Q3 2019 Earnings Call
Well I want to store capitals, Q3, 2019, earning swept past.
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Thank you operator, and thank you offered for joining us today to discuss store capital's third quarter 2019 financial results.
This morning, we issued our earnings release and quarterly Investor presentation, which includes supplemental information for today's call. These documents are available in the Investor Relations section of our website at <unk> IR Dot store capital Dot Com under news and results quarterly results.
I'm here today, with Chris Volk, President and Chief Executive Officer of store Mary feet away keep operating officer, and Cathy long Chief Financial Officer.
On today's call management will provide prepared remarks, and then we will open up the call for your questions.
In order to maximize participation, while keeping our call to an hour we will be observing a two question when it during the Q and a portion of the call participants can then reenter the queue. If you have follow up questions.
Before we begin I would like to remind you that today's comments will include forward looking statements under the federal Securities laws.
We're looking statements are identified by words, such as well Pete intent belief expect anticipate or other comparable words and phrases.
Treatments that are not historical facts, such as statements about our expected acquisitions dispositions or asset FFO and AFFO per share guidance for 2019 in 2020 also forward looking statements.
Our actual financial condition results of operations may vary materially from those contemplated by such forward looking statements.
Got you know the factors that could cause our results to differ materially from these forward looking statements are contained in our FCC filings, including our reports on Form 10-K , and thank you.
With that I would now like to talk to turn the call over to Chris Volk, Chris. Please go ahead.
Hi, Thanks, so much lesa and good morning, everyone and welcome to store capital from third quarter 2019 earnings call.
With me today are married to our Chief operating officer, and Cathy long, our Chief Financial Officer.
On the investment front, we continued to be very active during third quarter, but it doesn't activity at almost $400 million.
Well I'm hearing to the granularity and diversity that we're known for.
Mary will run through the number in more detail with you, but we're happy with where I'm going to step in penetrating the large market that we drop well maintained a focus on meeting the needs of our existing customers.
During the quarter, we also profitably disaster, approximately $290 million <unk> real estate, which included our first transaction in the 10 pretty one exchange market.
Year to date, we have invested well over $1.1 billion acquisition, that's called approximately $389 million real kicking back.
Our your state investments and property sales reflect our ability to consistently in back again and the best assets in ways that are accretive to our shareholders.
At the same time or portfolio remained extremely healthy NAXI rate of 99.7% and about 73%, but not lead contract rated investment grade quality based upon our store score methodology.
You will hear more about our property investment and field activity Evercore Your health Mary.
We raised our dividend by 6.1% during third quarter, and even so our dividend payout ratio approximated, 70% or adjusted funds from operation.
Turning to provide our shareholders with a highly protected dividend.
Reported eight <unk> about 8.8% for the first nine months of the year are healthy dividend increase nonetheless, it enables us to improve our conservative apropos payout ratio for the same quarter last year.
Importantly, it's such a low dividend payout ratio, we've been able to find a meaningful portion BARDA connectivity to retain the cash flow.
The care that reinvestment in our historical focus on maintaining and Youre kind of same store rent contractual increases nearly 2% to drive the majority of our expected yeah, Oh sure growth.
That's a crappy will illustrate the combined that internal growth with external growth. It is a critically funded could move your issuances, which the past two years had been successfully funded for fish and aftermarket program.
But your equity issuances have enabled us to also maintained it consistently conservative leverage profile, which at the conclusion of the third quarter was below our guidance range at 5.4 times.
Our 2000 19000 activity was funded through a combination of or continued operating cash flows.
Proceeds from asset sales newly issued ATM equity proceeds from our first quarter public unsecured term note issuance and the limited use of our revolving credit facility.
Our balance sheet remains well positioned at the conclusion of the third quarter a pool unencumbered assets stood at 5.3 billion dollar were about 63% ever gross bye.
Given our performance can be store had and people financing flexibility across a wide array of debt and equity options.
A particular note with our unsecured note holder, we have amongst the lowest read unencumbered assets. However, while we know.
No they do each quarter as your arsenal to fix it or relative to our third quarter in person that carry.
Our weighted average lease rate during the quarter was just under 7.7%, which is slightly below where we were last quarter.
I didn't the average annual contractual lease escalations heard buckets made during the quarter at 1.9% you get a growth rate of return at 9.6%.
The corporate leverage in the area, 40% are levered and back to return well part will approximate 13%.
With that returns after operating costs and a 12% range.
Our outperforming investor returns from store, it's a part of such a public company had been mostly driven by having a favorable property level rates of return, which is why would take the time to disclose investment yield contractual annual lease escalators investment spreads to our cost of long term borrowing and our operating cost the percentage of assets, which are the for it.
Central variable that enable you to compute expected rates of return.
The weighted average primary lease term or not that's made during the quarter continues to be long or approximately 17 years.
Immediate post overhead unit level fixed charge coverage ratio for assets purchased during the quarter was 2.7 to one.
The media you tenant Moodys Riskcalc credit rating would.
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Well break the potent contract level fixed charge coverage is an immediate new investment cocker upgrading or store score for investments with far more favorable beat up late Q.
Our average new investment was made approximately 79% of replacement cost.
80% of the multi unit net lease investments made during the quarter was subject to master leases and all 85, new assets that we acquired during the quarter are required to deliver a unit level financial statements.
Joining us with unit level financial reporting for 98% to properties that are within our portfolio.
Back is critical to our ability to evaluate contracts in already Andrew the quality as well as to our access to capital without I will turn the call over to Mary. Thank you, Chris and good morning, everyone had a strong third quarter with almost $400 million and real estate acquisition at a weighted average cap rate of 7.7% bringing out.
Our year to date acquisition nearly $1.2 billion.
All right that's not good quarter were spread across 29 separate transaction at an average transaction size of $13.6 million.
Added 27, new customer relationship I closed the quarter more than 460 customers further diversifying our granular portfolio of net lease assets.
Approximately three quarters of our net lease contracts are rated investment grade and quality based on our store score a methodology delinquency than vacancies remain low due to our strong kind of partnership and continued active portfolio management.
