Monday Morning Scoop - How NNN Investors Are Moving Forward in a Market of Uncertainty
How NNN Investors Are Moving Forward in a Market of Uncertainty
Last year, investment volumes plummeted across asset classes, and triple-net lease properties were no exception. Research from CBRE shows that NNN sales volumes fell 63% year-over-year in Q4 of 2022.
This year, however, NNN investment is expected to rebound, according to Beryl Grant, associate VP at Matthews Real Estate Investment Services, who says that investors are moving forward on deals that check the right boxes. Those boxes include elevated cap rates to offset higher interest rates, strong in-place tenants, and of course location. Plus, an increase in sale-leaseback transactions is providing steady inventory and helping to fuel new investment activity.
Investors Are Experiencing Yield Sensitivity
Due to the higher cost of capital, investors have become increasingly sensitive to yield. It is the primary metric investors are watching in this market. Before interest rates began to rise, Grant says that strong corporate-backed NNN deals were trading anywhere from 4.5 to 5.50% cap rates. The market has already begun adjusting over the past six months to reflect the higher cost of capital and are expected to continue to rise.
“We have already seen cap rates increase roughly 75 basis points, but there is still a disconnect between buyers and sellers. We are not at an equilibrium yet, and we expect to see cap rates continue to rise this year in order to reach that equilibrium,” says Grant.
Deals that are meeting buyer expectations on yield are trading, and fueling a rebound in acquisition activity. “There is much more yield sensitivity in today’s market, but there is still activity for higher yield deals that have strong real estate fundamentals,” says Grant.
Buyers Focus on Security
In addition to yield, NNN investors are focused on tenant quality, long lease terms, and location. Strong credit and location are both essential to managing the increased investment risk in the market.
“Buyers want to have certainty that the tenant will be able to pay rent throughout the term,” says Grant. Additionally, a strong location increases the probability of being able to replace your rent in the event the tenant vacates the property.
Grant has seen an increased appetite for car wash deals in particular, which come with credit, long lease terms and attractive tax benefits through depreciation. Car wash assets became increasingly popular in 2022 and the increased consolidation in that space continues to provide new inventory through sale-leasebacks.
Sale-Leaseback Opportunities on the Rise
In the second half of the year, Grant expects sale-leaseback activity to be a key driver in investment volumes. “There is a lot of sale-leaseback inventory, and we are seeing new opportunities come to market every day,” he says. Sale-leaseback deals are on the rise as business owners look for opportunities to unlock capital to continue to fuel their expansion.
Car washes, convenience stores and quick service restaurants are all utilizing sale-leaseback transactions as a way to raise capital. “These businesses make the most money off of their operations,” says Grant. “They can make the highest return on their investment by freeing up the capital they have tied to the real estate and reinvesting it into their core competency. It doesn’t make a whole lot of sense for them to have money tied up in their real estate.”
While investors are certainly proceeding with caution, Matthews’ Grant says that the market will begin to recover in the back half of 2023. His advice: “Be patient and stick to core real estate fundamentals.”
By: Kelsi Maree Borland