Real Estate

The resilience of triple net lease

December 20, 2023
Less than 2 min read

Commercial real estate (CRE) has long been held as a means to help hedge portfolios and provide diversification. The thesis was proven true once again in 2022, with CRE posting modest gains as stocks and bonds fell in lockstep.¹ Turning the calendar to the early stages of 2023 however, investors may find themselves confronting market dynamics that paint a difficult picture for traditional CRE investors, most notably in the office sector. There is another way to invest in real estate that may shield investors from these challenges.

Office landlords face several challenges in today’s market

Commercial mortgage maturities across banks, insurance, CMBS, GSE, Debt Funds, and other

US office physical occupancy versus pre-COVID

Based on recent trends, ORENT is under allocated to the office sector.

  • Pending maturities. 18% of all commercial mortgages are due to mature in 2023 and 2024, totaling more than $1 trillion.² The  rate environment in which these refinancings need to be executed is materially higher than when these loans were originated 5+ years ago.
  • Scarcity of available capital. Regional banks, which have historically been big providers of capital to CRE investors, are expected to be less active in today’s market environment,⁴ creating further challenges.
  • Deteriorating topline performance. Return to office momentum stalled over the past 12 months and has reached only 50% of pre-COVID occupancy to date, up modestly from 40% at year-end 2021. With declining occupancy and utilization, weakening gross rent becomes a real risk.³
  • Increasing expenses. Depending on geography, we have observed dramatic increases in insurance, tax, and general & administrative (“G&A”) expenses, which may further aggravate the other negative trends in the segment.

How net lease is different from CRE

Blue Owl’s real estate platform, formerly known as Oak Street, takes an approach to real estate investment that seeks to provide insulation from many of these concerns. In a triple net lease (“NNN”), the tenant is responsible for all property operating and capital expenditures. Blue Owl receives rent, net of all expenses including repairs, maintenance, insurance, and real estate taxes, and passes it on to investors in the form of monthly distributions.

Table highlighting the difference across office assets and ORENT assets when it comes to occupancy, average lease term, exposure to increased expenses, and tenant credit quality

  • Clarity on future revenue. Our focus on mission-critical assets, structured with long-term triple net leases (15-year average term) to single tenants, is designed to help deliver consistent cash flows.
  • Minimal office exposure, and owned office assets are performing. While there are signs of stress in office generally,6 ORENT is underweight the asset class with an allocation of 6.9%. The office assets in the portfolio are performing, with no missed rent payments since inception.
  • Potential Insulation from expense growth. Under a triple net lease, any increases in expenses are 100% contractually borne by the tenant.
  • Risk mitigation through tenant selection. As landlords to single tenant properties, we are focused on tenants, not issues facing landlords. We only transact with creditworthy, often investment grade tenants5 and our rigorous underwriting gives is conviction that the tenant can pay rent for a 10+ year duration.

Looking back on prior periods of market distress, including the Global Financial Crisis, net lease investment grade real estate has a track record of strong performance.

Net lease has demonstrated resilience in volatile markets

resilienceNNN_3

The net lease strategy employed by ORENT is highly differentiated and can be complementary to other core real estate strategies, while offering a compelling return profile. With a focus on long-term predictable income, downside risk mitigation, and a hedge against rising expenses, ORENT can help insulate portfolios from the challenges in broader CRE markets. 

 

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Past performance is not a guarantee of future results. The views and opinions expressed herein are those of Blue Owl and are subject to change as markets and other conditions fluctuate. Blue Owl is under no obligation to update or keep current the information presented.

Please see endnotes and important information at the end of this page.


 

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Endnotes
 
  1. NCREIF Property Index, S&P 500, Barclays Global Aggregate as of December 31, 2022
  2. NMRK Research, RCA as of March 31, 2023
  3. Kastle Return to Office Barometer as of May 3, 2023
  4. Reuters “Analysis: Small U.S. banks imperiled by big office loans”
  5. Investment grade companies must have “BBB-” rating or higher by S&P. Creditworthy refers to businesses that Blue Owl deems financially sound enough to justify an extension of credit or engage in a lease agreement. Tenants are creditworthy or investment grade at acquisition.
  6. Bloomberg “Wells Fargo Warns of More Office-Market Stress On The Way”
  7. NOI Index represents Net Operating Income, which is total income less operating expenses and adjustments but before mortgage payments, tenant improvements, and leasing commissions
     
Important information

Unless otherwise indicated, the Report Date referenced herein is Septetmber 30, 2023.

Past performance is not a guarantee of future results.

The material presented is proprietary information regarding Blue Owl Capital Inc. (“Blue Owl”), its affiliates and investment program, funds sponsored by Blue Owl, including the Blue Owl Credit, GP Strategic Capital Funds and the Real Estate Funds (collectively the “Blue Owl Funds”) as well as investment held by the Blue Owl Funds.

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