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Parkwest News 8

Rising Rates Pose Risk To Net Lease Sector

But Paycheck Protection Program loans could give the sector a boost.

By Lynn Pollack

Rising 10-year Treasury yields pose increasing headwinds to net lease REITs, but the sector is positioned to deliver better earnings growth this year as acquisitions increase and tenants regain post-pandemic footing. Most REITs outlined in new analysis by Baird Equity Research are posting favorable acquisition guidance, and quality assets are in big demand, which may lead to cap rate compression.

The 10-year Treasury recently rose 1.57% over a matter of weeks, up 107 basis points from an August 2020 low. Baird notes collapsing credit spreads have tempered the rise in 10-year Treasuries, and many net lease REITs ended last year with positive acquisition momentum, thanks in part to declining COVID cases and favorable capital markets for deals. Baird also points to the “meme stock rally” that paved the way for AMC Entertainment to raise equity as an example of how some brands were able to access low-cost capital.

The picture’s not entirely rosy, however: Baird is concerned about struggling large-format tenants like theaters, family entertainment centers and gyms, but says it can longer model bankruptcies and lease modifications in the first half of this year as many of those types of tenants are proving they can access capital. The firm also ranks rising rates as its key near-term concern.

Investors have flocked to the net lease sector as a more stable investment category during COVID-19. The five-year average of net lease’s share of all CRE investment activity is 11.8%, but that number spiked to 18.4% in the third quarter, according to CBRE. Industry experts are also hopeful the sector will continue to blossom under the Biden Administration, particularly as the latest round of PPP funding imbues tenants with a necessary cash flush.