Traditionally, the net lease market has been dominated by small investors, but increasingly, institutional players like hedge funds, pension funds and REITs also are investing in the space. The competition between small, private investors and large institutions was explored by members of the “Institutionalization of the Net Lease Market” panel at the National Net Lease Investment Conference, which was produced by NREI and RetailTraffic.com and held in Chicago on Nov. 1, attracting over 150 commercial real estate industry pros.
“So how is the institutional sector affecting pricing and the ability of small investors to getdone?” asked moderator Randy Blankstein, founder and president of net lease advisory company The Boulder Group, based in Chicago. “And does this mean small private investors are getting crowded out of the space?”
“I don’t think small private investors are getting crowded out, but I think it’s getting more challenging to compete,” said Andrew Fallon, assistant vice president at Washington, D.C.-headquartered national real estate investmentfirm Calkain Companies. “We’re seeing a lot of 1031 Exchange transactions and we’re seeing a lot of one-off bite-size deals go to private investors. I think private investors still have a place.”
Despite the competition from institutional investors regarding pricing, said Fallon, deals are getting done. But he noted that small investors have to be much more competitive on pricing, not only with institutions, but with other private investors.
Often, “there are three, four, five, six or seven institutional entities bidding on the same assets and oftentimes there is another handful of private investors, whether it’s doctors or dentists or a 1031 buyer,” he explained. “It’s a very good time to be a seller to take advantage of pricing, whether it’s being driven by the private investor or the institutional investor. Certainly, we’ve seen the number of REITs—whether publically traded, privately traded or non-listed—grow, and that is moving toward the institutionalization of the net lease sector. … As a broker, it’s a challenge, because the market is becoming much more efficient.”
Brandon Duff, director of investment sales for Stan Johnson Co., based in Chicago, said he sees the situation less in terms of private vs. institutional investment and “a little more deal focused and property focused than just kind of painting blanket across the market.”
On the institutional side, Duff said he has noted more “marked transactions [and] negative numbers.” But with deals of $15 million to $20 million, he said, “The institutions own that space and really take over there. The cost of institutional capital is cheaper than a private guy can achieve and so private equity gets squeezed out of the larger deals.”
And when it comes to smaller transactions of, say, $5 million to $10 million, he said, “It’s still really the land of the trade buyer.” And yet, from this deal perspective, Duff said, institutions tend to aggregate and grow vs. price. “There is incentive for a seller to say, ‘Hey, we’ll do more of an easy transaction with an institution than with a private client,’ but I think it’s kind of divided,” he said. “Right now [when that happens], it’s more property- and transaction-specific than [something that’s happening] across the market as a whole.”
“How is the institutionalization of the sector affecting business from an advisor perspective?” asked Blankstein.
For Fallon, being able to supply developer clients with “the most accurate and updated market information available” is key, in order to make them aware of their choices. “It’s not rocket science, what we’re talking about,” he said. “The options are do you want to take it to market at a very aggressive cap rate and try to find a 1031-type of buyer who’s just looking to park some equity in a safety net, or do you want to move quickly? Are you motivated by time? Do you want to close something within a 30-day window at year-end?”
“I think it’s important that the developer knows that question and the answers to those questions,” Fallon said. “It is going to be challenging to brokers as the market becomes more and more efficient but we certainly add value because we know the market and because we create that competition and bidding environment that all the sellers like to see.”
For Duff, the biggest change in the role of advisor has been in trying to meet the need “to help clients from the start—to sit with the developer, the buyers and the institutions—and really help your client from the start to the end. You help them from the front-end negotiating a lease, and you help them with costs, debt and equity—you really paint the whole picture. There’s a lot more front-end work going into advising before the actual transaction has occurred.”
Mark Goldberg, vice president, MidAmerica Real Estate Group, based in Chicago, said that he saw the first property that he sold to Cole Real Estate Investments 10 years ago as a turning point regarding the impact of institutions on investing.
“At the postmortem of that deal,” he explained, “my client, the seller, said, ‘These guys [at Cole] are the best guys I’ve ever worked with in my entire life—they’re creating a machine that does nothing but exist by real estate, expediting transactions.’ Cole has done everything to continue that, and there are many other institutional investors—be they public or private—who have similar machines set up to buy real estate quickly. They can do an 18-day due diligence period, where a private buyer would be hard-pressed to finish a contract in 18 days.”
Recently, said Goldberg, MidAmerica represented a 1031 buyer who was bidding on a property with a 7.5 cap rate which Cole was also bidding on. “Cole was many basis points over us,” Goldberg recalled. “And the seller said, ‘Well, for 10 basis points, why am I jumping out into the world of the unknown when I can get myself involved with somebody who I think I has a much higher chance of closing the deal?’ So the seller went with Cole. The institutions’ expertise and ability to work that efficiently is something that private buyers—especially 1031 Exchange buyers or bond-substitute buyers—who are looking at under-$5 million properties really have a difficult time competing with in this environment. The efficiency of the larger players is making it more difficult for smaller investors to compete for a lot of assets. When we talk about, say, a McDonalds ground lease, which is trading at 4 caps, or a bank ground lease, which is trading at 5 to 5.5 caps—the institutions are not playing there. They’re not involved in those markets. But as the cap rates go a little higher and the deals are a little large,r the efficiency and the experience of the institutional investors is something that weighs very heavily in a seller’s choice environment.”
Providing the institutional perspective, Boyd Messmann, senior vice president, acquisitions, office and industrial properties in the Midwest and West regions for Cole Real Estate Investments, based in Dallas, concurred with his fellow panelists. “We are a well-oiled machine,” he admitted. “We can process transactions as well or better than anybody in the industry, and it’s tough for the individual investor to compete with the machines.”
But that being said, Messmann noted that he is seeing not only an increase in pressure from institutional investors on private investors, but, to a lesser degree, from small investors on institutions. “Two years ago there were no 1031 buyers.” However, this year, he said he has noticed a high amount of pressure occurring during some one-off Walgreens and CVS deals. “We try not to buy them one at a time, but sometimes you have to,” he said. “And so we definitely see pressure from the 1031 buyers too. Most times we’re not the high bidder, so we’ll go in and forecast closing 17 to 18 days to do due diligence, and five days to close.
So, asked Blankstein, how do individual investors distinguish themselves from institutional investors to make the deal?
A private individual must “come to the table with a very aggressive number and financing already in place or in an all-cash position,” said Fallon. “The differentiation, in my opinion, is on price and it’s on time as well. If you come to the table with your financing in place, you can try to move in 30 to 45 days. But, realistically, for a private individual to close a deal with private financing, it’s 60 to 90 days from start to finish, whereas [an institutional investor like Cole] can close all caps with financing on the back end, so it’s very hard to compete in terms of timing.
“Qualification of buyers is absolutely key. You have to come and put all your cards on the table because everyone knows the sheets--Cole doesn’t have to come in and qualify itself. But as a private individual, you’ve got to come in with your proof of funds, your financing in place and a resume that says you do have a track record and you can close—and will close. It comes down to the probability of closing and the price.”