Shopping Centers Today is the news magazine of the International Council of Shopping Centers (ICSC)
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including its recent acquisition of American Realty Capital Trust. Realty Income is the largest net-lease REIT, with a market value of about $8.4 billion and 3,528 properties. By definition, net lease involves single-tenant properties in which the occupant handles maintenance and property taxes, usually on long-term leases with rent increases built in. Low risk and a consistent stream of rent income make for a bondlike return that has always drawn private investors and risk-averse investment groups. Benchmark interest rates are near historic lows, however, and with the 10-year Treasury yield hovering at about 2 percent, net-lease returns in the mid single digits are an attractive alternative. The Spirit-Cole merger and Realty Income's American Realty Capital acquisition demonstrate that REITs are capitalizing on market conditions to rapidly expand their portfolios. "The net-lease space, especially on the retail side, is increasingly an institutional space," said Josh Barber, an analyst at Stifel Nicolaus & Co. "You may not have 800-pound gorillas, but you certainly have companies of very large size [and] scale, and talented management teams that are out there and can afford to be a bit more aggressive than some of the private players." The scale, diversification and bondlike income streams associated with large net-lease portfolios give the largest net-lease institutional investors access to low-cost capital that enables them to outbid the competition in acquisitions. REITs in particular have a cost-of-capital advantage fueling their growth, Barber says. "Companies like Realty Income or National Retail Properties — another high-quality company that we've identified in that space — have just proven themselves to be very good stewards of capital over the last 10 years," he said. Each Spirit Realty share will be ex- 192 SCT / m a y 2 0 1 3 changed for 1.9 shares of Cole Credit. Although Cole Credit will account for 56 percent of the merged entity, Spirit Realty will manage the firm under the Spirit Realty name. Cole will hold two of the nine seats on the Spirit Realty board of directors. Spirit Realty, whose major stockholders include Macquarie Group and hedge fund TPG-Axon, launched in 2003 and completed an IPO last September. Cole Real Estate Investments registered the Cole Credit Property Trust II REIT in 2004, and the unit began buying properties the following year. Realty Income closed the American Realty Capital acquisition in January, paying American Realty Capital shareholders 35 cents and 0.2874 of a Realty Income share for each share of owned American Realty Capital common stock. In announcing the completed deal, Realty Income CEO Tom Lewis predicted an increase of about 19 percent in the company's annualized dividend, from $1.82 to $2.17 per share. "Today I think you're seeing companies like Realty Income flex their muscle," Barber said. "Realty Income has what we think is the lowest cost of capital in the space, and they're clearly using that to take advantage and do some things that they wanted to do with their portfolio." Spirit Realty, by contrast, appears intent on building up its efficiency and stability through portfolio growth. "Spirit wanted to get to the point of being a Realty Income, where their balance sheet is fixed, and Cole accomplished a number of things for them in terms of size, scale, tenant diversity and access to capital," Barber said. "So Spirit is a step or two away from being what Realty Income was before ARCT." Average annual transaction volume in retail net-lease properties has mushroomed since the recession, according to CoStar Group. Volume last year was $6.7 billion, on a par with 2011 and outpacing even the prerecession volume of nearly $3 billion tracked in 2006. "I'm impressed by the amount of volume in the market; it's basically triple what we were doing over the last few years," said Suzanne Mulvee, CoStar's director of research. "It has The scale, diversification and bondlike income streams associated with large net-lease portfolios give the largest investors access to low-cost capital. everything in the world to do with the interest in these bondlike returns." Those returns will remain bondlike over time, however, even if rising interest rates boost yields from alternative investments and dampen fervor for net-lease assets. That risk is minimal for the foreseeable future at least, observers say. "Over the next few years, we don't see interest rates rising enough to push up cap rates on net-lease properties and create losses in net-lease portfolios," Mulvee said. Guy Ponticiello, managing director for corporate finance and net lease at Jones Lang LaSalle, says he expects to see additional oversized net-lease transactions in the coming months. "I'm calling it the year of megadeals," he said. "Whether it's large portfolio transactions … or platform plays of companies merging with or acquiring potentially publicly traded companies, I think you're going to see quite a bit of that." Ponticiello sees two forces driving net-lease transaction volume: investor demand for a limited supply of suitable acquisitions, and pressure on REITs to place capital. On the supply side, the majority