At the end of the third quarter only eight of our more than 2400 property locations are bacon and not subject to already.
As we mentioned on our last call, we anticipated selling more properties in the second half of 2019 to take advantage of opportunistic game and to balance our portfolio.
During the third quarter, we sold 54 properties, which had an acquisition costs of $291 million generating net gains over that original cost of approximately $24 million.
Oh, the 54 properties 13 were opportunistic sales, resulting in a 21% net gain over original cost.
27 sales were strategic and resulted in a 6% gain over cost remain property sales were from our ongoing property management activities and resulted in an 87% recovery over original cost.
Now turning to our portfolio performance highlights our portfolio mix at the end of the third quarter remain consistent with 65% of our properties and the service sector.
19% and it's very on show and service driven retail with a substantial online content and the remaining 16% in manufacturing.
Our portfolio remained highly diversified with no single customer representing more than 3% of our annual revenue.
Our single largest customer <unk> farm group represented just 2.8% of our annualized rent an interest our top 10 customers were unchanged from last quarter and at the end of the quarter revenue realized on the top 10 was 18% of annualized rents and interest.
As we enter the fourth quarter, our acquisition pipeline remains quite thereby allowing us to be highly selective in our investments, while creating value for our customers and getting paid for that value. Our unique direct origination team continues to identify attractive new opportunities across a variety of industry that will reinforce our diversified portfolio.
Before I turn the call over to Cathy I want you mentioned that our fourth annual customer conference. The inside track Forum is coming up on January 29 to January 31st year in Scottsdale.
We're thrilled to announce that our keynote speaker will be John tougher hosted the popular TV show bar rescue and a long time food and beverage industry consultant. In addition to Mr. Catherine we have another stellar line up of speakers for this year's event, including an industry, leading economists a futurist and several capital markets.
Eric will help our customers get the inside track for 2020, and now I'll turn the call the Kathy to discuss our financial results.
You marry I'll begin by discussing our financial performance for the third quarter 2019.
Followed by an update on our capital markets activity in balance sheet.
And all of your updated guidance for 2019 and reduce our guidance for 2020 .
Beginning with the income statement, our third quarter revenues increased 25% from a year ago corridor.
$71.8 million.
Annualized base rent in interest generated by our portfolio in place at September Thirtyth increased 17% to 678 $9.
Total expenses for the third quarter right, how does $19 million, that's compared to $90 million in the third between 18.
Just over one third of the 29 million dollar increase is due to higher depreciation and amortization expense.
Related to our larger real estate portfolio.
In addition interest expense increased by seven or half million dollars to $39.3 million, primarily due to additional long term debt used to fund our growing pipeline of acquisition.
DNA expenses for the third quarter or $13.6 million up from $11.5 million a year ago.
Flipping the continued growth of our portfolio and associated staff additions.
As a percentage of average portfolio assets you know your expenses, excluding the impact of non cash equity compensation.
Decreased to 49 basis points average portfolio assets from 53 basis points a year ago.
Property costs increased by $2.4 million year over year.
With that amount was related to the new lease accounting standard that require a disaster items, such as impounded property taxes and the ground lease payments our tenants make on our behalf on a gross basis as both rental revenue and property costs.
On an annualized basis, excluding gift lease accounting gross up property costs totaled about 10 basis point average portfolio assets in the quarter.
With a slight increase your last year, primarily due to property taxes.
During the quarter realised $3.8 million of lease termination fee income and recorded a 7.3 million dollar impairment provision.
Both of these items were related to properties that we sold or are likely to sell in the near future and the termination fee income surged to augment our recovery on dispositions of the properties.
Well impairments are excluded from FFO and AFFO.
We've chosen to also exclude the lease termination fee income from asset, though as we don't consider these fees to be part of our core operations.
That's marrying noted we sold 54 properties in the third quarter.
Which on a book basis resulted in a $59.3 million gain on sale.
We mentioned on last quarter's call, we expected property sales to be higher in the second half of 29 chain and much of that activity occurred in September .
We continue to actively monitor and manage our portfolio and we may see so sales activity in Q4 as well the likely a smaller amount.
Oh, the 54 properties we sold.
One team were part of a 10 31 tax deferred exchange transaction.
The proceeds from the sale to acquire replacement assets.
Hey, AFFO increased 19% go hundred $16.1 million in the third quarter $97.4 million a year ago.
On a per share basis, I thought was 50 cents per diluted share a 6.4% increase from 47 cents per diluted share a year ago.
Chris already mentioned, our dividend increase so I'll just point out that since our IPO in 2014.
Increased our dividend per share by 40%, while maintaining a low dividend payout ratio and at the same time reducing leverage.
Now turning to our capital markets activity on balance sheet.
Refund is another strong quarter of acquisition volume with the combination of cash flow from operations proceeds from property sales availability under our credit facility at equity proceeds from our ATM program.
During the third quarter, we issued over 4 million shares of common stock under the ATM at an average price of $36.28 per share raising net proceeds of approximately a third and $59 million.
Year to date, we've issued over 13 million shares of common stock.
Average price of $34.20 per share raising net proceeds of approximately $453 million.
Our ATM program remains a very effective way for us to raise capital given a granular size of our acquisitions.
Substantially all our long term borrowings are fixed rate and our debt maturities are well laddered. The weighted average interest rate on our long term debt at the ended the third quarter remain consistent year over year at 4.4%.
A median annual debt maturity is $287 million and we have no meaningful near term debt maturities.
We expect that our free cash flow, which represents our cash from operations less dividends.
Plus proceeds from property sales well more than covered debt maturities coming due in any one year for at least the next several years.
At quarter end, our leverage ratio was at the low end of our target range at 5.4 times net debt to EBITDA on a run rate basis or around 39% on a net debt to cost basis.
And at September Thirtyth, approximately 63% of our gross real estate portfolio, but unencumbered.
Giving us considerable financing flexibility.
As we head into the fourth quarter.
Leverage remains conservative.
And we have access to a variety of equity and debt options to fund our large pipeline of attractive investment opportunities.
