San Francisco, CA (PRWEB) April 14, 2016
After an Uptick In Q4 ‘15, Cap Rates Plummet
The slight uptick in Cap Rates in Q4 lead many investors to believe that we had reached the top of the market. The new data that surfaced in Q1 ‘16 has suggested otherwise. Median Cap Rates dropped 16 bps over the past quarter to settle at an all-time low of 6.12%. Average cap rates dropped by almost twice as much (28 bps) to settle at 6.25%.
As Net lease investors stare into the headwinds of the future, there appear to be many negative factors at play including the likelihood of future rate increases, the fear of 1031 exchanges becoming extinct, lease accounting changes, and shorter term low interest rate debt maturing. With these factors in mind, one could easily speculate that the Cap Rate uptick in Q4 was much more than just a dead cat bounce. Unfortunately, it seems that it was just that, as Cap Rates have clearly begun to settle at an all time low.
Given these perceived headwinds, this sustained low cap rate environment seems unlikely, but of course there are some logical reasons behind it. March of this year marked the 7 year anniversary of the economy bottoming out in 2009. Since then, we have been riding the wave of an extended bull market, fueled by the Fed’s motivation to keep interest rates low and the economy moving forward. This upward rise has created an increase in value for many property owners.
When these owners sell, many of them now have large gains that require them to either pay capital gains taxes or defer this tax event. Enter stage, the biggest driver in today’s Net Lease market, the 1031 tax deferred exchange buyer. From these buyers perspective, a 4% return on a replacement property with some combination of credit, term, and quality location is a great deal as compared to the alternative of paying capital gains tax and losing a large piece of their gain. Insert low interest rates to this scenario and it is like gas on a fire.
The theme in one of our past reports was the tale of two Net Lease markets and it continues to ring true. The fist market continues to be the 1031 buyers, buying property for historically low cap rates in exchange for deferring taxes on large gains. The second market is the non-1031 sector. This group includes individuals and institutions who have been forced to survive in this low cap environment.
Non-1031 buyers have had to become more adept at underwriting risk in the form of shorter lease terms, below investment grade credit, value add propositions, and new development projects.