Bloomberg Gives Real Estate Two Sentences

By David Sobelman

I was listening to Bloomberg radio in the car today and they started talking about macroeconomic indicators. After they got done talking about retail sales and the Cash for Clunkers program, they began to delve into real estate. The most amazing part of the conversation was the length of time they spent on the topic. I was so ready to start my mental rolodex of every real estate term I have ever learned in order to keep up with their conversation. But low and behold, I was disappointed. They essentially mentioned real estate as an indicator and that, at this point of the “recovery,” everything would be fine. Discussing the decrease in pricing for homes while the volume of sales increased was mentioned. Commercial real estate got an acknowledgement insofar as to say that it’s a small part of the real estate market and an even smaller part of the economy; so they weren’t too worried. Does that mean I shouldn’t be too worried? Does our entire industry deserve a long segment of discussion from the economists on Bloomberg or should we be as blasé about the market turning around as they were? Two sentences are all we got from them. All I can say is that while I see signs of improvement on a daily basis, I think there is a little more to the real estate market than could be said in two sentences. Stay tuned, hopefully we’ll get more hindsight, insight and foresight from our experts.

Is Net Lease Back?

Last Thursday, Globe Street’s very own Michelle Napoli reported that Realty Income Corp, one of the larger players in the REIT market with a focus on net lease investments, has begun looking at acquisitions. Specifically, CEO Tom Lewis said:

“I know there will be some modest acquisitions in the third quarter, and I’ll define that as a trickle, and we’ll see where it goes from there.” He adds, “We are looking at transactions and buying again.”

This is highly significant information because, as Lewis states himself, “it’s been about 20 months since we put out an LOI on a property.”

The fact that Realty Income’s previously muted presence is coming to an end amongst a series of acquisitions could point to the long elusive light at the end of this recession wrought tunnel. At least, as far as the net lease market goes.

And who is the culprit for this recent spat of good news?

Why it’s those two eternal forces of capitalism, who until recently were not on speaking terms: Buyers and Sellers. The gap between them seems to be closing, especially in terms of seller expectations. Which are becoming, as Lewis notes, “more realistic.” This means that for those who have prudently stored capital, the time may be now to start buying. And in a market as tumultuous as this, net lease investments with their incumbent safety, may be the place to start investing.

Bolstering this perception is a recent upgrade by Friedman & Billings Ramsey Capital of Cap Lease Funding’s target, elevating it to $6.00 from the previous $4.00. This positive development for Cap Lease Funding, which specializes in Net Leases, could very well be indicative of the entire market. Taken together with Realty Income Corp’s new dalliances, we may be seeing the beginnings of a positive trend. So look out world, there may be sunny weather ahead.

Net Lease Solstice

By David Sobelman

When describing the point at which the Sun's apparent position in the sky to reach its northernmost or southernmost extreme, one can only wonder if that is what is happening in the net lease investment community; has there been an extreme change in the industry. We have all seen transaction volume decline, but is that the only variable driving the market? What about capitalization (CAP) rates, lease terms and values of underlying real estate. Has an extreme determination been concluded on the net lease investment market? Are we reaching the "solstice" and will we now see stabilization over time? One thing is for sure, investment parameters have changed, but an extreme polarization of the net lease market has not. CAP rates remain somewhat stable as compared to more volatile investment segments, i.e., vacant properties, land, multi-family, etc. So reaching the net lease solstice has not occurred and may not as the nature of the investment segment does not allow itself the volatility of extreme market changes.

Golf and Waffles?

By Bridget Lyons

Professional Golfer Phil Mickelson is taking a swing at the franchisee business. He recently made a bid to buy a Nashville based franchisee for Waffle House out of bankruptcy with his two business partners. GS Acquisitions LLC offered $20.2 million in cash and payments to the US Bankruptcy Court to bail out the ailing SouthEast Waffles, a 105-restaurant group that has locations in four states. The Waffle House parent company has a right to oppose the purchase and has declined to comment as of yet, however, they had placed an earlier bid of $19 million.

Does Greening Your Commercial Property Make Financial Sense?

By Joan Pino

The term ‘responsible property investing’ refers to the active selection and maintenance of properties that exhibit social and environmental conscientiousness. ‘Responsible’ in RPI expresses an objective of accountability as well as smart business, which translates into economic benefits directly passed on to the bottom line. Recently, commercial investors with RPI ambitions have been drawn to environmentally friendly or ‘green’ buildings on account of their clear alignment with the RPI outlook. At first glance green buildings may appear as an unnecessary increase in initial capital outlay, however; investors in green buildings have confirmed them to be sustainable ventures that maximize property value while minimizing risks associated with volatility of the market, creating an ideal investment for anyone.

Until this point in time, the ‘green cost premium’ has been a major deterrent to investors greening their properties. Over the past ten years, costs of green building materials have become more competitive with conventional materials, ultimately causing the green cost premium to disappear. According to a 2006 study conducted by the Davis Langdon firm, “many projects achieve sustainable design within their initial budget or with very small supplemental funding.” If this is holds true, the need for commercial real estate investors to financially justify opting for a green building would be eliminated.

