Trends & Insights

May 2023 The healthcare sector is by no means immune to changing economic conditions, but among commercial real estate investors, medical facilities continue to be among the most popular and desirable investments. An aging U.S. population has driven demand for all types of healthcare properties – from more traditional medical office buildings, physicians’ offices and urgent care facilities, to highly specialized properties including behavioral health, post-acute care facilities and micro-hospitals. But as healthcare facilities become more specialized, we’ve seen buyers become more specialized as well. Healthcare Specialty Assets: Investment Sales Volume Some healthcare and medical investors see value in acquiring assets with high acuity uses and expensive finishes and build-outs. High revenue potential and replacement costs for these properties provide investors with certainty of continued use by the tenant. Other investors have become focused on properties leased to health systems and see an opportunity to foster relationships with their tenants for long-term success. Still other investor groups recognize that high construction costs have created opportunities to acquire value-add facilities, including second generation medical office buildings that are ripe for renovation or redevelopment. Regardless of an investor’s chosen lane of specialization, ever increasing demand from consumers will continue to drive the need for new healthcare facilities, creating more and more opportunities for investors to enter the sector or add to their existing portfolios. Healthcare development is occurring throughout the U.S., as consumer demand can be found across all regions and in markets of all sizes. Unsurprisingly, the state of Florida currently leads the nation in new healthcare development. With more than 21 percent of the population over age 65, demand from retirees and aging Americans are keeping developers busy. As these new developments come online, they’re capturing the attention of a variety of buyer groups. While REITs and institutional investors have historically been quite active in the sector, changing market dynamics have caused these buyers to become less competitive over time. The desire to acquire healthcare assets remains strong, but with more buyers now active in the sector, the available supply of properties is not enough to meet investor demand. Private equity funds, family trusts and individual investors have come to appreciate the stability and increasing demand forecasted for the sector, and REITs and institutions are simply being outbid by buyers with access to low-cost capital and a strong appetite for the product. As a result of this demand, we have seen the single-tenant healthcare sector grow in annual transaction volume, demonstrating a nearly 150 percent increase in the last ten years. Looking ahead, however, the gap between buyer and seller expectations will cause transaction volume to decline, and activity is expected to be suppressed for at least the next 12 months. The ability to sell at unprecedented pricing is likely a thing of the past and is no longer a primary motivation for owners. Instead, in the next 18 to 36 months, conditions motivating a sale should center around debt maturity and the need to refinance. In today’s environment, sellers will need to price their assets for today’s buyers or risk chasing the market, while buyers shouldn’t ignore good fundamentals. As buyers and sellers see-saw their way closer to alignment on pricing in the coming quarters, the market can expect to see activity resume, although the lack of supply could be problematic for some time given anticipated demand.

As industry experts across the nation prepare for ICSC Las Vegas – the largest commercial real estate networking event focused on the retail market – we caught up with Ryan Roedersheimer, Senior Vice President and retail expert based in the Cincinnati, Ohio tri-state area. Here, Ryan shares advice on how buyers and sellers of retail assets can best navigate today’s market, what pitfalls to avoid and how to design an investing strategy for success. As we approach mid-year, what’s the most exciting thing happening in the retail market right now? What excites me the most right now is how the market is forcing greater unity in the retail community at large. I am seeing a greater desire for collaboration between landlords and retailers, brokers and investors, and developers and lenders. Those who seek solutions that benefit all will thrive in the current market cycle. Our team credo is “a rising tide lifts all boats,” and the spirit behind that concept is the very same spirit that will not only bring the entire retail community through these turbulent times but prepare us for the next