Net Lease: Commercial Real Estate’s Shining Star

Photo Courtesy of FunTap.

The net lease sector has seen a year like no other commercial real estate sector. Despite a once-in-a-millennium pandemic, the sector is riding a two-year high on fundamentals that have only strengthened over the past year.

While many sectors in commercial real estate have shown weak rents and lower occupancy levels leading to lower values, many subsectors of single tenant net lease (STNL) retail have seen compressed cap rates post-COVID. Essential retail has been the buzzword of the year, and excepting perhaps healthcare real estate, no other sector has more essential retail users that single tenant net lease. Retailers like drug stores, auto parts, gas stations, fast food/quick-service restaurants, dollar stores and grocery stores all saw strong results as investors quickly shifted their attention to essential retailers.

On the flip side, the single tenant net lease retail sector also contains some tenants who were limited in their ability to make sales or open in 2020, including entertainment concepts, casual and sit-down dining establishments and gyms.

Shopping Center Business spoke to more than a dozen net lease executives for our annual round-up of the single tenant net lease retail space. Here are our findings.

A Year Like No Other

At the beginning of 2020, the net lease industry saw a normal pace and volume as the first quarter progressed. Many expected, because of low interest rates and velocity heading into the first quarter, to have record-breaking years. They weren’t wrong, but how and why it became one of the strongest years will always be remembered. Beginning in March, as the COVID-19 pandemic took hold, deal velocity suddenly hit the brakes.

As the pandemic began to cause closures and shutdowns, many investors hit pause, and many intermediaries quickly had to change their operations to work remotely. While there was a pause lasting a few weeks, many intermediaries say they quickly heard from investors, who had been analyzing the trends that were already taking place in the retail market.

“In the middle of March when the pandemic hit and the U.S. economy began to shut down, we saw an immediate shift of interests from individual and institutional investors who were open to experiential retail — including theaters and gyms — quickly drop off,” says Ken Hedrick, executive managing director, net lease capital markets with Newmark in Tulsa, Oklahoma. “There was a huge shift in all levels of capital — private capital, 1031 exchanges, funds, institutional investors — quickly switching to this newly deemed essential retail category. Pharmacies, convenience stores, grocery stores and dollar stores took over their interest. It created a lot of competition in that space because there was a finite amount of inventory, but a lot of capital chasing that inventory.”

Essential retail quickly became what STNL retail investors sought.

“Tenants started to realize that there was a very fine line between who was essential and who was not,” says Preet Sabharwal, managing director of New York City-based SAB Capital. “Those who were essential really beat their chests and kept moving and opening stores. They picked their heads out of the sand very quickly. There were some unexpected numbers from dollar stores and fast food restaurants in March, April and May.”

Many abandoned long-held investment types to focus on acquiring more essential properties.

“Anyone looking at investing in casual dining quickly changed property types to convenience stores, dollar stores or other more essential properties,” says Anthony Pucciarello, executive vice president with Dallas-based Secure Net Lease.

Hanley Investment Group arranged the sale of a new construction single-tenant Aldi in the Minneapolis metro area, adjacent to the Hazeltine National Golf Club in an off-market transaction. The sale price was just over $3 million for the absolute triple-net ground lease.

In 2020, Pucciarello says approximately 5 percent of what the company sold was casual dining properties; in the past, that figure was closer to 25 percent of properties sold. One such buyer that Secure Net Lease had closed on five 7-Eleven locations by the end of the year, including one that sold at a 3.75 percent cap rate. The company also sold about $60 million worth of QuikTrip convenience store properties in 2020. Overall, Secure Net Lease sold 73 convenience store locations in 2020.

“The sellers who had the essential retailers, such as convenience stores and grocery stores, automotive parts and dollar stores, saw cap rate compression,” says Pucciarello. “We could not keep a Jiffy Lube, 7-Eleven, QuikTrip or Dollar General on the market for longer than a week.”

Essential retail assets have seen cap rates compress throughout the year, with many setting record rates. The extended demand has pressed cap rates lower in many markets (see “Supply” section on page 38 for more details).

“If you take all of the retail net lease investors and put all of their focus on essential retail, it creates a much smaller supply,” says Jeffrey Thomas, founder of Seattle-based The Thomas Company. “That creates a supply/demand imbalance, which is good for net lease sellers.”

“There was a definite flight to quality and security,” says Matthew Mousavi, managing principal of the national net lease group at SRS Real Estate Partners in Newport Beach, California. “There is a need for passive yield and income, which has accelerated with the turmoil you saw politically and economically. Investors are still seeking places where they can put their money for a passive return backed by hard assets and brands that they know.”

By the third quarter, the market had settled back to its routine of doing business, despite many investors and intermediaries still working remotely.

“Q3 was a quarter of recovery when we started to see lending stabilize,” says Sabharwal. “A lot of the lenders who had disappeared during the second quarter had come back alive. The fourth quarter has been one of the lowest interest rate environments I’ve ever seen. Lending is driving this cycle; liquidity in the banking sector is very strong.”

