STNL Market Demonstrates Resilience and Adaptability in Evolving Environment
In an evolving economic landscape, the single tenant net lease (STNL) market continues to demonstrate resilience and adaptability. As investors and lenders evaluate opportunities, focus remains on finding reliable and stable income streams in a fluctuating market. This update provides insights from three prominent investment sale brokers, Christopher Sheldon, Executive VP with Cushman Wakefield, Daniel Herrold, Senior VP with Northmarq and Putnam Daily, Managing Partner with Fisher James Capital, who participated in a short Q&A with Slatt Capital President, Michael Kaplan.
They shared intriguing insights about the state of today’s STNL market and where they think it is headed. Their responses to our questions reveal how higher interest rates have negatively impacted deal velocity and balance in supply. Yet, despite those underlying drags, capital and investors are finding opportunities and the STNL sector is expected to begin warming up.
The trio of experts each weighed in on the evolving role and value credit plays in today’s market. One says investors now place a premium on lower priced fundamentals and location, rather than tenant credit and lease term. Another opines that functionality or superior intrinsic value regardless of the asset class is the best approach. And a third perspective is that credits are fickle, and lease terms have a defined window, but a high-quality location is the best way to mitigate investment risk. They all concluded their responses with a few interesting views about the emerging environment in which e-commerce and traditional brick and mortar retail co-exist.
Q: (Kaplan) What is the current state of the single tenant (STNL) real estate market?
A: (Sheldon) The current state of the single tenant market is active but slow and sparse. We are seeing activity, but transaction velocity is slow, and investors are really picking their spots as to where they want to invest, whether it be credit, yield, lease term, geography or fundamentals. Deals that are getting done usually need to have a healthy combination of all those attributes, or at least most of them. 1031 velocity is as slow as I have seen it since the GFC. It seems to mostly be “situational” 1031 investors in the market, due to death, debt, divorce or change in lifestyle (reduction of management typically), etc. driving sales that lead to 1031 exchanges. We are not seeing any macro velocity of 1031 investors coming into the single tenant net lease market out of other asset classes.
A: (Herrold) The single-tenant real estate market is well off its 2021 highs, driven largely by elevated interest rates. We believe total volumes in 2024 are tracking to about the same levels as 2023 (roughly $40 billion), which is over 60% down from peak levels of 2021 ($110 billion). With fewer transactions occurring, 1031 buyers have diminished as well. As a result, inventory levels of product on the market for sale far exceed current buyer demand, creating the imbalance we’re seeing today.
A: (Daily) We remain heavy in the single tenant commercial real estate market. While two plus years of rate increases from the Fed slowed the investment market dramatically in 2023 and 2024, across nearly all commercial asset types, users continued to expand dramatically as consumers continued to drive revenues for regional and national companies in the retail, industrial, and healthcare segments. So, as developers continued to meet these expansion goals for tenants, investors’ ability to purchase those opportunities dried up as their returns dropped with higher rates and better alternatives in fixed income/bond markets. The market is beginning to warm up as the Fed announced what it was going to do in August and did what it said it would do in September by lowering its rate by 50 bps. As a result, we are seeing an improvement in the cost of capital for investors; we have seen more activity since late August and the beginning of recycled capital and exchange purchasers coming into the market as a result. But we have a significant amount of absorption ahead of us before we find stable footing in supply and demand in the single tenant market; we have upwards of three to four years of supply of certain credit profiles on the market for sale today.
Q: (Kaplan) Over the past couple of years, rising interest rates have curbed the volume in single tenant transactions. With rates coming off their recent highs have you seen a pickup in volume and if so, are there specific asset classes/tenants that seem to be attracting investor interest more than others?
A: (Herrold) No, and I don’t think we’ll see a pickup in volume until the second or third quarter of 2025, at the earliest. The Federal Reserve’s recent rate cuts are positive for the industry, but they don’t automatically clear the significant backlog of properties currently on the market.
For 1031 buyers to return, transactions need to happen first—and that process can easily take six to nine months. So, there’s going to be a lag between any drop in rates and an actual rise in transaction levels. And that doesn’t always correlate to a drop in cap rates as well.
A: (Sheldon) We saw some increased activity in July-September with the exuberance around the impending Fed rate cut in September and the corresponding dip in the 10-year treasury. There was palpable optimism in the market that seemed like it was transitioning into momentum and activity. The recent rise in the 10-year treasury (and interest rates) and the upcoming election have cooled activity in the last month and blown up a few deals. As for asset classes and tenants, we are still seeing good interest in well located industrial and QSR tenants with decent fundamentals, among other quality, credit tenants.
A: (Daily) Just as the Fed moved its benchmark rate down by 50 bps in September, long-term bond yields have gone higher since they did. So, while short-term debt is cheaper, long-term debt has popped back to where we sat mid-summer. This is benefitting certain asset classes, and we are seeing institutions begin to invest and divest again in some of the feeder asset classes to the single tenant space (i.e. multifamily, owner-user, land, some industrial). As a result of these volumes, we are seeing more activity in the single tenant space, and at higher price point values than we have experienced in nearly two years. Continuing to be the most attractive are the $1 to $5 million retail assets featuring a drive-thru component (i.e. QSR/coffee and unanchored strip product with drive-thru endcaps). That being said, we are seeing increased activity above $10 million across the board with stronger credits being the most sought after if they feature 15+ years of lease term.
Opportunities with term and credit remain the most attractive at any price point. Coming off a hot inflation market, investors are also more drawn to assets featuring annual rent growth over those that feature increases every five or 10 years.