challenge. As we come together this May at ICSC Las Vegas, I’m looking forward to uniting as a commercial real estate community. I’m eager to collaborate with colleagues and hear from clients about current concerns, new innovations, creative strategies and future outlooks. What are the most important things a new multi-tenant retail buyer needs to know? We speak with many investors who are entering into the multi-tenant retail sector, whether it's a shift in, or a broadening of, their current strategy. Our message remains the same despite the market. First, define your strategy and assess your risk tolerance. Next, understand the fundamental drivers of the specific asset type you are pursuing, such as quality of the real estate, access and visibility, market growth and economic drivers, a complimentary tenant roster and threats. Lastly, trustworthy, advisory relationships pave the path to inventory that fits your goals, lending partners that maximize your buying power and access to sound intel to drive confidence in your decisions. Are there any new trends or concepts investors should be watching in the retail space? Yes, there are several we’ve been following, and fitness centers come to mind first. My colleague, Brett Puckett, wrote an article recently about the benefits of having fitness centers as anchor tenants – it’s worth a read! As another example, concepts like Burlington and TJX brands are expanding into tertiary markets more than they have historically and have reduced their square footage requirements to cater to smaller markets. Kohl’s too has announced smaller footprint stores as they look to reach an expanded customer base, while Target has the reverse strategy, with plans to open a series of large format stores starting next year. We are seeing strong growth initiatives from many retailers who recognize they must be creative to keep up with demand. Landlords: don’t assume your investment isn’t a candidate for retailers who might have looked past your center in years gone by. What’s happening with new retail development activity? Currently, developers, lenders and investors are very methodical in their approach with both planning and commitments. While some are waiting for the dust to settle, others are teaming up with retailers, lenders and public sector leaders to safely move forward. The goal and desire of growth remains, but no one wants to catch a falling knife. Caution is the magic word in today’s environment. What is your best advice for would-be sellers right now? The market is not the enemy, it’s the playground. We don’t get to choose the circumstances, only our course of action. One of our closest clients said it best when asked how he was going to approach this current market, saying “I buy and sell real estate; that’s what I do; that’s what I’m going to do.” The best advice I can give is to find and lean on advisors who will tell you what you need to hear, not what you want to hear. Like the stock market, savvy investors ride the ups and downs. Wise counsel from those who are truly plugged in will not only help you mitigate the downturn but will help you be poised to capitalize when the market turns back upward. What are the biggest challenges you’re personally facing right now? As a broker, one of the most challenging things is establishing clear trust while advising new client relationships. There are brokers like me who truly put the interests of their clients over their own agenda. We take the long view, and it’s been very rewarding for all sides. I strongly encourage investors and developers to really dig into what their broker community relationships look like. A quality advisor is essential and more valuable than ever during times of market transition and uncertainty. How can we serve you?

April witnessed ongoing stress among the regional banks as concerns have moved from unrealized losses in bank securities and the flight of uninsured deposits to the quality of loans on bank balance sheets and implications of the ongoing tightening of lending standards. Although there has been no immediate plunge in economic activity associated with the banking failures of the past two months, activity has continued to slow. Nevertheless, the Fed raised interest rates by 0.25 percent at their May 3 meeting and promised to keep rates elevated through the end of the year. Markets, however, have a different take on the expected path of interest rates. Inflation The inflation picture continued its slow but steady improvement with the release of the March CPI report. Headline inflation increased only 0.1 percent month-over-month, and the year-over-year reading fell to 5.0 percent from the 6.0 percent year-over-year reading in February. Contributing to the soft reading in March, we saw year-over-year energy prices