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Hospitality Properties Trust’s Acquisition of the Spirit MTA Portfolio Underscores the Appeal of the Net Lease Sector

As interest rates are projected to stay flat or even go lower, net lease assets look like a particularly attractive bet.

The retail net lease sector is certainly enjoying a healthy run. In 2018, net lease REITs racked up an overall return of 13.93 percent, according to Nareit. And through April 30 of this year, those REITs had posted a return of 13.5 percent.

“There remains a voracious appetite among investors for net lease, specifically retail net lease, which is where we play,” Josh Lewis, senior vice president of acquisitions at Orlando, Fla.-based net lease retail REIT National Retail Properties Inc., told NREI in February.

Now, another player—a bit of a surprising player—is expanding its presence in the net lease arena in a move that industry observers say highlights the strength of the net lease sector.

On June 3, Newton, Mass.-based Hospitality Properties Trust said it was expanding outside its foundation of hotels and travel centers by scooping up a 774-property portfolio of net lease retail properties for $2.4 billion. The seller is Dallas-based Spirit MTA REIT.

The 774 Spirit properties include quick-service and casual-dining restaurants, movie theaters, health and fitness centers, specialty retail stores, automotive parts and services shops, and other service-oriented and necessity-based businesses. Among the top tenants are AMC Theatres, Goodrich Quality Theatres, Regal Cinemas, The Great Escape (furniture stores), Crème de la Crème (child care and early learning centers) and Heartland Dental (dental practices).

Hospitality Properties Trust expects the acquisition to be completed in the third quarter of 2019 at a cap rate of around 7.2 percent. After the deal closes, the REIT plans to sell $500 million worth of the acquired properties and $300 million worth of hotels and other assets in order to slice its debt.

Whereas executives at Hospitality Properties Trust view the deal as a way to strengthen the REIT, Alex Pettee, president and head of ETFs at Rowayton, Conn.-based investment adviser Hoya Capital Real Estate LLC, regards the proposed acquisition as a “head-scratcher” at a time when REIT investors “value specialization over diversification.” Newton, Mass.-based The RMR Group Inc. is the REIT’s external manager.

Nonetheless, Griffin Cogorno, vice president of client relations at Unire Real Estate Group Inc., a commercial real estate property management firm based in Brea, Calif., says the acquisition represents a “fantastic opportunity” for Hospitality Properties Trust, particularly given that large portfolios of net lease properties are in short supply.

In a research note, analysts at Arlington, Va.-based investment bank B. Riley FBR Inc. wrote they were “a bit surprised” by the Hospitality Trust Properties deal, given the REIT’s traditional focus on hotels and travel centers. However, the B. Riley FBR analysts noted that the deal isn’t entirely outside Hospitality Properties Trust’s wheelhouse, considering that the REIT’s current properties include restaurants, truck-servicing and retail components.

“It is a large transaction, however, and we expect some skeptics, at least initially. The financial and diversification benefits are clear and, we suspect, investors will see this in the results in 2020 and beyond,” B. Riley FBR analysts Bryan Maher and Matt Boone wrote.

According to B. Riley FBR, the deal will boost the mix of net lease income in the Hospitality Properties Trust portfolio from 31 percent to 43 percent. The B. Riley FBR analysts said 98 percent of the Spirit properties are occupied, with a weighted average lease term of 8.6 years, representing annual cash rents of $172 million as of March 31.

More broadly, Pettee says that for the net lease industry, the Hospitality Trust Properties deal represents a “clear win for a sector that has swung back into favor amid the plunge in interest rates.”

“A year ago, who would have thought that a portfolio of net lease assets would be the shiny object in an acquisition deal?” he says. “Net lease REITs deserve their time in the sun after a decade of being the ugly ducklings in the so-called ‘rising rate environment.’”

The net lease sector remains “very strong and steady” in the current environment of low interest rates, says Barry Wolfe, senior director of the national retail group at commercial real estate services company Marcus & Millichap. If interest rates stay low, Wolfe expects the sector to keep thriving.

In the net lease sector, buyers are especially interested in restaurants (mostly quick-service), discount retailers (namely dollar stores), and automotive and service-oriented retailers, he says.

“Buyers are very attracted to tenants that have limited exposure to Amazon,” Wolfe says.

“We continue to see many public and private REITs that are looking to aggressively grow their net lease presence,” he adds. “Like private parties, REITs are also attracted to the passive nature of net lease assets. It is possible for a REIT to acquire and own hundreds or thousands of assets across the country, as these assets require little or no routine maintenance since the tenant carries this obligation, if the lease is truly triple net.”

Patrick Healey, founder and president of Jersey City, N.J.-based financial advisory firm Caliber Financial Partners LLC, says he anticipates more deals to happen in the net lease sector if interest rates go down in the near future as opposed to going up.

“The state of the net lease market has been indirectly driven off interest rates,” Healey says. “Last year, expectations were that interest rates were going to continue to rise, which would not be favorable toward net leases, as those tend to be longer leases and not many opportunities for landlords to increase rent when the lease matures. But now, we’re starting to see expectations build more toward a reduction in interest rates, which favors the net lease sector.”

Hospitality Properties Trust’s acquisition of the Spirit portfolio underscores the appeal among many investors of the net lease sector’s defensive nature, Healey says.

“The more transactions in the net lease market, the more bullish investors and the firms that are looking to make acquisitions feel about the future of the space,” he notes.

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