The pressure’s on net lease from the long span of rising interest rates, says a report from The Boulder Group.
In its 3rd Quarter Net Lease Research Report, the firm said that cap rates have been rising for the last six quarters and nationally stand at 6.51%.
“Single tenant cap rates increased to 6.27% (+10 bps) for retail, 7.41% (+14 bps) for office and 6.96% (+16 bps) for industrial in the third quarter,” they wrote. “The consistent rise in interest rates continues to be the primary driver for the upward pressure on cap rates. Over the course of the third quarter, the 10 Year Treasury peaked at 4.68% which is almost 100 bps higher than the lowest level of 3.73% during the same time period.”
Although the 10-year recently had edged its way back down to 4.49% on November 8, it was back up to 4.61% on November 10 and could continue that upward movement. Buyers or current owners looking for a risk-adjusted return have to consider that they could get a significant risk-free return with Treasurys and so need a bigger upside than in recent years.
Interest rate increases have also “further amplified the pricing dislocation in the net lease market between buyers and sellers.” That has changed significant dynamics in the market. The pool of sellers has been increasing while that of buyers has continued to shrink. According to the report, “In the third quarter of 2023, the marketing time of net lease properties grew when compared to the prior year by 25% to more than eight months. Furthermore, the supply of net lease product on the market increased by approximately 10%.”
The fourth quarter usually has higher transaction volumes because CRE funds are looking to fill annual allocations and balance their investments to fit their strategies. But don’t count on a big holiday gift if you’re looking to make a sale.
“However, with many institutional and REIT buyers achieving their target allocations early, the expectation is for a slower than normal quarter,” the report says. “With interest rates and cost of capital at the forefront of investors’ minds, the focus will be on the upcoming Federal Reserve meetings. All cash and 1031 buyers, while limited, will look to take advantage of the increased property supply in order to buy assets at higher cap rates. Ultra-low cap rate assets will be concentrated in properties with “one-of-a-kind” attributes in top markets with long term leases and strong tenants.”
While few expect an increase in interest rates at the next Fed meeting, a drop in the federal funds rate is a virtual non-starter. Additionally, Fed Chair Jerome Powell recently reminded markets not to make premature assumptions that the central bank will back off from what it’s been doing.