In addition to our ATM, we have to full $600 million of capacity under our credit facility, which also has an $800 million accordion feature.
Now I'll provide an update on our guidance for 29 team and then in two days our guidance for 2020 .
Due to our strong investment activity in the third quarter, we're updating our guidance for 2019.
Now projecting at the FFO per share in the range of $1.96 to $1.97.
Up from the previous range of $1.90 to $1.96.
Hey, AFFO per share in any period is sensitive not only to the amount, but also the timing of acquisitions property dispositions and capital markets activities.
In addition, real estate acquisition volume often weighted towards the end of the quarter, which results in little impact FFO per share in the current period.
Our AFFO per share guidance for 2019 equates to anticipated net income of 93 cents per share excluding gains or losses on property sales.
Plus 97 to 98 cents per share as expected real estate depreciation and amortization plus six cents per share related to items, such a straight line rents equity compensation and deferred financing cost.
Finally, I will turn to our initial guidance for 2020.
Based on our current projections for real estate acquisitions for the remainder of 2019.
Plus estimated acquisition volume of $1.2 billion, which is not a projected property sales for 2020 <unk>.
We currently expect as AFFO per share in the range of $2.05 to $2.09.
At the FFO guidance, if they've done a weighted average cap rate, our new acquisitions a 7.7%.
On a target leverage ratio in a range of five and a half to six times run rate net debt to EBITDA.
Our assets AFFO per share guidance were 2020 equates to anticipated that income excluding gains or losses on property sales of a dollar to dollar aside per share plus 95 to 96 cents per share of expected real estate depreciation and amortization.
Well, it's approximately eight cents per share related to items, such as straight line rents equity compensation and deferred financing cost amortization.
And now I'll turn the call back to Chris.
Thank you so much Kathy.
Before turning the call over to the operator for questions I want to take a moment highlights some of the added disclosure in our quarterly investor presentation.
This quarter, we elected to in sort of cap on a corporate responsibility initiatives.
You are often referred to in the Investor marketplace is E F G.
For environmental social and governance matters.
Sometime back we had to the PTAB corporate responsibility to the front page of our website. So this effort is simply a continuation of that.
Candidly I prefer the notion of corporate responsibility, yes, cheap because the essential point is that our corporate successes should ideally benefit all are many stakeholders.
And no stakeholders naturally include our shareholders employees creditors customers suppliers and then many communities around the country that we impact.
With regards our corporate presentation personal responsibility slides were limited to a discussion of corporate governance.
Which is something which we have always excelled ocean pack for shareholders.
I would also note that supports the characterize from the outset by highly disciplined its business model.
Resulted in the highest gross unlevered rates of investment return amongst our peers the highest spread between both gross rates of return and our cost of borrowing.
The result of this effort is we've been able to be consistent leader in the creation of economic and value added and compound market value added growth, which we disclosed in our appendix, which today its performance metric emphasized why I assess and the revaluation of corporate leadership teams.
In addition to our hard work on behalf of our shareholders. We've included new corporate responsibility slide illustrate our commitment to other stakeholders.
We also included more extensive information on comparative lease durations this quarter.
On page 38 of the presentation, we illustrate the comparative stability newly originated primary lease terms over the past quarters.
Jos itself to our direct origination investment emphasis.
Stores also because we've been among the leaders and portfolio lease term with amongst the lowest levels at least maturities over the next five years.
This leadership results from consistently realizing amongst the longest primary lease terms on newly originated investments.
Our comparative corporate youth relative to a few more seasoned company.
And our market, leading use of master leases, which we often reset upon the addition of new property.
The importance of maintaining a low near term lease maturity profile is to insulate our company from volatility. It's it makes store more defensive should there ever be a recession.
Finally on page 39 included this slide that illustrates the comparative direct origination tenant diversity and lease profile.
You have a number of slice that we deliver the illustrate our unique place and market position within the net lease sector.
Slide 39 adds to this list and illustrates some of the important business model differentiation that have enabled store to have amongst the most highly diversified in high performing investment portfolios in our industry.
And with those comments I will turn call over to the Affleck questions.
Yes. Thank you.
Now I'll begin the question and answer session to ask a question you mean press Star then one on your Touchtone phone.
If you're using speakerphone, please pick up your handset before pressing the he's just try your question. Please press Star then too.
At this time, we'll pause momentarily to assemble the roster.
And the first question comes from the crossover with Bamberg.
Hey, guys, how you doing.
Yeah, good or maybe you can give us some color on an eight new tenants in the quarter what were the areas. They were in what were the three new industries and then on the disposition side, where there any trends there in terms of customers or industries. It sounded like you said some of that was strategic.
So any any help there as appreciated.
Made its married so the eight customers were actually and that was actually a number. So we actually added God 27, new customers and that was the crossed a plethora of asset classes, just like we always do.
In terms of the dispositions yeah, we did due primarily a good portion of them more strategic and rebalancing the portfolio and I think probably the biggest Ah Ah Ah result, you'll see isn't the manufacturing portfolio that came down from 7.1 to 16.1 on that.
Okay. So was it a specific tenant or was it just an area that.
Yeah.
Again, I'll characterize I've kind of.
Okay, maybe one just on the amount if you can I'm gonna sales in underwriting people can you just remind us how many people you have in those departments, how that looks as you guys continue to scale.
I'm just curious you know how that looks as you ramp because you put that slide and that you do the most direct origination of anyone in this space.
Oh, okay.
Okay. So we have actually on the about 17, each I'm on the front end and those departments.
Oh gosh, they like writing and then the outlook for next year I'm. Just is does there need to be any adds or are you guys have enough for what do you want to do next year.
I wish I could be some ask albeit the margin that's not going to be as it were not looking to do a huge number I mean, if you actually made if you look this year the net number its be in one so we're keeping that the guidance and see if we can beat that guidance I mean, if that's the assets as we would like to beat it but.
Hi, yes, given the sales activity that we've had this year you can do the math for yourself and your your acquisition.
Our total for this year isn't a whole lot different from last years last year, we did a little over billion six for the whole year. This year, depending on where the sales come in the acquisitions come in we can be very well kind of in that same ZIP code next year. You know our initial guidance is for a billion to net.
