As the stock market is plowing through to new all-time highs and RBC’s Robert Wetenhall says the retail housing recovery is underway, commercial real estate investors are “surprisingly unenthusiastic” about their deal pipeline. Morgan Stanley’s AlphaWise research reflect a degree of uncertainty after a significant if somewhat unexplained price run-up, particularly acute in one REIT sector.
Highest flying REIT is where most concern is expressed
Perhaps most interesting is that the REIT highest peformers, the Triple Net Real Estate Investment Trust (REIT), up more than 30% year to date, is where the real estate concerns are most acutely noted.
A triple net lease is the most advantageous to the investor, exposing them to the lease amount of risk. Under a triple-net lease, the tenant, often a business or warehouse, is required to pay property taxes, building insurance and repairs in addition to rent. The investor is primarily exposed to real estate valuation fluctuations that not only might impact core asset value but also rent income.
This elimination of key primary risk variables such as fluctuation from taxes or property damage from the investing equation has been in significant demand. A model portfolio including five triple net stocks — ADC, LXP, LTC, NNN and O – has increased nearly 370% since 2005. Investors benefited from a flight to safety in a low interest rate environment.
In this environment, Morgan Stanley analysts Vikram Malhorta and Landon Park like STOR as a top sub-sector pick. “It is uniquely positioned to benefit from its targeted strategy, strong investment spreads and potential for relative multiple expansion,” they wrote.
Brokers see flattening interest in professional segment, retail a strong point
Despite the positive pick, looking into the future pipeline, brokers are noting a decided flattening of opportunity. Approximately 30% of brokers see an increase of deal flow by close to 5%, while another 25% of brokers surveyed see a decrease. The average net reading of +6%, while positive, is nonetheless the weakest reading since mid-2014, the report noted.
Playing into Wetenhall’s theme, sentiment is most positive for retail assets, particularly noninvestment grade property. This sector has a net reading of +27%.
Contrast this with industrial assets and large-portfolios, those most markets that most impact the professional, each had negative readings of nearly 10%. “Looking ahead to 3Q, brokers were uncharacteristically downbeat,” the report noted.