Earlier this month, Sheila and I spent a week of vacation in Europe, sandwiched between a meeting with clients in Portugal, and a due diligence meeting in London. Many of you invested in ARC Trust (the original), ARCP (as a non-traded REIT prior to 2011, or a traded REIT since), ARC III, ARC IV, or ARC V. Each of these funds purchased assets that generally had long-term tenants (ten to twenty year lease) undertaken by companies that are considered high credit quality risks (e.g. Walgreens, CVS, FedEx). The terms of their leases are net of all real estate taxes, insurance costs, and general maintenance. So called “triple-net” leases reduce ownership risks, because the costs (including increases) are the contractual responsibility of the tenants, which reduces expense and risk to owners. In many cases, the tenant also bears responsibility for all maintenance, which could include roof replacement, and mechanicals, which provide a further buffer to owner expenses. One of the reasons the ARC net lease funds have been so profitable in such short periods (one to three year cycles rather than the expected five to seven year cycles) is because they were able to take advantage of relatively high capitalization rates and relatively low borrowing costs. Known as the “spread”, the ARC net lease funds were generally able to borrow at interest rates three to four percent less than the capitalization rates, or income rates of the investments. In the US, that spread rate has now compressed significantly, so that this type of purchase will not likely be as profitable as it has been.

By Frederick Baerenz
President & CEO