While we classify 2022 as a transitory year for capital markets, the trends of 2022 can help provide some guidance as to what we can expect for 2023 net lease activity.
As we move through the first two quarters of 2023, we should have a clearer picture on the trajectory of interest rates and the capital markets environment. For this reason, there remains an abundance of capital on the sidelines waiting for valuations to adjust. Given the efficiency of the markets and following stabilization of spreads and valuations, investment activity should resume its robust pace as other fundamentals remain generally sound.
Last year, active investment sales brokers had to overcome several transactional challenges, notably dealing with six rate increases from March to December, an unprecedented pace of increases. However, to the surprise of some, the abundance of capital in the marketplace has helped keep cap rates compressed relative to financing rates, and within certain categories and lower price points, there is already a steady demand from investors in early 2023 as compared with the slowdown of the second half of 2022.
Some macroeconomic conditions are showing signs of stabilization including inflation metrics, and while the benchmark 10-year US treasury yield has increased from approximately 3.45% to 3.92% as of the date of this release, it has still retreated from its November 2022 highs. Leveraged buyers remain challenged but the long-term stability and passivity unique to the net lease asset class has outweighed those issues of late.
To that point, net lease property and income-producing passive real estate leased to credit tenants has been in more demand over the past five years than ever before. A few property types stood out in 2022 and are expected to remain in demand for 2023. Here are the three property types that look to continue their dominance in 2023.
QSR Chicken Sandwich: In 2022, the NNLG sold a total of 22 properties occupied by Chick-fil-A valued at $87 million with an average cap rate of 3.77%. This makes up for a 32% market share for all Chick-fil-A-occupied assets sold last year nationally, giving the firm the largest market share among all other brokerage firms, with $46 million of Chick-fil-A properties for sale or currently in escrow. The NNLG confirms 2023 as another strong year for the firm for sales of the country’s most successful chicken sandwich quick service restaurant chain, and further demonstrating the continued hunger for this QSR category.
Childcare Centers: The once-overlooked childcare center-occupied triple net leased investment category emerged as a major asset group for STNL investors. 2022 proved to be a banner period for this segment with sales soaring nationally. As an example, in 2022, the NNLG sold 14 single-tenant retail properties occupied by KinderCare Learning Centers in separate transactions totaling $60 million.
Medical Assets: Competition for net lease medical properties increased significantly since the start of the pandemic driven by institutional investors who want assets unaffected by the pandemic or the acceleration of e-commerce. In 2022, the NNLG saw more than 100 basis points of compression in cap rates for these types of assets. To that point, the team completed the portfolio sale of eight single-tenant properties occupied by Fresenius Medical Care, valued at approximately $56.54 million as well as the $50.3 million leasehold ownership sale of a single-tenant office/lab property fully occupied by Clinical Labs of Hawaii (CLH), the largest pathology/laboratory medical company in the Hawaiian Islands. NNLG sees this trend continuing due to continued demographic changes with an aging population, the appeal of medical as an e-commerce resistant product type, and the fact that these operators tend to be well capitalized with strong financial positions.
Looking ahead, especially in a shifting market with several variables at play both domestic and globally, the uncertainty on valuations makes it much more difficult for owners and sellers to assess project viability and to model pricing. For this reason, it is critical for sellers to make prudent and realistic decisions, and to factor in the new cost of capital on exits versus looking at historical sales done in a prior market and rate environment.
Matthew Mousavi is Managing Principal, SRS Real Estate Partners – National Net Lease Group.