Some supply was created by retailers adjusting their business models, which not only made them attractive and available to consumers, but more appealing to investors.

“Many retailers in net lease products were able to transform and morph quickly so they were essential,” says David Hoppe, executive vice president, capital markets, in the Charlotte, North Carolina, office of Atlantic Capital Partners. “The stores that had a drive-thru and had a business plan in place to have their units open as much as possible thrived. We had restaurant tenants who saw their sales up 40 percent year over year because of how many people were coming through their drive-thrus compared to normal.”

As time progressed to the second and third quarter, investors had even more clarity, as did owners seeking to sell properties.

“What was interesting through that period was that an immense number of investors decided to put their properties on the market,” says Chris Sands, CEO of national brokerage company Sands Investment Group, who saw his company’s listings increase by more than 65 percent during the year. “The appetite for net lease has been unbelievable. We haven’t been able to keep product on the market. There’s a huge appetite for the yield, certainty of income stream from rents and the ease of management to ownership that net lease provides.”

Others also repeated Sands’ notes on performance, despite a rocky road of getting to strong levels.

“Despite the jolt of March, we were able to get out of it and have a record year,” says Mousavi, echoing what many net lease brokers told SCB.

In addition to clarity on property types, the STNL market was also bolstered by the election, as investors tend to fear the repeal of the IRS 1031 exchange rule in every election cycle.

“After Labor Day, the market became flooded with demand and the fourth quarter was one of the busiest in our team’s history,” says Jeff Lefko, executive vice president of Hanley Investment Group in Corona Del Mar, California. “The election definitely played a role in this, but more than anything, it was buyers’ desire to earn a return on their money through real estate investment that had previously been sitting on the sidelines.”


The supply of STNL properties was already constrained heading into 2020. With fewer retailers expanding, there were not as many properties being built as past years. When the pandemic began to impact retail and restaurant businesses in March, many retailers paused groundbreaking plans for later in the year, further constraining supply.

“There was a temporary pause in supply that came from new construction through retailer growth and developers,” says Daniel Taub, senior vice president and national director of retail for Marcus & Millichap. “Those deals that were in the pipeline were temporarily put on hold or completely taken offline. Some took a pause and they’ve come back. The good news is, especially in the active sectors that were actively growing before the pandemic hit, their business models have adapted and made changes that have allowed them to restart.”

“Supply was the lowest it had been in the past few years,” adds Lefko. “A lot of the new construction projects that would have come to market in the third and fourth quarters of 2020 were delayed or put on hold due to COVID. There are certainly more buyers than sellers in the market right now. This has created some cap rate compression for quality real estate. As long as a property is properly priced and exposed to the marketplace, there is a very high probability that it will sell.”

However, many expect supply to continue to be limited over the next 12 months, as fewer stores are being developed in the pandemic era. According to Hanley Investment Group, there were only 94 new construction single-tenant net lease restaurants constructed in 2020 in the U.S. listed for sale in early January 2021. Most of what comes to market is sold very quickly.

“Many of the deals that were out there [in 2020], ended up being sold,” says Hoppe.

Newmark sold this Krispy Kreme location in Concord, North Carolina, near Concord Mills mall. The list price was $5.5 million, representing a cap rate of 5 percent.

“There were not many new deals being built. There is going to be a lack of product available in the market. There is still demand, but retailers and other tenants halted development activity. Some tenants are living in fear and are not currently building new stores; they don’t want to be the last one building stores when everyone else is taking a break.”

One oddity of the past year has been the compression of cap rates on properties that do not have investment grade credit, but that are deemed essential retailers. Thomas Company sold a portfolio of grocery stores that was not investment grade. Some of the cap rates were lower than some investment grade net lease properties, says Thomas.

“I don’t think I’ve ever seen in my career where a non-investment grade offering will trade tighter than an investment grade offering simply because the nature of the tenant’s business. That was new,” says Thomas.

Experts caution that cap rate spreads between credit and non-credit properties are extremely tight.

“Not all single tenant net lease space is created equally,” says Taub. “When you really look at it, the better credit quality properties with long lease term and good real estate fundamentals are seeing cap rate compression. The difference in price is within 100 basis points from one extreme to the next.”

Another factor helping the industry drive activity is the formulaic approach that many investors take in choosing properties. The business itself is very transaction focused, with speed of execution, credit, location, tenant type and lease term setting the stage for most sellers and buyers.

“Over the past 10 years, net lease properties have become more commoditized,” says Sean O’Shea, managing principal with The O’Shea Net Lease Advisory in Rolling Hills Estates, California. “You used to be able to just quote a cap rate. In 2019, we had record low cap rates. That continued in 2020. All of the market intelligence we have now suggest cap rates might go down another 15 to 20 basis points.”