Basically a net number and that's up 9% from this year. The gross number if you were like looking at the <unk>. The sales of the number maybe just maybe 6% different so it's not we're not looking at doing a.
Quantum leap in terms of a acquisition or investment activity and so you're not going see us to a quantum leap and in terms of hiring new salespeople and new.
Credit people.
Okay. Thanks, I'll get back in the queue. Thanks, guys.
Thank you. Thank you and the next question comes on Caitlin Burrows with Goldman Sachs.
Hi, good morning.
Because of your exposure to Noninvestment grade tenants I think some investors are sometimes concerned about your <unk> risks in your portfolio in the case of a downturn. So just wondering if you could go through some of the other important aspects of your strategy that mitigate this perceived risk.
There's probably a long answer that we've talked a long time it out, but maybe some earnings call type first thoughts. Thanks.
Yeah, no worries Caitlin, you're you're you're leading with a massive cognitive bias start there.
Which is to suggest that if you don't have investment grade tenants that somehow you're more vulnerable and the VAT AFFO recessionary economic downturn.
And that might be true if our industry voted with investment grade today, but in fact.
They're not Lotus divestment Reits have so if you're looking at fitness clubs there no investment grade fitness clubs, there no investment grade veterinarian clinics or no investment grade early childhood education companies, they're a handful of investment grade restaurant companies, but they've never seen to put the other restaurant companies out of business and recession.
So.
You know I would put our portfolio up with anybody else portfolio anytime during a recession in fact.
The fact that we're investing and just profit centers tells you that we're going to be ahead of the head of the boat. So we're not just in a cost center for doing a profit center and most of our leases have enhancements like master leases were.
Additional credit enhancements that we might have enough. Finally, you just look at the new flights and we've added in our DAC about the lease term and our lease terms are far and away at the longest and the industry. So and that's important because theres a recession and people in our session might be able to walk away from leases and over the next five years, we have virtually no.
And one of the reasons we keep.
These Lisa long term is because since we have so many master leases, it's very common for us to Recharacterize master leases, when we actually add on new properties and so we extend those lease terms, which is why we've been able to keep up kind of consistent lease term out there in our in our portfolio. So and then finally I'd just ask why I mean, if you look at the last great risk.
Session and say, we're who added all the jobs I mean, they all the jobs were added by middle market companies and they were not added by March.
Some great companies and so.
So I hope that that puts you at is.
Got it and then maybe if you could come in.
Store share price has been pretty strong. This year can you go through what impact. This has if any on the teams thinking regarding acquisition volumes and funding of that activity.
Yeah, I you know, it's essentially so the marketplace when they when when people get multiple expansion.
And the whole net lease basis got multiple expansion. This year. So when people get multiple expansion. The the notion somehow is that oh by the streets asking you to buy a lot of real estate.
You'll note that this quarter, our net acquisition activity was about $100 million. So in fact, we.
Stuck to the game plan that we set out for US also beginning of the year on we were very clear that we are you selling real estate of recycling the cash which is which is important way of adding to our internal growth and also mitigating risk. We're all about here.
No not being the biggest company not going to fastest from an acquisition perspective, we're about trying to be creating the best investment opportunities offered the highest versus just the rate to return to create the most market value out of the most economically.
And.
So while the you know the high multiples basically tell you could sort of fog, a mirror and add to.
FFO per share growth I mean, you could buy almost anything and add a focus your growth from accretion perspective.
That doesn't mean, you're actually generating the highest risk adjusted return in a two totally different things out. So I support has had multiple fitness and this base bandwidth before we had it in the middle of 2016, and we just stuck right to our knitting and just continue to make investments that were not hugely accretive created market value added I mean.
Just want to create the most well for our investors and and the most benefit for our stakeholders and we're not going to just chase deals because they're accretive.
Got it thank you.
Thank you and then ask question comes from Craig Mailman with Keybanc capital markets.
Hey, guys.
If you just curious you mentioned you guys are kind of at the lower end to your leverage target here heading into the fourth quarter and next year I'm just curious as we think about.
Again, where your cost of capital is versus where you guys are buying person or maybe where we are in the cycle should we anticipate you guys trying to keep that a little bit lower and maybe a you know raising a little bit of incremental equity or would you expect that to kind of trend up is back into the range, maybe kind of middle.
Hi.
Movement.
Hi, Craig its Kathy.
Yeah, we are at the lower end of our target range at the moment, we feel very comfortable with our range. So you'll see us take advantage of opportunities to issue debt. This is a nice market to issue debt.
That being said the equity markets, great too and and as you know we.
Make good use of our ATM all during the year so.
Were mindful of keeping our.
Leverage within the range, we feel comfortable at the current range I don't think that we will take at lower though I mean, I think that we are very very comfortable and Craig. This is Chris I mean, our leverage today I think at the end of the quarter is 40% isn't.
30, 939 o'clock cost bases, which as you know so if you're if you're looking at the end you're trying to compare a companies.
Cost basis, probably a pretty good way to go about it.
So were 39% on a cost basis, not only with we've been in from the range of 40 to 42, its a ridiculously low number I mean, if you. If you think about just 40% levers if its insanely low.
And our our secured leverage is closer to 70% and we get single, a plus and even AAA financing it simply refinancing to 45% leverage on on the on the as it back side. So.
Okay. So think about this I mean, our unencumbered assets, which are 63% harass as you know this quarter are levered, a whopping, 25%. So if you asked us to lower our guidance and we are keeping our secure guys. The same then our 25% leverage would dropdowns that.
20% or 50% leverage on our on our I covered assets, which is something I think our shareholder should like because it doesn't really help them with returns which is important.
Moving on makes sense then the blended yield you guys had this quarter came down a bit sequentially as kind of consistently you guys are viewing for.
2020 is that are you guys seem cap rate compression and specific parts of where are you guys are putting capital out or is it just a function of the 10 year coming back in.
Do you guys are just trying to be a little bit more conservative.
We're not seeing like an abundance of cap rate compression, but a year ago today, roughly a we did our guidance for this year and.
