Net lease real estate has become a popular asset class due to attractive yields that exceed bonds and stocks, stable income from long-term leases, and potential for appreciation. However, not all net lease strategies are equal. To maximize returns, investors should seek high-quality assets with long lease terms to investment-grade tenants in desirable industries, and align with managers focusing on credit quality, asset quality, and long investment horizons. Prioritizing these components can provide stable income, inflation protection, and total returns exceeding fixed income over the long run.
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How to WIn at Net Lease Investments
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How To Win In Net Lease Investments
By Shelby Pruett | Commentary
Over the past decade, net lease real estate has secured one of the top positions among the major asset classes. Demand
for net lease real estate is high for a number of reasons. With the increased popularity of the sector, however, comes a
blurring of the line of what constitutes a high-quality net lease asset or investment strategy within the sector. Investors need
to be cognizant that not all net lease real estate is created equal. Those who understand what to look for in the net lease
market and understand what makes a net lease asset or strategy truly high quality are those who will be better positioned to
take advantage of the asset class over the next decade.
So here, in question-and-answer form, are some strategic insights to maximizing investments in net lease assets.
What Is Behind the Increased Demand for Net Lease Real Estate?
We have seen a significant shift in the overall investment market and the traditional portfolio
allocation models of institutional and individual investors. Forecasts of modest growth and
extremely low interest rates have many investors questioning whether bonds and equities
can deliver the returns they have in the past. As a result, a significant number of investors
are moving from traditional stocks and bonds to alternative asset classes that can provide
competitive total returns including stable income and equity-like upside. Real estate,
particularly net lease real estate, is one of the assets classes into which they are moving.
Many investors have realized that this asset class, if executed correctly, can offer a
compelling mix of yield, equity-like upside and inflation protection superior to fixed income or
equity investments on a risk-adjusted basis.
Why Is This the Case?
Investors have seen yields in this asset class that, in many cases, have been well above
the yields currently available from fixed-income or equities. Investors are attracted to the stability of the asset class as a
result of the underlying long-term contractual rent, especially when the rent is derived from high-quality assets and
guaranteed by corporations with investment-grade credit ratings. Given the uncertainty in the markets and the forecasts
for modest growth over the next several years, investors are also attracted to the high current income and role it plays as
a percentage of total return, as well as its role as a wealth-preservation tool, especially if the economy remains weak.
Equally important is the ability of the asset class, if approached correctly, to appreciate in value in both strong and weak
markets.
Investors who want to maximize the yield and upside potential while retaining the risk protections associated with net lease
will need to understand the sector or align themselves with a manager who does. The net lease label is broad, and the
strategies employed within this sector by public REITs, private REITs, private equity managers, and others third-party
investors are varied. If not approached correctly, an investor may achieve only some or a fraction of the potential benefits of
investing in net lease. Not all net lease real estate or investment strategies are created equal.
What Are the Essential Components of an Effective Net Lease Strategy?
An investment manager needs to structure a transaction correctly or buy an asset “right” from the beginning to create a
foundation from which to build. To do this, there are a number of components with which the investor or their manager
should be familiar. Lease type, lease duration, asset quality, credit profile, tenant industry outlook and pricing are all critical
in determining if an asset is being structured or bought correctly. In addition, the investment horizon is important in shaping
the overall strategy. Maximizing each component is important. Many of those who operate in this space utilize a strategy
that leaves out certain components which can be detrimental to a strategy or investment and open the manager and
investor up to risks that they might not otherwise face.
Why Are All Net Lease Strategies Not Created Equal?
Even though a lease or investment strategy might be characterized as net lease, you may not be getting what you think you
are getting. There are different types of net leases, the terms of which vary and have an impact on the owner’s
responsibilities and future capital requirements. Additionally, some managers and strategies focus on assets that have lease
terms that are shorter than others, which removes some of the benefit of the guaranteed lease stream and opens the owner
up to near-term releasing risk and capital exposure. Asset quality and age, as well as location, have a significant impact on