Q: (Kaplan) When considering investing in single tenant properties what specific metrics / deal profile should investors be looking out for? Does asset class (retail, industrial or medical) play into the investor decision in finding security and value?
A: (Sheldon) As always, credit, fundamentals, location and lease terms are the center of focus. After that, some investors have specific thoughts relating to asset classes or types of tenants that drive their decision making. We are seeing fundamentals play the most important role in decision making as of late. Investors are leaning in on lower priced fundamentals and location, ahead of tenant credit and lease term, as for driving their decision making in certain investments.
A: (Herrold) I think each of the three asset classes—retail, industrial, and medical—has its own merits. The “flavor of the day” over the past five years has been industrial, driven by significant expansion and rent growth fueled by tenant demand. Meanwhile, retail is in a great spot too, with occupancy levels at record highs and tenants continuing to expand. So, the outlook for both product types is strong. When evaluating single-tenant properties, investors should focus on the “three legs of the stool:” the tenant’s credit quality, the lease’s length and economics, and the quality of the real estate. Credits can come and go (just look at Walgreens), and lease terms will always wind down as time passes. The best way to protect yourself from risk is by investing in properties located in high-quality locations—this is where investors should place the most weight.
A: (Daily) With high supply comes opportunity but the added challenge to find deals that check all the boxes. Finding intrinsically sound opportunities coming out of a higher rate, higher construction cost environment of the last three years can prove challenging. We push investors to find functionality or superior intrinsic value no matter the asset class and through zoning, improvement quality, excess land or coverage ratio, or strong tenant performance where there is transparency.
Q: (Kaplan) We are seeing some significant changes across the top tier tenants with “gold standard” credits such as Walgreens, Big Lots, 99 Cent Only and several others having announced significant store closures or additional bankruptcies. What credits currently stand out for investors looking to have security of long-term stable cash flow?
A: (Herrold) In my 20+ years in this industry, I’ve seen credit quality come and go, even among well-established companies. This further supports our thesis: always invest in the quality of the real estate first! That said, when it comes to credits, focus on market leaders in their industry segment. In the QSR space, McDonald’s and Chick-fil-A are at the top of the list. In the home improvement category, Home Depot continues to dominate. Sticking with segment leaders with strong financials will help keep you somewhat insulated from changes in credit quality.
A: (Sheldon) E-commerce and Covid have really shaped the way investors are looking at single tenant investments. As mentioned previously, industrial and QSR, in addition to medical and certain retail tenants, are still perceived as being resilient to such threats. The aforementioned tenants, Walgreens, Big Lots, and 99 Cent Only, are examples of tenants that were not necessarily resilient to the e-commerce/Covid disruptions, and therefore investors are trying to be strategic in investing in e-commerce resistant and necessity-based asset classes and business models as they look at tenants in the STNL space.
A: (Daily) As noted above, we feel intrinsic value can be found no matter the credit profile; where store closures exist, so does opportunity within those credit profiles on sites that are well developed or where rents are low enough for investors to backfill and enhance yield down the road. That being said, most of those closures are tied to non-performing sites that are not functional in a 2024 paradigm for that segment; as a result, we feel focusing on credits that are pushing sales volumes through refreshed or enhanced business models are the best place to start when reviewing the market (i.e. drive-thru oriented product, well trafficked strip product, manageable square footage and depth to layout on an arterial or within a shopping center or submarket, etc.). We like top tier quick service restaurant-coffee tenants like Chik-fil-A, Raising Cane’s, McDonald’s, Starbucks, Dutch Bros, etc. And we like hybrid users (retail-industrial) like Tesla who continue to change the markets in which they operate. Additionally, regional and national healthcare groups offer excellent staying power in their respective facilities after big investments made into the properties themselves.
Q: (Kaplan) Will e-commerce continue to have an impact on brick and motor retail, or have they come to a point where they can co-exist and benefit each other?
A: (Sheldon) I am not a retail leasing specialist, but it seems like we are nearing a point of equilibrium. E-commerce will continue to flourish, but I believe brick and mortar retail will always be needed by the consumer as well. Consumers are figuring out what works with e-commerce, as not everything does. The rapid rise in construction costs and lack of new development of shopping centers and retail space on a macro level has really helped bolster the existing brick and mortar retail as seen with the rise in retail rents and low retail vacancy nationwide. It seems like brick and mortar retail is in a healthy place right now.
A: (Herrold) When e-commerce took off over the past decade, many retailers had to shift their business models to make it a major part of their revenue, rather than relying only on brick and mortar sales. Those that didn’t make the shift? They’re no longer around. Today, e-commerce and physical stores co-exist more than ever, but there’s still room for innovation. Retailers and restaurants are finding new ways to blend the two, like offering click-and-collect or using physical spaces for experiences that can’t happen online. The two sides now feed off each other, creating a stronger, more dynamic way to do business.
A: (Daily) Yes, e-commerce will continue to have a major impact on brick and mortar retail as it makes up 16% of total retail sales nationally as of this year. That number continues to rise annually. But brick and mortar complement this rise in online activity and most major operators have incorporated and are maximizing sales through a hybrid model with strong distribution models in larger markets. This co-existence is several years deep at this point and a major growth engine for some of the world’s largest retail brands. The dynamic of square footage needed to enhance and create sales for retailers will change based on demographics within a specific market and how quickly operators can serve or deliver to those customers.
Christopher Sheldon
Cushman & Wakefield
Executive Managing Director – Capital Markets | Net Lease Group
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Daniel Herrold
Northmarq
Senior Vice President
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Putnam Daily
Fisher James Capital
Managing Partner
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