Connect Media will sit down with the industry leaders on March 16 at Connect Retail West for a panel entitled: “Opportunities in Net Lease: Capitalizing on Current Trends.” We’ll examine both the challenges and advantages in the NNN space and what retailers are doing to expand their portfolios. The panel will also address how changes in 1031 exchanges will affect the marketplace, and how to prepare for what’s ahead. We asked SRS Real Estate Partners’ Patrick Luther to share a sneak peak into what he will discuss in our latest 3 CRE Q&A.
Q: What are the current trends shaping the net lease market?
A: We’re seeing the end of cap rate compression as a result of rising borrowing costs. From a broker’s standpoint, it is becoming more challenging to create liquidity and find buyers on merchant developer driven product. Return on cost versus exit cap rate metrics are in some cases under 100 basis points. This will drive developers to hold their product and explore permanent financing alternatives out of construction debt to sales. The country as a whole is over-retailed, primarily in apparel and department store categories in the heartland and Midwest. Thankfully, this is less of an issue for us in coastal California markets, but similar issues exist in the Central Valley and Inland Empire.
Q: How can companies navigate the issues?
A: Developers will need to be cautious about what returns they will accept for construction risk heading into a flat or rising cap and interest rate environment. They will need to have options available to convert construction debt to perm and to hold assets and cash out versus a sale. Oversized retail spaces, as mentioned above, will eventually need to convert to entertainment uses from apparel or department store, or potential be re-zoned to housing to drive foot traffic, consumer demand and density to what retail remains.
Q: What opportunities do you see ahead in 2017?
A: Right sizing big box spaces, retailer contraction and consolidation will make quality space available to alternative uses. Focus continues to shift toward mixed-use and all-in-one retail and housing. Food, service and entertainment uses will continue to replace once bellwether department store and apparel retail spaces. Box sizes overall will shrink as a function of direct deliveries, overall tightening of margins and softening of sales growth in certain segments – essentially anything that can be cheaply shipped or sold online.