NNN players are taking what they can get – steadying interest rates rather than cuts – while navigating a turbulent economy. Kidder Mathews, the largest fully independent commercial real estate firm in the Western U.S., recently shared insight with Globest.com on how this could impact the commercial real estate market.
Selective buyers and reluctant sellers have defined a challenging net lease investment sector marked by interest rate stagnation, but positive signs are now emerging. While cash buyers rule the real estate roost, steady capital costs have led more investors to come off the sidelines and capitalize on deals combining value and good real estate.
“Stabilized interest rates have solidified the economics of single-tenant investment property,” says Michael Morris, Kidder Mathews VP in El Segundo, California who advises clients on net lease investment strategies. Morris partners on the Phillips Morris Net Lease Team with VP Nick Phillips, who notes that while the market is finding its footing, questions still remain.
Hot & Not Investment Targets
Coping with today’s uncertain economy, net lease investors increasingly fly to quality, which is found in good locations with strong tenant creditworthiness and longer lease terms. Such targets can range from mission-critical industrial to the convenient and strong unit-level sales of quick-service restaurants (QSRs).
“The QSR sector typically fits these criteria more than other asset types, and the drive-thru tends to add an extra sense of stability to push QSR properties over the edge,” says Morris, who feels the casual dining sector is coming back to life.
Medical services – such as dental, dialysis, veterinary clinic, and behavioral health tenants – have some fresh NNN investment appeal due to their non-cyclical demand, “sticky tenancy,” and favorable renewal probabilities, according to Kidder Mathews’ SVP Mike King, CCIM, in Seattle. King partners on the Swanson King Investment Team with Erik Swanson, SVP in the firm’s Seattle office, who notes that “with 1031 exchange buyers driving so much of the net lease market, any tailwinds in the wider CRE landscape tend to magnify activity in this space.”
On the other hand, King lists pharmacies with weaker credits or challenged formats, car wash roll-ups with aggressive leverage, boutique fitness concepts, and discretionary soft-goods retailers as weak targets in the sector. In addition, he notes that dollar stores will suffer from tariff exposure, especially in secondary and tertiary markets.
The Net Effect: Money Talks
Given the current cost of capital, cash investors remain in the driver’s seat and have been opportunistic and selective. “[They’re] most competitive on certainty given tighter lending and proceeds constraints,” explains King.
An all-cash buyer recently acquired a 10-property retail portfolio for $75.9 million, due to a “portfolio cap rate” of slightly less than 7 percent, according to Paula Danker, CCIM, Kidder Mathews SVP in San Diego. The large, publicly traded client was drawn to good locations, long-term leases, and especially the enticing tenant composition of five grocery stores, four auto service centers, and a nationally recognized coffee brand.
Elsewhere, a “significant” decrease in 1031 exchange activity has led to a deferred-exchange backlog across all net-lease product types, says Phillips. Sale-leaseback deals also seem to be on the wane, with Danker pointing to increased development costs and expensive rents prohibiting projects from penciling. Phillips adds that the sale-leaseback strategy is still being deployed across the QSR and automotive sectors, albeit not as frequently as in prior years.
Net Lease Investment Outlook
Looking ahead, macroeconomic trends are a potential stress point for NNN investors. Tariffs will impact the bottom line of many net lease retail tenants with supply chains that are “so deeply tied to foreign economies,” according to Phillips. Morris calls the “One Big Beautiful Bill” restoration of 100 percent bonus depreciation a “godsend” for developers and owners of properties that qualify, adding that interest rate cuts would provide even greater relief.
“There is no question we will see cap rates compress over the next couple of years in the affected sectors,” Morris says. While challenges persist, Kidder Mathews experts see stabilization as paving the way for selective opportunities across the NNN market.