At that time, we set our cap rate would be around 785. The tenure treasury it was around 3% at the time.
I'm expecting will probably close out this year at a cap rate is somewhere around 780, or so we're well we're lucky to fall short of the something maybe five number.
As you saw this quarter worth 770, so what's happening answers I take a slight trend on us.
Now that's that's on the cap rate side on the borrowing side.
We issued 350 million offered the senior debt in the first quarter. This year at a cost of for 65.
Today, if we were to do that same debt would probably be sub 350 or.
So you so our cap rates have come in five basis points, our cost that that's come in hundred 15 basis points or spreads basically 110 basis points better Oh and by the numerator does matter. So like I think it yeah. We're not just in the spread business. So whether we do a deal was they cap or seven cap or six cap that top line number.
Matters and really adds to return so investors need to pay attention to that as well, it's true to the spreads, but but nonetheless, I would say our spreads or watch easier than they were if we're at 770 for next year.
It's really a function the fact that we see.
Right slow there is a loose correlation between tenure treasury rates and cap rates, because obviously you that it affects the price at which people can borrow money and keep in mind at 90% of the marketplace that gets studies done away from all the public companies you cover so and all those people that are financing all those assets are doing it was secured debt or using.
Higher levels of leverage than we are so their way how much more highly levered than 40%.
On a transaction basis, which in fact helps a little lower cost to capital in some respects right then public company. So.
Since those people are gonna be focusing on the cost of debt to be able to finance the assets.
If I if tenure treasury rates fall or were like were falls all things being equal.
You're going to see the cap rates tend to get compressed throughout the space.
Thing that will stop that is if banks start getting nervous need and they get concerned about where we are in the cycle, which is the other question. So.
So they're concerned about recession and then the me elevate the spreads. So so we're going to see some given take on that's.
We think 770 is doable number for next year and I know if.
The spreads hold and we'll have one of the nice to spread eurs that we've had in our history hopefully.
Thank you.
Thank you and the next question comes from the color I'll start with Morgan Stanley .
Hi, everyone. This is Kevin on for Vikram I, just a quick question here.
First question was just in terms the real estate expenses I notice if I take a look at that as a percentage of the gap rent I understand there was an accounting changes obviously went up over 2018, but it was little bit higher than we thought it would be around 2% of GAAP rents for the third quarter. Just looking forward is that kind of a run rate you'd expect to see about 2% real estate expensive as a percentage of gap.
Brent or is it really is going to kind of fluctuate kind of hard to determine.
Oh, hi, its Kathy so we kind of look at it as a percentage of assets as a percent has got the portfolio itself and and it does range I mean, we've headquarters as low as four basis points of our assets.
And its highest 10 basis points of our assets so.
Projecting next year, you know that we're not projecting its highest 10, but we're not projecting at the lowest for either so I think if you think of it that way as a percentage of assets is probably a easier for you to moderate the other thing is it a lot of as soon as accounting driven relating to the lease accounting. This you're right about half of it is about half of it with Reimbursable.
If you're looking out to compared to last year, they're not really comparable because of that you have tobacco the reimbursables right [noise].
Got it. Thank you very helpful. And then just one additional one just in terms of the stores a store scores of the assets you dispose off I just kind of looking into can you disclose or just give us any idea of where those were out relative to the medium the portfolio and I guess really kind of what I'm looking at it.
With this I understand some was opportunistic summer strategic but wasn't also managing the portfolio and looking at kind of credit. It kinda just you know doing some pruning that makes us.
Yeah. This is married Kevin So as you know our disposition strategy. It is across you're correct. We have some opportunistic sales awesome strategic sales and then property management and I would say in the strategic area. In particular, we are always looking to make the portfolio that we can hold better. So you can probably assume that you know that is the case.
I'm on the opportunistic side the same same mission, but I'm a lot of times, we're looking at that we haven't done business, where you know this isn't a repeat customer. This is something maybe a reverse inquiry someone would like to buy the property I mean, we have a credit upgrade and we're going to and we won't be doing business with that customer so little bit different on the opportunistic side, but yeah says.
We're calling the portfolio, we definitely are looking to.
To have to make stronger portfolio.
Great. Thanks, a lot very helpful.
Thank you and the next question comes from Giovanni seed with Deutsche Bank.
Hi, good morning.
<unk>.
The lease termination.
Can you give us.
Lies.
Meaning exposure might be there.
So this is Chris spoken I'll I'll kick the can answer every call answer the question [laughter] went up.
But I think I wanted I want to take you to a higher plane.
So I see the lease termination fees this quarter amounted to $3 million.
Hi, and rights to me in box it related to three individual on tenants they related to assets that were nonperforming and about to be sold one of the reasons. We did not include our lease termination fees in the air for FFO, which can be a common practice is because.
We thought that from from a principal perspective, they are really associated with the sale of assets. I mean, we were looking at trying to liquidate properties and lease termination fees are part of that and I. So so if you. If you take a look at the Big picture names can give you. Some some thought food for thought here. So so last year we sold.
$227.8 million worth of assets at cost in our gain on that was $23.6 million, which is about a 10.6% gain on cost the more important number actually though is that they can operate at which we saw a 50 basis points less than a cap rate that we were buying so there was a 50 basis points accretion there when we are.
A new assets so.
And were you've been fortunate to be able to do that.
Year to date.
We sold 389.2 million actually caused the gain over cost is $20.7 million, but that does not include $3 million and lease termination fees, which were really part of the strategy for that gain and when I'm doing this by the way ignore all the notions about a loss impairments lot requirements or just.
Timing issues like I'm going to be selling a property the next quarter, but I'm hearing it this quarter, it's an accounting convention not enough and he has convention. So what I'm, giving you is just sort of the raw financing, which which encompasses all the accounting. So we had 389.
0.2 at cost assets are gain over that cost original cost off was $20.7 million, which is a 5.3% game, but if you add in the 3% $3 million and disposition fees that gets you to 6.1% gain and because we think that way.
