Q3 2021 Essential Properties Realty Trust Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to essential properties Realty Trust third quarter 2021 earnings Conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation.
Anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.
Conference is being recorded and a replay of the call will be available two hours. After the completion of the call for the next two weeks the dial in numbers for the replay can be found on today's press release. Additionally, there will be an audio webcast available on our central properties website at www Dot essential properties Dot com, an archive of which will be.
Bailable for 90 days. It is now my pleasure to turn the call over to Dan Donlan, Senior Vice President and head of capital markets at essential properties.
Thank you operator, and good morning, everyone. We appreciate you joining us today for our central properties third quarter 2021 Conference call. Chris Me to discuss our operating results are people bodies are president and CEO, Gregg Seibert, our CFO and Mark Patten, our CFO. During this conference call, we'll make certain statements that may be considered forward.
Statements under Federal Securities Law.
Actual future results may differ significantly from the matters discussed in these forward looking statements. We may not release revisions to those forward looking statements to reflect changes after the statements were made.
Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings release.
With that Pete please.
Go ahead.
Thank you Dan and thank you to everyone who is joining us today for your interest in essential properties.
The third quarter was another strong quarter for us on all fronts as we saw a continuation of the trends that have been present throughout the year, including strong portfolio performance, a robust and attractive investment environment and supportive capital markets.
In terms of the portfolio.
With collections at 100% and only one vacant property today, our portfolio has fully stabilized.
In fact over the trailing 12 months ended September 30, we experienced recovery of 87% on all re leasing activity, which is a strong indicator of the quality of our real estate and our disciplined underwriting.
Two in terms of investments.
Motor to past quarters, our industry relationships drove the bulk of our growth is over 80% of our investments in the quarter or prior relationships.
During the quarter, we invested $231 million and to 85 properties at a weighted average cash yield of 7%.
With 84% of investments originated through direct sale leasebacks, and 80% containing master lease provisions.
While we expect this high level of investment activity relative to our historical averages to persist into the fourth quarter, our future investment activities levels are likely to moderate for three main reasons one activity pause during the pandemic demand has largely been recaptured.
Two product from sellers are motivated by the potential changes in the tax laws should dissipate next year.
And three pandemic induced M&A activity moderates back to more normalized levels.
Lastly in terms of the capital markets.
We remain active on the equity issuance front with approximately $103 million of gross ATM issuance during the quarter.
Which helped lower our leverage sequentially.
As such we continue to have ample capacity to capitalize on our investment pipeline.
Turning to the portfolio more specifically we ended the quarter with investments in 1300 97 properties that were 99, 9% leased to 297 tenants operating in 17 industries.
Our weighted average lease term stood at 13.9 years.
With three 8% of our ABR expiring through 2025.
Our weighted average unit level coverage ratio was three five times, which improved versus last quarter's coverage of three two times.
While our traditional credit statistics, which focus on an implied credit ratings and unit level coverage experienced solid sequential improvement. This quarter. These statistics remain negatively negatively skewed for certain industries like movie theaters.
Early childhood education, and health and fitness, which face continued state level shut downs and capacity restrictions well into the spring of 2021 and certain areas of the country.
However, with most of our tenants reporting to us on a trailing 12 month financial basis with a one quarter lag. We expect these statistics continue to experience solid sequential improvement over the next few quarters.
Looking out to the balance of the year. We expect these positive trends to continue and we are reaffirming our 2021 <unk> per share guidance range of $1 30 to $1 32.
In addition, we are establishing our 2022 <unk> per share guidance at a range of $1 46 to $1 50 per share.
We continue to believe our strong <unk> growth potential.
Bind with a well covered dividend and our commitment to prudently manage our balance sheet and portfolio of risks.
Investors are compelling total return opportunity.
With that I'd like to turn the call over to Greg Our CFO, who will take you through the portfolio and investment activities in greater detail.
Thanks, Pete during the third quarter, we invested $231 million through 31 separate transactions at a weighted average cash yield of 7%.
These investments were made in 12 different industries with 70% of our activity coming from grocery auto service equipment rental and sales early childhood education in casual dining.
The weighted average lease term of our investments this quarter. It was 16.4 years.
The weighted average annual rent escalation was one 6%.
The weighted average unit level coverage was two eight times with the average investment per property being $2 7 million.
Consistent with our investment strategy, 84% of our quarterly investments were originated through direct sale leasebacks, which are subject to our lease form with ongoing financial reporting requirements and 80% contain master lease provisions.
Looking forward, we are seeing increased competition from existing and new market participants due to the growing appreciation for the durability of the asset class as a result, we continue to see cap rate compression as we seek to service and protect our relationships.
