article whytherealestatemattersinnetleaseinvesting

Why the Real Estate Matters in Net Lease Investing MORGAN STANLEY REAL ESTATE INVESTING | August 2025

Elevated market volatility and a slowing economy favor net AUTHOR

lease investments that are characterized by durable, long-term TONY CHARLES Global Head of cashflows with fixed escalations in sectors and assets that are Research & Strategy, generally less sensitive to the cyclical economy. However, given Morgan Stanley Real Estate Investing heightened credit risk with some tenants who may struggle to absorb higher input costs from tariffs, it is critical that investors truly understand the residual value of the underlying real estate in addition to the credit of the tenant in assessing the attractiveness of a net lease investment.

Net lease investing has grown increasingly popular for its stability and inherent low-risk approach to real estate investing. In a world awash with uncertainty, net lease investments provide a predictable income return that is fixed and durable, with inherently lower volatility given the long-term nature of the lease. Relative to other types of real estate, net lease is particularly attractive today as it is much less exposed to risks associated with both slowing economic growth (exposure to rent volatility) and rising inflation (as the investor is not responsible for increases in wages, capital expenditures or insurance costs). Net lease investing also provides investors with unique tax advantages and inflation protection plus the appreciation potential of hard asset ownership.

MSREI adopts a targeted approach to net lease investing, focusing on properties leased to credit-worthy tenants in the strongest real estate sectors and markets which benefit from long-term structural megatrends that power through cyclical ups and downs. One such megatrend, extremely topical today, is the onshoring of manufacturing throughout the US. This trend is likely to accelerate given the onset of tariffs and should lead to more sale leaseback and build to suit activity in key manufacturing clusters in Midwest and Southeast markets that have established manufacturing ecosystems.

In a typical sale leaseback transaction, the investor acquires mission critical real estate directly owned by a business, and then leases the real estate back to the business under a long-term lease agreement. The investor receives a series of fixed and often contractually escalating rental payments in which

the new tenant is responsible for capital expenditures share of leasing are significantly higher (+30-50 percentage and operating expenses of the real estate. Thus, the sale points)1 in a premier submarket such as South Dallas, leaseback structure is both a credit investment and a real compared with secondary locations such as East Dallas, estate investment. The income stream is downside protected suggesting higher tenant stickiness in better locations. with predictable characteristics of private credit, and the Net lease investing demands rigor in both credit and real real estate ownership provides appreciation potential and estate underwriting. Today, the value of the underlying tax advantages to the investor. real estate is even more important than in other market In our view, mission critical net lease real estate provides environments given the elevated credit risk associated with more security than equivalent private credit for investors. tenants in sectors that will be adversely affected by tariffs. Since the tenant may not be able to operate their business Higher input costs could negatively impact tenant coverage without its truly essential real estate, the net lease structure ratios if operators are unable to pass through the costs to is functionally senior to traditional corporate debt. “Four their end-customers. High quality, well-located real estate wall economics”, such as the share of total corporate will have a greater likelihood of being released or sold to a revenue generated at the site and the ratio of annual third party. revenue generated by the facility versus annual rent, are In conclusion, net lease investments may provide a critical metrics in assessing the mission criticality to the compelling risk-adjusted return…