turn negative – it’s been a year since Russia invaded Ukraine causing energy prices to spike – and grocery prices eased for the first time in many months. Shelter inflation (rents) also eased, and this is expected to continue. Core CPI, excluding energy and food, increased 0.4 percent month-over-month and the year-over-year figure increased to 5.6 percent, a 10-basis point increase from February. The Fed’s preferred measure of inflation – Core Personal Consumption Expenditures – showed a slight improvement to 4.6 percent year-over-year. Improvement in inflation is expected to continue, but the rate of improvement appears to be slowing and measures of inflation remain stubbornly above the Fed’s 2.0 percent target. Consumer Spending, Manufacturing & GDP Retail sales fell 1.0 percent in March, while overall personal consumption expenditures were flat. After starting the year with strong readings in both measures, it is apparent that the unseasonably warm weather in January was a major factor for the early strength. Consumer spending has been slowing since the beginning of the year, and when adjusted for inflation, year-over-year retail sales are down 4.0 percent. The Leading Economic Indicators declined for the twelfth consecutive month and continue to indicate an upcoming contraction in the economy. The ISM manufacturing index for April showed a slight improvement but remains at a level that indicates contraction in the manufacturing sector. There was a corresponding report showing that Nondefense Capital Goods Orders, excluding aircrafts, were down again in March and have been down in five out of the last seven months. Rising interest rates and tighter lending standards are most often mentioned as the reason for the slowing. The first reading of Real GDP in the first quarter indicated that the economy grew at a disappointing 1.1 percent annualized rate, down from the 2.6 percent annualized rate for the fourth quarter of 2022. Productivity in first quarter 2023 declined at a 2.7 percent annualized rate while unit labor costs grew at a 6.3 percent annualized rate. Employment & The Labor Market The employment report for April showed a strong 253,000 gain in jobs. That was offset by large reductions in the previous two months, and a total of 149,000 job gains in February and March were removed through revisions. The three-month average gain in payrolls is now down to 222,000 – the lowest number since January 2021. In another sign that the labor market is softening, JOLTS (the Job Openings and Labor Turnover Survey) reported that job openings are down 20 percent year-over-year. Employers are not as aggressive in looking for new workers, but they have not started broad-based layoffs either. Instead, they are reducing the average hours worked. The unemployment rate dropped to 3.4 percent from 3.5 percent, but the average work week is now only 34.4 hours – the lowest level since April 2020. Average hourly wages increased 0.5 percent, which is the most since July 2022, bringing the year-over-year figure to 4.4 percent from 4.3 percent. The Fed’s favorite measure of wages, salaries and benefits – the Employment Cost Index – rose 4.9 percent year-over-year through March. Although wage growth is elevated, the average weekly earnings on an inflation adjusted basis are down 1.6 percent year-over-year and have been trailing inflation for the last two years. This is a predominant reason that consumer expenditures for non-discretionary items have been slowing. Interest Rates & The Fed Finally, the Fed held their scheduled Federal Open Market Committee (FOMC) meeting on May 2-3. The target range for the Fed Funds rate was increased by 0.25 percent to 5.00-5.25 percent. It is expected that this is the last increase in the Fed Funds rate for this tightening cycle. Chair Powell acknowledged that the potential impact of the banking crisis may effectively have the same impact on credit conditions, as would further increases in the Fed Funds rate, and he reiterated that the Fed intends to keep rates at least at this level through the end of the year. The most recently released Senior Loan Officer Survey indicated that banks are continuing to tighten their lending standards – a process that began in third quarter 2022. The survey also indicated that demand for loans in all categories, except credit cards, was declining. So, we have a contraction in both the supply and demand for credit – a definite recipe for a slowing economy going forward. Despite Powell’s rhetoric, markets are expecting a recession to commence that will drag down inflation more quickly than the Fed’s forecast. Consequently, three interest rate reductions by the end of the year are currently anticipated by the markets, beginning as soon as the September 19-20 FOMC meeting.    

