National sale leaseback spotlight

As interest rates remain elevated, sale leasebacks offer an attractive source of capital to sellers.

Jobs

An increase of 800,000 job postings since November 2023 and steady unemployment below 4% since February of 2022 suggest a strong and growing economy despite elevated interest rates.  As companies consider raising capital to fuel growth, and with corporate bond yields at relatively high levels, alternative capital sources are more likely to be considered. 

STNL cap rates vs. corporate bond indices

Over the past 10 years, Single Tenant Net Lease (STNL) cap rates saw steady compression until the end of 2022.  As interest rates rose in 2022, financial instruments such as the 10-YR UST, investment grade (IG) and non-investment grade (non-IG) corporate bond yields followed.  Though delayed compared to the corporate bond market, STNL cap rates also rose in early 2023 as the market reacted to the new lending environment.  Despite rising STNL cap rates, the relative increase of effective IG and non-IG corporate bond yields to STNL cap rates make credit driven STNL transactions, particularly sale leasebacks, much more attractive to corporate users.

STNL cap rates vs. corporate bond yields

STNL cash on cash returns

Utilizing publicly available CMBS data on loan spreads, loan-to-value ratios (LTV’s), and cap rates, the chart below estimates the market cash-on-cash (CoC) return for STNL Industrial, Office, and Retail properties.  Coinciding with rising interest rates in 2022 and 2023, estimated CoC returns fell significantly from around 10% to below 7%.  As with the broader real estate capital markets transaction volume, the increased cost of leverage and thus lower returns to investors likely contributed to the reduced STNL transaction volume in 2023. 

Note: 2014 Q1 to 2022 Q4 all-in coupons are priced off 10-Yr SOFR Swap.  2023 Q1 to 2024 Q1 all-in coupons are priced off 10-Yr UST.

CoC returns vs. corporate bond yields

STNL loan-to-values and all-in loan coupons

Historically, typical new financings had LTV’s between 65% to 70%. With increases in interest rates and decreases in asset values in late 2022 and 2023, lenders have tightened their lending standards in STNL transactions with LTV’s hovering in the 55% to 60% range for the last 3 quarters. 

STNL LTV and loan coupons

Cap rates and transaction volume by asset class:

In conjunction with the rising costs of capital and increases in cap rates across all STNL asset classes, pricing dislocation between would-be buyers and sellers has been a common theme in the current capital environment.  With sellers unwilling to realize losses and buyers unable transact at 2022 price expectations, transaction volume has fallen significantly, particularly in the office and retail spaces.  

STNL cap rates and transaction volume (US aggregate by asset class)

Conclusion

As a microcosm of the overall economy, commercial real estate, and more specifically STNL investments, initially saw a significant decrease in transaction volume at the onset of the pandemic. Transaction volume started to recover in the second half of 2020 as the initial shock of the pandemic wore off, but then it tapered off again in Q1 2021 given battered corporate performance resulting from supply disruption and government mandated shutdowns. Since Q3 2022, volume has fallen significantly due to the rising interest rate environment.

As anticipated fed rate cuts materialize later in 2024 and 2025 and as businesses continue to demonstrate positive performance, transaction volume is anticipated to recover significantly.