Fast-Food Buildings Beating Bonds Spurs Deal Surge

Sales of single-tenant retail properties -- buildings leased to fast-food joints, pharmacies and other store operators -- have soared to a six-year high as investors seek real estate that performs better than bonds.

Acquisitions of companies that own single-tenant buildings also are rising as landlords seek a more diverse mix of renters and lower risk. Spirit Realty Capital Inc., for example, agreed last month to a merger with Cole Credit Property Trust II Inc. in a deal valued at a record $3.66 billion, according to data compiled by Bloomberg.

So-called triple-net-lease landlords rent to pharmacy chains including CVS Caremark Corp. and Walgreen Co. and such food outlets as Chick-fil-A and Red Robin Gourmet Burgers under multiyear agreements, with tenants paying property expenses. The leases often have rent increases built in over their lifespans, providing steady cash flow and protection against rising costs, much like investing in an inflation-adjusted bond.

“It’s very stable and very predictable,” Ryan Severino, senior economist at New York-based research firm Reis Inc., said in a telephone interview. “That’s what’s been drawing a lot of interest to it.”

Some targets of company takeovers have been public, non-traded real estate investment trusts such as Corporate Property Associates 15 Inc., bought by its manager, New York-based WP Carey Inc., for $3.1 billion. American Realty Capital Trust Inc., which had been a non-traded REIT before its public listing in March, was sold to Escondido, California-based Realty Income Corp. last month for about $3 billion.

Transactions Climb

Sales of single-tenant retail properties totaled $3.1 billion in the fourth quarter, the highest for any three-month period since the fourth quarter of 2006, according to data from New York-based real estate research company Real Capital Analytics Inc.

Tenants in triple-net leases are responsible for paying all of a property’s costs, which minimizes expenses for the owner. Triple-net leases get their name from tenants paying the net amount of three types of costs: real estate taxes, building insurance and common-area maintenance.

The average capitalization rate for single-tenant retail properties in the fourth quarter was 7.1 percent, the lowest since the second quarter of 2009, Real Capital data show. Cap rates, a measure of yield for the real estate industry, is net operating income divided by purchase price. Cap rates decline as prices rise.

Drugstore Bonds

Still, those yields are luring investors because they’re higher than returns offered by such alternatives as corporate bonds, said Dan Fasulo, managing director at Real Capital.

“That’s why people are interested,” he said.

Walgreen’s $1.2 billion of 3.1 percent bonds due 2022 yielded 3.18 percent as of yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. CVS’s $1.25 billion of 2.75 percent bonds due 2022 yielded 2.97 percent.

An index of five publicly traded single-tenant REITs rose 16 percent in the 12 months through yesterday, compared with a 9.1 percent gain for the 124-member Bloomberg REIT Index.

The deal for Phoenix-based Cole Credit allowed Spirit Realty to diversify its tenants and reduce its cost of raising capital, the Scottsdale, Arizona-based company said in a statement Jan. 22. With the merger, Shopko, a discount retailer based in Green Bay, Wisconsin, and Pamida, now part of the same company as Shopko, will account for almost 16 percent of Spirit’s portfolio after its merger, down from about 29 percent at the end of the third quarter for Spirit alone, according to a regulatory filing.

Tenant Improvement

Shopko, which operates almost 350 stores in 22 states, is owned by private-equity firm Sun Capital Partners Inc., based in Boca Raton, Florida. Annual rent from Shopko and Pamida totals $83 million, or about 30 percent of Spirit’s annual rental revenue, according to the filing by Spirit.

“The big thing for them was reducing that Shopko exposure,” Jason Lail, manager of the real estate research team at Charlottesville, Virginia-based SNL Financial LC, said in a telephone interview. “It was an improvement on who their tenants are.”

The diversification may help lead to a credit-rating upgrade from Standard & Poor’s, the New York-based company said in a report on Jan. 28. Higher credit ratings help cut borrowing costs because investors view the risk as lower.

‘Big’ Focus

Institutional-investor demand for single-tenant retail is rising as well. Buyers such as pension funds, money managers and insurance companies were involved in 10 percent of deals last year, up from 9 percent in 2011 and 5 percent the year before, according to Real Capital.

Rich Moore, an analyst at RBC Capital Markets in Solon, Ohio, said he expects additional non-traded REITs to either list their shares on stock exchanges or sell themselves.

“The private REITs are big on these things,” Moore said of triple-net-lease landlords. “There will be these private companies that come to market.”

Leasing a property to a single tenant does have risks, Severino said. An occupant may go out of business or break the lease, and not all tenants are created equal, he said.

“You do ideally like to lease to high-quality tenants,” Severino said. “There’s no certainty in the world.”

As interest in the sector increases, additional investors are likely to enter the market for single-tenant real estate amid a search for higher-yielding investments, said Joshua Barber, an analyst at Stifel Nicolaus & Co. in Baltimore.

“For a long time, it was just a niche property type,” he said. “You’ll see more and more people coming to that particular sector over the next couple of years.”

(Updates with stock-index performance in 12th paragraph.)
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