Net Lease Investors Come Off the Sidelines and Flock to Sure-Bet Deals

Real Estate

It should come as no surprise that the COVID-19 pandemic sent the investment market reeling. When the full impact of the crisis was setting in back in the first quarter, all sectors of the net lease market felt the dire pinch. Slowly, however, investors seem to be coming out of hiding and creating some activity, as our Q2 Cap Rate Report reveals. Note: We said “some.”

On one hand, overall activity volume is still suffering, to the tune of a 37% drop in Q2, from 416 in the prior quarter to 264 trades. This was on top of the 27% drop the market sustained in Q1. The good news here is that cap rates for the net lease sector overall held surprisingly steady, rising only three basis points on average, this the by-product of the high-quality deals that did get done. In Q2, investors and lenders sought to place money only in the rarified spaces of highest credit and longest leases.

That points to the Pharmacy and Dollar Store sectors, both dominated by a handful of trusted, high-credit names deemed essential businesses at the start of the crisis. Cap rates in the latter sector rose from 6.94% to 7.11% quarter over quarter, with only a one-year change in lease terms to 12.8 years. But if we sift out deals with leases shorter than 10 years and concentrate exclusively on higher-quality 10-year-plus trades, cap rates fell 19 basis points to 6.69%. (Dollar Store claimed the bulk of those deals at 84% of the activity.)

Cap rates in the Pharmacy sector showed a more substantial swing, dropping 62.9 basis points (bps) to 6.31%. Q2 lease years remaining were substantially flat with the prior quarter, at 13.8 years.

It should be noted that the report tracked 43 deals in the Pharma sector for Q2 and 77 deals in the Dollar Store market—making them two of the three most active sectors for the quarter (The Quick Service Restaurant field posted 49 trades).

What does all of this mean against the backdrop of the overall economic and business climate? Save for employment numbers, the stock market and the 10-year are very much as they were in the early days of Q1, when few of us knew what COVID was. 

But, as we get accustomed to the impacts of the pandemic, we swing to another driver of uncertainty—namely, the upcoming presidential election, which always tends to dampen investors’ enthusiasm for risk.

Nevertheless, there is money—a lot of money—on the sidelines right now. And we believe that when it is all tallied up, we will have seen more deals getting done in the last half of the year than we saw in the first half, pre-November unease aside. 

No matter the outcome or which horse you are betting on, the election will bring certainty about the economic and business climate we will be saddled with for the next four years. Simultaneously, we are making peace—even if it is an uneasy peace—with the so-called new normal of a post-COVID environment. That, and the capital now burning a hole in investors’ pockets, should bode relatively well for the net lease sector in coming months.

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