Northmarq’s investment sales team has announced the addition of Michael Zimmerman as Vice President – Commercial Investment Sales. Zimmerman specializes in the disposition and acquisition of single tenant and triple net lease retail properties, further expanding Northmarq’s commercial investment sales. With over 20 years in the commercial real estate business, Zimmerman has been involved in over $1 billion of sales for shopping centers, single tenant, strip centers, office buildings and land deals. Prior to Northmarq, Zimmerman served as principal owner at Ground & Space. He has also served as a partner at Atlantic Retail Properties and a managing director at Calkain Companies. “I am thrilled to join Daniel Herrold’s team and Northmarq’s rapidly growing investment sales platform,” said Zimmerman. “Providing best in class data and the ability to leverage our debt and equity services are just some of the ways we can bring more value to our clients.” In his new role, Zimmerman joins the commercial investment sales team led by Daniel Herrold, Senior Vice President of Northmarq’s Tulsa office. Zimmerman will be based in Chapel Hill, North Carolina, and brings his expertise to support merchant builders, private owners and institutional clients with their retail investment needs. “I’m excited to have Michael join our team,” said Herrold. “Michael is a veteran in the net lease space having over 20 years of experience in the business. We needed to fill a void in our team of focusing on retail investors and developers throughout the Southeast, and Michael fits that void perfectly with his existing clients and business activity.” Zimmerman is a graduate of San Diego State University and holds a broker’s license in North Carolina and Florida. He is also a long-time member of the International Council of Shopping Centers.

At Northmarq, we are committed to offering our clients the latest trends and expert analysis to power their decision making. Our MarketSnapshot suite of reports contains critical market data covering a variety of commercial real estate property sectors. In each report, you will find: Investment sales volume data Average cap rate information Buyer distribution analysis... and more! Single-Tenant Overall Market    Single-Tenant Industrial    Single-Tenant Office    Single- Tenant Retail    Multi-Tenant Retail         

The past month has seen further slowing in most economic activity reports. Inflation is improving but is still elevated, and there is ongoing evaluation of the fallout from the collapses of Silicon Valley Bank and Signature Bank that occurred in the first part of March. The quick responses by the Fed, the FDIC, and the Treasury have, for the time being, helped ease the panic that ensued following the bank failures. The Fed’s job has become more challenging, however, as it now must address both inflation concerns and bank solvency matters. The stress in the banking sector will only increase the tightening of credit conditions that had started even before Silicon Valley Bank and Signature Bank failed. Lending standards for commercial and industrial loans, and commercial real estate loans had already tightened to levels that historically were associated with economic contractions. The impact is likely to be most evident in small and midsize banks as they hold nearly 70 percent of all commercial real estate loans. This is important to monitor as these are the banks that play an important role in the financing of small businesses. The next few months will provide better color as credit tightening impacts everything from capital spending plans to labor demand Consumer Metrics  Looking at recent reports, the Consumer Price Index for February was released just days after the onset of the banking crisis. Although the year-over-year rate of headline inflation is improving – dropping from 6.4 percent in January to 6.0 percent in February – the core inflation index, which strips out food and energy prices, recorded a stronger than expected monthly reading resulting in the year-over-year core CPI only falling from 5.6 percent in January to 5.5 percent in February. The inflation situation was further complicated recently by OPEC’s announcement on April 3 to cut oil production by 1.2 million barrels per day. Improvement in inflation is expected to continue, but the rate of improvement appears to be slowing, and measures of inflation remain stubbornly above the Fed’s 2.0 percent target. Both retail sales and overall personal consumption expenditures in February eased from their strong January readings that were attributed to the unseasonably warm weather at the start of the year. Consumers have become more price conscious but are still willing to spend. Leading Economic Indicators have now declined for 11 consecutive months and continue to forecast a slowing in the economy. Such a string of declining readings has always been an indication of an existing or upcoming contraction in the economy. The ISM manufacturing survey index for March fell to a new low for this cycle. It has indicated contraction in the manufacturing sector for five consecutive months