And we're thinking about and we're not adding back our gains or losses in the air for FFO than we thought it was not proper for us to ask lease termination fees, either Navajo, even though a lot of people do to do that and we probably it would probably wouldn't acceptable we chose not to do it.
Appreciate that I was just trying to get more color on the actual today.
And if there are no shirt you that today.
The after they're not there's no exposure to the tenants are done yes. So okay.
So there are three three individual assets.
Great and then I'm just can you give us an update on how you're thinking about exposure to the full service.
Restaurant space, just given sort of the softer kind of course, the income out of that subject and Mariana cycle. It looks like ahead ticked down as a component of the pipeline, but wasn't sure if that was the numerator denominator.
So yeah, you're you're correct. It is it is down this quarter. This is Mary and it's probably a combo of pipeline and and actually denominator effect too as we grow but for the most part restaurants and we've we've talked a lot about does there so well heeled asset class people like them. They are they get a lot of.
Activity again, Chris mentioned earlier, 90% of look at San gets on away from US. So you got a lot of people sort of bidding on restaurants, so let's pick our spots, where we're going to stick to our vision of creating our own contracts have been no profit good profitable unit to be able to get paid for the rest that we're taking a sell on so often times. We don't when are we don't I get to play much in the rest.
Fraud space as a result, but I would say I'm like space and we take a look and pick our spots and we don't see any concerns and then at this at this time.
Thanks.
Welcome.
Thank you and then especially constant mandelson just with Mizuho.
Hey, there.
So ill handle hi can you talk a bit about I guess the level of dispositions in the quarter, how much was it sort of budgeted or in your plans versus maybe incrementally opportunistic.
They include any.
Bulk or many portfolio failed and what was a cap rate on the asset sold.
Hi, handle I'll start and you know when we first I'm good guidance for the year, we were anticipating that the sale would occur earlier in the air and said we are fortunate that the bulk of the sales activity happened in September . So we were able to keep more or the AFFO that wasn't being generated by that portfolio.
In the quarter. So you know.
Outperforming wherever we expected to be for the quarter, and then I'll, let Mary comment on mix and things like that yeah. So handle as I mentioned earlier, but you'll see the biggest result of our sales in third quarter, what are the manufacturing portfolio coming down from 17.1 to 16.1, so you'll see that that was a rebalancing of the portfolio.
A lot of it was just rebalancing so little bit more on the strategic side. The certainly some opportunistic wrapped in there and <unk> as Chris mentioned earlier, you know, we're still able to sell assets that you know about a 40 50 basis point or at least a cap rate lower than what we're acquiring at so I'll give you some feel for disposition Kathryn and then as far as.
Hi, there were other portfolio stuff, we don't really come to comment on on the how we do players or individual acquisitions may sometimes we do small groups, but it.
It varies.
Got it fair enough and then maybe a bit on the use of the 10 31 channel I guess I'm curious.
How much of that channel you may use going forward and maybe outline some of the benefits you see via using that channel.
So I kinda give you some specific numbers on this but the at the at a high level. The issue is that ask we I get more season as a company and we're selling assets the tax bases of assets declines over time, and so the gain for tax purposes exceeds.
The the gain for on a cost basis, I mean, a and.
And so and those gains are are sort of fundamental underlying pennings off of what you're able to FFO or your funds from operations your dividend payout ratio needs to be and so the dividends that we pay out are dictated by taxable income non-GAAP income and.
So so to be able to minimize taxable income one way. So you can do I want to tools you have is to be able to do tenthirty changes were basically it does the wholesale doesn't go through taxable income.
It doesn't give you the same kind of issue that lets say most the big reach out their offerings. So they have incredibly low tax bases on on all their assets underlying the right in our case, we don't we just it but we will start to have some lower tax basis, not hyper low, but lower tax basis on some of the assets as we decide to.
10, 31 assets over time to be able to essentially defer those gains and you can differ them pretty much infinitely as long as you just keep doing company when exchanges.
Yeah and now this is Kathy so.
There were 17 properties, where we deferred the gain and it was about 35 million dollar tax gain that was able to be deferred through this transaction and we've already a replaced the properties used to proceed for replacement assets. So that done and we'll look forward and we'll be watching it going forward.
Great. Thanks, then one last one maybe talk a bit about art been still a top but it looks like top three or four tenant here, 2% of revenue unchanged just curious how you're feeling about that exposure today looks like there's a lot of.
Band on the market so lot of other people seem to be wanting to sell just curious about how you're thinking about your exposure. Thanks.
Oh, Hey, that's an area. So I will tell you like I realize you know as far as is sponsored by Thomas actually they have an acquisition and integration strategy that they're working on they've also they bought other furniture companies as well so they're working through that integration and as you know integrations can sometimes be difficult.
And take a you know takes some time, so from that perspective, where where we've committed to being a partner with them and they're working through that so I would say, that's where we are with it we felt we feel good about what you're doing it just you know not all of our fans, Arkansas. So so our fancier name, but actually includes Oh, well then.
Well for 11 I better about so early on we sold some of the our fans off we visit to diversify and make sure that we had a geographic diversified footprint.
Got it got it okay. Thank you.
Thank you and the next question comes on Rob Stevenson with Janney.
Hi, good morning, or afternoon, guys. Chris are you talking about how close you guys were 200% payout of taxable earnings run rate. When you did the dividend increase in other words, how much of the 6% increase was required because of strong earnings growth over last year plus versus how much was discretionary how the board thought about that making.
Rescission.
Hi, This is Kathy actually so we do pay out pretty much all of our taxable income part of the issue is gains right gains on sale a property do create taxable income and you have to consider that when youre thinking about.
Dividends and and the pay out there and the gains of course are hard to predict so one of the tools. We use is to do the 10 31 transactions to be able to defer those gains so that you're not I'm looking at having to increase your dividends because you happen to have a lot of gains.
Hi, taxable gains in the here does that help.
Yeah, I mean I've got the other thing.
So from your standpoint, how much how much of the 6% increase was discretionary versus what you were going to need to do due to maintain the 100% pay out and whatever you needed to do with gains et cetera, I'm thinking I I'm, just gonna say this and it could be it could be a little bit off here, but.
