Net Leasing Trends in Commercial Real Estate

The net lease sector is showing no signs of slowing down in 2018, especially when it comes to investor interest. The United States net lease investment volume, including office, industrial, and retail properties, totaled $57.8 billion in 2017, increasing 3.3 percent from 2016. The sector is projected to see comparable investment volume in 2018, according to NREI’s most recent exclusive research into the sector.

That’s not to say all asset types in the net lease sector are trending upward. A number of factors point to some very mixed results when it comes to investor interest by asset class. According to NREI’s Net Lease Research Report, respondents ranked retail one of the lowest net lease sectors expected to see demand in 2018. From what we have seen throughout the year, retail cap rate for net lease properties have continued to rise. Conversely, the industrial sector had the highest net lease outlook rating, with 50 percent of respondents saying it was their preferred sector of interest for the upcoming year, and industrial cap rates have been shrinking to record lows. One factor contributing to this inverse relationship may be the rise of e-commerce, which has dampened investor interest in traditional brick-and-mortar single tenant retail, yet increased demand for industrial spaces as companies compete for fastest delivery.

The report sites e-commerce as the leading driver for industrial assets, which makes sense considering the competitive e-commerce market. Companies are logistically trying to get their products to their customers efficiently. The single-tenant net lease is particularly poised to meet the current market needs in the industrial sector.

An industrial single-net lease is attractive for tenants competing in the e-commerce space for multiple reasons. One of the most significant factors being the freedom the tenant has to manipulate the space to their needs. A tenant with a net lease is responsible for bearing part, if not all, of the building’s maintenance, taxes, and insurance. Rapid changes taking place in distribution right now, like innovative in-house storage and infrastructure features, can be easily applied to the space, as the tenant deals with all operating and overhead costs themselves.

The set lease rates and long duration of net leases is also appealing for companies in e-commerce. Net leases are usually long-term (10 years or more) with fixed annual rent increases throughout the lease duration. This means that the tenant is protected from suspected rental rate hikes caused by the increasingly competitive e-commerce logistics landscape.

Many times, the single-tenant net lease is a popular choice for CRE investors. The investor is shielded from fluctuating operating expenses and is provided with a steady income, both of which are atypical for real estate investments.

As with any investment, there are some risks to single-tenant net leases. The biggest risk is if the tenant leaves, the vacancy rate becomes 100 percent, and the investor is accountable for all expenses without the steady cash flow. But, industrial net leases are particularly safe bets right now as the demand for warehouse and distribution facilities is only expected to increase. This is especially true for large credit-worthy companies competing with Amazon in the e-commerce market.

While investor interest in the net lease sector as a whole is projected to remain sound for the foreseeable future, e-commerce is affecting both retail and industrial net lease properties, hindering one while strengthening the other. Demand for industrial space along with the nature of the net lease makes this asset type extremely attractive for investors. While no one is sure how the e-commerce will look a decade or two from now, investors are making a safe bet with industrial net leases as company needs for warehouse spaces somewhere along the supply chain is certain.

About the Author:

Jim Clark brings the depth of 32 years of commercial real estate experience, encompassing investment banking and brokerage, asset management, and structured finance. Jim began his real estate career in 1984 and formed EnTrust Realty Advisors in 2002. One of the industry’s most seasoned transaction specialists, Jim’s prior positions include President, Investment Services Group, Transwestern; Managing Director, Institutional Services Group, Grubb & Ellis Company; Regional Vice President, MONY Real Estate; and Vice President, Real Estate Investment Banking Group, Lehman Brothers, Inc.

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