Investing in Single Tenant Properties When Interest Rates are Higher Than Cap Rates

In times of economic uncertainty, many investors look to the stability of investing in single tenant net leased (STNL) properties with long term leases in place. These high-credit tenants have very low default rates, and there are typically no investor/landlord management duties or costs. The high demand for these properties tends to keep cap rate increases modest, even as interest rates rise.

Interest rates increasing so quickly over the past several months, in most cases, has caused negative leverage for investors if they are financing acquisitions. An investor buying a STNL property might buy at a 5% cap rate and finance a portion of the acquisition at 6%. This is referred to as “negative leverage.” In the case of negative leverage, increasing the loan amount reduces returns, but does not imply a bad deal.

While transaction volume has slowed, investors are still acquiring properties, and most are applying some amount of leverage. Some investors question the notion of acquiring properties with debt when interest rates are higher than cap rates.

There are many reasons why investors have done well acquiring properties in situations like this-

• Most investors buy real estate as a long term hold. When interest rates are higher than cap rates there is less buyer competition, which typically results in slightly lower prices per square foot. As a long term hold, often the original purchase price is more important than the initial financing rate.
   
• Investors may also be able to secure a better location or tenant profile than they would in a more competitive buyer market. Quality locations can make a big difference.
   
• Investors can refinance later if interest rates are lower (if we see lower rates in our lifetime).
   
• The safety and stability of real estate and a credit tenant can be a comforting alternative to investing in more volatile startups or the stock market in times of uncertainly.
   
• Leveraging a STNL property, even if it’s negative leverage, still provides the benefit of less cash out of pocket and principal reduction on the loan over time.
   
• Inflation and a slowing of new supply in more volatile times can cause replacement value of competing properties to increase further benefiting existing property values.
   
• STNL properties are still looked at favorably by lenders even in more challenging economies. Available financing for acquisitions and dispositions keeps values stronger than some alternative investments.

There are many investors who only buy when financing is more difficult, when they have better pricing and options. If everyone at the cocktail party is talking about how great the real estate market is, it may be time to sell. If everyone is talking about how bad the market is, it may be time to buy. Contrarian investing has worked well for many over time.

Michael Bull, CCIM is an active broker with Bull Realty with 35 years and $7 billion in transactions experience.
Michael@BullRealty.com 404-876-1640 x 101

Nancy Miller is Partner with Bull Realty and leads the Single Tenant Investment Sales Division at Bull Realty. 
Nancy@BullRealty.com 404-876-1640 x 118