Net Lease Owners: Is Now the Time to Sell?
The net lease market is currently highly advantageous for the potential seller. Demand for net lease properties especially credit tenants in prime locations heavily outweighs supply. Cap rates are dropping to levels not seen since 2007 and more investors are getting comfortable with franchisee credit, shorter lease terms, or private non rated companies. In short, we could be witnessing an historic sellers market that intelligent investors should take advantage of.
The entire net lease market has seen compressing cap rates. A combination of multiple factors has led to this declining cap rate environment. First, low interest rates and a low yield investment environment have heavily impacted cap rates. Because cheap debt is available and the risk free investment returns are so low, investors are able to pay premiums (lower cap rates) for net lease assets and still achieve a spread that is appealing in today's market. Unlike the 2007 environment where interest rates hovered in the mid to high 4.00% range - current interest rates are below 2.00%. This environment has fostered an unbalanced demand for net lease properties.
Furthermore, there is limited net inventory available due to the fact that retail slowed their expansion and growth plans since 2008. It's no secret that construction fell to a near standstill during the recession and even today has not recovered. This has created an ever dwindling pool of net lease investments on the market.
Finally, with a flight to quality by investors the simple fundamentals of supply and demand are driving cap rates lower. Among the most demanded properties are well situated urban retail within high traffic locations in diverse residential, office and retail communities. These provide investors with broadly adaptable real estate ensuring a long lasting intrinsic value. High quality urban properties provide a stable income stream with real upside potential that far exceeds anything offered by a suburban pad site in the shadow of a big box store.
Another important event on the horizon is the expiration of the Bush Administration tax cuts set to expire on January 1, 2013 unless the President and Congress step in to extend or amend this legislation. Presently the tax rate for sellers of income producing real estate is 15% in capital gains tax. Unless something is done prior to year end 2012, the capital gains tax rises to a minimum of 20%. This is effectively a 33% tax increase to the selling entity. For property owners who hope to avoid this tax hit the time to sell is quickly dwindling.
This current collusion of factors has uniquely given net lease sellers high negotiating leverage. Furthermore, some of these advantages are not likely to exist for long. Interest rates are at historic lows today but many predict them to rise in the near future. Lack of construction has led to a dearth of properties but the wheels of development are slowly getting underway again. And finally, we may not see a lower capital gains tax rate for many years once the current 15% rate expires. Potential net lease sellers will not likely ever see such an advantageous environment.