It used to be, before interest rates began their upward journey, that Matt Berres and Samer Khalil with the Newmark Net Lease Capital Markets team would receive between five to ten emails a week regarding 1031 deals in the $1 million to $5 million range. “Those mom-and-pop investors who buy long term stable properties were always the bread and butter of the business” says Matt Berres, vice chairman. “We could always count on having several of those in play at any given time,” he tells GlobeSt.com.
That side of the business has shrunk significantly as transactions in net lease – indeed all of commercial real estate – has slowed.
But as these particular emails dwindle down to one or two a week, Berres and Khalil are seeing an uptick in another sort of request for 1031 deals: Namely in the 10 million to $30 million range, sometimes as high as $50 million. These investors tend to come from one of two buckets:
- Those selling their downleg to capitalize on where the most aggressive capital is (i.e. where buyers still exist at attractive cap rates), or
- Those selling their downleg property as a way to reduce risk in their portfolio, such as a shorter lease term or a tenant that doesn’t have a good credit profile or long-term outlook. These participants are primarily private or family office investors, although Berres and Khalil have seen a few of these 1031 exchange requirements from institutional investors, and it is here where deals are getting done.
This is what a typical deal in this range looks like. The seller is looking to offload a property that has some kind of inherent risk to it and thus a higher cap rate that is more likely to make financing viable in light of where interest rates are. There are many investors in the market with capital to deploy, but it’s just a matter of finding compelling risk-adjusted returns that justify taking the capital off the sidelines, Khalil explains. “None of these investors are willing to go into a negative leverage situation, so our clients are being very selective about what they put their capital into – it has to make sense given the overall returns that are achievable today while being congruent with their general portfolio criteria and long-term outlook.”
However, not all deals are possible simply because of a property’s shortcomings. There still are deals underway where investors can sell a property at a lower cap rate and go exchange into something at a higher yield, typically by changing asset classes (i.e. from multifamily or industrial to retail).
Khalil tells of one situation in which a private investor sold a multifamily property in Los Angeles for close to $20 million and is currently in a 1031 exchange with $17 million in equity and looking for a single- or multi-tenant triple net retail or industrial property outside of California. In this case, it didn’t sell because the property had some hair on it; rather they had a buyer at an attractive cap rate and they were confident they will be able to find an upleg property that offers a higher yield and is well suited to their investment objectives.
Berres adds, “Another example we have found interesting is a client of ours who is selling their business after 50 years to a competitor and owns their real estate associated with the business. Given the attractive nature of net lease investments with long term cash flow from tenants with strong balance sheets and approaching retirement, they are now in a position to put approximately $20 million to work as they transition into a diversified portfolio at an attractive risk adjusted basis while enjoying their golden years.”
“The clients in these scenarios are typically looking to achieve some leverage and given where financing and interest rates are currently, the minimum target cap rate is in the low to mid 6% range and we believe they will be able to find an attractive property that meets their criteria transacting with a seller who understands pricing has shifted, but the overall sale still matches up with their general portfolio goals and objectives,” Khalil says.