Single-tenant-net-lease (STNL) properties are a popular option for investors seeking low-maintenance investments. These net leased assets can be appealing in an economy with low bond yields and ongoing inflation. As a result, STNLs are attracting increased capital and investor interest in Q2 and Q3 of 2021.
According to Colliers, STNLs have the potential to provide stability and predictability to a portfolio by smoothing out volatility and providing a triple-net lease structure, which may help to avoid potential risks.
What is a Single Tenant Net Lease?
The term "single tenant net lease" applies to any property leased to only one company. The tenant signs a long-term lease on the property, which offers potentially more stability for investors. Often these leases are "triple net", meaning that the tenant is responsible for all property taxes, insurance, and maintenance for the real estate.
Strengths of a STNL
Potential Predictability & Stability - With a strong tenant in place for a long-term lease, an investor can expect potentially stable returns over the course of the investment. This stability is especially important in times of market volatility.
Capital Preservation - STNLs can possibly help to protect against inflation, as the value of the tenant's rent may rise over time.
Finance Vehicles - The availability of favorable and long-term financing for these assets is greatly influenced by their strong underlying tenants and potential for revenue stability.
Low Turnover - STNLs are often attractive for investors due to the generally low turnover of strong single tenants resulting in reduced costs for tenant turns and make-readies.
What Are Some Issues to be Aware of with Single Tenant Net Lease?
Tenant Risks - The strength of the investment leans heavily on the stability and financial health of the underlying tenant. Many titanic-like companies can experience major headwinds over a long-time horizon, increasing investor exposure.
Ownership Horizon - Long-term leases can be a double-edged sword for principals as long-term leases can lead to exposure to changing market conditions.
Spin-off Risks - STNLs can present risks to investors when a company intends to spin off a portion of its business unit, further weakening the tenant.
Single Tenant Net Lease Trends for 2021
As investors are increasingly looking to diversify their portfolios with potentially stable, income-producing assets, STNLs have looked increasingly attractive.
STNLs are also viewed favorably by institutional investors thanks to their relative historical stability, liquidity, and diversification across markets, tenants, geographies, property types, sectors, etc. As a result of this interest from institutions and retail investors alike, sales activity has risen in recent years. The average sales price rose 12% year over year in Q2 2019 compared to just 4% the previous year.
Trends for retail STNL continue to demonstrate a shift from traditional suburban malls and power centers toward urban mixed-use projects, transit-oriented developments anchored by grocery stores, and redeveloped community shopping centers in secondary markets.
According to Colliers’ commercial data analytics, STNL retail volume is showing healthy signs of growth. At $4.1 billion, Q2 volume was consistent with prior-year norms before the pandemic (2015-2019). Cap rates are steady at 6% and, in the first half of 2021, total sales volume was up 77% compared to the same period last year.
In 2021, the single-tenant space was 5.3 percent vacant, up 50 basis points from 2020. Multi-tenant retail vacancy rose 80 basis points to 6.6 percent during the same period, according to CBRE's data. Vacancy rates are projected to rise modestly in the coming years, with most of the increase concentrated in neglected spaces or neighboring multi-tenant complexes that have deferred maintenance issues.
Industrial STNLs are often viewed favorably by institutional investors thanks to their perceived historical stability, liquidity, and diversification across markets, tenants, geographies, property types, sectors, etc. As a result of this interest from institutions and retail investors alike, sales activity has risen in recent years.
The industrial real estate market is seeing its strongest first half performance since at least 2018. Industrial real estate volume in the first six months of 2021 is by far the most robust on record. Overall volume has risen 83% from last year's levels, and first-half numbers are about 30% higher than they were a year ago. The fundamentals of the sector continue to be strong, and rising interest rates are not anticipated to have a significant negative effect on the sector.
Demand for industrial capital assets is high, with an increasing number of investors seeking out these structures as a way to diversify their portfolios. Subsequently, yields have been compressed, and cap rates have dropped by about 100 basis points since 2018.
It is expected that investors will continue to seek out industrial assets. The industrial market has enjoyed a great run, but the increased demand may create additional pressure on cap rates and potentially drive them to new lows.
Office STNL has been in back in favor, and investors were becoming more interested over the past 18 months. The market is recovering from a period of little to no investment activity in 2019 and 2020, when there was limited demand for office space and few transactions were taking place.
In 2021, the average cap rate on new transactions remained at 6.5 percent, but the share of transactions with cap rates greater than 10% increased to 13%. The total volume in Q2 was $4.7 billion, which is a 62% increase compared to last year's pace and 33% ahead of 2018.
The office real estate market has seen its strongest first-half performance since at least 2018, driven by industrial vacancies in markets like Raleigh-Durham and Nashville. More important than volume records were price levels, which were flat from 2019's levels.
In 2021, office net absorption increased to 3.5 million square feet compared to last year's pace of 1.9 million square feet. These figures represent increases of 133% and 22%, respectively. The office real estate market has been in a period of stabilization, with speculative construction slowing down considerably over the past four years.
STNLs, as a potentially stable income-producing asset that provides diversification across markets, tenants, geographies, property types, sectors etc., have become an increasingly attractive investment vehicle. While the single tenant net lease model is not for everyone, those looking to diversify their portfolios with a blend of possibly solid cash flow from many diverse sources may find this unique type of investment appealing.
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1031 Risk Disclosure:
• There is no guarantee that any strategy will be successful or achieve investment objectives;
• Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments;
• Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;
• Potential for foreclosure – All financed real estate investments have potential for foreclosure;
• Illiquidity – Because 1031 exchanges are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.
• Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;
• Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits