Rising Interest Rates and the Impact on Single Tenant NNN Cap Rates
Hi everyone. I am relatively new to the commercial real estate game but have been watching the market for the past couple of years. I am currently looking to buy another property or two with a particular interest in single tenant triple net leases with zero landlord responsibilities. Everything I have been seeing in the market with properties in good locations and with good tenants and long leases in place are being offered for sale at 4% - 5.5% cap rates. I could buy something all cash but would prefer to leverage a bit with a loan so I can buy multiple properties. However, when I last spoke with my banker a couple weeks ago, the interest rates were around 5% making these deals a wash (or net loss in some cases). From the numbers I was running, it really doesn’t make sense financially to invest unless you’re getting at least a 7% cap if you’re paying 5% interest on a loan. But of course, the problem is it’s hard to find a good tenant and long lease term at a 7% cap rate or higher these days. The question I have for everyone here is if you think the rising interest rates will have an impact on cap rates. It would seem like cap rates have to increase as interest rates increase, otherwise the only people buying these properties would have to be cash buyers. Any thoughts on what impact the interest rates will have in cap rates and when we might see the change happen in the market with cap rates rising? Thanks all in advance for any input or opinions you have.
[{"id": "i5srq0k", "text": "Am a capital markets analyst working at one of the big4 in Canada. We've already been seeing cap rates increase and prices get lowered.", "replies": [{"id": "iersp37", "text": "For what kind of asset class in CRE? Also curious to know what you are seeing now(as your comment was from 2 months ago). Thanks!", "replies": [{"id": "iesatmn", "text": "Indus retail", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i5sw6br", "text": "Even when cap rates come back to earth, you\u2019re still going to have a difficult time finding 7 caps. \n\nHave you looked at Dollar Generals &amp; Dollar Tree / Family Dollars? \n\nIf you\u2019re looking for quality tenants for 7+, start there.", "replies": [{"id": "i5sxjzo", "text": "&gt;Even when cap rates come back to earth, you\u2019re still going to have a difficult time finding 7 caps\n\nCurious why you think this. Not challenging you, just interested in your opinion.", "replies": [{"id": "i5t03im", "text": "the sought after NNN\u2019s are going to continue to trade sub 5.5 cap (imo)\n\nWhat real credit tenant traded above 5.5-5.7 pre covid?", "replies": [{"id": "i5tkui6", "text": "This. \n\nRising interest rates don\u2019t deteriorate the credit strength of a tenant (which is what drives the value in the first place as cap rates don\u2019t take debt service into consideration  \u2014\u2014 only investors do). \n\nAlso, CRE is widely seen as a safe harbor during high inflationary times. \n\nHowever, I do believe that there have been so many new \u201ccap-rate-focused\u201d investors entering the market in the last 10 years who don\u2019t fully appreciate the fundamentals, that rising interest rates will likely cause less transactions, which would increase the supply, which could move the market.", "replies": [{"id": "i5vu27p", "text": "Interest rates absolutely do have a relation to cap rates. The 10 year treasury is commonly used as a \u201crisk free\u201d rate and market cap rates generally incorporate a spread above the risk free rate to compensate for the risk of owning real estate. Cap rates might lag interest rates because real estate is much less liquid than treasuries, but they are absolutely correlated.", "replies": [{"id": "i5vwfz3", "text": "Correlation would indicate that they change together\u2026 As one variable changes, so does the other. That isn\u2019t the case between cap rates and interest rates.\n\nI do agree that there is a causation effect that COULD occur (meaning a change in one variable might cause the other to change over time\u2026 And for very astute investors (REITS, etc) it should alter their risk tolerance).\n\nUnfortunately, In CRE land today, I\u2019ve never seen an offering memorandum that reinforces the strength of an investment opportunity by telegraphing to potential buyers the risk of an investment opportunity as compared to the 10-year treasury. I\u2019d argue that most brokers in the game today don\u2019t even understand what this means.", "replies": [{"id": "i5vxsuo", "text": "Just because brokers don\u2019t understand or market properties based on interest rates doesn\u2019t mean they don\u2019t have an effect on the market. Large investors like REITs do pay attention to treasuries and their moves can and do change the market, but again changes aren\u2019t instant there is a lag because it takes time for real estate transactions to go from price agreement to closing.", "replies": [{"id": "i5w30yz", "text": "I think we\u2019re saying the same thing here just in different ways\u2026I feel like this is turning into a \u201chedge fund vs WSB yolo\u2019ers\u201d argument, lol. Of course your comment is correct - there\u2019s an innumerable amount of variables that impact the market (like the thousands of unsophisticated invoosters who have jumped into the CRE &amp; sfr rental game over the past 10 years). To boot, all you\u2019ve needed is a pulse to sell real estate for the past 5 years making the broker herd overpopulated.