What is up with Dollar General?

[Howard Klahr]

I haven't checked the spread recently but I recall the last time I looked the spread between cap rates and 10-year T bonds were not at, or near historical lows. There could still be a lot of compression in that spread which would soften the blow to cap rates.

That exact argument could also be used to support the position of why cap rates may rise in tandem with interest rates. You have not addressed why the market would accept compression only that there is room for it to occur.

 

[Michael S]

That exact argument could also be used to support the position of why cap rates may rise in tandem with interest rates. You have not addressed why the market would accept compression only that there is room for it to occur.

Here's a couple of article by people with far more knowledge of these matters. http://www.cbre.com/AssetLibrary/Interest_Rates_and_Cap_Rates.pdf This is from early 2013 with data through 4Q2012 and it shows that historically spreads are still high and that when interest rates rise, cap rates have risen at a much slower rate.

This article is titled "Two Tales of Future U.S. Cap Rates: the Fed and Global Capital Flows" https://www.cbre-ea.com/index.aspx?_title=AboutRealEstate&_id=3763 it requires free registration but it's from November 2014 and has data through 3Q2014 with forecasts for the next few years showing two scenarios of rising interest rates, fast or slow. In both cases the projections are for cap rates to rise only about 100 basis points over the next four years with interest rates rising approximately 200 basis points.

 

[PL1957]

In my email inbox this morning ...

Two (2) Dollar General Locations:
Romayor, TX: $1,278,992 | 6.35% Cap Rate
China, TX: $1,313,196 | 6.35% Cap Rate

· New 15 Year, NNN Leases
· TX Has No State Income Tax
· Corporate Guarantees

 

[Dean Adams]

As a retailer, DG and the other dollar stores are doing well. Same-store sales are increasing faster than most retailers, and Dollar General, Family Dollar and Dollar Tree are all adding stores and still not cannibalizing existing ones. From my observation, dollar stores are hitting a pretty good niche, more convenient than Walmart and other big discount stores, and more affordable than C-stores.

I just appraised a proposed DG, and I had a bunch of sales to pick from, with new stores selling right after completion at cap rates of 6.5 percent. The attraction is a 15-year lease guaranteed by DG. It's like a bond alternative. Would I buy one? No, that's not a high enough return to me, as I wouldn't count on DG staying past the 15-year mark. I'm seeing them leave 10-15 year old buildings for new ones. Now, the buildings are pretty generic, and you could probably find a new tenant, but you might also have to wait awhile.

 

[Michael S]

As a retailer, DG and the other dollar stores are doing well. Same-store sales are increasing faster than most retailers, and Dollar General, Family Dollar and Dollar Tree are all adding stores and still not cannibalizing existing ones. From my observation, dollar stores are hitting a pretty good niche, more convenient than Walmart and other big discount stores, and more affordable than C-stores.

I just appraised a proposed DG, and I had a bunch of sales to pick from, with new stores selling right after completion at cap rates of 6.5 percent. The attraction is a 15-year lease guaranteed by DG. It's like a bond alternative. Would I buy one? No, that's not a high enough return to me, as I wouldn't count on DG staying past the 15-year mark. I'm seeing them leave 10-15 year old buildings for new ones. Now, the buildings are pretty generic, and you could probably find a new tenant, but you might also have to wait awhile.

I haven't seen many dollar stores repurposed yet like you'll see with an old Walgreens where they've built a newer one on a better corner a few blocks away. However, a lot of these are still in their initial 10-15 year lease term so there hasn't been as many where they've come up for renewal and decided not to exercise. If it's a location in a decent size city I think they will be backfilled pretty well. The real risk is in those small towns of under 5,000 or so. I've appraised a few of these in places where there's barely 5,000 people in a 15-mile radius. Who is going to lease one of these if it goes dark, and are they going to pay anywhere near the $12-15/SF that FD and DG are paying now? The market apparently makes little distinction between a solid corner location in a decent size city and the only retail store in a 10-mile radius. I've had a few brokers tell me the cap rate for a rural location might be another 25-50 basis points but considering that risk of non-renewal that seems like a small consolation.

 

[Howard Klahr]

Not to drag this thread up again but here is another one for sale for those interested

Dollar General Brunswick GA

 

[normando]

At first I was thinking of buying a Dollar Store because of the high cap rates. Before I read this thread, I did notice the locations which could be hard to lease if not renewed. I don't want that risk. Now I'm looking at Citibanks which have many branches for sale. It has lower risk being a large bank but lower cap rates. What do you think?

 

[Michael S]

At first I was thinking of buying a Dollar Store because of the high cap rates. Before I read this thread, I did notice the locations which could be hard to lease if not renewed. I don't want that risk. Now I'm looking at Citibanks which have many branches for sale. It has lower risk being a large bank but lower cap rates. What do you think?

Never appraised a bank branch but I've seen some closed in the last few years after the various bank failures, mergers, buyouts, etc. I don't see as much reusability, especially when they've got the multiple drive through lanes. I appraised a struggling shopping center and there was an old two-story bank branch that had been converted into purely office space. The owner got pretty lucky and leased the whole building to an existing tenant in the retail space for an adult daycare for handicapped/mentally disabled people with administrative offices upstairs. The drive through canopy was still there but they put up a fence around it.

Net lease cap rates are pretty much at historic lows right now. Every time I talk to brokers on these deals they say that cap rates can't get much lower but then the money keeps flowing in and chasing a limited number of deals and the cap rates and yields keep falling. If you buy at a 6% cap today and a few years from now it's at an 8% cap that's a 25% drop in value. It's a sellers market right now. Unless you've got 1031 money burning a hole in your pocket I don't think now is a good time to be buying a single tenant net leased property.

 

[normando]

I've been looking to buy a single tenant (chasing higher yields) property but always the land value does not justify the list price. I once asked a commercial appraiser in how one should appraise a Walgreens. Do you base on rental income or consider land value? He said since Walgreens is a Triple A tenant, they are like AAA bonds and you can appraise based on its long term lease. I intuitively think that's wrong.

 

[Michael S]

I've been looking to buy a single tenant (chasing higher yields) property but always the land value does not justify the list price. I once asked a commercial appraiser in how one should appraise a Walgreens. Do you base on rental income or consider land value? He said since Walgreens is a Triple A tenant, they are like AAA bonds and you can appraise based on its long term lease. I intuitively think that's wrong.

Fundamentals (location, location, location) are somewhat immaterial to most single tenant net leased deals. A lot of investors (and brokers) will buy and sell these properties sight unseen. If you've seen one Family Dollar, Walgreens, McDonalds ,etc. you've seen them all. All that matters is if that tenant will keep paying their rent.

The market for net leased properties is fairly efficient compared to typical real estate markets. I've seen a lot of investors who are simply planning to park some cash in one of these properties for a couple of years because they know that they can sell it relatively quickly when they do find a property they want to invest in long term. It's all cap rate driven and for new product it's a pretty narrow range that it will trade in.

We'll do a cost approach on a new Walgreens or other single tenant deal but since these are build to suit the contract rents are more a function of construction costs or projected sales than anything else. If the developer has to spend a few hundred thousand more to get the site the tenant wants they just get a higher lease rate and sell the property for a little more.

The leasehold value is huge. I've got some pretty good data that showed a new vacant drug store will sell for about 40% of what a leased one will sell for. Market rent of $15/SF for a regular retail tenant instead of $25-30 for a Walgreens or CVS. Couple that with a higher cap rate and you can see that in some cases more than half the value of the property is tied up in that lease.