Sell for More News is a weekly blog series with interesting information from the world of commercial real estate.
I recently had a long conversation with a woman who completed a 1031 Exchange into a net leased bank branch. Long story short…there were tears. She was overwhelmed with regret in her purchase. And she was angry that no one told her that bank branches were a bad investment. In fact, shortly after closing she put the property back on the market…and a year later she still hasn’t found a buyer. So, is she right? Are bank branches a bad investment in 2020?
Bank branches are vanishing, albeit slowly. In the past decade, the U.S. banking industry has shed more than 13,000 branches. Much of this decline is explained by the rise of digital banking.
The positives
For one, bank branches aren’t in danger of disappearing anytime soon. Every city still has lots of them.
Secondly, customers continue to visit bank branches…just not as often as they used to.
What exactly is happening?
Some experts argue that buyers should target top-tier banking tenants like Bank of America, Chase, PNC and TD Bank. That said, regional and community banks are driving much of the new branches being constructed.
Banks are very much in the net lease mainstream. Most banks offer investment-grade credit and long-term leases, and thus remain desirable despite the uncertain long-term outlook for branches.
Nonetheless, interest in net lease branches is expected to stay lower than interest in other net lease asset classes. That’s partly due to a decrease in the number of branches with lease terms longer than 10 years.
Leases with terms of 15 to 20 years are the sweet spot for net lease bank branches. If a bank property has an in-place lease with a primary term of less than 10 years…that’s when the real estate is scrutinized and the rent is looked at closer as to whether it is a replaceable rent.
From 2010 through 2015, rents for net lease branches in major metro areas were inflated…roughly $300,000 to $400,000 a year…as banks competed for coveted corner sites. Since then, annual rents in major metros have come down considerably, ranging from about $175,000 to $250,000. That drop, has made net lease branch transactions more attractive.
Newer bank branches typically measure 2,000 to 3,500 SF…compared with the 5,000 to 7,000 SF branches of the past.
Last year, 165 single-tenant bank branches were sold in the U.S., up slightly from 151 in 2018. Cap rates on these properties averaged 6.08% in 2018 and 6.18% in 2019. By comparison, 210 single-tenant branches were sold in 2017, at an average cap rate of 5.65%.
We attribute the volatility in bank branch transactions to concerns about the future of bricks-and-mortar locations…along with higher-than-normal rents in some submarkets…and the challenges of repurposing shuttered branches.
In addition, the FDIC data indicates about three-fourths of all U.S. bank branches currently in operation are more than 15 years old. Although many of these 66,000 banks are in excellent locations, many of them are outdated in terms of their size, technology and facility efficiency.
Besides location…what other factors do buyers consider?
A bank branch’s total deposits should be the #1 factor when looking at a net lease transaction. Branch deposits below $35 million to $40 million are worrisome. Anything in the universe of $60 million to $100 million in deposits signals that a branch is on solid footing.
Another aspect to weigh is whether a branch has a drive-through. Without a drive-through, it can be difficult to lease a branch to another bank or a credit union, or to retrofit it as a fast-food or quick-service restaurant.
Additionally, it’s important to pay attention to the intrinsic value of the dirt…as well as the strength of the tenant’s credit. Outside the urban core, it’s key to look at residual value. The potential for adaptive reuse, such as a restaurant, rises if a branch sits on at least 1 acre and provides adequate parking.
Conclusion
Over time bank branches will be largely replaced with technology. Only the best locations with modern facilities will remain. If I’m the owner of a net leased bank branch I would think hard about trading into a different type of asset that’s more future proof. I can’t imagine a scenario whereby the average bank branch goes up in value from here.
I would be worried about branches larger than 3,500 SF. I would be worried if I didn’t have a drive-through. I would be worried if my location wasn’t in the path of growth.
That said, its hard for many investors to pull the trigger because its rare for a bank branch to go dark and not continue to pay rent. So, many procrastinate. The real risk is what you do with the property when the lease expires.
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About Beau Beach, MBA CCIM
Beau is a tenacious Commercial Real Estate Broker, author and adoring father of four. His clients appreciate his no-nonsense demeanor and his legendary work ethic.
Beau leads Beachwood which is a commercial real estate broker for sellers in the Nashville, Milwaukee and South Florida markets.
He’s the author of the books The 3 Reasons: Why Most Commercial Properties Don’t Sell and True Wealth: What Every Seller Should Know About 1031 Exchanges.
Beau can be reached at 800-721-3287, click to schedule a call or Beau@BeachwoodSells.com