Pricier debt and signs of stress

Together with

Good morning. Net lease investors face a challenging environment of tougher lending conditions as buyers and sellers continue to disagree on valuations. Compelling value-add features—such as top-credit tenants and healthy rent escalations—are often key to successfully completed acquisitions.

Today’s edition is sponsored by Bullpen. Find out why 500+ CRE companies use their talent network to find top, pre-vetted experts.

👋 First time reading? Sign up here.

Net Lease Investors Press Pause as Price Discovery Gets Tougher

Net lease investors are finding it difficult to execute acquisitions in today’s market due to a tightening lending environment, decreased transaction activity, and pricing discrepancies. The challenge for many investors lies in trying to accurately price assets that fit their criteria.

Setting the scene: Net lease sales volumes have been in decline for two years, and net lease retail/office that previously traded well is struggling. As interest rates went up, transactions went down. This year, the situation is no different.

By the numbers: Net lease retail properties on the market fell by more than 8.6% in Q1 2023, and net lease office properties declined by 1.48%. Sales volumes also declined between 30–40% YoY in Q1 2023. LTVs on loans for net lease acquisitions have dropped by an average of 10% since last year, and interest rates on retail loans have also risen to 6% from 5.25–5.5% last year, with office and industrial cap rates near or at 7%. Net lease investment sales also fell 25% last year compared to 2021, as investors remain cautious in a turbulent environment.

Fewer deals to be found: Investing has become increasingly difficult due to a diminishing group of potential buyers and investors, including those involved in 1031 exchanges. The Fundamental Income Net Lease Real Estate Index has experienced a year-over-year decline of 18%, while the total returns on the Fundamental Income Net Lease Real Estate ETF (NETLX) dropped 15% over the same period.

Investment opportunities: Despite the market’s decline, investors with deep pockets can still find investment opportunities, as seen with ElmTree Funds’ Q1 2022 total of $800M in net lease acquisitions. Meanwhile, REIT Agree Realty Corp (ADC) is estimated to have reached $1B in acquisitions in Q1 2023 by taking advantage of several opportunities in the merchant builder space as institutional sellers are forced to adjust their pricing expectations.

Higher rent escalations: Investors are focusing on credit tenant ratings and looking for short-term rent escalation on the higher end, according to Joey Agree. Properties with rent escalations of 3.0% or more built into their leases are attractive to ElmTree Funds’ net lease private equity firm. Deals that close—like the sale of a quick-service restaurant by Northmarq featuring a great location, good tenant credit, and 10% rent escalations every five years—are few and far between.

➥ THE TAKEAWAY

Pickier and trickier: Net lease investors are facing challenges when it comes to acquiring properties. These challenges arise from several factors such as stricter lending requirements, a slowdown in property trades, and a gap between buyer and seller expectations. As a result, investors are becoming more selective and are focusing on assets that feature top credit tenants and long leases with rent escalations. Deals that do end up closing tend to have highly sought-after features like good locations and special attributes.

At the same time: The number of net lease retail properties on the market is declining, and pricing accuracy challenges are causing some investors to forgo attractive buying opportunities. Despite these difficulties, well-funded buyers are still able to find attractive investment options. Some are targeting industrial net lease acquisitions, while others are looking to buy and redevelop existing properties.

‍Hire the Top 3% of Real Estate Talent

Revision Real Estate Partners was rapidly growing and needed help – fast.

However, the nature of Revision’s client work demanded a unique blend of commercial real estate skills and a technologist’s mindset. Christie, Revision’s CEO, contacted Bullpen to find the right person for the job.

In less than 3 days, Bullpen introduced Christie to Josh, a commercial real estate professional with over a decade of experience. In addition to expert-level modeling skills, Josh came with a finesse that was perfect for the client-facing nature of the role.

As a real estate veteran, Josh gave Revision a day-one increase in capacity and instantly became a client favorite. Beyond his client work, Josh came to the table with actionable ideas for Revision’s operations and added a big brand credibility boost as part of the business development team.

After working together for a few successful months, Revision brought Josh on full-time. By starting as a contractor and scaling to full-time on a natural timeline, Josh and Bullpen rapidly boosted Revision’s capacity while providing peace of mind that an expensive permanent hire wasn’t being rushed.