'cause it because what you're asking wasn't really discussed that way at the board meeting because.
We haven't really been close to the issue of having to increase dividends in order to meet our taxable REIT status. So we have room that we could move lower if we want to on our payout ratio I'd be issue you know the volatile issue. They copies talking about is the gains from the sale. So if you're looking at sort of core FFO or core.
FFO from operations, New nor are they died gains on sales activity. We would have been find there would have been no issues at all so if we wanted a raised our dividend left it could have done that but.
And how much less who might have been able to not race for dividends. So I mean, but but if you included.
The gains on sale and that creates a different picture altogether. Its which is why are you want to make very yourself as a 10 31 market.
Sure, Okay, and then Mary what's been your success ratio these days.
In terms of when a property goes darker tenant moves out in terms of you guys releasing it versus just deciding to sell it.
So year to date, we've had we've had actually an 87% recovery lap.
Okay, perfect and sales definitely thought I'd, aquas and and I would say, we're agnostic on what do we leased and sell them.
So would you have to be so if we if and when we calculate recoveries, we don't calculate it necessary the way everybody else. So Oh. So for example, let's say we have a property cost me a box and we get a million bucks back for that may not be 100% recovery. The recoveries defined by what you can do with the proceeds that you're reinvesting were really.
Focusing on AFFO per share. So so if we're if we have a million dollars and rent coming in we replace it with $900000 and wrap that's a 90% recovery. If we have a million dollars <unk> property cost and.
And we sell it and we get.
And we reinvest the money and we get 90% of the rent back from reinvesting. It then it's a 90% recovery. So so we're looking at it from that perspective, and we're going to try to maximize their phone for share which is the whole goal.
Thanks, guys.
Welcome.
Thank you and ask question comes from Keybanc, Tim with Suntrust.
Thanks, I'm just want to go back to the kinda earlier topics about tenant quality and recovery ratios.
Hi, I'm not sure how you want to answer this question, but maybe this year or over the past five years, how often are you, giving rent relief to tenants just trying to get a sense of the leakage or the casual leakage that might occur overtime.
Well the.
The answer is at once a year and our book, we actually put down we have a whole flight on losses, and we do it on an average basis. So we don't do on an annual basis, but in me a poster presentations on page 43.
And.
And so you have losses on annual basis for property management and also you have to sort of work in process not only to the only good working process includes all of leakage to you're talking about so do you want and you want to include everything so if you're giving somebody a 50% rent break or something like that it's going to get included Mehta special servicing it's a loss you know and we're treating that.
At the same ways were for your vacant assets.
Net lease companies are good at reporting vacancies, where net lease companies tend not to report, our how many vacant and paying less than optimal.
Now I properties are our and that's just because it's just.
Hi, there there's no consistent way of doing it so what we do as we.
Sure calculate this for you and then we basically do it on an annual average for you it's going to swing from year to year you know.
And.
And sometimes it swings can be meaningful and.
By now and.
And that's one of things that we also tries to get people to sort of avoid looking at because if you have like some year that that's a bad year doesn't mean that there's some huge secular trend going on it's just part of the business cycle like 12 months in this business is not equate to a business cycle.
Quarters, not business cycle, so what we're having a from a portfolio nonperformance issue on a quarter is not going to be business cycle. So the reason, we disclose our cumulative nonperformance Saturdays to ever today everyday lives here and I would say that collectively you know out of the whole portfolio. There have been lets say 40.
Instances 40 somewhat instances of of tenants nonperforming you know we've had recoveries for including people that went bankrupt and never paid us to people that you know I just from off let us out it's been like 40, plus you know.
Tennis over nine years so.
And it's there and it's all there for you to say.
<unk> do you said page 43 is that what you're looking at <unk>.
Yep, Okay and.
Well update page 43 ended the year so for so for Q1, and we're doing it the 2019 numbers, you'll see page 40 pick it up have you see those numbers tick off it'll be meaning that we have more activity that happened in 2019 than we had previously so you'll know that the trend with fire and then on next quarters or any color you can ask us about it.
Okay. Similar question when you look at the.
Credit quality and how resilient that credit quality is or the median cash for while coverage ratio whatever metric you want to look at.
Overtime.
As the cohort H, meaning you're at 2014 investments right, how that credit quality ages overtime, how to 2015 cohort investments age over time.
Obviously, there's a natural tendency probably to come down a little bit and credit quality does this normal business up but any kind of lessons.
Learn from that.
We learned a lesson I just like every day and ER and whenever we have issues. We're looking at what those issues are.
And as you know, we try to look and <unk>.
We try to learn from the stuff I think I come to conclusion I keep in the thing to look at is you know two two things are really important one is do we really like the business people are in a.
I mean, do we think they have a good business model and the second is Oh, we're focusing on me get level coverages and the third is of course, we're looking at the leadership in my management team and the alignment of interest I mean, those if you're looking at big things look as we look at that stuff credit moves around all the time, so a credit individually company.
Is that we're really great credits them sell to other private equity firms and then they get hooked up and the credit profiles change.
We spend a lot time looking at capital stack issues. So for example.
You know if you're looking at.
Slide 40, which will give you a three years' worth of credit histograms overtime overlaid on to each other.
Which will give an idea of sort of how the whole portfolio looks that you're going to see that there can be some gaps where on a Moody's media score basis. The credit for profile of the pool has gapped out a little bit so north where we were better in 2017 as a pool than we are in 2019 and so then the question.
Is why what would cause those issues and a lot of them are driven by by growth of our tenants. So they're just growth driven I eat.
We don't have a four years worth of revenue is what we have that stack that reflects less the full year for the revenue. So that's a big piece of it another piece of it is some of the Super recaps, the somewhere kind of gone through and that's part of it but if you look at the store score store square as haven't really changed at all I mean, they've been pretty flat and one.
Things that we're going to be looking at you know and then in the years calm are going to be capital adjusted store. So for example.
A lot of our tenants have.
