Net lease properties are commercial real estate assets in which the tenant pays rent, as well as a portion, if not all of the taxes, along with insurance fees and maintenance costs involved with a property. This is the overall, accepted “umbrella” definition.
Digging more deeply, net lease properties encompass everything from the neighborhood Starbucks to the Auto Zone on the corner, or the CVS Pharmacy perched on a retail center pad site. These assets can be sorted into the following sectors:
- Big Box
- Casual Dining
- Convenience Stores (C-Store)
- Dollar Stores
- Pharmacy (Retail)
- Quick Service Restaurants (QSR)
Because not all net lease properties are created equal, investing in them requires more than a quick geography or demographic analysis. As an example, let’s take a look at the dynamics impacting two segments: retail pharmacies and QSRs.
The pharmacy sector is experiencing a lot of change, in response to healthcare industry shifts. In the past two years, Walgreens Boots Alliance bought most of Rite Aid’s stores, while CVS Health acquired Aetna. Meanwhile, the QSR arena is responding to different impacts. QSR Magazine recently said that smartphone apps, combined with consumer convenience, is driving fast-food restaurants “redesign their store space” and designate “areas for customers to pick up their orders.” Restaurants are undergoing redesigns and upgrades to stand out in a highly competitive market.
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While the retail pharmacy sector is active with mergers and acquisitions, the chances are pretty good we won’t see a Burger King-McDonald’s alliance anytime soon.
Industry trends is one point of differentiation. Another is cap rates. The list below shows average cap rates for net lease properties, as of Q4 2018.
|CAP RATES FOR NET LEASE PROPERTIES — Q4 2018|
|NET LEASE PROPERTIES||CAP RATES|
|Quick Service Restaurants (QSR)||5.65%|
Cap rates can be impacted by everything from supply, to tenant credit, to the economy. Dollar stores have been hot commodities during the Great Recession and its aftermath. Casual dining restaurants, on the other hand, were not. The large expansion of dollar store supply every year has prevented a compression of their cap rates as demand has remained high.
Tips to Consider
While a 7-Eleven store, a Chase Bank, and an Applebee’s restaurant can all be net lease properties, they are influenced by different variables. As such, before jumping into net lease ownership, investors should focus on the following:
Industry trends. In addition to studying a property’s geographic location and demographics, it’s a good idea to research the sector in which the tenant operates.
Supply and demand. How much product and how many investors want that product to vary from property type to property type. Another factor in this category is property competition and location.
Retail type. Education and medical centers are niche real estate, located mainly in shopping centers and near hospitals. They perform differently from, and are not as plentiful as, convenience stores or casual dining, which can be found on pad sites and corner locations.
The takeaway here is that not all net lease is the same. To ensure that net lease investments perform within expectations, buyers and owners need to have a good understanding of industry trends, market conditions, and product type.
Jonathan Hipp is president and CEO of Calkain Cos. The views expressed here are the author’s own and not that of ALM’s Real Estate Media Group.