Cap Rate Trends: What’s Next?

Now that we are in the middle of the third financial quarter of 2019, it’s time to look at what changes cap rates have undergone since the final quarter of 2018. Last year saw stagnant cap rates and a tendency toward caution when it came to commercial real estate transactions writ large. Interest rate fluctuations and a U.S. government shutdown were just two of the many factors investors took into consideration when choosing to buy or sell commercial real estate properties. Now that investor confidence and optimism are beginning to rise, the commercial real estate market should see steady cap rate trends in most areas, although some segments of the market could experience fluctuations.

Changes by The Federal Reserve

Although the job growth market is continuing to drive the U.S. economy, the Federal Reserve recently cut its policy rate by a quarter of a percentage point, marking the first time that the central bank has lowered interest rates in more than a decade. What does this mean for the commercial real estate industry? Probably nothing. According to many industry experts and reports, this interest rate cut is unlikely to change or boost commercial real estate values in any appreciable way. Since the end of 2018, there has been a noticeable decline in financing rates. Despite that decline, cap rates for commercial real estate properties throughout the nation have remained stable. Although increasing access to capital is always a positive, there is no research to support that this access will translate into a surge in transaction activity.

Commercial Real Estate Forecast

The first few months of 2019 brought about another round of corporate bankruptcies and store closings. Companies like Toys ‘R’ Us, Payless ShoeSource, Shopko, Dressbarn and even Pizza Hut have all been selling off property and leases. However, store closures and bankruptcies have been impacting the commercial real estate industry for some years now. Retail cap rates climbed significantly throughout 2017 and 2018, often rising above 7.9 percent. Most of these cap rate increases were driven by Class B and C retail, while Class A commercial real estate yields have stabilized in some markets thanks to well-placed assets with strong, credit-rated tenants and high rental rates. Cap rates for properties like destination mixed-use projects and freestanding buildings with nationally recognized tenants should fare well, although older properties with vacancies will pose their own unique challenges.

Interested in maximizing your investment opportunities? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to receive a full evaluation of your commercial real estate assets. We can help you determine whether now is a good time for you to sell your property.


The Need-to-Know Considerations of a Triple Net Lease Investment

A triple net lease, often called a net-net-net (NNN) lease, is a commercial real estate agreement in which the tenant agrees to cover the net real estate taxes, building insurance, and maintenance fees in addition to the agreed-upon rent. Every triple net lease is different, however, and typically has unique scenarios and parameters. Accordingly, an investor, landlord or tenant must perform a thorough assessment of the agreement before proceeding. Below are the most applicable considerations regarding triple net lease investments.

Unit Economics

Unit economics outline the direct revenue and cost associated with the business model within the space. A proper unit-economics assessment enables the investor to determine the relative likelihood of lease renewal as well as predict potential profits. The type of tenant and operational expectations will greatly affect the unit economics, and thus the parameters and considerations of the NNN lease. A Starbucks has different operational expectations than a Mattress Firm, for example, and may want to negotiate a different NNN lease structure. Unit economics analyses are also helpful in comparisons between similar or neighboring locations.

Tenant Quality

Tenant quality in commercial real estate refers to the expected reliability, character and performance of an occupant. Low-risk tenants are typically favorable, primarily because NNN leases often involve single-tenant properties. An investor cannot risk the possibility of losing all forms of cash flow to cover expenses if a high-risk tenant fails and declares bankruptcy. High-risk tenants, however, offer the potential for higher cap rates and higher cash-on-cash returns, and different investors may prefer different levels of risk.

Rent and Term Length

Long-term triple net leases provide stability and longevity, but an investor must pay careful attention to ensure adequate stipulations and predetermined rent raises to account for inflation. Neglecting to account for the gradual decrease in the value of the dollar can cut into profit margins or offset them entirely, depending on the length of the NNN lease. Additionally, triple net leases can include renewal options, which provide investors, landlords and tenants with a viable alternative to a long-term contract. Triple net leases with renewal options are worth considering for less-proven business models.

Early Termination

An early termination clause gives the tenant the ability to sever ties before the lease term is completed and results in a severe risk of cash flow loss in an investment. A tenant is typically required to give ample notice of early termination accompanied by a lump sum payment.

Co-tenancy

A co-tenancy clause is a provision of a retail NNN lease agreement that specifies terms for the potentialities of neighboring businesses. Co-tenancy clauses offer the tenant some form of protection against a major competitor moving next door, or if an anchoring, adjacent business ceases operation or relocates. These types of scenarios can result in a significant change in consumer traffic and tenants may negotiate a co-tenancy clause as a precaution.

Interested in commercial real estate investment? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!