In a recent article titled, “Despite Optimism, Data Suggest Cap Rates Are Still Increasing,” Executive Vice President & Managing Director Chad Kurz provided his analysis on the topic.

The value of NNN assets has decreased owing primarily to rising interest rates. According to Kurz, despite market confidence, history suggests that the pricing adjustment may not be over. He has been closely monitoring transactions volume and inventory data, comparing it to historical data in order to understand pricing trends. He estimates that there has been around $300 billion in lost equity in the net lease retail market, since interest rates began their climb.

“A rising tide lifts all boats, and rising interest rates have lifted all cap rates across all asset classes,” says Kurz. Even so, many triple-net-lease retail assets tend to be more sensitive to abrupt movement of interest rates than other commercial assets. This is primarily due to the structure of the lease, which typically contains longer-terms, with options, and modest rent increases.

According to Kurz, “bond-like assets have seen the biggest pricing correction over the past few years as buyers have often chosen credit above real estate fundamentals.”

Regarding the continued adjustment in triple-net-lease pricing, Kurz’s analysis of overall transaction volume in comparison to inventory levels, shows that the market doesn’t appear to have hit the floor yet for pricing.

Net lease assets that formerly traded 300 basis points above the 10-year Treasury are now trading only 100 basis points above the benchmark. “There’s always been a historical spread, and that spread has been at all-time low levels the past several years,” explains Kurz.

Kurz points out that buyers have not been able to “take advantage of the all-time low spreads” over the last several years. The “best buyers” are often selling out of other sectors, multifamily, industrial, or land, and “exchanging into single tenant net lease retail for the first time.” The inability of many brokers to directly market their deals to owners that haven’t previously owned retail, according to Kurz, “is putting pressure on owners and developers. We are starting to see a shift in what owners are demanding of brokers.”

The idea of heightened demand for net lease assets driving spreads to historically low levels, ultimately justifying the compression and remaining regardless of shifts in interest rates is “more wishful thinking than reality,” says Kurz.

“There’s been a record amount of US household liquidity over the last several years, so there’s certainly capital available. If demand were strong enough to justify these lower spreads, we’d expect to see higher transaction volume. Instead, volume is trailing even the 2014-2019 (pre-COVID) period,” explains Kurz.

He notes that predicting where interest rates are going to be in the future can be risky. Kurz utilizes current supply and demand analysis to gauge the direction of the market, in addition to reviewing historical spreads.

“Lower interest rates would balance the equation without requiring further pricing adjustments,” says Kurz. “However, without using the assumption that rates are going to decrease in the short term, the data suggest that price reductions are likely going to continue for the next several months.”

Read the full article here to gain more insights on why pricing adjustments are not over yet, despite market optimism.