From an industry perspective early childhood education.
Our largest industry at 14, 5% of a B R closely followed by quick service at 13, 22%.
Our washes at 12, 9%.
Medical dental at 11, 7%.
Continue to view these four business segments as tier one to industries for a central properties and therefore, they are likely to remain our highest concentration of industries for the foreseeable future.
Of note, we continue to selectively invest in proven operators of profitable locations.
Both the entertainment and casual dining industries, which can you continued to experience strong rebounds in revenues and profits.
From a tenant concentration perspective, no tenant represented more than two 7% of our ABR at quarter end and our top 10 tenants account for just 19% of ABR, which was down 50 basis points versus last quarter.
Increased tenant diversity is an important risk mitigation tool and differentiator for us and it is a direct benefit of our focus on large unrated credits and middle market businesses, which offer has a significantly more expansive opportunity set that is strategy concentrated on publicly traded companies.
And investment rated credits.
In terms of dispositions, we sold 11 properties this quarter for $10 1 million in net proceeds when excluding transaction cost and properties sold subject to tenant buyback options, we achieved a 6.5% average cash yield on these dispositions.
We have mentioned in the past only liquid properties is an important aspect of our investment discipline.
As it allows us to proactively manage industries tenants unit level risk within the portfolio.
With that I'd like to turn the call over to Mark Patten, Our CFO, who will take you through the financials and balance sheet for the third quarter.
Thanks, Greg and good morning, everyone.
As Pete noted the third quarter was another strong quarter for us. The notable elements of our reported operating results for the third quarter of 2021 are as follows.
Our total revenue was up $16 7 million or almost 40% versus the same period in 2020 totaling $59 6 million for Q3 2021.
Which reflects the benefits of a full quarter of our $223 million of investments in Q2, 2021 and more broadly our net investment activity. So far this year, which is totaled nearly $600 million.
Total G&A was just under $5 $6 million in Q3, 2021 versus $5 $9 million for the same period in 2020, a decrease of five 4%, which was largely due to a decrease in noncash stock compensation expense.
More importantly, our G&A continues to scale as our cash basis G&A as a percentage of total revenue was just seven 5% for Q3, 2021 versus 10, 6% for Q3 'twenty 'twenty net.
Net income was $27 $6 million in the quarter.
R F O totaled $43 $6 million for the quarter or 36 cents per fully diluted share a 38% increase over the same period in 2020.
Our nominal F O totaled $42 million for the quarter.
$13 $9 million over the same period in 2020, which on a fully diluted per share basis was 33 cents.
That's an increase of a bit more than 22% versus Q3 2020.
Turning to our balance sheet the elements I would like to highlight include the following.
With another great quarter of investments by our team our income producing gross assets reached $3 $1 billion at quarter end.
From an equity perspective, our ATM program generated approximately $101 million of net proceeds during the third quarter.
As Pete noted our balance sheet remains strong with net debt to annualized adjusted EBITDA at four five times at quarter end and total liquidity of $428 million.
As a result, our balance sheet and liquidity position continue to provide a strong foundation to support our investment pipeline and our future growth goals.
Lastly, I'll reiterate Pete's important note that our current investment pipeline, our portfolio outlook and our strong performance. This quarter provided us with a basis to reaffirm our 2021 <unk> per share guidance and establish our 2022 <unk> per share guidance at a range of $1 46 to $1 50, which implies.
13% year over year growth on a midpoint to midpoint basis.
With that I'll turn the call back over to Pete.
Thanks Mark.
Encourage that the operating environment in capital markets have allowed us to capitalize on our robust pipeline of accretive investment opportunities.
Which are the predominant driver of earnings growth.
More importantly, we believe our disciplined and differentiated investment strategy has created an incredibly resilient net lease portfolio that should continue to generate attractive risk adjusted returns as we grow into the future.
And with that operator, let's please open the call for questions.
Thank you we will now be conducting a question and answer session.
Like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May Press Star two if you would like to remove your question from the queue for participants using speaker equipment. It may be.
Necessary to pick up your handset before pressing the star keys, one moment, please while we poll for questions.
Our first question comes from the line of Greg Mcginniss with Scotiabank. Please proceed with your question.
Hey, good morning.
Thank you for the color you provided on the acquisition pipeline you opening remarks, and I appreciate that you're hesitant to provide strict acquisition guidance, but.
When you speak about the pace of acquisitions, maybe moderating should we take that to mean, you know pre pandemic level is reasonable going forward, so $160 million to $200 million per quarter or do you anticipate even greater headwinds in 2022.
