Friday, April 23, 2010

Walgreens Goes Urban With Duane Reade

Walgreens recently closed the purchase of Duane Reade, a deal which included “all 258 Duane Reade stores in the New York City metropolitan area, as well as Duane Reade’s corporate office at 440 Ninth Ave. and two distribution centers”. The transaction was all-cash and involved the absorption of $457 million in debt. This bolsters Walgreens already impressive presence in the drugstore/pharmacy market, adding a prominent urban chain and presenting new opportunities for net lease investors.

Duane Reed, which had struggled under debt and in July 2009 was downgraded to CCC+ by S&P, will certainly become more appealing now that it’s helmed by A+ rated Walgreens. In addition Walgreens has “agreed to repay or redeem Duane Reade’s outstanding debt related to the local chain’s July 2003 credit agreement, its 9.75% senior subordinated notes due 2011, its 11.75% senior secured notes due 2015, and its senior convertible notes due 2022.” The looming question is whether Walgreens will back Duane Reade leases or if they will be allowed to stand alone. If Walgreens does agree to back the leases, a high investment grade product would be added to the net lease market, if not, the asset will at lease become more attractive under the Walgreens flag.

This transaction also represents a great expansion into one the largest urban areas in the country by Walgreens. Duane Reade is centered in the New York metropolitan area and this purchase shows Walgreen’s desire to enter the urban market with force. This situation deserves close monitoring by those who are considering a net lease asset or have interest in investing in the surging urban market.

Friday, April 16, 2010

US Apartment Uptick = Net Lease Impact

It has been recently reported that the US apartment market may have reached bottom and be poised for a rebound. Apartment vacancy rates have stopped rising and rents even showed a modest increase in the first quarter. As life is pumped back into this market, 1031 exchanges could subsequently rise. Apartment investors heavily utilized 1031 exchanges to move from active to passive assets (such as net leases) in the past. Will this trend repeat?

To gain insight, we have solicited the help of James Brennan Esq., LL.M., Managing Director and Corporate Counsel of Exchange Solutions Group, one of the foremost experts of 1031 exchanges.

1. With the possible return to health of the U.S. apartment market, do you expect to see increased 1031 tax exchange action?

The Baby Boom generation flocked to real estate as an investment class, particularly multifamily. With Baby Boom private investors aging and looking to make life decisions regarding retirement, relocation, and estate planning, and all of those activities are distinguishable from the active process of “adding value” to apartment complexes through sweat equity and property management. Many of those B and C investors are looking to get out of active management. After living through this cycle, they want out more now than ever.

2. What makes apartment owners keen to move from an active to passive asset?

Passive triple net leases are net insurance, net utilities, and net taxes to the tenant. Apartment owners that have built a net worth over $5 million are looking to create annuity-like income for their heirs who often are not in the real estate business. These family patriarchs and matriarchs are not looking to burden their heirs who often are busy professionals in metropolitan areas with decisions regarding leasing up property or fixing the roof. Triple net leases provide credit-rated tenants with predictable cashflow.

3. How popular are net leases for those exchanging out of apartments?

Net leases are not only used by multifamily baby-boomers but also multifamily “financial engineers”. While multifamily financing is often favorable from agencies like Fannie and Freddie many borrowers are in troubled financial shape with distressed assets. These assets often don’t pass muster to be financed or refinanced with agency debt. These investors can 1031 exchange either with low equity or after conducting a deed-in-lieu 1031 into a net lease. Once in the net lease asset, the equity can be unlocked fairly easily through either credit-tenant-lease paydown readvance or through a standard refinance. These strategies allow multifamily borrowers to get an asset banks trust more with a credit rating.

4. What is the psychographic profile of a typical investor who executes this strategy?

Apartment developers are often drivers or family stewards. These decision-makers have built wealth from the ground up often not in a traditional white-collar methodology. These hard-driving decision-makers have provided for their family, and also probably have setup life insurance trusts to allow for estate planning liquidity. Triple net leases go well with this concept of transitioning wealth to the next generation without many opportunities for losing value by the heirs. The family stewards have built wealth and are now simply trying to preserve it.

