Real Estate Forum - October 2015

that other investors are not equipped to
evaluate, structure and negotiate.”
Hanley says competition has increased
as more lenders have entered the market
trying to keep pace with new purchases
and refinancings at historical low interest
rates. “Borrowers are paying closer atten-
tion to future exit strategies, including
potential pre-payment penalties and
assumption fees. Interest-only compo-
nents within the initial portion of a fixed-
rate loan are very prevalent, again offering
borrowers increased cash flow at the
beginning of their loan period.”
Investors Faris Lee places into net lease
properties are increasingly utilizing
smaller, local banks and credit unions to
finance their purchases, says Mousavi.
“Traditionally, larger, more-recognized
banks, life insurance companies and insti-
tutions were tapped for financing net lease
properties, and small and local banks
focused on relationship borrowers and
local lending. Today we are seeing a high
number of smaller, local and regional
banks aggressively pursuing loans collater-
alized by net lease properties on a national
basis. The investor, bank and net lease
property are all located in different states
in many of our transactions. This is a new
‘national lending’ dynamic we are witness-
ing and is a major positive for investors.
Larger and institutionalized banks are hav-
ing to compete with local banks and credit
unions, thereby increasing competition
within the lending space and reducing the
cost of capital to investors.”
Sands says while the majority of the new
acquisitions are either cash purchases or
conventional financing (given the attrac-
tive interest rates that are benefitting bor-
rowers), his firm is now seeing an increase
in seller financing. “Sellers don’t want to
miss an opportunity to take advantage of
the values they are getting for their real
estate, but they are also concerned about
whether there will be another investment
of equal or greater value available into
which they can exchange their capital
gains. The installment-sale approach to
selling is allowing buyers to acquire prop-
erties without having to perform an
appraisal. For sellers, they can benefit
from both the possibility that their prop-
erty would not have appraised equal to the
incredible values they are selling for, and
they are also getting reoccurring cash flow
that is collateralized by the property they
owned. While this is not frequent, it is a
strategy that we are seeing to avoid the
appraisal process and to continue the
reoccurring cash flow that benefits the
seller, without having to acquire a new
property.”
O’Shea’s firm appreciates that due to
the compressed cap rates, buyers and their
lenders are structuring many deals with
“IO” debt. “While understandable in craft-
ing a short-term yield solution, this type of
debt is subject to lease term and possible
lease escalations that could be accretive,
and the loan-to-value leverage is very
important. We are counseling the lowest
LTV to secure best coupon rates, and only
tenants with a minimum of 10 years
remaining on their lease are the best can-
didates. In our best judgment, too much
debt and not enough term, combined with
real estate intrinsic, could yield a short-
term solution and a long-term refinancing
problem that could endanger NNN assets’
residual value. This is a serious issue that
not everybody is taking seriously enough.
We are apparently ‘old school’ in terms of
locking in fixed longest-term debt to ride
out the next six to eight years. Accepting
lower-than-hoped-for yield may be tough,
but it’s a sound strategy.”

INSTITUTIONAL INVESTORS’
YIELD-CAPTURING STRATEGIES

Institutional investors have their own unique underwriting criteria for any type of real estate transaction, and that goes for the net lease sector as well. What is this sector doing in an attempt to capture necessary yield?

Hanley says institutional investors are
trying to purchase in bulk (i.e. portfolios)
in order to get a higher yield. “Due to
increased cap-rate compression of core
tenants such as Walgreens, CVS, O’Reilly
Auto Parts and AutoZone, many institu-
tional investors are now willing to consider
non-investment-grade tenant net lease
properties in proven locations in primary
markets. They’re looking at second and
third-tier credit tenants, which opens them
up to double or triple the amount of oppor-
tunities.” Still, he adds, this is driving down
cap rates as the competition gets more
heated. It also pushes private investors into
the secondary and tertiary markets in
search of higher yields.

According to Mousavi, the number of
private investors within the net lease
space has increased dramatically. “At the
same time, public REITs and institutions
targeting net lease properties have also
grown exponentially as capital flows
through the equity markets, private
equity funds and other capital sources
into net lease REITs and institutions. In
order to compete with the private market
and to secure a higher yield and deploy
capital, institutional investors are target-
ing larger-price-point acquisitions ($50
million to $100 million-plus), portfolio
acquisitions and other higher-price-point
transactions where competition from the
private market is dramatically reduced.
There’s also been a considerable amount
of multi-billion-dollar corporate mergers,
acquisitions, and overall consolidation
within the institutional net lease sector as
another method of growing assets, engi-
neering a higher yield and increasing
operating efficiencies.”
Sands says there are two prevalent strat-
egies that institutional investors are using
to capture yield. “The first is they are
acquiring short-term lease opportunities
at a better yield and then restructuring the
lease with the tenant in order to create the
term that they typically desire when acquir-

The way we
capture yield
is over the
long term,
so we not
only evaluate
initial yields
but also look at contractual
escalations over the life of
the lease.”