In the stock market, in times of volatility there is always a flight to safety. Generally, when there’s uncertainty in the market, investors move to fixed-income securities such as bonds and government debt instruments. These investments are considered among the safest because they are backed by major corporations, municipalities and, in the case of government securities, the full faith and credit of the United States Government.
Are there real estate investments that are almost as safe as these fixed income securities? In real estate, risk is measured the capitalization rate investors will pay for the asset. The capitalization rate or “cap rate” can be determined by dividing the Net Operating Income (revenue less operating expenses) by the sale price. Generally, the lower the cap rate the safer the real estate investment.
The lowest cap rates in the market are in three categories: (1) National Credit Tenant properties; (2) Regional Credit Tenant properties; and (3) Apartments. A credit tenant is given its investment grade rating based on its size and financial strength.
Such companies as AT&T, AutoZone Inc., CVS Health, Dollar General, Dollar Tree, Home Depot, Kohl’s Corp., Kroger Co., Lowe’s Cos., Nike, Nordstrom, O’Reilly Automotive, Target Corp., Walmart, Walgreens Boots Alliance, are all listed on the S&P 500 and lease commercial space from real estate developers. The lease rates these companies pay tend to be lower but the likelihood of the rent being paid each month is very high.
You can expect the cap rates for these companies to run between 4% and 6%. Regional credit tenants, which have strong credit but are not national in scope, have cap rates that run between 5% and 7% while apartments also command low cap rates around 5% to 7%.
When you invest in a project that is leased by these tenants you can expect a high degree of safety, but the tradeoff is a lower overall return. However, the return is significantly higher than what you can expect to achieve by investing in fixed-income securities.