Investors in green buildings have reported gaining several significant benefits unattainable with non-green properties. Studies have documented improvements in rental performance (rates, occupancy, and retention), risk management, and tenant relations. In addition to actively seeking green buildings, investors can make upgrades to buildings already in their portfolios through a variety of improvements which will make their properties superior investments. The costs of these upgrades can even be passed on to the tenant, the entity which stands to gain the most from the evident benefits (decreased operating costs, improved environmental air quality, increased employee productivity, etc.), through a green lease. The EPA’s ENERGY STAR® program has developed a tool called the Building Upgrade Value Calculator (BUVC) which allows building owners and/or tenants to assess the financial costs, benefits and implications of energy efficient measures specific to their building and situation. The tool provides a useful financial summary (net investment cost, pay back period, ROI, NPV, IRR, etc.) calculated from the given inputs (square footage, annual utility bill, costs and predicted annual savings of energy efficient measures, possible rebates and additional savings) to give investors an estimation of how green upgrades will affect their bottom lines. The BUVC works off the income approach of asset valuation (asset value=NOI/Cap Rate), assuming energy savings flow directly to NOI. Although the tool was originally designed for office buildings, most of its functionality is applicable to all space types (the figures that the tool generates specific to office buildings are potential impact on NOI and asset value). The BUVC is a MS excel workbook that can be accessed here. The ENERGY STAR website also has suggestions for cost-effective upgrades appropriate for different building types (retail, QSRs and casual restaurants, grocery stores, office buildings, etc.).
Investing in green buildings may have been impractical and costly in the past, however; the eradication of the green cost premium coupled with increasing risk aversion begs the question, why not go green?

Calkain in the Spotlight

Calkain Companies is highlighted during an ABC interview with James Brennan, Managing Director of Exchange Solutions Group 1031. Mr. Brennan overviews the ways a 1031 exchange can help many Americans defer their tax liability and speaks on possible future trends. Click on the video below to watch!

Flight to Quality Now Boarding

Posted in Globest.com/Florida on July 5, 2009

By David Sobelman

I first heard the phrase “flight to quality” during my first job in commercial real estate. I was a research analyst sitting in a cubicle, staring at my computer screen and wondering why there was over 500,000 square feet of negative absorption of office space in Washington, DC--in one quarter.

The year was 2002. That was quite a rude awakening for not only me, but every landlord in our nation’s capital. What do you do with all that vacant space in such a short period? The answer: Lower your rental rate. Tenants began filling vacancies and getting better office space. It was a flight to quality.

But net lease investments are different when considering quality, which is a popular word these days. In the net lease investment industry, we’re typically not discussing the leasing of a single-tenant office building, a large warehouse or a small retail center. We’re discussing investments--the purchasing of assets for an immediate return.

So how does one define a flight to quality when considering a net lease? It depends who is buying.

People want more for their money in today’s market. However, quality varies in any investment, let alone net leases. The first quality adjustment we are seeing is a desire for choice real estate. Location is still of the utmost importance to investors.

Buying a Walgreens location in Dubuque, IA is different than buying one in New York City. You may be getting the same credit and same lease terms, but the real estate has become a big consideration for investors today.

The investor has to know that at the end of the day, they are still buying real estate. Consider the worst-case scenario: If my great tenant leaves, what am I left with? Where is the building? What is around the site? How can I access it? We are all real estate professionals, but the quality real estate was forgotten for many years.

Additionally, investors are focusing more on the credit of their tenant. Gone are the days that you can put a very aggressive cap rate on a one-unit franchise operator of a concept that you have never heard of before and close the transaction in 21 days.

The investor’s flight to quality for tenancy has become drastically more apparent in the last 12 months. In 2008, when it truly did seem that the sky had fallen and was actually beginning to dig a hole to the center of the earth, no one was really sure of how to rate a company’s credit. Those institutions that had a credit rating by a major agency, such as Standard & Poor’s or Moody’s, were being questioned because they got so many things wrong.

Companies with “A” credit or better were going bankrupt or being downgraded so fast that it was hard to keep track of them. The term “investment grade” almost became a joke. But now that the economics of the industry have calmed down and recovery is under way, the credit of a company seems to have taken on a new meaning.

History has proven that credit matters. Over the last half-decade, it was proven that if you had a net lease investment, you could get financing. Now, you truly need a credit rating of “A” or better to get above-average financing. Otherwise, you’re left with a full recourse loan with a very low loan-to-value ratio.

Credit tenants are still comparably garnering somewhat stable cap rates, but those that lack the financial reporting worthy of an overly scrutinized underwriting process are seeing their returns rise and prices lowered because of the perceived risk. The credit of the tenant has seen new meaning and the credit tenants are sought out more so now than ever before.

Lastly, the lease terms are becoming a talking point that quality seekers seem to be discussing more. The words “absolute” and “bondable” are heard more and more as investors seek new purchases. Triple net assets are trending to become, well, triple net.

The mere definition of the investment class started with the understanding that the tenant would be responsible for taxes, insurance and maintenance. Yet somehow over time, triple net became defined however you wanted to define the structure of the lease. Maybe the landlord is responsible for the roof and structure of the building, but not the daily maintenance. Or maybe the HVAC system falls on the landlord, but no other items.

Whatever the case may be, triple net became double net, single net or half a net. If there is some responsibility of a landlord, then the investor wants to be compensated for it with a higher return. So when an investor says that they want a triple net investment, they want to sit back, collect a check and never even get a phone call about the property. They want to think of the property once a year when they are filing their tax returns. The flight to quality is in the lease terms and investors are seeking out the absolute, most passive form of real estate ownership.
But a true flight to quality still depends on the individual investor. We have to realize quality can be defined a number of different ways. But net lease investments have truly seen a change in recent months, with scrutiny being placed on the attributes of an investment that haven’t been considered in years.

One may be able to take a great parcel of land but have it encumbered with an old and outdated building with a terrible credit tenant and turn it into a goldmine over time. But today’s investor has a somewhat different destination--a nonstop flight to an oasis called “quality.”