increases.

That helps an investor or owner make a clear decision on the property. For example, you bought the asset when rates were low. Now they are higher. You can choose to sell the property and recognize the change in value. Or you can continue to hold the property and collect the cash flow.

The important consideration is that, at this point, the “default risk on that real estate is still relatively low” if the tenant has strong credit and, as typical in net lease, has a lease that might last for 10 to 20 years. “If you’re not forced to sell, you probably feel good holding it,” he said. “You’re disappointed because it’s not worth what it was.” But it’s far from a disaster.