April 21, 2017

Consumer Optimism Buoys Net-Leased Sector

Confident Consumers Boost Positive Economic Momentum

The economy maintained momentum to perform admirably in 2016 following a slow start to the year. This trend will carry into 2017 as consistent job creation across a wide array of employment sectors provides momentum for the economy while compressing the unemployment rate. Also, tight labor markets are translating into robust wage growth, with the latest employment report showing an annual increase in average hourly earnings of 2.8 percent. These trends have given way to a tremendous rise in consumer confidence, particularly following the election, with the measure at its highest level since 2000. Steady economic growth will likely continue through 2017, benefiting a wide range of single-tenant net-lease concepts that will dominate the development pipeline over the coming year.

Rising Interest Rates Spark Investor Recalibration

The recent interest rate surge forced many investors to reconsider investment strategies, though the limited use of leverage by net-leased investors tempered the pullback in transactions. Still, the pronounced downward pressure on net-leased asset yields during the cycle has flattened in response to higher interest rates.

The popularity of these assets, particularly among investors exchanging out of more-management-intensive assets, will minimize any upward pressure on cap rates. Properties in great locations in major metros, long lease terms, backed by strong credit remain in demand. However, the declining  velocity in other property sectors could reduce exchanges. The future of the section 1031 tax-deferred exchange is a major consideration for net-leased assets. The scrutiny of this provision by Capitol Hill amid a broader tax reform plan is raising concerns among investors and developers, but little guidance on the future of this tax provision has yet emerged.

Developers Favoring Net-Leased Properties Amid Strong Demand from a Variety of Tenants and Tight Vacancy

Throughout the current business cycle, builders have overwhelmingly delivered projects favoring single tenant concepts, specifically in the pharmacy, quick-service restaurant, and dollar-store segments. Single-tenant offerings have accounted for more than 80 percent of retail construction since 2009, which is up from below 70 percent before the recession. Despite the upswing of net-leased deliveries, demand for spaces remains well ahead of supply growth. Net absorption has exceeded development by an average of nearly 16 million square feet annually since 2010, causing vacancy to fall 240 basis points to 4.8 percent nationwide during this time. This level is 100 basis points below the pre-recession peak, underscoring the vast improvement in the sector.

Consumer and Job Statistical Trends:

  • Job growth gains averaging 195,000 positions per month over the past year. As a result, the unemployment rate fell to 4.7 percent, the lowest level since 2007.

 

  • Consumer Sentiment posted its highest level since 2000, with expectations also elevated. The index is 11.9 percent above the average reading since the survey began.

 

  • Core retail sales vaulted 5.7 percent year over year in February, highlighting the strength of consumers. Lead growth categories include e-commerce, food and drink establishments, and health and personal care stores.

Net Leased Trends:

  • Net-leased properties recorded a 3.9 percent advance in the average asking rent last year, more than doubling the pace of multi-tenant shopping centers over the same period.

 

  • Asking rents in net-leased properties are less than 2 percent below the pre-crisis peak, averaging $19.62 per square foot nationwide.

 

  • For 2017, store openings will be led by the dollar-store segment in 2017. In addition, consistent expansion in the fast-food sector will continue over the coming year.

 

  • After Walgreens’ management reworked the details of the pending Walgreens/Rite Aid merger, approval is likely to occur in July. The renewed offer involves selling 1,200 Rite Aid locations to Fred’s in order to gain antitrust approval.