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How to Strike a Deal In a Stagnant Net Lease Market
Transactions have slowed in just about every category for commercial real estate and net lease is no exception. The reasons are myriad for that but let's boil them down to two in particular: 1) sellers do not want to sell their property for less money than it was worth previously; and 2) sellers are taking on more risk and getting the same return.
Sellers, quite understandably, do not like the idea of selling something for less money than it was previously worth. Unfortunately, with many net lease assets having minimal or no rental increases in the base term, a diminishing lease term, and difficulty backfilling the locations at similar rent, values for these asset classes might never return to what they were just a year ago in our professional lifetime. This psychological issue prevents transactions from occurring. Most net lease owners didn't realize or wouldn't acknowledge the bond bubble that propelled property values had ended at some point, and many owners still don't understand what that means.
The second issue is a real problem. Today's sellers with existing financing have to take on more risk to get the same return they are currently getting. With interest rates and thus, the debt constant, higher today than yesterday, replacing cash flow means buying at a higher cap than the one they're selling. Since a cap rate is a measurement of risk compared to alternative investments, they're taking on more risk to get the same return. Furthermore, their current loan is an asset, and once they sell their property, that asset disappears. For many owners that might normally transact, it simply doesn't pencil, and they stop transacting.
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