driven by seven consecutive months of contracting new orders and a declining order backlog. This survey also recorded a three-year low in its employment index. The Labor Market  March’s establishment employment report showed the smallest monthly gain since December 2020 with non-farm payrolls increasing by 236,000. The average weekly hours worked is at the lowest level of the past year, and year-over-year average hourly earnings growth is at 4.2 percent – the slowest since June 2021. Additionally, the jobs opening report, released prior to the employment report, showed another drop in job openings suggesting that labor market conditions are loosening. There are now 1.67 job openings for every unemployed worker, which is the lowest ratio in 15 months. Providing a different view of the jobs market, the household survey – which is used to calculate the unemployment rate – saw a stronger increase in jobs of 577,000 with the labor force increasing by 480,000. This resulted in the unemployment rate declining to 3.5 percent from 3.6 percent in February. In short, the labor market continues to be the most resilient part of the economy, even as some metrics indicate some easing in the demand for labor. Interest Rates & The Fed Amid everything else in March, the Fed held their scheduled Federal Open Market Committee (FOMC) meeting on March 21 and 22. The target range for the Fed Funds rate was increased by 0.25 percent to 4.75 to 5.00 percent. Taken by themselves, the current elevated inflation readings would likely keep the Fed on a clear path of increasing interest rates, but following the meeting, Chair Powell acknowledged that the potential impact of the banking crisis may effectively have the same impact on credit conditions as would increases in the Fed Funds rate. Consequently, the official statement from the Fed said, “some additional policy firming may be appropriate.” Powell also said that no members of the FOMC saw interest rate cuts as likely this year. Despite Powell’s rhetoric, market expectations are now looking for possibly one more increase of 0.25 percent at the May 2 and 3 FOMC meeting, with two or three interest rate reductions by the end of the year, which could begin as early as the mid-September FOMC meeting.

Originally published by GlobeSt Cap rates in Q1 2023 represented the highest levels since Q3 2020 for both the single-tenant retail and office sectors, according to a new report from The Boulder Group. Decreasing transaction volume for the greater real estate market continues to limit 1031 exchange buyers transitioning into net lease properties, it said, as cap rates in the single tenant net lease sector increased for the fourth consecutive quarter within all three sectors in Q1 2023. New construction properties with recession-proof tenants including 7-Eleven and McDonald’s represent some of the lowest cap rates in the sector. “However, these tenants are not immune to upward cap rate pressure,” according to the report. “In Q1 2023, cap rates for new construction 7-Eleven and McDonald’s properties increased by 35 and 15 basis points, respectively. Furthermore, the spread between asking and closed cap rate increased for all three asset classes.” The spread rose to 30 basis points for retail, 40 for office, and 27 for industrial, according to the report. “Investors will continue to follow the Federal Reserve’s monetary policy,” The Boulder Group writes. “Investors largely believe there will be an end to the larger rate increases, of 50 basis points or more, in the near term.” Transactions will be driven by low leverage or all cash 1031 buyers for the highest quality product, The Boulder Group said. “However, given the overall uncertainty in the broader real estate market, the depth of the 1031 buyer pool will be limited when compared to historical standards.” Lower-Credit Assets ‘Back Where They Should Be’ Mike Philbin, Northmarq senior vice president, tells GlobeSt.com that “we are closely approaching the one-year mark of when we started to see the peak of the net lease investment market fizzle away. “Due to the repeated interest rates hikes, this was inevitable. However, not all net assets had as drastic of CAP rate shifts. The higher-credit, investment-grade tenants have had a maximum of 50 bps upward movement in this time. “The lower credit, smaller franchisee, in tertiary market tenants have seen closer to 150-200 bps. We did have a very frothy net lease investment market moving into Spring 2022. But relatively speaking, the lower credit assets are back where they should be and the investment grade net lease assets are back to the 2018-2019 range, which was a strong market.” Price Maximization Especially Difficult for Larger Transactions Alex Sharrin, senior managing director, JLL, tells GlobeSt.com that investment momentum persists for performing retail that can be acquired with positive leverage. “The net lease market sits at the crux of real estate and credit, but intrinsic fundamentals are trumping credit amidst volatility,” he said. “Private capital continues to lead the bidder pool for NNN assets across the country and is often winning