Net Lease 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 transaction volume, including office, industrial, and retail properties, increased 3.3% from 2016 to 2017. Investment sales volume in the single-tenant retail category was just shy of $3.2 billion in the first quarter of 2018, according to the Stan Johnson Co., a brokerage firm specializing in the single-tenant net lease sector. However, a number of factors point to some coming headwinds. The average retail cap rate for net lease properties during the second quarter of 2018 reached 6.2 percent, an increase of 10 basis points from first quarter, according to Second Quarter National Net Lease Report from the Boulder Group, a national net lease commercial real estate firm. One factor may be the rise of e-commerce and experiential retail which have dampened the interests in traditional brick-and-mortar single tenant retail.

Net lease properties are usually office, retail, or industrial buildings that are leased by a single tenant. A tenant with a net lease is responsible for bearing part, if not all the building’s maintenance, taxes, and insurance, depending on the type of net lease. By placing these costs onto the tenant, the investor is shielded from fluctuating operating expenses. The net lease is usually long-term,10 years or more, with fixed annual rent increases throughout the lease duration. This provides a steady income atypical for real estate investments.

Currently, higher-quality assets are those that are positively affected by the rise of e-commerce or not affected by it at all. According to NREI’s Net Lease Research Report, the industrial sector had the highest net lease outlook rating with 50% of respondents saying it was their preferred sector of interest for the upcoming year. According to an article in Real Estate Journals, e-commerce is the leading driver for industrial assets as companies are logistically trying to get their products to their customers efficiently.

Other environmental trends can affect the attractiveness of these net lease sectors. For example, an aging population and consumer preference changes can also attribute to the demand in healthcare. The need and desire for more hospital facilities in convenient locations has benefited the net lease sector as retail strips are increasingly becoming repurposed as medical centers. While functional product like branch banks are suffering, fitness centers, restaurants, dollar stores, entertainment venues and convenience stores are flourishing.

Net lease may also be the long-term beneficiary of the continuing decline of indoor malls. Enclosed malls and down-market centers are continuing to lose tenants and customers as major retailers vacate malls in favor freestanding net-leased buildings.