You know massive amounts of unsecured are under secured borrowings that are way behind us, which is sort of equity like from a from a forced perspective, which would effectively make the credit a lot better and I think that would tick up the credit by probably three not just from a credit rate perspective and moved those bought a numbers on the corporate PDF just way up you know.
So so we spend a lot of time looking at this we've been investing a lot of FBI system through using S.A.P. at Tablo and looking at how to trends the stuff and you will start to see the fruits of that become.
Revenue in the years to come.
Alright, Thanks, Chris.
Sure.
[noise]. Thank you and once again in light of time, we ask that you do limit yourself to one question. Please next question comes from drama Southern with Ladenburg Thalmann.
[noise] good morning.
Internationally and I'm just a question should do you expect given in 2020 guidance do you expect the disposition volumes to kind of remain more than 2019 level versus kind of what you're doing in 2018 2017, well more elevated.
Yes. This is Kathy we do okay, and then touch again, maybe on a page 40. This slide 43 of the presentation quickly if I'm trying to think about you know maybe backing into kind of analysis in a wide gross number for you guys.
It's essentially just the internal gross unlevered ex the kind of portfolio management, you kind of you build your realized gains on dispositions me is that kind of a fair assumption and then as a result, whereas that number kind of trended in prior years I mean, just as it did you were kind of saying Stephen's question and measurement of the entire history of the.
Portfolio.
Right. So so if you look at our our average.
Tapped.
Yeah.
Lease escalation number is 1.8% 1.9%.
We have not historically always gotten the one point here and 1.9% because inflation is sometimes dipped below the one point I hear what 0.9% so.
Which is what happens if that's going to create issues, but you would take your basically a and also by the way keep in mind that Ah, yes about 63% of that happens every year and then the other ideas. The the rest of it is mostly every five years and that five years can be lumpy too in terms of when it when it comes in.
But on average is 1.81, 0.9%. So then you take your 1.81, 0.9% subtract your losses from property management track your losses from work in process, just 50 basis points that gets you to.
Secondly, same store NOI long run average of 1.3%, Okay, which is what you would look at if you were looking at like office reach or anything else I mean, if you're trying to compare same store it same store.
If you kind of 1.3 yeah.
And then and of course, then you add in the fact that we're reinvesting all the say AFFO.
And then you get more term growth on top of 1.3, but.
That's how you doing okay, but at 1.3 that kind of comes out in slide 43 is fairly comparable today to the entire history the portfolio.
We don't make comments about what happens in 2019 versus 2018 in specific and we obviously have some views on on where it is but we I would say we're not seeing anything in 2019 as this strange and we're seeing in fact, a a watch list it's less than it was the beginning of year so of assets. So.
Okay.
Is it for me thank you very much.
Thank you and the N., especially constant Spencer out away with Green Street advisors.
Hi, Thank you I'm, just going back to the credit loss discussion I realize you guys provided that average annual or the annual average.
Just back into the same property NOI number, but why not provide like enhanced disclosure and show a true same property NOI number quarterly I realize you said you know Chris is not reflective of a fall business cycle, but I think the investment community. You know, obviously realizes that I would just benefit from having the enhanced disclosure and that the transparency on how that business is doing quarter to quarter.
[noise].
Well, we'll consider it I mean I'm a you know weve gotten that question I mean, I think that.
No I think we're the only read and then at least based even do page 43, no so and.
You know if everybody else wants to sort of give you a revenue walk on and by the way you can't it's got to be again, it's got to be a cash revenue walk. So it's got to be sort of an AFFO revenue walks you gotta back out all the noncash stuff, which there's a lot of noncash stuff in the revenue stuff. It's I mean for example, we have on the revenue side, 10% of our business includes construction.
We don't always get the rents on the construction in there there are there things are yes, as you're accruing some of that stuff or you're not getting arrest.
But so it is what you're asking for as a very big undertaking and it will result in perhaps volatility from quarter to quarter. That's a business that were in but if you you know on your hand, if you're sitting back in your chair and you're looking and saying well I'm going to just take a store capital I can't take there and NOI I try to backup the noncash stuff and then.
And then divided into the gross fixed asset number, let's see what might yield as it's going to be in the ballpark it should be so.
Right and I certainly understand obviously you know the components you just laid out construction apparel Oh lets you know, it's volatile and it varies quarter to quarter, but you know I think there's something that he said obviously for you know being an industry leader on that disclosure best practice front and I. Just think that you know there. There's a lot of good I think that just comes from the enhanced transparency on you know in the business quarter to quarter.
Oh it was across everything.
Thank you.
We'll take on her but.
Thank you and the next question comes from call. It <unk> and last question also column inches Raymond James.
Thank you good morning out there every one.
Hi, Collin how are Ya.
I just wanted to quickly follow up on the disposition discussion I know we've covered a lot of ground there already but I specifically just wanted to drill into your rebalancing comments on the manufacturing front marry it looks like there was a notable decrease quarter over quarter and the plastic and rubber products bucket, but then further growth and metal fabrication, just tying that together.
There are with the pipeline just want to get a better sense for how you're feeling about the <unk>, where there's the most opportunity and that broader category and potential for further refinements.
Okay, Great. Great question, we just really really don't look at it like that we just look overall, it manufacturing and starting to call. The portfolio. So I wouldn't get into sorta industry types, but as you know we're looking for profit center manufacturing assets.
That make a product and so metal fab I happened to come up a little bit in this quarter again, we've spoken a lot about a quarter not being a trend, but no. Our manufacturing goes anywhere if I'm you know supplying a good or to a finished good from metal real theme to chain link fences to making you know pet bed to a steel for high rises.
So it's a <unk> if that goes across a lot of different industries. As you can tell and I would say the disposition of was not in industry specific like that.
Okay. Thank you.
Welcome.
Thank you at this time I would like to return to sort of course revolt for any closing comments.
Well. Thank you very much operator, and I just to say happy Halloween to everybody a fair and Oh were RMB, It's an area in Los Angeles on November 12, and 13, if you if not already set up an appointment to CEO CFO .
We look forward to see new them and without goodbye.
Thank you see conference has concluded. Thank you mentioned in today's presentation. You may now disconnect your lines.