deals due to the unleveraged nature of the capital/underwriting. “Capitulation has been faster than expected for liquidity and re-investment.” Sharrin said price maximization has been especially difficult for larger transactions (i.e. $75MM+). “Instead of making comparisons to early 2022, a more realistic pricing benchmark is 2018/2019 levels or, pre-pandemic and pre-stimulus,” he said. Transaction Volume Will Soon ‘Level Off’ Ryan Butler, managing director and senior vice president, Northmarq, tells GlobeSt.com that investors across all commercial real estate asset classes have been paying close attention to the responsive actions of the Federal Reserve and US Treasury as they work to address the ongoing regional banking crisis and continue the fight to tame record-high inflation. “As a result of the swift actions taken by both bodies, we are starting to experience a broad expansion in capitalization rates across the Net Lease sector,” Butler said. “However, it is important to note that this cap rate expansion cannot be painted with a broad-brush stroke. Investors in our space are still seeking well-positioned industrial and retail assets leased to ‘recession-proof’ tenants and, as a result, still transacting. “We anticipate a leveling off in the downward trend in transaction volume through the end of the year as investors make sense of this changing market. Realizing that the net lease asset class will continue to be a safe and stable investment vehicle within the real estate sector.” Bid-Ask Gap Widening Eli Randel, COO, CREXi, tells GlobeSt.com that cap rates on closed net lease assets have risen almost 5% YoY with transaction velocity slowing as buyer demand has cooled because of macro-market conditions. “The segment a year ago was at parity between asking and closed prices whereas now sales are transacting below asking prices illustrating a widening of the bid-ask gap,” Randel said. With increases in interest rates, both costs of capital have increased, and similar alternative vehicles are now generating attractive yields (for instance a liquid “risk-free” savings account at Marcus has a 3.75% interest rate), Randel pointed out. “Yet, net-lease real estate still has many benefits to passive investors and remains historically active and strong. Net lease continues to attract 1031 buyers and real estate investors looking for good yields with future upside and often buying in cash. “While slightly less active, higher-yielding, and with more discriminatory underwriting of terms (largely term-length and credit), net lease remains an important category and a great investment product for many in today’s environment.” Stale Assets on the Market, Decreasing Inventories Geoffrey West, senior vice president, MDL Group/CORFAC International, tells GlobeSt.com that amid the historic pace of interest rate increases experienced over the past year, single tenant net lease sellers have been reticent to quickly meet the increased cap rate market expectations resulting in decreased transaction volumes, stale assets on market, and decreasing inventories of available product. West said specifically in the California, Arizona, and Nevada markets, multiple surveys of available fast-food STNL assets (excluding ground leases) conducted over the past year in conjunction with maintaining market positioning of existing listings indicate an overall increase in average asking cap rates from April 2022 to April 2023 from 4.1% to 4.7% and a significant decrease in the quantity and quality composition of the available assets. And within that survey, secondary and tertiary market locations in those states appear to be adjusting to a higher cap rate environment more quickly while primary and core market locations lag as they seek to maintain historical premium cap rate levels. “The recent restabilization of the US 10-year treasury rates around the 350bps level appear to have put reduced upward pressure on asking cap rates as surveys conducted in February 2023 and April 2023 only reflected a 10bps increase in asking cap rate,” West said. “While prospective buyers with 1031 Exchange motivations cannot acquire treasury note assets and those don’t enjoy the benefits and burdens of real estate ownership, the yields being offered in those financial instruments, especially short-term yields, are often superior to core location yields being sought by sellers.” West added that, as such, investors without 1031 Exchange motivations and flexibility may look to temporarily park monies in these alternative investments and benefit from the premium yields being offered by the inverted yield curve until Seller expectations and the current bid-ask spread tighten and transaction activity levels rebound. © 2022 ALM Global Properties, LLC. All rights reserved.

Summary of future growth plans for the top 100 retailers, as selected by brand recognition, expansion rate and frequency of investment sale transactions Average cap rate and sale price information for the most commonly traded retailers Credit rating summary with parent company information Average square footage ranges and store counts for each tenant