No listen I think when we came public in 2018, we thought we had an organizational infrastructure to kind of support you know $500 million or $125 million a quarter that has grown since.
Since that time, and and you know I think when we think of moderating it's more closer to the eight quarter average you know looking backwards, you know kind of in and I think you're in the right range there.
Okay. Thank you.
And then so not mistaken I believe the unit level rent coverage. This quarter at three five times is the best you've ever had in the portfolio.
Could you help me understand the drivers of the improvement over the historical levels, obviously, yeah.
Ignoring the pandemic and then also much categories generally have higher or lower coverage, especially with the top four categories that you mentioned.
Yeah listen I think you know that that number is as a headline number and and I think you know not a true indicator of what's going on in the portfolio, which is why we try to provide additional disclosure around that.
In our supplement.
But it's great number we're happy about it certainly.
You know some of the industries that are going to have higher coverage are going to be things like the equipment rental things like medical dental.
And and other services you know things that are going to have lower coverage.
We're going to be the industries, where you know the businesses is solely revolved around the real estate.
You know clearly the movie theaters in the current environment quick serve restaurants should be kind of in that two two plus range.
So that's why there's a wide dispersion of coverage.
But we certainly think that headline number is healthy.
Great. Thank you.
Thank you Greg.
Uh huh.
Thank you. Our next question comes from the line of Sheila Mcgrath with Evercore. Please proceed with your question.
I guess good morning, I was wondering Peter if you could give us a little bit.
More detail on the G&A outlook in 2022 what was in your guidance and do you expect that youre going to have to add.
More acquisition personnel or just personnel in general.
Yeah, I'll start and then the tickets to Mark.
Obviously, we don't we don't guide to G&A, but you know Mark and give you. Some color you know on a trend there, but you know.
Our staff Sheila we're transacting at a very high level and I think the team is operating you know and you know really.
Great Great form and you know so.
So we don't see a lot of additions in G&A and and I think the team and the hiring is in a good spot as we sit now but mark you know from a trend perspective, what should they expect yeah, Sheila thanks for that question.
First of all just mentioned that you know sort of the puts and takes in 2021 that gave us some good efficiencies was.
Paying off the ABS was not just a benefit to being 100 per cent unencumbered and 100% on its unsecured but it allowed us to kind of get more efficiencies in some of our outsource expenses and we also kind of benefited from you know.
The world around our controllable expenses that has to do with sort of conferences and the like still we're generally virtual so and in our travel just generally was moderated. So we got some benefits from that in 2021, but you know the way I kind of think about it cause stock comp is sometimes a variable that you can't you know peg, but oh.
On a cash basis as a percentage of revenue.
If you ran out of Q4, 'twenty, one that kind of a similar level of where we've been and use that as your kind of percentage of revenue I think that's a good metric.
'twenty, two maybe with just a little bit of inflation.
Okay, Great and then on the same store NOI profile. It was significant for retail and experience I was just wondering if you could provide some detail what was driving those changes.
Yeah listen I think if you think back to a year ago, we had some significant repositioning in the portfolio, where we're sites were taken offline in and re let to new tenants in and I think that's the noise you're seeing in the same store sale number Sheila.
Okay. One last one equipment chairs now your biggest tenant I was just wondering if you could provide us a little detail on about that business that company.
Yeah, they're they're a a growing <unk> equipment rental firm with a very differentiated technology platform.
We've been doing business with them for a number of years now and I have seen them.
Execute on their growth plan are very reliably and efficiently and predictably and and so we were.
Happy to continue to partner with them as they continue to kind of grow in and I think they are well over 100 units at this point in time hundreds site locations and have a national footprint.
Yeah.
More specifically, we generally like the real estate underlying the equipment rental space.
You know large yards width with good buildings and industrial.
Industrial zoning tend to have great fungibility and in an appeal to them.
Multiple users.
So great company, we're happy to continue to do business with them.
And really solid underlying real estate fundamentals I would say it at 2.7% of ABR, there's room to grow there.
You know, we certainly are ideally you wouldn't have a tenant over 5%.
But.
We feel comfortable where they are at.
Okay, great. Thank you.
Thank you Sheila Sheila.
Thank you. Our next question comes from the line of Nate Crossett with Baird. Please proceed with your question.
Hey, good morning, guys.
Just a question on pricing I mean, you know there is increased competition.
But if you look historically you guys have kind of been able to stay above that 7% Mark and I know you don't give specific.
The guidance on this measure, but what are you kind of expecting I guess.
Going into next year, you know is that 7% holder.
How should we be thinking about that I guess.
Yeah listen I think you know we're facing increased competition. We fight for every basis point, we get we specifically focus on an investment strategy that allows us to compete on the strength of our relationships and our reliability as a capital provider and all.
