Investor interest and capital flows to the single-tenant net-lease sector have skyrocketed. Many private investors are attracted to these low-maintenance investments and are targeting single-tenant net-lease properties, selling other property types and utilizing 1031 exchanges to redeploy their capital.
Significant demand has pushed cap rates in the single-tenant sector down to just under 8 percent, compared with 8.6 percent in 2002. For well-located properties occupied by top-tier tenants it is not uncommon to see cap rates of less than 7 percent. Ever-popular Walgreens stores that were selling at 8.5 percent to 9.0 percent cap rates several years ago are now trading in the 7.0 percent to 7.5 percent range, and some deals are going for as low as 6.5 percent. It is the ultimate sellers' market, with buyer demand far outweighing the inventory of for-sale product. Today's buying frenzy is characterized by short marketing periods and intense competition for quality assets. Many 1031 buyers are paying up for properties in order to meet deadlines imposed by their exchange requirements.
The next 12 to 18 months should remain scorching in retail real estate. Once the economy gains momentum and interest rates start to rise, we will see upward pressure on cap rates as some investment capital is siphoned from the single-tenant sector. Markets that are capturing investors' attention include the Sunbelt metropolitan regions such as Atlanta, Dallas, Los Angeles, Phoenix and San Diego as well as numerous Florida MSAs, where retail is driven by continued population increases and employment growth. Retail markets in other large metropolitan areas such as Chicago, New York, Washington, D.C. and Philadelphia are all primed for growth as both retailers and real estate investors seek properties in high-growth infill locations.
Following are the outlooks for a variety of single-tenant retail property types.
Investor demand for drugstores, one of the highest-growth components of the retail sector, far outpaces the supply of available for-sale product. Some of the sector's top retailers include Walgreens, Rite Aid and CVS, all of which are pursuing aggressive expansion plans. Walgreens, for example, now has more than 4,250 stores in 44 states. The company aims to open 450 stores in fiscal 2004. The 3,400-store Rite Aid chain plans to open 75 new stores by early 2005.
CVS, which has more than 4,100 outlets, recently bulked up by acquiring approximately 1,200 Eckerd stores, primarily in Florida and Texas. While some growth focuses on locating in second-generation facilities left dark by other types of stores, particularly in the Northeast, the majority of new drugstore development is taking place in free-standing properties in large metropolitan regions. Competition between drugstore chains for prime locations in urban markets should continue to blaze.
Investors covet properties with a long-term lease secured by a top-tier credit tenant such as Walgreens. The company is coming off a stellar year in 2003, and in the first quarter of 2004 it recorded a same-store sales increase of 13 percent. However, competition for Walgreens properties is intense; well-located properties in top markets have sold for $325 to $390 per square foot. Investors in this sector need to be well connected to source available properties and be ready to act quickly. Well-located properties are scooped up in the blink of an eye at cap rates hovering around 7 percent.
Sandwich chains are continuing their expansion across the country, and the fast-food giants have responded in two general ways: by broadening menus to include more health-conscious items and altering retail space to create a more upscale experience. The result has been positive; these fast-food restaurants are seeing more green both on the menu and in the cash register. McDonald's comparable sales have increased and its stock price has shot up. Wendy's stock is also significantly higher than a year ago. Growth among sandwich shops and other healthier alternatives continues unabated. For example, Quiznos opens a new store every 16 hours, and Panera Bread has more than 400 additional active franchise commitments in place.
Traditional clustering of casual restaurants should lead to great opportunities in accessible locations. Chain restaurants that operate larger casual dining facilities offer strong investment opportunities and are very active. Corporate guarantees enable chains such as Applebee's, Chili's, Texas Roadhouse, LongHorn Steakhouse and Firebirds to sign 20-year leases. LongHorn plans to add 24 restaurants on 1.5-acre pads in 2004, and Ruby Tuesday adds up to seven new restaurants per month.
Everyone loves a bargain and dollar stores are flourishing as a result. These retail concepts remain an extremely strong option for investors. Dollar General's sales increased 14.6 percent since 2002, Family Dollar sales rose 14.1 percent, Dollar Tree experienced a 17.2 percent jump and Big Lots a 12.7 percent increase. Dollar General operates 6,709 stores in 27 states with over half located in Tennessee, Kentucky and the states bordering them. It plans on opening 675 stores in 2004. Family Dollar operates 5,102 stores in 43 states and expects to add 565 stores this year. Smaller chains, 99 Cents Only in the West and Fred's in the South, are also growing rapidly. Watch for even greater growth soon as chains begin carrying more groceries as rising interest rates create a middle class ready to shop at dollar stores.
Wal-Mart and Target continue to dominate the discount retail category. In 2004, Wal-Mart plans to open 306 stores. Target's stock rose over 25 percent during the previous year. Target has 1,109 stores in 47 states and 118 SuperTargets in 19 states, and plans to open 100 new stores in 2004. Eight SuperTargets, including two each in Illinois and Virginia, are scheduled to open in 2004. After emerging from Chapter 11 and shuttering more than 600 stores, Kmart hopes to carve out a niche in its efforts to compete with Wal-Mart and Target. Big-box construction in the general merchandise sector, which includes Wal-Mart, Target and Kmart, was up by 29 percent in 2003. Comparatively, total retail construction grew just 4 percent last year.
Membership warehouses such as Costco, BJ's and Sam's Club continue to attract customers from all parts of the economic spectrum. Costco has 315 domestic locations and opens three new warehouses per month. Costco began fiscal 2004 with same-store sales increases of 11 percent over the previous year. There are more than 500 Sam's Clubs in the United States, and 21 new facilities opened in 2003. Sale prices for retail warehouses have increased 68 percent since 1999 to an average of $9.7 million.
Even with increased competition from discounters, dollar stores and drugstores, investor demand remains high for supermarket properties. The average sales price per store has nearly doubled in the past five years. The median price per square foot rose 21 percent last year, to $82. Specialty grocers such as Whole Foods and Trader Joe's are enjoying success filling separate niches. Whole Foods, with its natural but high-end inventory, is enjoying double-digit same-store sales growth, while discount specialty food retailer Trader Joe's has plans to expand into several new markets across the United States.
BERNARD J. HADDIGAN
Atlanta-based national director of Marcus & Millichap's National Retail Group.