By: Jared Morgan, Head of Acquisitions at Four Springs Capital Trust
Here are a few thoughts for all the people who touch the net lease world (now with gloves and hand sanitizer) on a daily basis – owners, operators, brokers, advisors, bankers, analysts, developers, and anyone who brought up “cap rate compression” at a cocktail party.
With 25 years in commercial real estate and 15 years in net lease, I have weathered a dotcom bust, post-9/11 downturn and the Great Recession. I thought I had seen most challenges a global economy can throw at you. The beauty of being a diversified buyer in net lease is that I have my hands in a lot of industries and businesses that are crucial to the US economic machine.
As a result, I see stress and early indicators from the ground level through the different sectors we constantly underwrite at Four Springs Capital Trust. But with the COVID-19 health crisis and resulting fallout, I have witnessed a disruption that was never considered as part of a deal credit write up previously. These are truly unique times, and it has only been two months since the pandemic has impacted us.
There are a lot of us on the sidelines right now. Deals have been postponed, terminated and renegotiated throughout the marketplace, most of this starting in early March. Some buyers are continuing to bid, but at wider spreads. We are all dealing with in-house issues, remote management and stress to our rent rolls. Many acquisition teams have temporarily transitioned into asset management roles as we deal with deferral and abatement requests.
As we endured a difficult April and gear up for a challenged May, I start to ponder these questions:
- How will this affect relationships coming out of this crisis?
- How will we look at credit and underwrite transactions differently?
- How will the template lease agreement that had evolved into a fairly uniform industry document change?
As I wrestle with these questions, I fall back on now popular phrase “day by day”.
While I don’t have answers for all these questions, I can start to speculate where we might be heading. There is confusion and caution in the marketplace. This creates opportunity, but I still see a large divide between the bid and ask on transactions. I believe there will be cap rate adjustment upwards, but it will be industry and company specific.
As a diversified buyer of net lease product, I have exposure to a wide range of industries. This diversity provides good insight into the overall marketplace and creates flexibility to make smart investment decisions. Here are some thoughts on how the following assets classes might be impacted:
Industrial will continue to hold its position as the new “darling” of net lease. This sector looks to be the strongest of the asset classes in both our portfolio and the general industry. More investors will likely take notice and continue to crowd an already competitive landscape. This should be the first asset class to recover as sales volumes pick up and pricing remains competitive for the strongest credits. Buzzwords will be “distribution facilities”, “cold storage” (watch out for those that supply restaurants) and “core manufacturing” that has proved critical and remained open during this crisis.
Medical has been impacted because of the incredible stress on major systems and local practices. I believe there will be less supply of new construction into the market as hospitals and healthcare systems put projects on hold. There will be an overhang of struggling, non-rent paying practices coming out this pandemic. Buyers will focus on strong credits, necessity-based services that have remained open (dialysis centers, blood plasma).
Retail has clearly been the hardest hit. This was happening before the pandemic and the pandemic will accelerate the carnage. There are a large number of non-paying tenants throughout the sector, some that can’t pay and some that refuse to pay. Post-crisis there will be a correction in net lease with more supply and less demand in the hardest hit sectors. Investors will be selective chasing essential services, strong credits, and e-commerce resistant businesses. The new norm in underwriting will be asking “were they open and paying during the crisis?”
The net lease sector will remain a favored investment class because of its long-term leases and the importance of the locations to the businesses that occupy them. A minimum of 10-year term can survive cycles, although now we will ask: can it survive a pandemic?
The market will hit reset and figure out how to take advantage of cheap debt and opportunistic equity looking for access into the space. Portfolios will be re-positioned and the long-awaited mergers and acquisitions in our space will start to emerge. At the end of the day investors love our space because of its bond like quality. With an industry weighted average lease term (WALT) in the 10-year range, Spring 2020 will become a footnote (albeit significant one) in the life span of many of our leases.
It bears mentioning that I reside in the Princeton, New Jersey area only 70 miles from Penn Station New York, an area that has been hit hard in this crisis. We have been in quarantine going on nine weeks and normalcy is still down the road for us. However, I am anxious and excited about getting back in the game and back on the road, continuing to work with the tenants and industry players that make this such an incredible sector to work.
Please stay safe.
Jared Morgan has served as senior vice president, head of acquisitions at Four Springs Capital Trust since August 2016. From May 2013 until July 2016, he served as vice president of acquisitions at Spirit Realty Capital Inc. (NYSE: SRC), responsible for sourcing new acquisitions in the marketplace. From August 2006 until July 2011, Morgan was the vice president of dispositions and acquisitions at Sovereign Investment Company, where he bought and sold over $2 billion of net lease assets. He has served as operating partner of Excess Space Retail Services, Inc. and was co‑founder of an Apollo Real Estate Advisors venture. Morgan earned a B.A. from Colby College.
The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.