Q&A: Chicago’s Zahr hunts single-tenant properties unloaded by big companies

Oak Street Real Estate Capital head juxtaposes pandemic with Great Recession

A photo illustration of Oak Street Real Estate Capital's Marc Zahr (Oak Street Real Estate Capital, iStock)
A photo illustration of Oak Street Real Estate Capital's Marc Zahr (Oak Street Real Estate Capital, iStock)

Marc Zahr isn’t in the business of predicting the real estate market’s volatility.

Yet the CEO of Chicago’s Oak Street Real Estate Capital says he’s ready to deliver parachutes in case of a crash involving well-known companies ready to unload large portions of their real estate to lease it back and free up cash.

Since launching in 2009, Oak Street has raised billions of dollars from investors to pull off deals such as a $725 million purchase of Big Lots real estate in 2020 that the retailer leased back. Large deals with investment-grade, creditworthy tenants have also been made between Oak Street and companies such as Walgreens and other name brands that offload single-tenant retail and industrial properties to Oak Street and sign triple-net leases — putting all the operating expenses, taxes and insurance costs on the tenant’s shoulders in long-term deals.

It’s a real estate investment strategy that mitigates risk and paid off in the wake of the Great Recession, which Zahr called an unmatched buying opportunity. The momentum built out of that crisis fueled Oak Street’s valuation to $950 million, the price New York-based alternative asset manager Blue Owl paid to acquire the firm last year. Oak Street may fetch another $650 million through the deal based on its performance.

Critics of the approach point to periods of inflation like today’s market and the inability to capture rent price growth due to 15-year lease terms and annual rent increases of 2 percent of the landlord’s net operating income. Zahr shrugs it off in favor of stability.

“I’m in the business of eliminating risk, eliminating variability and getting a predictable long-term cash flow stream for investors,” Zahr told The Real Deal. “That’s why we focus on investment-grade rated tenants — companies like Walgreens, Whirlpool, Johnson Controls, Kroger, 7-Eleven, Shell. Things we use every single day in our lives. Regardless of the economic environment, regardless of inflationary pressures, we still need that stuff. Those are the companies whose real estate we want to own.”

Read on for Zahr’s take on why the pandemic hasn’t been as strong a buying opportunity as the Great Recession and how the market for single-tenant properties has evolved since to be more favorable to sellers. This interview has been edited and condensed for length and clarity.

Have you seen or heard of long-term triple net sale leaseback players getting into trouble, or being regretful that they’re missing out on potential rent increases in an inflationary environment?

People could get in trouble one of two ways. If the tenant in your building doesn’t have good credit quality, meaning they can’t cover those rising expenses and can’t pay that contractual rent they owe you on top of that. Some would argue if that happens in a rising cost environment like this, you should be able to re-tenant the building. The counter to that is you want these short-term leases so you can capture all that rent growth you’re able to. To me, now that means we’re gambling. No one knows what the world is going to look like in 24 to 36 months. If you’re saying you want to make sure you’re in a position to have all these short-term leases and feel so confident that the expense side of the equation won’t go so out of whack that you’ll be able to increase expenses and rents on top of that dramatically to capture all that movement, we’d all be thinking and making assumptions on what’s going to happen. I don’t like to do that.

The second way groups can get into trouble is their debt exposure. If you’re using floating-rate financing in a rising interest rate market, you can eliminate your profit margin. Our strategy seeks to eliminate that risk. We’re using fixed-rate financing. We have a great credit quality in our portfolio. So I can tell you down to the penny for the next seven years approximately what our cash flow looks like.

Has the health crisis motivated companies with nationwide real estate footprints to consider sale leasebacks? How does the pandemic market compare to the Great Recession in that way?

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The best buying environment I’ve seen in my lifetime was the global financial crisis. Better than Covid, because (in) Covid, the window was so short before the government came in and intervened with massive stimulus. During the financial crisis, there was real distress for a decent period of time and the credit markets had collapsed. There was no trust in the financial system for a period of time. The lending environment was upside down. That’s the highest we’ve seen cap rates go. Single-tenant, net lease investment grade-backed deals had cap rates with a 7 percent yield. As long as you can buy between a slight spread to the general market and can lock in fixed-rate financing, you will likely be able to deliver better returns based on the risk you’re taking.

Do you think a better opportunity could be on its way with signals of a recession getting harder to ignore?

I hope so. We have a lot of capital to put to work. All I can tell you is in the world that we live in, I have not seen the expansion in cap rates that I would have hoped to. It feels like it is still a very frothy environment. The consumer staple assets that we are buying, you’re not seeing those cap rates expand dramatically. That said, as we continue to see tightening in the credit market, that can change very quickly and groups that can buy all cash and have a good reputation will likely be able to take advantage of that moment in time.

What are the biggest differences between the current crisis and the financial meltdown in 2008?

The market has become more educated on the value and predictability of the downside for an investment grade rated triple net lease. You’re seeing more people that have gone through many cycles and seen different asset classes and how they performed versus our asset class and how it performed. In times of uncertainty, generally there is a flight to safety. I also think there is a substantial amount of money on the sidelines. When you take all those things together, it can prop up pricing.

Even without the expansion of cap rates you’d hoped for, has the uncertainty in markets resulting from the pandemic and the European conflict given more reason for companies to focus on their main business and unload real estate in sale leasebacks?

We have just been through something completely unprecedented that none of us saw coming that could have been substantially uglier than how it played out. Based on where we are as a country today and where interest rates are, where inflationary pressures are, based on the massive intervention that took place, I don’t know if we can wave that magic wand again if something else dramatic happens. So I think it was prudent for a lot of people to evaluate other ways to fortress their balance sheets. I think it’s something companies and CFOs and treasurers should be considering.

Does the opportunity for sale leasebacks dissipate in the event another massive threat to markets emerges before we’ve paid for the pandemic response?

Absolutely not. It becomes even more important and beneficial. With more uncertainty, volatility and less credit, the options for companies generally become more scarce. It becomes a buyer’s market. Today companies can have the ability to unlock the value of non-earning assets on their balance sheet. These companies and their shareholders aren’t earning any return on these assets. It’s objectively a good idea to create more liquidity in your balance sheet and save up for a rainy day by selling and leasing back and fully controlling the real estate that you want to be in. You can today, but you may not be able to later and the cost might be substantially higher.

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