Net Lease Grapples with Potential Changes

June 23, 2021

The first panel discussion of the GlobeSt. Net Lease event wasted no time in addressing the elephant (or, more accurately with Democratic control over the legislative and executive branch, the donkey) in the room: The potential elimination of the 1031 exchanges by the Biden administration.

“Right now it’s a lot of noise,” said moderator Jimmy Goodman of The Boulder Group. “Nobody knows what’s going to happen.” But he encouraged everyone in the room to contact their Congressional representatives. “It’s all we can do. Doing nothing will not help.”

Goodman led a panel including Gordon Whiting, managing director of Angelo Gordon; Glen D. Kunofsky, executive managing director of Marcus & Millichap; Mark West, senior managing director of JLL Capital Markets; and Gino Sabatini, managing director, head of investments at W.P. Carey. The discussion was entitled “The State of the Industry: Examining the Implications of a Transformative Year.”

Most of the panel took a muted approach toward the 1031 issue. “People think of 1031 relative to the middle-market investor, investing in small multi-family” Kunofsky said, going on to opine that he didn’t think it would devastate the industry even if 1031 was eliminated completely. “This is an investment type that has capital across the spectrum,” he explained. “It’s an aspect class that people want exposure to, whether it’s a tax deferral or not.”

Others on the panel took a more expansive view. “I think people are just so upset that they haven’t created a situation in their own life where they’re able to be successful and then they say, ‘You know what? If I can’t be successful, I don’t want anyone to be successful either,’” mused Whiting. “It’s viewed as an unfair advantage. Nobody looks at the rationale behind why any of these things were instituted.”

Asked if anything changed for the panel in terms of acquisition post-pandemic, responses varied.

“At W.P. Carey, nothing has really changed,” said Sabatini. “We really cut office out of our acquisition strategy about five years ago.” Retail is big for W.P. Carey in Europe, however. “In Europe retail’s about a third of our volume over there,” he said.

“I think all that COVID really did is crystallize that we didn’t want to be in retail,” said Whiting. “We’ve done distribution centers. I think if you buy a well-located distribution center at the right basis with the right rent, you’ll be able to replace a tenant pretty quickly. But I think retail is tough.”

“I wouldn’t say that we’ve seen a major shift in the strategy,” said West. “I do think it’s an interesting dynamic, though, because industrial’s so popular that the cap rates are going down by the month. You can sell a Lowe’s in the 5s today—a retail store, you know, newly built, well located, reasonable rent—but if it was a distribution center a mile away … it’d be in the 3s.”

On the subject of aggressive moves, Sabatini offered an anecdote. “I just heard that one of the largest owners of industrial real estate, all their leases they’re insisting on 4% annual bumps, and they do mostly short-term leases—two, four, five, seven years. But they’re asking and getting 4%.”

“Getting?” exclaimed Goodman?

“That’s what I’ve heard,” replied Sabatini.

Asked about compressing cap rates in retail and whether or not they’re plateauing, West said, “There’s too many variables. The chatter about 1031, there’s many people making decisions to invest or sell or trade this year vs. next year, and when you throw all those things in the mix, if you’re making investment decisions that are outside of the fundamentals of real estate investing, then you can get some artificial pushdown in cap rates, which may be going on.”

Kunofsky expanded on that point. “If you can buy a five and a half cap Dollar General and finance it at 3% and get to a 6% cash on cash return in the right place for the right buyer, then sure, that works. And it’s the same on the institutional side. When it’s an Amazon warehouse at a 4 cap and there’s a buyer that can go and finance an Amazon warehouse at 85% at 1.9%, 2%, that’s what drives the cap rate. It’s supply and demand and financial engineering.”

Inevitably, talk turned to post-pandemic remote work vs. a return to offices.

“I think, like a lot of companies, we learned we could be almost as effective for many functions remotely,” said Sabatini. ”Like a lot of companies, we’re trying to figure out what our policy’s going to be going forward. IS there going to be built-in flexibility? Is it going to be zero flexibility? Department by department? We’re still trying to figure that out.”

West took a more hardline approach. “Our CEO says we’re ‘work from work,’” he quipped, noting that in Dallas and Houston they’re “100% back in the office.”

Kunofsky agreed. “I believe in being in the office, the collaboration. I also believe the face to face interactions, seeing properties, taking people to dinner, doing what we’re doing here [attending events], is an important part of the industry.

“Very difficult to tour a property over Zoom,” he said.

“I think one of the questions is, how do you maintain corporate culture?” asked Whiting. “How do you pass on corporate culture? Should corporate culture change now that we’ve been able to work from home? If your office is here in New York and you have somebody who lives in Westport, CT, does it really make sense for them to spend three hours a day traveling to the city? If they’re not traveling, they’re going to be less stressed. It’s more time that they could be putting into work. You split he difference. These are things that we have to grapple with. And if you look at younger folks, they look at things very differently. For me, if I were just out of college and living four people in a two-bedroom apartment, I would want to get back to the office. But that didn’t seem to be as big an issue for a lot of folks.”

Lastly, Goodman asked for predictions about fitness properties, casual dining, and movie theater properties coming back.

Referring to the previous keynote presentation regarding restaurant sales overtaking grocery, Sabatini said, “People are going back to restaurants, that means they’re going to be attracted to investors again.”

Kunofsky was also confident. “We just did a portfolio of Applebees in the Midwest. I’m just amazed at the numbers. The first half of 2021 was up like 16, 18 percent, over 19 comps, record comps. I think it’s gonna come back strong, the dining sector.”

West was philosophical. “We’ve never been through a pandemic before, but we’ve been through downturns. And when they first hit, everybody thinks there’s no way we’ll ever get out of this and everything’s gonna change.”

“And now we’re back in New York,” Goodman said.

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