Top-Tier Single Tenant Net Lease Properties Are Poised To Outperform

written by Brandon Gayeski, published in Colorado Real Estate Journal

Single tenant net lease (STNL) retail properties have been one of the most attractive and sought-after investments throughout the past decade. The STNL investment market posted a record $40.1 billion in sales during the first half of 2022.

STNL properties are highly desirable due to their passive triple net leases which offer investors minimal or no landlord responsibilities. The tenant is typically responsible for maintaining the property in addition to paying all operating expenses such as taxes and insurance. STNL properties often feature long-term leases (10-20 years) providing stable and predictable cash flow, they typically have fixed rental increases, and are leased to high-credit tenants (investment grade rated companies, publicly traded companies, and/or large franchisees). Long lease terms and high-quality tenants offer investors stability across market cycles.

Investors are attracted to STNL retail properties due to their familiarity with the tenants. Some of the most popular tenants include Walgreens, Chase Bank, Starbucks, Chick-fil-A, McDonald’s, Chipotle, Dollar General, and 7-Eleven. STNL properties are often well-located along major thoroughfares and at highly visible locations allowing investors to acquire properties with valuable underlying real estate. In addition, many are strategically located at signalized intersections and/or outparcels to larger developments. As investors enter their retirement years, many are acquiring STNL properties due to their passive nature and predictable cash flow.

With increasing economic volatility, rising interest rates, and other headwinds facing the general real estate market today, “top tier” Colorado STNL properties priced under $5 million will outperform the market and continue to be a highly sought-after investment. We define “top tier” STNL properties as those featuring long-term leases, investment grade tenants, new construction, locations in major MSA’s, and leases containing fixed rental increases, etc. Cap rates for these property types are going to be the least impacted as the market shifts.

Over the past five years, “top tier” STNL properties in Colorado have traded at a premium relative to the rest of the U.S. due to a supply-demand imbalance. Historically, there has been a limited supply of “top tier” STNL properties with substantial capital chasing these deals. The vast pool of buyers targeting Colorado STNL properties can be attributed to the strength of Colorado’s economy, population growth, strong demographics, and educated workforce.

STNL properties priced under $5 million are generally less sensitive to rising interest rates as the buyers are often all-cash or have minimal debt. Moreover, the STNL retail buyer pool is largely made up of private 1031 exchange investors. As of today, there are currently only fourteen “top tier” Colorado STNL properties on the market that are priced under $5 million per Crexi.com.

Moving forward, the supply of available “top tier” Colorado STNL properties is expected to stay limited. As a result, cap rates for these properties will remaincompressed. The shortage of “top tier” STNL properties can be attributed to reduced expansion plans of many retailers due to market saturation, rising construction/land costs, and challenges with local municipalities approving new construction projects. Cap rates are anticipated to increase for all properties; however, cap rates for “top tier” Colorado STNL properties will experience less cap rate growth compared to less desirable STNL properties and other asset classes such as multi-family, office buildings, or shopping centers.

STNL properties expected to see the largest cap rate movement are the less desirable ones with short-term leases, non-investment grade tenants, and/or locations in secondary markets. Properties with limited or no rental increases will also experience a more significant cap rate increase as investors seek shelter from inflation.

Over the next 6 to 18 months, transaction volumes will decline, and cap rates will continue to increase across all asset classes.Many investors are on the sidelines trying to navigate the various headwinds facing the commercial real estate market as we enter a period of price discovery. For investors in 1031 exchanges, “top tier” Colorado STNL properties will remain at the forefront of demand. With limited “top tier” STNL properties expected to be available in the near term, pricing will remain relatively strong for these properties. With continued economic uncertainty, STNL properties will remain an attractive investment as they offer investors the stability required to withstand the volatility and various headwinds facing the real estate market moving forward.