Looking to expand your own bench of talent? Get in touch here.

📖 Read about how investors can apply modern portfolio theory (MPT) to real estate investment to diversify their portfolios and reduce risk.

🖥️ Watch as OpenAI cofounder Greg Brockman shares the design principles of ChatGPT and demonstrates unreleased plug-ins for the chatbot in a TED talk.

🎧 Listen to the latest episode of Fort with Chris Powers to hear Jake Wurzak, founder and CEO of Dovehill Capital Management and president of Wurzak Hotel Group, discuss how he built a hotel empire.

📚 Learn about how cap rates are used in commercial real estate transactions to measure the expected rate of return on an investment

• Real estate fundraising: Non-traded REIT fundraising bounced back in March with $1.2B raised, a 156% increase over February levels.

• On the blockchain: Inveniam Capital Partners, a fintech firm specializing in digitizing and automating the middle-office for private assets, will provide tech to Cushman & Wakefield to enhance global private market asset trading with real-time data surveillance.

• Deeper and wider: The current CRE downturn is distinct from previous ones. The dual pressures of higher rates and low demand have not been seen on this scale since the 1970s.

• The Great Remote Escape: Remote work has reduced U.S. federal office occupancy to about 5% of pre-pandemic office space, creating economic challenges for Washington.

• Asian RE dominance: Asian investors were the largest source of capital for real estate funds globally in 2022, putting up $94.3B, or about 35% of the $270B raised, according to INREV, ANREV, and NCREIF.

• Real estate woes: U.S. commercial and residential property is in decline, with SL Green (SLG) reporting its NYC occupancy rates dropping to around 90%. Meanwhile, office sales in DFW have fallen by 80% YOY from $1.1B to $227M.

• Domino effect: CRE firm The Dilweg Cos. handed First Citizens Bank Plaza in uptown Charlotte back to its lender after WeWork (WE) defaulted on its tenant lease.

• The keys to the city: NYC Mayor Eric Adams is offering grants of up to $25K to landlords of 400 rent-stabilized homes to fix up vacant apartments, with the funds dependent on the homes being vacant for rent and rehabilitating the apartments to service the homeless.

• Blackstone’s crystal ball: Blackstone (BX) predicts a 58% decrease in real estate earnings for Q1 2023 compared to 2022, with profits from sales down 54%, although corporate private equity and private credit funds rose 2.8% and 3.4%, respectively.

• Luxury Texas living: Hanover Republic Square is one of Austin’s most luxurious apartment buildings, featuring a vinyl parlor, movie theatre, dog-grooming spa, rooftop pool on the 44th floor, and a neighboring 66-story skyscraper with three pools.

• Out with the old: SGA’s survey found coffee shops, air-purification systems, outdoor patios/roof decks, breakfast/lunch options, and quiet lounges are all in high demand at offices, with only 35% of respondents citing a fitness center as desirable.

• Too big for change: The $1.9T American Rescue Plan Act offers a chance for state and local governments to stabilize and expand services for constituents following the pandemic, but may be unrealistic in the coming years.

• No more DTC: Walmart (WMT) has sold Eloquii to FullBeauty Brands, marking the third divestment of a direct-to-consumer (DTC) brand this year, reversing the company’s former e-commerce strategy.

• Big Apple Bucks: NYC’s top 10 loans for March amounted to $1.2B, down from $1.8B a year ago. The biggest loans went to office buildings, including Tishman Speyer’s (TSIBU) 66 Hudson Boulevard.

• NC welcomes Mickey: Three North Carolina senators filed a bill to bring Disney’s (DIS) theme parks to the state amid accusations that Florida Governor Ron DeSantis was retaliating against Disney.

• Downward trajectory: U.S. median home prices dropped 3.3% in March, as new listings declined by 23.3%, according to Redfin.

Inventory levels have increased for 2023, with 80,000 new single-family listings this week. However, there are 10% fewer new listings than last year. Despite this, 21,000 of the new listings are already under contract, indicating strong demand. It remains to be seen if the sales rate in May will also increase.