The late-cycle appeal of net-leased assets

The strategy is attracting an increasing amount of international capital, even as overall foreign real estate investment into the market has dropped

TA Realty bought the net-leased Continental building for $138m in April.

As the world’s largest property market, the US has benefited from strong inflows of foreign capital over the past several years. This year, however, overseas investors became net sellers for the first time since 2012 and cross-border investment in the US fell by 37.6 percent during H1 2019, according to a Real Capital Analytics report. The drop resulted not from investors writing off the US as a market, but from the fact that the big-ticket transactions that many foreign investors pursue have become more difficult to execute in the US in the late-stage real estate cycle.

One bright spot in that pullback, however, is in net lease assets. Through the first half of 2019, net-lease investments totaled $33.4 billion, according to a report released this week by CBRE, a real estate brokerage. This equates to a 17.2 percent increase year-over-year, outpacing the broader market’s 13.4 percent growth rate.

This uptick could be written off as a flash in the pan given the small footprint net-leased buildings holds in the universe of investable real estate. Post-global financial crisis, such transactions have hovered just above 10 percent of the US market annually and prior to 2009 they represented an even smaller share of the market. But to disregard current net lease investment activity would be to ignore the strategy’s attractiveness, particularly to offshore capital.

Last month, the Connecticut Retirement Plans and Trust Funds committed $100 million to Oak Street Real Estate Capital’s Net Lease Property Fund. It joins the likes of the Pennsylvania State Employees’ Retirement System, the Teacher Retirement System of Texas and the Teachers’ Retirement System of the State of Illinois, which committed $300 million apiece to the open-end vehicle.

Launched in October 2018, Oak Street’s net lease fund has already raised $1.6 billion on a $2.5 billion target, according to PERE data, and it is not the only manager to have success with this strategy. New Mountain Capital Partner’s debut sale-and-leaseback fund was oversubscribed earlier this year and Angelo Gordon launched its fourth net lease realty fund in March.

Typically boasting a single, blue chip tenant on a long-term contract, net-leased assets can be relied upon for stable, bond-like returns. The Kentucky Teachers’ Retirement System, which committed $50 million to Angelo Gordon’s Net Lease Realty Fund III in 2013, has seen net returns of 7.11 percent over five years, 7.77 percent over three years and 8.31 percent over one year, according to a March 31 meeting document. As of 2017, KTRS had seen a 20-year return of 8.78 percent and a 10-year return of 8.28 percent on its in-house triple net lease portfolio.

The appeal of such stability to investors is reflected in the numbers: more than $74 billion was invested in net-leased assets between July 1, 2018 and June 30, 2019, the highest 12-month total on record, and CBRE projects 2019’s year-end total will surpass last year’s $68.3 billion record. Transactions involving single-tenant properties totaled $20.6 billion during the second quarter alone, or 15.1 percent of the total US real estate market, the highest share since 2013.

Overseas investors accounted for close to 19 percent of second quarter activity, the highest share since 2015. With nearly $6 billion of acquisitions closed through the first six months of the year, international buyers are on pace for a banner year in 2019. Prior to 2015, cross-border investment never surpassed $5 billion, but in the past two years, five countries have accounted for $12.5 billion in cross-border net-lease transactions: Canada, Germany, South Korea, Singapore and China.

Interest in net leased assets tends to surge during times of economic uncertainty. In 2009, net-leased transactions spiked to 16 percent of the US market, the highest share on record, according to CBRE. That is not to say a major dislocation is likely, but concerns over trade wars, interest rates and a looming recession have many investors preparing for the worst.

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