The Calkain report identified several factors that appear to continue to force upward pressure on cap rates. These include persistently tight credit markets and lingering concerns over the economy. However, other factors appear to be pointing to at least a modest stabilization in cap rates, if not during the second half of 2010 then into 2011. These include perceived improvement in economic indicators, scarcity of quality inventory, and slight influx of 1031 tax deferred exchange money and a flight to quality investments.
In looking at the four studied sectors, only Quick Serve Restaurants (QSR) experienced cap rate "compression" in 2010. It is presumed that this was the case due to the fact that most QSRs are located in major markets and have strong brand recognition although other factors were cited as well.
Apparently the largest beneficiary of recent market trends is the Dollar Store sector. This sector is composed of three primary tenants--Dollar General, Family Dollar, and Dollar Tree. These retailers have actually added a significant amount of new stores over the past year, apparently due to their role as a "Substitute Good," or more specifically a "Substitute Retailer." (See previous blog post) Dollar store cap rates averaged approximately 9.5% in 2010, up slightly from their 2009 average of 9.2%. These higher cap rates are attributed to the fact that dollar stores are generally located in secondary or tertiary markets and that most of their leases have been NN rather than NNN.
Pharmacies continue to be viewed as quality investments and remain stable. The perceived creditworthiness of tenants such as Walgreen's and CVS has driven demand in this sector. Walgreen's, perhaps the "flagship" pharmacy investment, had an average cap rate of 7.7% in 2010, some 50 basis points below the pharmacy sector average of 8.2%. Demand for pharmacy investments are typically driven by long lease terms, tenant stability, and strong locations/market presence.
One noteworthy issue is the continued bid-ask spread among all net leased retail sectors. We at Sperry Van Ness/Fiducia Properties have experienced this phenomenon acutely. Although the re-entry of buyers into the market is noteworthy, getting those buyers to agree with sellers as to the worth of a specific asset is extremely challenging. We've observed an approximate 40-60 basis point difference of opinion between buyers and sellers of net leased assets, specifically in the Dollar Store class.
Although the Calkain report suggests more of a return to normalcy and cap rate compression in 2011, others are not so optimistic and anticipate continued upward pressure on the returns for NNN retail investments. Undoubtedly many factors will come into play which will affect specific cap rates in specific markets for specific assets.
You may review the Calkain report in its entirety at http://calkain.com/reports/CAP-Rate-Report-2010.pdf.
For more information on specific investment opportunities in the retail NNN market, please contact us at 888.879.2083 or via email at greg.finley@svn.com.
