Targeting Properties with Higher Returns
Many net lease investors want to acquire assets with highly recognizable national credit tenants. While owning a Starbucks, Chick-Fil-A, or Chase Bank in a core market is a very attractive concept, with those types of properties currently trading in the 4 – 5% cap range, the numbers simply don’t make sense for most investors.
As cap rates for net leased assets have continued to compress to historic levels, savvy buyers are willing to consider lesser credit tenants that can be acquired at a more reasonable price.
Demographic and Traffic Analysis
The key is locating quality properties in high traffic areas with strong demographics that are valuable no matter who leases the space. The price mark up for national credit has reached a point where it is only logical to consider lesser known tenants that are still quite successful despite their lack of national brand recognition. Local and regional tenants have become prime targets. Pinpoint hard corner sites or power center outparcels in areas with healthy income levels that have experienced strong growth over the previous five years, with projections for additional population increases over the next five years.
Market Familiarity and Shorter Lease Terms
Familiarity with the market is crucial when evaluating local or regional credit assets. Location is less critical when an investor’s primary criteria is based on tenant credit rating and name recognition. Those types of properties provide “coupon clipper” income and require little knowledge of the market. Often times these low-cap assets are purchased by out of state buyers that are willing to accept lower returns in exchange for the comfort provided by a tenant that has huge revenues throughout thousands of locations nationwide. When evaluating a tenant or franchisee with a small number of stores, the underlying real estate becomes extremely important. The upside potential for a McDonald’s purchased at 3.75% with a newly inked 20-year lease is limited, but a lesser known tenant with a shorter term lease paying below market rent in a prime urban location could have massive upside. It is difficult to understand those opportunities without having intimate knowledge of specific markets and which areas are primed for growth.
Shorter lease terms may seem unattractive on the surface, but they can actually prove to be highly valuable if an investor understands the opportunity for rent increases and/or property repositioning.
Another perk of working with local or regional tenants, besides the significantly higher ROI, is the ability to build a long-term relationship. Many major national retailers have real estate departments with dozens of staff members, which makes it difficult to reach the right contact and develop a relationship. When dealing with a smaller tenant, you may speak directly with the operator or someone local who truly has a vested interest in the success of that specific site. Building rapport through frequent discussions with a tenant and watching their business grow is a very rewarding experience.
As demand for net leased assets continues to increase and the market tightens, the ability to uncover unique investment opportunities becomes extremely valuable. Don’t dismiss a core property simply because the tenant isn’t highly recognizable. Perform a full evaluation before making a decision. The results could have both immediate and long-term positive effects on your portfolio.