The social, economic and financial disruption caused by the global pandemic and subsequent quarantine has been profound. The degree of delays and disruption, however, has not been consistent. Some industries have proven to be more resilient than others, and some sectors within industries have gone through a full cycle of initial shutdown, followed by tentative reopening and adaptation.
Some of that pattern is evident within the commercial real estate industry in general, and the net lease market specifically. At a time when uncertainty is a liability that everyone is grappling with, the net lease marketplace benefits from the fact that it is the simplest type of real estate transaction: net lease deals are relatively straightforward, with little uncertainty about key details like the location, the building, and the tenant(s).
The Net Lease Market
Despite those structural advantages, when the COVID crisis exploded in March, the net lease market experienced the same initial slowdown that affected so many commercial industry transactions. When the first round of COVID-related shutdowns went into effect, new transactions essentially ground to a halt: everything that was not part of a tax-trade exchange essentially froze—and, for the most part, has remained somewhat in stasis. Most like-kind exchange transactions that were already in motion continued their path to conclusion, and while some experienced slight government deferments, most of those transactions are now complete.
The big question now, of course, is what’s next?
There is also some clear variation within the net lease market, with a stronger appetite for high-cube industrial distribution product as demand for fulfillment centers booms. While volume is still lower than pre-quarantine, we’ve actually seen some slight pricing increases lately. The news is less rosy on the retail side, where bankruptcies have hit hard–especially single-tenant properties. Medical office, while generally one of the stronger commercial real estate segments, has been somewhat difficult to assess in the current climate. With doctors dealing with an increase in virtual exams, the future remains somewhat unclear with respect to any long-term trends with regard to space requirements for medical tenants.
One of the sticking points to returning closer to pre-COVID transaction volumes is valuation. Trying to determine the true value of properties on the market has become a challenge, with clear disparities between the perceived value on the part of owners and current market pricing. We have seen little-to-no seller pricing capitulation, which is perhaps unsurprising given how recently circumstances have changed and how difficult it can be to shake ingrained perceptions of asset value. Value perceptions linger long after marketplace realities have shifted, and the unique situation in which the industry finds itself today makes that lag-time likely to be even longer than usual. Regardless of other factors, transaction volumes are unlikely to pick up in any meaningful way in the near term, as long as seller reluctance persists.
We are seeing an uptick in activity lately in single-tenant sale-leaseback transactions. With banks becoming more conservative, and a general overall tightening of the lending environment, transactions that can help monetize a company’s real estate assets have some obvious appeal. Assets are still being brought to market, but they are sitting on the market longer as both sides of the transaction equation continue to play the waiting game. Something to watch going forward is while overall market pressures aren’t motivating many sellers yet, individual pressures may begin to loosen things up.
We also can’t ignore the fact that there is a lot of investment capital on the sideline—and lots of pent-up demand for single-tenant net lease transactions. The critical questions of how much quality is out there and when that quality will be available remain unanswered. However, there are good reasons to believe that when things do begin to open up, that process will unfold with impressive speed. A crisis is unavoidably disruptive, but it also creates opportunity. The pent-up demand is significant, and when new businesses begin to appear—seemingly out of thin air—the post-COVID market will roar to life with remarkable speed. With the net lease market always one of the first segments to pick back up and return to liquidity after a slowdown, there are plenty of reasons to think that the months ahead could be both fascinating and extremely active for this integral feature on the commercial real estate landscape.
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