Demand for single-tenant net-leased retail assets will remain strong among investors through 2006, but the market is expected to experience some noticeable shifts. After declining rapidly over the past few years, cap rates in the higher end of the market are expected to level off, as even a moderate increase in interest rates will leave little room for further compression. On average, cap rates still trump returns for apartment properties.

As Baby Boomers move toward retirement, we expect a strong flow of exchange capital to shift from apartments into the no/limited-maintenance single-tenant sector. While returns for some of the most desirable assets have fallen below 5 percent, the marketwide average is in the high 6 percent range, 100 basis points greater than the average in the apartment sector. The favorable cap rate spread, along with the no-maintenance nature of single-tenant investment, will continue to draw exchange capital into the sector.

Out-of-state capital dominates

Returns for single-tenant assets vary considerably, and with no significant management required, buyers can search nationwide for properties that fit their specific investment criteria. Growing shares of investors are recognizing the advantage of expanded searches. Up to three-quarters of the transactions last year involved buyers from another state than that in which the acquired property is located.

Sellers are also benefiting, as even properties in markets previously overlooked are generating strong interest. The majority of capital is coming out of the most heated metro areas, primarily in California and Florida. Californians were the most active, as the average cap rate for single-tenant properties in their home state is 6.1 percent, down 50 basis points over the last year. California investors have geographically diversified to nearby states where cap rates are higher, such as Arizona (6.9 percent), Nevada (7.1 percent) and Texas (7.6 percent), and farther east to Florida and Georgia, where cap rates average in the low- to mid-7 percent range.

Immediate growth for fast-food

The average price for fast-food properties sold in 2005 was about $1.4 million, while cap rates averaged 6.2 percent, more than 100 basis points lower than in 2004. Additionally, the median price per square foot climbed 19 percent to more than $475. McDonald's, the nation's largest fast-food chain, may start competing with Blockbuster Video and Netflix. McDonald's is testing drive-through DVD rental boxes — the first such concept in the country-with about 700 sites.

And it's posting solid success: The company projects that revenues from the kiosks will reach $3 billion per year by 2009. Sales of McDonald's real estate were limited over the last year, but strong demand resulted in a median price per square foot of nearly $550, 16 percent above the median for all fast-food stores. Co-branding of fast-food restaurants, where two different fast-food concepts share and occupy the same space, continues to increase in popularity both from an industry and investment perspective. The good news is that at $465 per square foot, these investments are selling below the industrywide median, while cap rates of 6.5 percent indicate a slightly higher return.

Brand recognition vs. creditworthiness

Although demand from consumers will sustain these types of properties, as a real estate investor, there are a lot of non-credit franchisees and start-ups across the country. From an investment point of view, there is a disconnect because the risk premium an investor should be looking for with some of these non-credit deals is not priced into the marketplace. The risk premium for non-credit tenants has been removed over the last several years due to the abundance of capital chasing deals. This has translated into private capital frequently analyzing a Burger King franchisee the same way they analyze an investment-grade single-tenant deal. They confuse brand recognition with creditworthiness. That has been a phenomenon unique to this last cycle. Logic tells us this trend will not last.

Casual dining prospers

There has been an explosion of casual dining concepts, with Applebee's the leader. From an investment point of view, everyone loves Applebee's. Based on our view of the market, it appears as though some of these restaurant operating companies are getting bigger, offering a wider range of concepts under the parent company. For instance, there is a brand new Target-anchored center near Marcus & Millichap's Atlanta office. The property encompasses between 1.5 million and 2 million square feet of space. Five of the restaurants come from the same parent. As a real estate developer, you can go to that company and sell an opportunity to control all of one parent company's brands within the development, so it's a virtuous circle for the developer and restaurant operator.

Convenience store alternatives

Convenience stores remain a popular choice with many investors. Over the past year, the nationwide median price for convenience stores increased to more than $253 per square foot, up from $238 per square foot in 2004. On average, convenience stores traded at a 6.3 percent cap rate, which falls 60 basis points below the average for all single-tenant investments. Returns, however, can vary greatly depending on the credit of the tenant and the location of the asset. Properties in primary markets with well-known tenants, such as Circle K or 7-11, typically trade at much lower cap rates, and prices can often exceed $450 per square foot. Properties with these same national tenants in rural areas, though, have been trading at cap rates in the low- to mid-7 percent range.

For instance, several Circle K convenience stores traded in rural Florida over the last year at a median price per square foot of $225, with the average cap rate at 7.3 percent. It should also be noted that both corporate-owned and independent stores that sell gasoline typically sell for premiums. The median selling price for convenience stores with an attached gasoline station is more than double that of regular convenience stores at $551 per square foot.

Marcus & Millichap's growth strategy

The commercial real estate industry has transitioned from a local business to a national, mainstream capital market asset class with institutional investors and private capital converging. As the market becomes more transparent, the main challenges to investors will be accessing investment opportunities and executing transactions with sufficient knowledge. We have addressed these investor needs through our continued national expansion, implementation of extensive research capabilities, an ongoing reinvention of technology, the implementation of our capital markets group as well as offering major clients specialized services through our national specialty groups. The local presence of our agents and their ability to interpret and act on local conditions is critical to investors. A consistent culture and operating policies with local management have also been critical to delivering better results for clients. Our structure results in a substantially more efficient process of matching buyers and sellers on a national level.

Senior Vice President and Managing Director of Marcus & Millichap's National Retail Group.