By M.P. MCQUEEN
WALL STREET JOURNAL
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."
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Brian Shumway for The Wall Street Journal
Michael Federman at his property in Lower Manhattan, which houses a new Chipotle Mexican Grill restaurant.
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."
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Birmingham area real estate suffered in 2009
By Michael Tomberlin -- The Birmingham News
March 19, 2010, 6:30AM
The Birmingham area's commercial real estate business took some lumps in 2009.
All the industry's key sectors -- office, retail and industrial -- found the going tough in one of the roughest markets in memory. The findings in a new report by EGS Commercial Real Estate, one of the city's largest commercial real estate firms and a major player in all three sectors, tell the story.
"In all sectors of real estate, 2009 was a very challenging year," EGS President Bill Pradat said in an interview. "All of these product types have something in common and that's the fact that they depend on jobs."
The bottom line: While some geographical areas fared better than others in specific sectors, really about the best thing that can be said about 2009 is that it's over.
And what about the prospects for a recovery?
"Everybody is cautiously optimistic about a bit of an upturn in the latter part of 2010," Pradat said.
But, he added, there will be almost no new development this year in the Birmingham area, where the jobless rate stood at 11 percent in January.
"Until we see employment return, we won't see a recovery in the industry," he added. "There also needs to be a growing sense of consumer and corporate confidence. We're not seeing that yet."
'Challenging year'
The strain caused by a down economy has been keeping consumers' pocketbooks closed -- and that is bad news for the retailers that lease space in shopping centers and malls.
During 2009, some big retailers collapsed into the bankruptcy, including Bruno's Supermarkets, Linens-N-Things, Circuit City and Goody's. That left nine separate large vacancies totaling more than 250,000 square feet in the Birmingham market.
"Birmingham's retail market faced one of its most challenging years in 2009," the EGS report says.
Still, retail space in the Birmingham area actually showed increased occupancy for 2009: 88 percent, up from 87.5 percent for 2008.
A gradual recovery in 2010 could have retailers and developers scouting potential new locations in anticipation of a return to growth later, the report says.
EGS said the Eastwood-Irondale area was the weakest market, with 84.3 percent occupancy at year's end. The U.S. 31 corridor stretching from Hoover to Pelham, Alabaster and Calera was strongest, at 92.3 percent.
Worst over?
Landlords with office space didn't have much to cheer about in 2009.
Occupancy rates in multi-tenant buildings dropped 3 percent, average rents were mostly flat, and net vacancy rose sharply, meaning more space was vacated than occupied during the year. While 2008 saw a net vacancy of 25,500 square feet, last year's figure was 490,000 square feet for the year, the EGS report says.
Office rental rates averaged $19.42 per square foot at year's end, a slight uptick from $19.15 per square foot in 2008. Landlords stuck to charging quoted rents in most areas, choosing to give tenants other concessions, such as increased tenant improvement allowances, the EGS survey found.
The good news: Signs emerged late in the year that the worst may be over as brokers reported increased activity in the fourth quarter. The EGS report predicted a gradual recovery for the area's office market this year.
The market that includes Homewood, Mountain Brook and Vestavia Hills was the strongest office market last year, with occupancy at 94.6 percent. Struggling the most was the Vulcan-Oxmoor market, with 85.4 percent occupancy. Overall occupancy stood at 90.5 percent.
Industrial space
Birmingham's multitenant industrial market -- warehouses, distribution and plants -- had a vacancy rate of twice the national average at year's end, according to the EGS survey. Overall occupancy slipped nearly 3 percent to 80.3 percent.
Net vacancy totaled nearly 308,000 square feet for the year, meaning more space was vacated than occupied. The 2008 figure was 294,000 square feet.
The Oxmoor Valley area was hit the hardest, with a net vacancy of nearly 158,000 square feet and an occupancy rate 82.9 percent. The Southwestern market actually saw a gain in occupied space by 55,500 square feet, but its occupancy rate was 64.4 percent.
The problem? The EGS report says the poor economy and a lack of lending were to blame, along with contractions in the construction industry that slammed suppliers.
The report found there's light at the end of the tunnel -- in the form of trains. A new CSX railroad hub in Bessemer and a planned $112 million Norfolk Southern in McCalla could boost demand for industrial space "as companies from outside the Birmingham market that utilize this mode of transportation will look to open distribution centers, warehouses and manufacturing plants."
Join in the conversation by commenting below or e-mail Tomberlin at mtomberlin@bhamnews.com.

EADS CEO looking for acquisition in the US
By CHRIS KAHN AP Energy Writer Published: Thursday, March 18, 2010 at 9:45 a.m.
Last Modified: Thursday, March 18, 2010 at 9:45 a.m.
The head of European plane maker EADS says the company is looking for a "medium-sized" acquisition in the United States following a failed bid for a $35 billion Pentagon contract.
EADS, the parent of Airbus, has been looking to expand in the defense industry, and a larger presence in the U.S. will help, CEO Louis Gallois said in a news conference with reporters Thursday.
Earlier this month, EADS pulled out of bidding for the Pentagon air tanker contract, saying the deal seemed to favor rival Boeing Co.

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