Despite the market volatility and uncertainty caused by the COVID-19 pandemic, investor activity within the net rental space for certain uses and loans remains relatively strong, albeit at a lower level than before the COVID. The industry is concerned and uncertain about the long-term and short-term effects of this crisis and no one can give a clear answer to the short-term effects. This crisis did not begin with a deterioration in financial conditions or a collapse in credit. It's a health crisis that, in turn, will affect virtually every corner of the economy.
In the SRS National Net Lease Group's Second Quarter 2020 Net Lease Market Review, we found investor activity continued to be strong in net leases for on-demand purposes, public companies with strong financial positions and uses such as fast food restaurants (QSR) with drive-thru.
The continued interest in net rentals, and what makes it a strong investment option now, is due to some of the same fundamentals that were shown during the Great Recession. Because single-tenant assets are priced lower than large multi-tenant centers, the majority of net rental buyers and owners are small private investors or groups seeking returns and are attracted to owning a tangible asset. Since the beginning of the COVID-19 crisis, SRS's National Net Lease Group has completed 140 transactions valued at $ 502 million. In addition, the group has nearly $ 800 million in assets under LOI or escrow and $ 2 billion in assets currently available for sale.
For the report, SRS reviewed Q1 and Q2 2020 sales for the following sectors: Automotive, Bank, Big Box, Casual Dining, C-Store / Gas, Dollar Stores, Education, Fast Casual, Grocery, General Retail, Medical STNL , Pharmacy and QSR. It is especially important to understand what impact the ongoing pandemic has on the relationship between the lease term and capitalization rates for all product types, and how the pandemic has affected buyers' tendencies towards specific sectors.
Sectors that are showing their resilience include:
Grocery store: Investors continue to look for stable cash flows in this sector. The average cap rate is down 48 basis points, which can possibly be explained by a combination of 1) increased demand for these safe assets and 2) a majority of grocery stores made up of strong grocers with high credit.
Pharmacy: Average cap rates for pharmacy net leases compressed by 25 basis points. This was partly due to the longer average rental period and the broad “flight to quality” due to the pandemic.
Convenience: The C-Store / gas station room remained a very active sector of net rent, as it is an example of Internet resistance and is classified as essential. Cap rates rose by just 8 basis points, mainly due to the geographic location of the properties settled in the second quarter versus the first quarter.
Sectors of concern include:
Big box: The big box sector under the net lease has seen a decline in activity for numerous quarters due to online competition.
Casual dining: The casual dining lease has been heavily impacted by COVID-19, with most transactions likely early in the second quarter prior to COVID. While the cap rates were compressed in the second quarter compared to the first quarter, this is due to transactions that only take place in primary markets with tenants of higher quality.
Currently, investors are responding short-term out of concern, but the basic characteristics of net rental and investment property in general are based on a long-term investment approach, specifically the fundamentals of investor base, tenant credit and location. Based on these attributes, the phrase “survival of the fittest” will likely apply after the COVID-19 recovery.
Matthew Mousavi is a Managing Principal at SRS National Net Lease Group.