Cashing in on a Real Estate Boom

The Wall Street Journal

Most Commercial Properties Are Slumping, But 'Triple Net Lease' Deals Are Hot

Are you overlooking a commercial real-estate boom?

If your definition of the category is limited to splashy office parks and shopping malls, both of which took a pounding during the financial crisis and haven't fully recovered, then you probably are.

But think a little smaller—like fast food-restaurants, convenience stores and gas stations—and the returns get bigger. Such ventures, known as triple-net-lease properties, are "the best-performing sector of the commercial real estate marketplace," says David Bailin, head of global managed investments for Citi Private Bank, which serves ultra-high-net-worth clients. "It is the sector that lost the least value [during the recession] and rallied the quickest."

Triple-net-lease properties are usually freestanding buildings in which a tenant agrees to take responsibility for maintenance, taxes and insurance during a long lease—leaving the investor with little to do but collect checks. Investors typically buy individual properties through commercial real-estate brokers like Marcus & Millichap, CB Richard Ellis Group or others, either alone or in limited partnerships with a few other investors, and then lease them out to occupants such as drug store chains, quick-serve restaurants, convenience and dollar stores, medical outfits, and in some cases big-box retailers like Costco.

Triple-net-lease properties are generating annual returns of as much as 12% these days, estimates Bernard J. Haddigan, managing director of Marcus & Millichap Real Estate Investment Services' National Retail Group. Individual investors and small groups of partners generally invest $300,000 to $5 million per building.

Some publicly traded real-estate investment trusts concentrate on triple-net-lease properties, too. They returned 16.9% during the first quarter—compared with 11.1% for Dow Jones Equity All REIT Index, which includes all types of commercial and residential property.

Triple-net properties suffered during the recession, but less than other types of real estate. Whereas overall commercial prices fell by about 40% during 2007-09, prices for triple-net properties fell by about 15%, according to Mr. Haddigan.

Like all kinds of investing, triple-net-lease plays are based on risk: the more you're willing to take, the greater the potential returns. There are several important factors that determine a triple net deal's riskiness: the creditworthiness of the tenant, the location, physical condition and functionality of the property, and the remaining term on a lease (shorter is riskier). Also important: the "occupancy cost" or "health ratio," defined as the percentage that the tenant pays in rent relative to store sales. (The lower the ratio, the better.)

Besides overall economic risk, there's the risk of picking a tenant whose product or service might fall out of favor. Changing consumer trends can wipe out cash cows, as happened with some video-rental stores during the last decade.

"You need a good tenant," says Jeffrey Rogers, president and chief operating officer of Integra Realty Resources, a commercial real-estate appraisal and consulting firm that doesn't own or broker real estate. "Then you need an optimal location and to know what the market rent is. That is absolutely key."

Investors who lack the time or inclination to invest in triple-net-lease properties directly can get into the category via REITs such as the publicly traded Realty Income Corp. and Lexington Realty Trust in New York, as well as American Realty Capital Trust in Jenkintown, Pa., which is not traded on a stock exchange. These REITs invest mainly in triple-net properties, and they're generally sold through broker-dealers. They sometimes have minimum-net-worth and other requirements.

As with most income properties, investors can come out ahead—or behind—on triple-net properties in two ways: through price appreciation and income. The best measure of income potential is the so-called capitalization rate, or the net operating income divided by the purchase price of a property.

In recent months, cap rates have been falling because property prices nationally are rebounding. More investors are going after fewer high-quality properties, driving prices up. This is considered a positive sign for the broader commercial real estate market—but it means the easy money in triple-net-lease properties might be coming to an end.

But there is still opportunity for savvy investors. Michael K. Federman, 38 years old, is an attorney in New York who began investing in triple-net properties in 2004, during the previous recession. His first acquisitions were fried-chicken restaurants in upstate New York, followed by a Circle K convenience store in Arizona. He later sold the Circle K and purchased more buildings, and currently owns a portfolio of 15 properties.

A self-professed "conservative" investor, Mr. Federman now concentrates primarily on single-tenant properties, he says. Most recently, he and a business partner in March purchased a long-term lease property for about $4 million housing a Chipotle Mexican Grill in Lower Manhattan with a cap rate of 8.5%. That return was in line with the national average for casual dining restaurants in 2009, according to Marcus & Millichap.

"For me it was a perfect deal," he says, "because it combined prime real estate, stellar credit and minimal management responsibilities."

Median Home Prices Up in 60% of U.S. Cities

USA Today

Home prices rose in nearly 60% of U.S. cities in the first quarter of this year, the National Association of Realtors says.

The median sales price for previously occupied homes rose in 91 out of 152 metropolitan areas tracked in the January-March quarter versus a year ago. There were double-digit price increases in 29 cities.

That's a sharp improvement from the fourth quarter of last year, when prices rose in about 40% of cities. The national median price was $166,100, or 0.7% below the first quarter of last year.

Sales of foreclosures and other distressed properties made up 36% of all sales in the first quarter.

