Net-Lease Investors Seek Credit and Essentials

written by Zach Wright, published in CREJ

The COVID-19 pandemic undoubtedly has impacted all facets of commercial real estate, including single-tenant net-leased retail properties. In the second quarter, transaction volume for STNL retail properties was down 38.4% nationally and down 41.3% in Colorado, when compared to the second quarter of 2019.

In addition to the fear and uncertainty felt by most investors during the height of the pandemic, the extension of 1031 exchange identification and purchase deadlines also impacted transaction volumes. Investors with deadlines to identify or purchase replacement properties after April 1 were granted extensions by the IRS to July 15. This extension allowed many investors time to monitor the impact of the virus and government-imposed lockdown on the economy and real estate market. The STNL retail buyer pool is largely made up of private 1031 exchange investors.

Despite a dramatic decline in overall second-quarter STNL retail transaction volume both nationally and in Colorado, several STNL subsectors continued to transact at an unchanged pace in comparison to prior years.

Investors sought and continue to seek properties leased to essential businesses with high-credit tenants. Dollar store and drugstore properties arguably have benefitted the most from this investor flight to security.

In the second quarter, there were 139 dollar store properties sold nationally, a 2.2% increase in comparison to the second quarter of 2019. These dollar store transactions accounted for 9.6% of all STNL retail transactions nationwide in the second quarter. This is a substantial increase in comparison with the second quarters of 2018 and 2019, where dollar store transactions accounted for 5.9% and 5.8% of all STNL retail transactions, respectively.

Dollar General, Family Dollar and Dollar Tree have all fared well throughout the pandemic and experienced increased store sales as consumers stockpiled affordable and essential goods. Dollar store properties have been highly sought after among net lease investors throughout the pandemic. These investments offer strong corporate credit and are essential businesses that are thriving. Further, dollar store deals offer long-term leases, low price points and attractive cap rates.

In the second quarter, there were 118 drugstore properties sold nationally, which is consistent with the average number of drugstores sold in the second quarter of the past five years. These drugstore transactions accounted for 8.2% of all STNL retail transactions nationally in the second quarter. This is a significant increase compared with the second quarters of 2018 and 2019, where drugstores accounted for 4% and 5.7% of all STNL retail transactions, respectively.

STNL properties leased to Walgreens, CVS and Rite Aid historically have been the quintessential STNL investment. In recent years, these drugstore deals began to fall out of favor among net lease investors due to increased consolidations, store closures and the emergence of e-commerce in the sale of pharmaceuticals. However, drugstores have been at the forefront of investor interest since the start of the COVID-19 pandemic due to their strong credit, essential nature of their business and typical high profile locations.

Dollar stores and drugstores are not the only subsectors currently garnering significant investor interest. The STNL retail market has been bifurcated into essential and nonessential properties. Other essential deal types in high demand include auto parts stores, quick-service restaurants, convenience stores and banks. In addition to their essential nature and ability to successfully operate amid the pandemic, these deal types are primarily guaranteed by investment grade rated companies or large publicly traded companies and feature long-term leases with fixed rental increases.

Meanwhile, STNL properties such as movie theatres, fitness centers and casual-dining restaurants have been the most adversely impacted properties. In addition to their inability to fully operate during the pandemic, many of these property types feature tenants with weaker credit and more specialized buildings. As new companies seemingly announce bankruptcies each week, there is substantial investor concern regarding the longevity of some of these tenants.

STNL retail properties historically have been sought after as a safe investment because of their bond like features. Due to their long-term leases, STNL properties have offered investors stability and the ability to withstand market downturns. Other product types such as multifamily, office buildings and shopping centers are much more susceptible to adverse market conditions. With increasing volatility facing much of the real estate world, STNL properties will outperform and provide investors a safe haven.