The average cap rate from Q2 to Q3 compressed slightly. This downward movement in an already low cap rate environment has caused the average to fall to its lowest level in net lease history. While rising interest rates are expected to push cap rates higher in the future, the increasing proportion of ground leases and falling number of double net leases across a number of sectors has pushed the average cap rate to historic lows.
|Q2 2017||Q3 2017||Change in:|
|Sectors||Avg Cap||Low||High||Avg Lease Term||Sample Size||Avg Cap||Low||High||Avg Lease Term||Sample Size||Average Cap Rate (bps)||Lease Years Remaining|
|Total Sample Size||513||479|
1Other retail includes retailers who don’t otherwise neatly fit into one of the above categories such as grocery stores, cellular stores, mattress stores, and fitness centers.
DISCLOSURES: As part of our market research, we collect sales price, cap rate, and lease years remaining for all publicly advertised and sold STNL properties.
a) We are not able to capture 100% of the off-market transactions that occur; however the nature of off-market transactions typically limits their value as true market comps.
b) Sources include public records, sales announcements, Calkain sales, and appraiser obtained sales amongst others.
c) Our collection process, while thorough, is not all encompassing and there may be biases in the data as it relates to geography, tenancy, or brokers involved in the transaction.
d) Public records often lag behind when transactions actually close, months in some cases. Consequently the data supplied here for any given quarter is likely to miss a material amount of transactions that actually closed in it.
e) In sectors with a skew of greater than |2|, we have replaced the mean with the median to better describe these sectors.
The automotive sector saw a decrease of 17 bps while the average number of years remaining on leases fell by just under a year. These movements are usually inversely related to each other, however an increase in the number of highly desirable and credit rated tenants during Q3 caused the cap rate to fall.
The banking sector saw a slight compression accompanied by a higher number of years remaining on leases. As lease term remaining increases cap rates will tend to decrease. The downward pressure was offset to some degree by a measurable proportion of the sales being regional banks which tend to be lower credit ratings. They tend to carry a slightly higher cap rate than their national counterparts.
The big-box sector saw cap rates fall while the number of years left on leases decreased significantly. This small compression of cap rates was due primarily to a changing mix of the lease types traded. More ground leases and fewer double net leases traded during Q3, both of these factors have put significant downward pressure on the average cap rate. A falling number of years remaining acted as a balancing force, preventing the average cap rate from compressing even further.
The casual dining sector saw a small increase in the average cap rate due largely to the number of years remaining on the leases falling.
In the c-store sector, the 28.7 bps decrease can be attributed to a few factors. First, more deals closed in Florida and California, which tend to trade at a premium to the rest of the country, during Q3. Second, an increase in the number of brand new Wawa properties trading aided in the cap rate compression. Wawa’s trade at low cap rates because they tend to sign long, ground leases with a strong corporate guarantee.
The educational sector incorporates a wide variety of tenants with varying leases and guarantees. The movement in the average cap rate and average term remaining is due to a changing mix of tenants from Q2 to Q3.
The medical sector had a large decrease in cap rates which can be attributed to fewer double net leases. Double net leases leave an investor with some form of landlord responsibility, commonly repairs to the roof and structure. This exposure to some costs of ownership causes double nets to trade at higher cap rates.
The quick service restaurant (QSR) sector has two common types of leases across the multitude of tenants, triple net and ground. Both leases feature no landlord responsibilities. From Q2 to Q3 the average cap rate for each type of lease has remained very stable, however a growing proportion of tenants with ground leases caused the entire sector’s average to fall by 22.2 bps.
The dollar store sector saw an increase of 37.7 bps from Q2 to Q3. During Q2, the dollar store sector had such a wide range of cap rates, the skew of our sample was greater than 2. This results in our use of the median to describe the sector rather than the mean which would have painted a “skewed” picture.
The change in the national average for Family Dollar and Dollar General can be attributed largely to the change in the average term remaining. Family Dollar’s average years remaining increased from 10.09 to 11.17 years, causing the cap rate to decrease by 32 bps. Dollar General’s average years remaining stayed nearly constant, moving from 12.12 to 12.13 years.
When looking just at comps with at least 10 years remaining, the quarter to quarter change has been small. Dollar General falling by only 2 bps and Family Dollar falling by 15 bps.
The pharmacy sector saw cap rates decrease by 12 bps while the number of lease years remaining increased by 0.3 years. The largest tenants in the pharmacy sector, CVS and Walgreens, are moving against the national trend. The third largest pharmacy, Rite Aid, having a drastic shift in the average term remaining, has caused the national average to not follow the same trend as CVS and Walgreens. From Q1 to Q2, Rite Aid saw their average cap rate rise over 240 bps while their average term remaining fell by 8 years. Now we see Rite Aid’s average term remaining return to Q1 levels, 13.5 years, and their cap rate has compressed by 214 bps, helping cause the 12 bps overall change in the pharmacy sector average cap rate.
When looking at cap rates for properties with 10 or more years remaining, CVS saw a 20.8 bps increase in average cap rates. This increase has been caused by more CVS’s selling in subprime locations. These locations may have a small population or low traffic count and are therefore unable to attain a low cap rate.
STNL Tenant Change in Average Cap Rates Quarter Over Quarter
7-Eleven’s cap rate compression was due mainly to an increase in sales in premium markets.
The Fresenius locations that sold in Q3 tend to be closer to city centers than the locations that sold in Q2 causing a 50 bps drop in cap rate.
Q3 saw an increase in the number of Burger King ground leases trade, causing a compression in average cap rates.
Dunkin’ Donuts saw their average cap rate fall by 40.5 bps due to an increase in the average number of years remaining on leases.
Jack in the Box
In Q3, many of the Jack in the Boxes that sold were located on the in-demand West coast. Properties on the West coast, especially California, have been selling at lower cap rates as compared to the rest of the country.
A sizable increase in the average term remaining is responsible for a 66.5 bps cap rate compression. In Q2 the average term remaining was 13 years while in Q3 the average jumps to 17.5 years.
Over the last three quarters, Wendy’s cap rate has moved around significantly with a constantly changing mix of locations and varying numbers of ground leases trading. Q3 saw an increase in ground leases and sales in California, both of which tend to trade at lower cap rates, creating a large cap rate compression.
|Tenants||Q2 2017 Avg Cap Rates||Q3 2017 Avg Cap Rates||Change in Avg Cap Rates (BPS)|
|O’Reilly Auto Parts||6.38%||6.25%||-12.3|
|The Learning Experience||7.16%||7.00%||-16.0|
|Jack in the Box||5.80%||4.89%||-90.5|
*All calculations are based upon available comps for each specific quarter with 10+ lease term remaining. The total number of sale comps for respective tenants in each quarter also varies significantly.
STNL Cap Rates vs 10 Year Treasury Rates
- The Single Tenant Net Lease (STNL) average is at its lowest point in history.
- The spread between the STNL average and the 10 year treasury rate has been under 4% for the fourth quarter in a row.
- Currently the spread is at its second lowest point over the last 5 years.
- The Federal Reserve did not issue a rate hike during Q3, but increased rates are expected in the future in order to give the Fed more room to adjust rates in reaction to any future shocks.
- The Federal Reserve is set to begin their balance sheet normalization program in October, which is expected to increase rates on Treasuries.
- Increasing rates and balance sheet normalization will begin to put upward pressure on cap rates in the future.