Net lease REITs should continue to reap healthy deal volume over the near term, with historically tight credit spreads and easy access to capital creating more-than-favorable conditions for the sector.
A new analysis from Baird Equities shows that cap rates declined 9 bps to 5.91% for retail net lease, and indicated that while lower-quality product is coming online, supply of high-quality assets with long-term leases for sale remains tight. The firm examined bank loan and corporate debt for scores of top tenants and also noted that while a subset of tenants are showing debt yielding higher than B-rated debt—concentrated mostly in theater, fitness, family entertainment and early education—the cost of debt has improved for some of those, including marquee brand LA Fitness.
Perhaps unsurprisingly, buffets are feeling the pain. Fresh Acquisitions LLC/Buffets LLC and Platinum Corral (Golden Corral’s second-largest franchisee) both declared Chapter 11 bankruptcies last April, and though market liquidity is helping other similar tenants survive in the short term, they are laboring under increasing operational pressures due to COVID.
Baird analysts noted that inflationary pressure is building, with CPI for all urban consumers increasing 2.6% over the TTM as of March 2021. TIPS breakeven inflation remains near multi-year highs at 2.36%, the firm noted. But, “net lease REITs are insulated from the operational impact from inflation outside potential pressure on coverage ratios,” the analysis says. “The biggest potential concern would be rising yields; however, the initial rise of the treasury was offset by contracting credit spreads,” which are near decade lows.
The five-year average of net lease’s share of all CRE investment activity is 11.8%, but that number spiked to 18.4% in the third quarter, according to CBRE.
The median price to NAV premium for Baird’s net lease coverage is 21% with a cap weighted premium of 27%, the firm said, noting that it views valuation “as rich considering there is limited transaction activity for tenants in struggling categories.”