The following is a writing sample which I prepared two months ago as part of a small project. The author, myself, has had no experience with the net lease industry.
During the great recession, most businesses faced difficulties raising or maintaining the level of their net operating income, which in turn lowered their cap rates. Now, with the economic recovery after the great recession, access to capital has improved and so has the net lease industry which, compared to $40 billion in sales activity in 2007 is expected to have reached more than $55 billion in sales in 2015, as JLL Managing Director Guy Ponticiello said in October.
The main aspect to keep in mind in the net lease industry is always the cap rates. In a more diversified economy than ever, cap rates will vary by industry throughout 2016 not only in their percentage levels but also in their upward or downward direction. For example, the decline in car ownership, including the decline in new car purchases, is taking its toll on the automotive industry where, with the exception of O’Reilly Auto Parts, as Calkain Companies’ Net Lease Advisor indicates, its cap rate has been decreasing and the expectations for 2016 are not any different. On the other hand, arguably because of the Federal Reserve’s recent decision in December 2015 to raise the interest rate for the first time in nearly a decade – an indication that the economy is starting to strengthen – the financial sector is expected to see growth in its net operating income (NOI) which, holding the current net lease development land’s market value constant, will raise its overall cap rate. Raising the interest rate also comes at a time when industries that appeal to the low-income population and tend to be especially prosperous during economic recessions, such as the dollar store industry and some big box retail stores like Wal-Mart, have started experiencing a drop in their cap rates – another indication of economic recovery. However, the magnitude of the latter remains under question. Considering that the grocery, convenience store, QSR and table service industries have generally been having decreasing cap rates over the past year, 2016 is likely to bring the same outcome, though at a diminishing rate.
Meanwhile, part of the reason for decreasing cap rates could be attributed to the increase in the current market value of net lease development land. The demand for net lease properties is greater than ever and considering the tighter supply of these properties their current market value is considerably higher than in case of a market equilibrium. The trend is expected to remain throughout 2016.
With diminishing cap rates in most industries, some managers are expected to make hard decisions about the property that their company is currently occupying considering the downward trend in cap rates, which is expected to persist throughout 2016, especially if there are escalations associated with the property that are also due soon.