Texas Real Estate Business

MAY 2016

Texas Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in Texas.

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40 • May 2016 • Texas Real Estate Business www.REBusinessOnline.com professionals expect 1031 Exchange activity in particular to keep cap rates in their current neighborhood. The 1031 Exchange program allows sellers of a property to defer paying capital gains taxes if they funnel proceeds into a similar or "like-kind" asset. But to qualify the exchanger must com- plete the purchase of the new prop- erty 180 days after the initial sale. "If a 1031 buyer really likes a deal, they don't care so much about the cap rate on the last trade (of a similar property), they just care about ful- flling their trade," Odom says. "So they're willing to pay a little higher price." Schroeder adds that many 1031 Ex- change buyers are second- or third- generation owners of apartments rotating out of the management-inten- sive properties and into more "hands- free" net lease real estate. As long as investment interest keeps cap rates compressed in the multifamily sector, he predicts, demand for net lease as- sets will stay strong. Similarly, retirees are also seeking net lease properties, whether they are 1031 Exchange investors getting out of "hands-on" properties or more conventional investors frightened by stock market volatility and low- yielding bonds, says Parker Carroll, a managing director in the net lease in- vestment group with Coldwell Banker Commercial in Austin, Texas. "Right now we're seeing a big trend of people preparing for retirement, and they're using net lease properties to replace bonds in their portfolios," Carroll explains. "We're seeing that on a bigger scale than we've probably ever seen before." Carroll's team began marketing seven renovated Dairy Queen restau- rants operated by a major franchisee in small Texas markets in February, and three were sold or under contract to separate investors within roughly a month. The buyers accepted cap rates of around 6 percent for the proper- ties, which feature 19 years left on the leases and annual rent increases of 1.5 percent. Each of the seven properties listed for around $1 million, and the remaining properties were generating high interest, he says. "We believe that's a pretty aggres- sive cap rate for those markets," Car- roll says. "But I think the assets served as a price point where a lot of buyers could go in and buy for cash." Demand for net lease retail prop- erties continues to outstrip available product, which should also keep downward pressure on cap rates. The supply of net lease retail assets for sale plunged 12.5 percent in the fourth quarter of 2015 from the third quarter, according to Boulder Group. It dropped an additional 1 percent in the frst quarter of this year. "Limited construction is the main driver of the decline in supply," Blankstein states. Seller's Market Foreign investors that prefer a tepid economy in the U.S. to the lack of any growth in other countries continue to buy net lease assets, especially in ma- jor markets on the coasts, observers say. Institutional net lease investors re- main buyers, too, but some are ratchet- ing up dispositions to take advantage of strong demand. Four of the largest publicly traded net lease REITs that predominantly invest in retail properties – National Retail Properties, Store Capital, Re- alty Income and Spirit Realty – have indicated that they'll pare back acqui- sitions and sell more assets this year than in 2015, according to statements and fnancial disclosures made by the companies. Looking at their combined transac- tion activity, National Retail, Store Capital and Realty Income acquired nearly $4.1 billion and sold $47.4 mil- lion net lease properties in 2015. But together those three REITs predict that they'll spend $2 billion on acquisitions and sell upwards of $250 million in 2016, according to their guidance. While Spirit Realty doesn't provide guidance, executives during the com- pany's fourth quarter earnings call in February projected that the REIT would be a net seller of assets in the frst quarter this year after disposing of $547 million and acquiring $889 mil- lion of properties in 2015. Tom Nolan, chairman and CEO of Spirit Realty, told investors that the REIT would seek to take advantage of a 1031 Exchange market that was "on fre" to pare of some its non-core properties. To illustrate the point, he revealed that the company had just completed the sale of a Taco Bell/KFC at a 5.7 percent cap rate. "We're at an interesting time where the market is a little volatile, so we're being very cautious in terms of the ac- quisitions we're looking at," he said. "Yet at the other end of the spectrum, we've got a very robust acquisition market for the type of assets we own." Debt Riddle The ability of 1031 Exchange buy- ers and other investors to complete net lease deals without debt — or with leverage amounting to only around 60 percent of the transaction — could give them an advantage over buyers that need more fnancing as a handful of forces cloud lending markets. Stock and bond market volatility early in the year prompted investors in commercial mort- gage-backed se- curities (CMBS) to demand higher re- turns, for example, which efectively shut down CMBS deals. CMBS issu- ers sold only $9.5 billion in the frst quarter this year, a paltry fgure that's far behind the $26 billion that closed in the same period in 2015. It also all but dashed hopes that CMBS issuance in 2016 would approach or build on last year's total of $95 billion. On top of that, Trepp's estimate that some $205 billion in CMBS loans will need to be refnanced through the end of 2017 emphasizes the need for a functioning securitiza- tion market. Cram, president of private lender Envoy Net Lease Partners, wonders whether lenders like banks and life insurance companies will have the capacity — and tolerance for risk — to meet the debt requirements in the commercial real estate market, includ- ing net lease buyers, even if the CMBS market rebounds. Late last year, the Fed and other reg- ulators warned banks that they would more closely watch commercial real estate lending in 2016, which has made banks more cautious, he says, and life insurance companies allocate only a certain amount of capital toward real estate. Plus, Cram suggests that antici- pated bankruptcies and defaults in the energy industry could amplify a grow- ing aversion to risk, which could bleed into the mortgage market and increase loan costs for net lease borrowers. "We're in a market where execution risk is higher than it has been in sev- eral years, because the fnancial play- ers — especially the CMBS players — don't know where they are (in terms of pricing loans) with all the market volatility," Cram says. "The whole is- sue on the debt side is that we have some rollover happening, never mind any new projects that need fnancing. So where is that capital going to come from if CMBS isn't there?" n Ian Schroeder CBRE We're seeing a trend of people preparing for retirement, and using net lease properties to replace bonds in their portfolios. — Parker Carroll, Managing Director in the Net Lease Investment Group, Coldwell Banker Commercial Come Visit Us ICSC RECon 2016 Las Vegas Convention Center S255Q Street May 22 nd -25 t h NAI Robert Lynn Retail Team Dallas Fort Worth Ellis County 4851 LBJ Freeway 1200 Summit Ave. 229 S. 9th Street 10 th Floor Suite 800 Midlothian, TX 76065 Dallas, TX 75244 Fort Worth, TX 76102 214.256.7100 214.256.7100 817.885.8333 Dan Avnery President, Dallas Retail 214.256.7144 [Dallas Offce] Monica Greer Transaction Manager 214.256.7151 [Dallas Offce] Cameron Haddad Market Director 817.872.3906 [Fort Worth Offce] M o n i c a G r e e r C a m e r o n H a d d a d Ryan Lee Market Director 214.256.7143 [Dallas Offce] Jon T. McDaniel President, Fort Worth Retail 817.872.3902 [Fort Worth Offce] Basil Mitchell Market Director 214.256.7154 [Dallas Offce] Bobby Montgomery Market Director 817.872.3908 [Fort Worth Offce] Tom Heraty Partner, Dallas Retail 214.256.7175 [Ellis County & Dallas] T o m H e r a t y Kornel Romada Executive Vice President 817.872.3904 [Fort Worth Offce] Andrew Shaw Market Director 214.256.7100 [Dallas Offce] Mike Smith Associate 214.256.7152 [Dallas Offce] Retail Property Listings 350 + 3 Local Offces Active Retailers & Restaurants 50 + Hunter Hayes Market Director 817.872.3900 [Fort Worth Offce] H u n t e r H a y e s NET LEASE from page 38

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