Moderator Stephen Jacobson, framed the Capital Markets panel at the National Net Lease Investment Conference, produced by NREI and RetailTraffic.com and held on Nov. 1 in Chicago by observing, “There is a general sense out there that there is ample capital on the debt and equity side to finance net lease acquisitions. The capital costs appear attractive. Never before have treasury rates been lower and spreads tighter.”
Jacobson, a senior managing director, credit tenant lease finance for Mesirow Financial, added that, “Cap rates have also been trending lower. The question is whether this is in fact the case, and what types of transactions are currently being closed.”
Panelists drew on their experiences to provide a variety of perspectives on that outlook.
James Turner, managing director for the commercial real estate group at PrivateBank, said banks have a significant amount of capital allocated for chasing a small pool of available net lease deals. “A lot of banks are looking for growth, and the middle market out there is not necessarily borrowing at the levels you might expect,” he said. “The national growth rate is 2 percent to 3 percent and the banks are trying to grow more than that, and real estate is something into which they have gotten actively involved.”
Turner added that equity is also more important today than during the boom years. “Five years ago, in a standard Walgreens transaction, you would be able to do a construction loan at nearly 100 percent—basically 99 percent would not be a problem. You got an 8 percent return, and the banks would be able to fund everything. You would put some moderate recourse on that until the construction was done, and then sell it off at a much lower cap rate.”
In contrast, today investors have to put in a minimum of 20 percent equity and most deals require 25 percent to 35 percent, Turner said.
Another shift that Turner has seen is that “Banks are trying to get growth because there are not that many construction projects out there, and they are looking at doing five-to-six year money. Bank’s capital is a little more precious than for some of the other institutional entities out there, such as life insurance companies, so the pricing will be a little higher. You will see banks doing more five-to-seven-year deals, if they can hit their pricing.”
Daniel Baker, senior vice president at KeyBank Real Estate Capital, said that another factor shaping the market is that CMBS lending has opened up. “We are seeing volume pick up dramatically, as spreads have come crashing in, and it is much easier getting things done than 12 months ago.” Baker said.
Nathaniel A. Sager, vice president at Mesirow Financial reported that, “hedge funds and private equity funds are looking into investing what they would call traditional equity money into debt, via B note or mezzanine structured debt on top of CTLs. There is a lot more of it going on, and it allows borrowers to send amortizations beyond the 2020 term.” Sager described it as “a burgeoning market and it is something on which we are pretty focused on trying to build right now.”
Panelists also described the shifts that they are seeing in the business sectors in which net lease activity is taking place.
“It is clear that retailers have been shrinking their growth plans,” Turner said. “Where we used to do 20 Walgreens a year, we may do one a year, if we are lucky, at this point.”
In contrast, Turner pointed to two areas of increased activity: “Medical office buildings – especially standalone types of facilities in the 5,000- to 10,000-sq.-ft. range and food retailers franchise-food type of assets that are the standalone type buildings.”
Luke Stifflear, senior managing director at PPM America, also mentioned a slowdown in retail-related activity.
“We continue to see the traditional drugstores, but the amount of building is significantly less than a few years ago,” he said.
On the other hand, Stifflear reported that “One area that we are seeing a great deal more request for is in the oil and gas industry. With the explosive growth in natural gas, we see net lease financing for several hundred acre tracts for single and multi-family homes for the oil and gas companies to provide employees with housing.” Stifflear added. “We have seen acquisition financing requests on a net lease basis for investment grade oil and gas companies for tracts of land.”
At KeyBank, “We also are seeing a lot of medical offices—all of the sudden—with large health care groups that seem to have come out of the woodwork,” Baker said. “Another thing that we are seeing—and are not sure what to do with—is a lot of data centers.”
There also was discussion of opportunities with not-for-profits, especially universities.
“We have been very busy in the not-for-profit arena, and we have seen a fair amount of university transactions, particularly in the public sector,” said Mesirow’s Jacobson. “Many states have put caps on the ability of their universities or their underlying divisions to incur additional borrowing, but these universities are generally pretty strong from the credit perspective, and we find a strong appetite to lend to those kinds of institutions. We have seen a fair amount of activity for these universities that are having buildings built for them on a build-to-suit basis.”