\n\nPersonally, I hope rising interest rates reduces the volume of bad brokers in the space today selling overpriced homes and STNL CRE with irreplaceable rents (imo, these folks don\u2019t give a shit about the fundamentals and shouldn\u2019t be practicing professionally). Unfortunately, as much as institutional investors have an effect on the market, I believe that bad brokers are a major factor as well.", "replies": [], "depth": 8}], "depth": 7}, {"id": "i5wmdxy", "text": "Correlation can be staggered. That is, an increase in treasury rates could trigger a cap rate increase six months from the movement. They don't have to move lock step in real time to be correlated.", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "i5tqwqe", "text": "I have seen a ton of these dollar stores available around 6.5% - 8% cap rates but the buildings usually look like shit. Assuming I could find a decent building, what is your general opinion on having one of these tenants?", "replies": [{"id": "i5u37px", "text": "I hate those dollar store NNN properties.  You are paying $800k+ for a building that won\u2019t sell for $300k without the tenant.  The tenants often leave and you\u2019re stuck with a crappy building that no one will rent.", "replies": [{"id": "i5um2pr", "text": "Isn't that the case with all net-lease? All the value is the lease. Starbucks selling over $1000/sf where other retail tops out around $250/sf is the same as what you describe for the dollar stores. I agree they aren't pretty, but the value is the lease, not the building.", "replies": [{"id": "i5vculh", "text": "You\u2019re correct.  But it feels like a crappy investment to me because the underlying asset is worth half the value at the end of the lease.  Let\u2019s say that you hypothetically pay $1 mil for a Starbucks with a 5% CAP.  After 10 years you\u2019ve recouped half of your investment and have a building that\u2019s worth $500k.  So you\u2019ve made nothing.  On the other hand, you could buy $1 mil of Verizon stock with a 5% dividend and make the same return and your stock will likely appreciate in value as well.", "replies": [{"id": "i5vhzqq", "text": "I agree to a point in that you have to buy the right location (intersection, demos, etc.) to make sure you get into renewals to make these yield a lot for you long term. I see a lot of deals in my job (CRE appraiser) and you can tell the people who know what they\u2019re doing (picking Starbucks or DG in a very good location) from Johnny Malibu Beach House who is just placing money in a run of the mill Family Dollar in some random town in the Midwest because he doesn\u2019t see the difference and his broker is just trying to get a million sale\u2019s commission.", "replies": [{"id": "i626gro", "text": "I'm dying at the Johnny Malibu Beach House.  Please tell more.  Is this an actual derogatory term or something you just made up?\n\nI'm a buyer under contract and the seller is unloading this property because he actually wants to go purchase a Beach house.", "replies": [{"id": "i62y4ii", "text": "Not an official term, just one I made up. There are a lot of buyers of STNL deals throughout the Midwest with addresses in NYC, California and Florida. Many of those people wouldn\u2019t know the difference between Indianapolis and Detroit let alone what a given town outside of one is like. I used the term of Johnny Malibu Beach House just to represent all of those people who are buying a Dollar General in a rural town and not understanding that all of these towns are not created equal despite the fact they pay the same cap rate on all of them with the same lease term", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "i5vcs1a", "text": "I own Dollar Generals. \n\nI don\u2019t have an issue with them as a tenant. \n\nHowever; my biggest concerns are: they could wake up one morning and decide they want to relocate it next door or right across the street lol. \n\nThis has happened to me multiple times before!", "replies": [{"id": "i5vde5v", "text": "What did you do in those cases? Are you located near them so you were able to pivot to another tenant easily? Do you typically own NNs?", "replies": [{"id": "i5vdmf3", "text": "In the one\u2026 it was in the middle of nowhere. \n\nI should have never bought it. I knew that going into it. \n\nAlmost 4 years later I finally got a regional to lease the location for the same rent. No idea how it ended up working out. (On that one, anyway) \n\nIn most cases you just have to make a decision if you want to sell it for $200K-$300K.", "replies": [{"id": "i5yjgmh", "text": "It took 4 years to re lease it? We have one with a few years left, it was a 15yr lease I sure hope that doesn\u2019t happen", "replies": [{"id": "i5yjuk4", "text": "Yes. It\u2019s literally in the middle of nowhere.", "replies": [{"id": "i5yk5nu", "text": "Ughh but aren\u2019t they all..", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "i5vdqt6", "text": "No. I don\u2019t typically own NN\u2019s. \n\nA good friend was selling these and they only had 2 years of term left. \n\nI have a very good relationship with DG so on all but 1 they gave me 10 year extensions.. so I reluctantly pulled the trigger.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i5tc243", "text": "Hi lads, net lease broker here. Prices will adjust but in my opinion, it still takes a little time for the market adjust because of the significant amount of cash buyers (many in 1031s) who still are purchasing competitively and are not interest rate sensitive. I\u2019m still selling all of my deals pretty reliably and have been looking only around a 10 bps discount compared to last month when the 10 year was sub 2. \n\nPrices will change though.", "replies": [{"id": "i5tqqoi", "text": "Thanks for the feedback. In your opinion, when do you think prices will start to adjust?", "replies": [{"id": "i5u23uz", "text": "Buddy of mine who's been a stnl medical broker for about 20 years says his rule of thumb is two quarters minimum for cap rates to catch up to interest rates.", "replies": [], "depth": 3}], "depth": 2}, {"id": "i5tquov", "text": "Good take", "replies": [], "depth": 2}], "depth": 1}]