The Role of Tenant Characteristics in Retail Cap Rate Variation

Abstract

This study examines the pricing of tenant credit risk utilizing variation in cap rates for single- tenant net lease (STNL) properties. Despite an abundant literature on micro- and macroeconomic factors that influence capitalization rates there is virtually no existing literature to evaluate investment risk pricing for individual tenants. Using a unique dataset of more than 8,200 single-tenant retail property transactions from 2001 to 2019 in the United States, we quantify the asset pricing implications of risk associated with tenant credit characteristics. Our results show that these tenant characteristics play an important role in explaining cap rate variations, and that investors are especially sensitive to expected income risk. Pricing implications of expected tenant income uncertainty, tenant income growth and asset location quality are also explored.