Profile of Net Lease Buyers

Investors targeting sale and leaseback opportunities are not a single pool - many have differing requirements and priorities. A key difference which divides the market is whether the investor focuses their underwrite on credit or real estate. Credit investors price the strength of the tenant's covenant first and treat the property as secondary security; others are led by the asset - its specification, location, alternative uses and relettability. Profiles also vary based on target lot size, pricing aspirations and fund structure. Knowing where a business and its real estate sit across these buyer types shapes the price, liquidity and the lease terms.

Credit first or real estate first

There isn't a single type of sale and leaseback buyer. Some are exclusively dedicated to these investments - often referred to as ‘Net Lease’ investors due to the Triple Net Lease structure they require (the triple referring to the tenant obligation to insure, maintain and pay property related taxes) - whilst others are more opportunity driven and are exercising a wider property investment strategy. The market is split between those which are real estate first and those which are credit first.

Investment grade tenants on prime assets attract the lowest cost of capital. These opportunities are frequently acquired by institutional investors which require both the strongest covenants and real estate fundamentals. Many net lease investors cannot compete on pricing for these opportunities.

Move down the credit spectrum and the picture becomes more nuanced. Sub-investment grade, non-rated and PE-backed businesses can still see strong investor appetite, particularly for mission critical assets. This interest is almost always from dedicated Net Lease buyers adopting a credit-first approach. They possess sophisticated credit underwriting capabilities and can underwrite secondary/tertiary locations and/or weaker, bespoke assets. Their underwrite and pricing is based on their opinion of the tenant’s ability to pay the rent throughout the term.

Real estate quality works as an independent and sometimes compensating factor. A critical, hard-to-replace asset can attract strong investor appetite even against a weaker covenant, because criticality provides a form of downside protection some investors will underwrite in place of credit strength. Prime, well-located real estate also lets investors accept more covenant risk as these assets are easier to relet should a tenant default on its lease obligations.

The opportunities with the least liquidity are businesses which are distressed, operating bespoke properties in tertiary locations. This combination is priced by a small, specialist pool of buyers. Pricing is wider and additional structuring such as extra deposits or guarantees are often required.

Lot size

Deal size also determines which pool of capital is likely to be interested in an investment opportunity. The market can be categorised into three areas; each will view transactions differently and have their own priorities. There is overlap in the middle where competition, and frequently pricing, is strongest.

The credit-first buyers occupy the second and third categories, they typically require an opportunity to be £15m - £20m+ before they are willing to underwrite it. Below this threshold, investors are more likely to be focused on real estate fundamentals. This can result in more limited liquidity for opportunities with weaker/bespoke real estate coupled with weaker credit strength where the lot size is sub £20m.

Pricing

Cap rate - the initial annual rent divided by the purchase price - is a key pricing metric adopted by investors. This number reflects an investors combined view on credit quality, property quality and lease structure.

Below are the pricing ranges we are currently observing in the market from dedicated Net Lease investors. There are other categories of investors such as institutional investors which are not covered by the below diagram:

Liquidity at the two extremes of the spectrum is lower. Due to cost of capital, there are a limited number of net lease investors which can deploy at the tighter cap rates, sub 6.75%. At the higher end of the range, opportunities tend to be riskier due a combination of reasons and many investors are not willing to underwrite these risks, even with the higher return on offer.

Structure

Net Lease investment funds are broadly split into two structures:

• Perpetual and open-ended vehicles, traded and non-traded REITs, have no defined exit and hold indefinitely in theory. Regular distributions are the priority and these investors require longer leases which are index-linked to generate stable income. Pricing from traded REITs can be sensitive to their share price which can move independently of the underlying real estate.

  
  

• Closed-ended, fund-life vehicles operate on a defined horizon, typically five to ten years, and are focused on IRR and total return rather than income alone. A meaningful number are pursuing an aggregation strategy: building a portfolio with a view to selling it to a larger, often perpetual, investor. Because these vehicles have a fund life, they also have a deployment deadline which can create opportunities for sellers to capitalise on. Capcore actively track the market on an ongoing basis to advise which of these investors are currently deploying rather than mid-hold or between funds.

  
  

The final word

There are dedicated net lease investors which exclusively target sale and leaseback opportunities. This group is segmented by those which are real estate first and those which are credit first. Beyond this categorisation, investors are structured in different ways, have varying size and pricing requirements. Before going to market, it's worth establishing which segment of the buyer universe will be interested in the opportunity and where possible, tailor the process to their priorities to boost liquidity.