At Westwood Net Lease Advisors, we get asked daily, “How long will triple net (NNN) demand remain this hot?” Though we aren’t financial forecasters, we do keep an eye on trends and can share a few tidbits of what we know for sure, and what we foresee happening in the NNN market over the next few months. In this blog, we’ll answer the most frequently asked questions:
- Will cap rates stay low?
- Will interest rates stay low?
- How long will NNNs remain hot and when will demand come down?
1. Will Cap Rates Stay Low?
As we close out Q3 2021, we still see relatively low cap rates due to limited NNN property supply. Cap rate compression has taken average triple net cap rates from 5.50%–7.00% to 5.00–6.50%. Will cap rates stay this low? Yes, until supply increases. Right now, NNN demand is higher than it’s ever been for these reliable investments.
When it comes to 5.00–6.50% cap rates on NNN lease property investments, however, these rates don’t necessarily mean less income or asset value. Typically, the tax opportunities and financial freedom combine to provide a higher internal rate of return (IRR) – anywhere from 8–10% – which is in line with other types of commercial real estate (CRE), without the hassles and unpredictable costs.
2. Will Interest Rates Stay Low?
Will interest rates stay low? This is a tough question to answer. At the beginning of 2021, we saw rock-bottom commercial mortgage interest rates that slowly crept up in Q2 and into Q3, and just as we thought they would level out or even increase a little more, they came back down again in August.
As of August 15, financial experts predict mortgage interest rates will stay low and hold fairly steady for the foreseeable future, with the possibility of a few fluctuations as we approach the end of the year.
Interest rate fluctuations will depend on many factors, including:
- The Delta variant possibly drifting down treasury yields.
- Whether Congress continues to spend.
- If the Fed is forced to pull back on asset purchase programs.
- Inflation (YOY core CPI is up 4–5%; expected to stay up through 2022).
- Jobless claims.
The good news is that even if interest rates increase slightly, they should still hover at figures lower than pre-pandemic rates for the next few months.
When it comes to interest rates in relation to absolute NNN lease properties, it’s good to know these investments are not directly or immediately influenced by increasing interest rates. It generally takes six months to a year for this market to be affected by rising interest rates.
Conversely, when commercial mortgage rates are exceptionally low, NNN investors could benefit right away. Low interest rates can create an interest-to-yield rate spread that allows you to potentially pay down the loan and increase your cash-on-cash (CoC) return with positive leverage. The opportunity also exists to take on debt to purchase more than one NNN investment, expanding your wealth and diversifying your portfolio, with the same possibility for a higher CoC and positive leverage.
We don’t know how long interest rates will stay as low as they are now, but the indication is that they will remain lower than pre-pandemic rates for at least the next three to six months.
How Long Will NNNs Remain Hot & When Will Demand Come Down?
How long will NNNs remain this hot and when will NNN property demand come down? Again, more tough questions – with such an uncertain six months on the horizon due to the pandemic, the Fed’s movement, and the Biden Administration’s potential tax policies, we can only base this answer on what-ifs.
NNN Demand Under Biden Tax Policy
First and foremost, regardless of the pandemic and interest rates, if Biden’s tax policy changes go into effect for fiscal year 2022 (Oct 1–Sept 30), it is likely that NNN investors, including those who utilize the 1031 exchange, will hang on to their real estate until a new administration reforms or rolls back Biden’s new tax policies. The result: fewer available properties and decreased demand.
Potentially removing the 1031 exchange tax deferral could reduce liquidity in the market because holding periods would increase. It is also possible that real-estate investment would decrease, short-term property prices would fall, and rents would rise in the longer term.” Bloomberg
NNN Demand Amid Economic Uncertainty
Triple net investors tend to invest differently than traditional CRE investors. Most see the value in buying these stable, income-producing properties and continue to invest despite economic uncertainty. They know a worry-free NNN investment is a dependable source of guaranteed monthly income for 10–15 years or more, no matter what the economy is facing.
- Even if interest rates rise, NNN investments typically garner better mortgage interest rates than gross lease or residential rental properties. During the pandemic when lenders were not issuing loans for most CRE, our clients continued to close deals with favorable interest rates.
- It is true that if the 1031 exchange rules change, capital gains are taxed at 39.6% versus 20%, and individual income taxes rise as planned, CRE investing will slow down, as will demand, but these factors are unlikely to stop determined, savvy NNN investors.
- If inflation slows the economy, consumers’ demand for low-cost, essential goods typically increases. Corporations like Dollar General, McDonald’s, Walgreens, 7-Eleven, Starbucks, Firestone, DaVita, and other major brands evolve with their customers’ needs and partner with their NNN real estate investors to continue to grow.
Due to the corporate guaranteed lease, reliable, recession-resistant income, and no or very few landlord responsibilities, NNN investments will always be in demand. Now that most major brands have weathered a never-before-experienced pandemic and come out on the other side, many of them more profitable than before, we don’t see the demand dropping drastically anytime soon. We predict they will be in hot demand for the foreseeable future.
To Wrap it Up – Cap Rates, Interest Rates, and Changing NNN Demand
Overall, NNN property demand will likely come down if interest rates increase significantly and swiftly, and Biden’s tax policy changes become a reality. When NNN property demand goes down, supply goes up, and cap rates typically follow. If interest rates increase, you can expect those rates to influence the NNN market six to twelve months later, at which time, it could mean very little to your actual IRR.
Historically, a slowing economy increases the need for essential businesses, which comprise the majority of NNN properties. The simple, touch-free, income-producing nature of NNNs keeps these investments in hot demand in just about any economic situation.
Ready to Have a No-Obligation Conversation About the NNN Market?
Now is a great time to consider NNN investing – nothing is as certain as the present. If you have any questions about NNN investing or would like to explore your options further, be sure to contact us. Our no-obligation conversations are free, as is our buyer representation, from the very first conversation through closing, and thereafter. 314-997-5227