The triple-net retail sector is not unfamiliar with challenges. Online shopping, a global pandemic and inflation have forced retailers to routinely adapt and respond to new consumer demands. Now, rising interest rates have pushed investment capital out of the market in 2022, plummeting transaction volumes 72% year-over-year in November, with the expectation of a sharper decline in December.
But, there are rewards for patient capital during tough times. While cap rates are expected to trend upward for the next 12 months, Josh Bishop, SVP and director of single tenant net lease at Matthews Real Estate Investment Services, says that “lucrative” buying opportunities are just around the corner.
Retail Fields a Rough Year
The single-tenant net lease market struggled in 2022 sector-wide. “It has been a rough year for all property owners of net-lease retail tenants,” says Bishop. Property values have declined approximately 10% to 15% since the beginning of the year, directly driven by a rise in interest rates and the subsequent rise in cap rates.
As a result, the vast majority of 1031 exchange funds have run dry—a dire sign for retail transaction volumes which are driven by 1031 exchange purchasers. Bishop notes that cap rates have increased for all retail tenants, but shopping centers and strip centers have had the highest increase, along with some big box retailers, like Bed, Bath & Beyond.
Weathering the Storm
Not every retailer is yielding to economic pressure. Discount retailers and dollar stores have been outperforming the broader retail market, and attracting investment dollars along the way. “Historically speaking, these tenants have been able to thrive in times of economic prosperity and economic hardship, so we will see investors continue to favor these assets,” says Bishop. Dollar General net sales are up 11.5% and Dollar Tree net sales are up 8.1% in Q3. That alone is enough to standout to investors, but dollar stores also offer investment-grade credit behind their leases.
Chick Fil-A, Walmart, Tractor Supply, 7-11 and Kroger stores have similarly outperformed the market in the last year, and helped to prop-up investment activity amid deteriorating market conditions. Bishop remains optimistic about the performance of these assets in 2023.
Buying Opportunities Coming in 2023
Bishop is realistic about the challenges in the coming year. Overall, he has a bearish outlook on triple-net retail—but he also sees good buying opportunities on the horizon for investors that are ready to move on them. “I am telling my clients to hang tight,” he says. “Investors are remaining patient and standing by for more lucrative buying opportunities.”
The market distress is creating those opportunities. Economic pressures may force investors to sell as lease terms or loan terms come due. “Smart money is waiting on the sidelines, ready to strike,” says Bishop. “As a whole, the industry is expecting better buying opportunities in the near future.”