5. Are there any aspects of this strategy conducive to estate planning techniques?

In an effort to defer capital gains while family stewards are still living the patriarch or matriarch often engages in a like-kind exchange to transition between apartment assets and net lease assets. In a like-kind exchange you can trade into multiple replacement properties. Therefore, if you have three children and you sold your apartment complex for $15 million, you can buy three $5 million dollar net lease assets that produce income that can be divided up amongst the heirs. This avoids management by the one heir that may be more real estate savvy.

Equally as important, the credit-rated aspect of net leases allows trust officers and advisors to sleep at night knowing that they made defendable decisions on behalf of the trust. Therefore, if a real estate trust officer is transitioning from apartment assets, net lease income streams are fiduciary friendly.

Wednesday, April 7, 2010

Urban Growth

A new trend is emerging across our nation’s urban areas. Driven by a desire to spend less time in traffic, live in a smaller footprint and work/play within an urban atmosphere, aging boomers and Gen XYZers alike are leaving the edge and making their way back to the city. Developers and retailers are benefiting as properties located in these urban areas are taking advantage of the changing demographic landscape.

This trend is highlighted in a recent Retailing Today story, concerning J.C. Penny’s move into Manhattan. For most of its history, J.C. Penny shied away from Manhattan because of the number of competitors and their store space needs. However, recent times have seriously cut down the level of competition, while also providing new vacant space to occupy. The result was a two-level, 153,000 square foot store, which opened on July 31st. In its first month, the new store surpassed sales expectations by “double digits”. The location, which sits above a subway station and a commuter rail line terminal, relaying 250,000 people past the store’s gates each day.

From a NNN investment perspective, NNN urban properties, like a typical strip center, benefit from a strong anchor or even shadow-anchored presence. A unique aspect of urban properties is that the anchor can be a dense concentration of office space or even a Metro station because the flow of subways, buses, cars, taxis and pedestrians is the engine that drives the street scene. As a result, NNN urban properties are experiencing increased demand, as they have remained successful in spite of the recession.

This coincides with the changing tastes of many investors from high risk/reward properties to ones with more stability and alternative uses. In today’s market, suitable NNN investment property is hard to find. Quality NNN investment property is harder still. Perhaps the hardest of all, are the $1 million to $5 million size transactions where the average investor and 1031 Exchange buyers focus their attention. Urban investments fit this niche and NNN investors have demonstrated a willingness to acquire these assets, often at premium prices.

Rick Fernandez is the Managing Director of Calkain Urban Investment Advisors (CUIA), a division of Calkain Companies, specializing in premier investment properties in high density, urban districts throughout the United States. CUIA builds on Calkain’s record of success in brokering some of the most notable transactions within the urban net lease market and focuses strictly on assets located within metropolitan regions. Calkain’s newest and proven division understands the ever-growing NNN urban investment market and the requirements of investors and developers working within the space. Our advisors guide clients through the many aspects which affect their prospective properties.

Thursday, April 1, 2010

Net Lease Cap Rates vs. T Bills

Cap rates are an important economic indicator for the net lease market as they effectively reveal supply and demand of NNN investment property and the return investors expect for their NNN investments. Furthermore, when compared with Treasury Bills, NNN investment property and the Net leases behind them offer an interesting picture of the ebb and flow of credit and risk and a window into the behavior of lenders and investors alike.

If we think of Net Leases as a bond like asset backed by real estate and the credit strength of the tenant, we see that cap rates and T-bills move in opposite directions in response to the rise and fall of interest rates. The returns offered by T-Bills rise when interest rates fall. For NNN properties, a fall in interest rates has an opposite effect driving cap rates lower as the drop in the cost of debt makes a lower return tolerable to NNN investors. Said another way, T-bill rates typically rise during periods of business expansion and fall during recessions. The economic engine that drives up the return for T-bills typically drives down the return offered by Net lease investments. This effect is compounded as the competition amongst investors pursuing Net lease properties drives cap rates down even further.

So where are we today? It is still too early to tell but preliminary data for 2010 suggests that the steady rise in cap rates that began in 2008/2009 may be leveling off. Lack of quality product, low interest rates and a very modest thaw of the frozen debt market may be responsible. Warren Buffet and others have pointed out that it is a fool’s game to try and time the market but the day of bargains in Net lease investments may be coming to an end.