The Effect of Market Asset Returns, Economic Conditions, and Firm Fundamentals on Net Lease Capitalization Rates

Abstract

This study fills a void in the literature by examining real estate capitalization rates for single-tenant net lease (STNL) properties. First, we examine cap rate variation in relation to market and firm-level fundamentals using individual transaction data in a multistage regression approach. Second, our single-tenant dataset, which allows us to control for characteristics such as industry and tenant credit ratings, gives us unique insight into not only the pricing of cap rates, but also their underlying drivers and their relationship to market fundamentals and returns on alternative assets. Using this unique dataset of more than 8,000 single-tenant net lease retail property transactions, we develop a quarterly cap rate index controlling for Metropolitan Statistical Area (MSA) and industry fixed effects, property and lease characteristics, and localized influences such as population density and household income. Third, we examine the effect of excess corporate bond spreads, excess stock returns, stock market indicators, firm financials, and economic and demographic indicators. Finally, we examine the effect on cap rates of MSA characteristics such as size, wealth, poverty, crime, gross domestic product, and growth. The findings show that, besides the systematic risk from stock and bond returns, national and metropolitan economic forces and firm fundamental factors explain variation in cap rates.