The largest percentage price increase was in Saginaw, Mich., where the median price doubled to nearly $61,000. Prices in Akron, Ohio were up 95% to about $95,000. Prices in Cleveland were up 54% to $106,400.

The largest price decline was in Orlando, where they dropped 15% to nearly $132,000. Prices in Ocala, Fla., fell 14.5% to a median of nearly $93,000. Prices in Cumberland, Md., fell 14.4% to $98,300.

Fed Planning to Sell MBS

The Wall Street Journal

Fed Officials Develop Plan to Shrink Central Bank's Mortgage Portfolio

Federal Reserve officials have agreed to sell some of the central bank's $1.1 trillion of mortgage-backed securities at some point, but have been unable to reach a firm consensus on how soon or how aggressively to do that, according to several people familiar with the matter.

Many Fed officials want to wait until after the central bank has started to raise short-term interest rates and tighten financial conditions, which could be many months away, but a minority is eager to move sooner.

The internal debate about the Fed's mortgage portfolio is important to households and investors because sales of mortgage securities could push down prices of the securities and push up mortgage borrowing costs.

Fed officials have been debating asset sales for months. Minutes of the Fed's late April meeting, due out in two weeks, are likely to show the debate has intensified but hasn't been completely resolved. The Fed started buying the securities in early 2009 as part of an effort to drive down long-term interest rates to speed an economic recovery. But now, most officials are uncomfortable holding them.

One issue underlying the debate is inflation expectations. Some Fed officials worry that holding such a large portfolio—which entails pumping money into the financial system to fund the purchases—fuels fears that the Fed will allow inflation to take hold in the future.

Sale proponents also are averse to holding instruments that seem to favor housing over other parts of the economy. But many officials worry that markets would interpret even a program of modest sales as a sign that the Fed wants to tighten credit, before it is actually prepared to do so or before the economy could bear it.

The Fed's conventional way of tightening credit is to raise a short-term interest rate called the federal-funds rate, which is what banks charge each other on overnight loans. Many officials are inclined to maintain that as their main mechanism for tightening policy when the time comes, and to put mortgage sales on a slow track at first.

One approach attracting a following within the Fed: After the economy improves enough, the Fed would change the way it communicates to the market, no longer saying rates would stay low for an "extended period." Then, it would pull some cash out of the financial system with operations called reverse repos and term deposits. Next, it would raise short-term rates by increasing the rate the Fed pays banks to keep money on reserve at the central bank. Then it would announce a modest asset-sales program that it might ratchet up after six to nine months as recovery gains steam.

"The best argument for this sequence is that the Fed and markets have lots of experience analyzing the effects of rate hikes and should be able to gauge their effects with reasonable accuracy," economists at Goldman Sachs said in a commentary on the Fed's debate earlier this week.

The goal would be to substantially reduce the Fed's mortgage holdings within four or five years after tightening starts. Fed officials believe they will need to sell substantially less than their overall holdings of $1.1 trillion because many of the securities will retire on their own as borrowers refinance mortgages and the securities mature.

The idea of ratcheting up sales later is one that is gaining support at the Fed and could be a compromise to allay the worries of the officials most eager to dispose of the securities. The Fed would also have the option of tapering down the sales if the economy responded poorly.

"I would start slow and then move based on the economy," James Bullard, President of the St. Louis Fed, said in an interview with the Wall Street Journal last week. "I would want to ensure markets that you would do it slowly over a longer period of time."

The process of just getting started could take as much as a year or more to unfold, depending on how the economy performs. Though the Fed's anti-inflation hawks want to get going soon, many officials are still comfortable with their assurance to the public that rates will stay low for an extended period because inflation might still be slowing and unemployment is high.

"With inflation expectations stable, core inflation rates declining, and significant excess capacity in the economy, accommodative monetary policy remains appropriate," Federal Reserve Bank of Boston President Eric Rosengren told a gathering in New York Wednesday night.

An added reason for caution: Rising concern about financial risks in Europe related to Greece's debt woes. Though Greece is small relative to the U.S., Fed officials are concerned that turmoil in European markets could spill into U.S. markets and hurt the recovery here.

More N.C. Residents Being Counted in Census

WRAL

Raleigh, N.C. — North Carolina residents are doing a better job at being counted in the 2010 census than they did 10 years ago, census officials said Tuesday.

Each of the state's 100 counties has met or topped the rate at which of residents mailed in their 2000 census forms, making it one of the few states nationwide with a boost in early participation in the current population count.

The average increase in 2010 census participation is 12.9 percent, officials said, with 66 counties increasing their participation by at least 10 percent.

Seven counties had a 79 percent mail-in rate, including Chatham and Person counties, while Avery County had the lowest participation statewide at 63 percent.
 

The mail-in rate for Wake County real estate was 76 percent, while Orange County's was 78 percent, Johnston County's was 75 percent, Durham County's was 72 percent and Cumberland County's was 70 percent.

The door-to-door segment of the census, in which workers try to contact households that didn't mail in their census forms, begins Saturday. The Census Bureau estimates that 48 million households nationwide will be visited by a census taker during this segment, which runs through July 10.