Research Report

Q1 2018 Cap Rate Report

Auto, Casual Dining Sectors Lead Cap Rate Expansion Trend

A counter-intuitive trend marked cap rate movement in the first quarter of 2018. While the expectation in a period where the number of ground lease increased and double-net leases decreased might bring cap rate compression, rates actually expanded by 2.7 basis points (bps) in Q1. Overall, it’s still a fairly neutral shift. Posting the largest changes for the quarter were the automotive and casual dining sectors.

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.

Sectors in Brief

Naturally, set against the backdrop of cap-rate expansion, specific sectors of the net-lease market performed based on their unique characteristics. Here are the sector-by-sector highlights, presented in alphabetic order:

  • The automotive sector saw the second largest growth in cap rates, 31-bps. This was “driven” by a 1.8 year decrease in the average number of lease years remaining.
  • Big-box stores experienced a cap-rate expansion of 23-bps while the average term remaining fell by 1.9 years. Typically with a decrease of this magnitude, a larger expansion in cap rates is expected.
  • The casual dining sector experienced the largest change in cap rates from Q4 to Q1. This large difference was caused by the decrease in average term remaining and the difficulties facing many tenants across the sector. Shifting consumer preferences has led to declining sales and locations
    closing.
  • Quick-service restaurants, meanwhile saw minimal movement in average cap rates while the average number of years remaining fell by 0.9 years, again, a trend that defies expectations. A large increase in properties trading in Florida, a premium market, have caused average cap rates to trend down slightly even while remaining term fell.

 

Dollar Stores

The dollar store sector experienced a slight compression of cap rates and a minor change in the term remaining. The Dollar General average cap rate was consistent from quarter to quarter, increasing one bp overall and three bps based on terms with at least 10 years remaining.

 

 

 

 

 

 

Family Dollar saw some compression in cap rates. The negative 61-bps movement of Family Dollar contributed to the entire sector’s compression. Family Dollar’s movement can be attributed to their growth in higher density areas. As Family Dollar expands into these areas, which also feature more valuable real estate, the cap r ates of these properties reflect the change fundamentals.

The recent credit upgrade of Family Dollar’s parent company, Dollar Tree, will also result in lower cap rates going forward. This upgrade occurred too close to the end of the quarter to have a measurable impact during Q1. That said, the change in credit puts all of the major dollar store tenants in the “investment grade” level.

Pharmacy

The pharmacy sector experienced a 25-bps compression in cap rates with average terms remaining near constant. CVS and Walgreens experienced some compression in average cap rates, while Rite Aid saw a larger movement from Q4 to Q1, over 100-bps. In the 10 or more years remaining category, CVS and Walgreens saw their cap rates moving in opposite directions. From Q4 to Q1, CVS had a decrease in the number of sales in premium markets while Walgreens saw more sales in California and Florida. This has pushed the CVS cap rate up and the Walgreens cap rate down.

Rite Aid has been a volatile tenant over the last few quarters with only a handful of sales and lots of uncertainty about the company’s future. Some Rite Aid stores are being acquired by Walgreens and converted, while the rest of the portfolio is being acquired by Albertson’s. As uncertainty about the brand diminishes, Rite Aid properties will trade at less of a discount and with less instability.

STNL Tenant Change in Average Cap Rates

  • Bob Evans: Cap rate compression due to the higher average number of years remaining during Q1.
  • Burger King: Cap rate expansion due to a smaller proportion of properties trading in premium markets.
  • Dairy Queen: A drastic change in cap rate, attributed to location. Q1 had more sales in premium markets and in locations with a high population density.
  • Denny’s: A rise in cap rate due to no sales closing in premium markets during Q1.
  • Dunkin’ Donuts: The number of sales in Florida spiked in Q1, causing a drop in the average cap rate.
  • KFC: Over half the sales in Q1 occurred in the high-demand markets of Florida and California, causing cap rates to drop. Multiple ground leases traded during Q1 contributing to this.
  • Sonic: The average term remaining increased from Q4 to Q1, causing the cap rate to compress by 39.5-bps.
  • Starbucks: Nearly half the sales in Q1 occurred in California, a market known for its low cap rates. This has caused the negative 29.1-bps movement in average cap rate.
  • Wendy’s: The falling number of years remaining have caused average cap rate to expand 42.3- bps.

*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

Single Tenant Net Leases (STNL) cap rates have increased slightly for two straight quarters. Meanwhile, the Federal Reserve issued a rate hike during Q1, setting the target federal funds rate between 1.50% and 1.75%. Further, two more hikes are expected through the course of the year. Our expectation, therefore, is for a rise in cap rates during the course of the year.

Nevertheless, the spread between STNL and 10-year treasury rates has been at historic lows, under four percent for six consecutive quarters due to interest rates rising faster than cap rates can adjust.

Conclusion

The first quarter of the year was marked by a certain degree of drama, as witnessed by Rite Aid and some surprises, as in the counter-intuitive cap rate expansion noted on page 2. Each sector clearly has its unique characteristics, and while overall trends are important, the individual market breakdowns remain the most compelling evidence of future performance.

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.

 

Albina SuQ1 2018 Cap Rate Report

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