Are there to get you know appropriate risk adjusted returns.
The cap rate as you know is really the blend of the 30 transactions that we did in in the quarter across 16 industries and that can vary greatly from a low of a six to a higher than eight or.
There are seven and a half and so.
If you look back you know it's been seven 171 seven.
Could it dip to six nine or thereabouts, certainly it really just depends upon the opportunity set that we get in any given quarter.
Yes.
Yeah. That's helpful. And then just a question on I guess, the other side of the equation.
I saw one of your peers did their first preferred offering this quarter.
Just curious to get your thoughts on that funding source and how you view it.
And if you had priced out anything in that market.
We haven't priced out preferred.
We have a pretty simple and efficient.
Efficient capital structure today, certainly you know getting our inaugural ABS bonds are our inaugural unsecured bonds done earlier.
Earlier, this year and paying off the secured bonds that we had in the ABS went a long way to bringing up that capital structure.
You know I think we have a little ways to go with the rating agencies before the preferred market is truly efficient for ours for us, but it's certainly.
A market that will keep our finger on the pulse and you know and evaluate over time.
Yeah.
Okay. That's it for me thank you.
Thank you thanks, Dave.
Thank you. Our next question comes from the line of Handouts St Juice with Mizuho. Please proceed with your question.
Hey, good morning, Thanks for taking my questions.
I guess the first one I just one follow up on the competition. You noted I'm curious any particular subsectors appetite you'll size are you seeing that most comment and I think most folks would have thought you were focusing on smaller deals and to provide you. Some insulation. So curious on what impact what level of competition, you're seeing and what impact, it's having on pricing and where things.
Yeah listen I think the competition is most acute for larger deals and larger credits and and you know I think bigger credits with bigger deals get more people excited in and they are better able to move the needle in the you know.
They get it gets more competition with us.
Transacting.
$230 million in the quarter and 31 separate transactions.
That's we believe is a differentiator for us our ability to do small deals and deliver capital through a sale leaseback reliably allows us to compete and get outsized risk adjusted returns.
But the bigger the deal and the bigger the credit the more competition I think you're going to see.
I appreciate that second question is on I guess, a follow up on the 2020 guidance I'm curious what's embedded in there from a.
Maybe a recovery are prospective for sectors that haven't quite recovered to pre COVID-19 levels like say a.
Our child care early childhood centers in any other sectors that are you still can swing back towards pre COVID-19 levels and on the other deferral income or recoveries baked in there.
Yeah listen as we said in the call in the prepared remarks.
We think the portfolio has recovered and and we're collecting 100 cents on the dollar and and while there is hum recovery to go yet with the movie theaters and the child care operators and some of the gym operators those guys are paying us the current.
And we expect that to continue into 2022.
We baked in a normalized credit loss assumption into or our model, which is baked upon very specific views of individual situations.
But I would say that's more tenant specific and more normalized and not a recovery of COVID-19 sort of analysis.
In terms of our deferrals.
Essentially the vast vast majority of our deferrals are behind us.
From a recognition perspective, and we're probably halfway through the collection of those deferrals and you know we've been collecting.
Collecting substantially all of that's been due to us.
One clarification I could normalized credit losses that definition or the level of a preserve any different.
Versus say last year, or maybe maybe pre COVID-19 and any any change in the level of reserve.
You take that.
No I think that normalized as you know based upon historical experience in this asset class and you know what we're seeing in 2022 would have been very similar to what we were seeing or expecting you know prior to COVID-19.
Yeah.
Thank you.
And to put some color around that that handle you know as we've said.
A number of times.
We build in roughly one six times you know.
Growth into our lease and the actual growth that we realized over time is offset by a credit loss of somewhere between 25 and 40 basis points.
I appreciate that.
Thank you. Our next question comes from the line of Caitlin Burrows with Goldman Sachs. Please proceed with your question.
Hi, good morning, it looks like leverage was four and a half times as of <unk> would seem somewhat low. So I was wondering if you could go through your view on expected leverage going forward and to what extent you'd be comfortable having an increase.
Yeah listen our our leverage has largely been in.
A output.
Output of our desire to Derisk, our external growth and keep the keep the dry powder on the balance sheet to ensure that we have the ability to execute reliably on our growth plan and you know it is.
Somewhere between a four and a little over five since coming public and you shouldn't expect that to change materially going forward.
Kind of sitting right in that middle of the range kind of feels appropriate now, but it certainly we don't think about it as a as a spot estimate given the pace at which we're deploying capital in and there's sometimes chucky niche in which we raise capital.
Very.
But generally within that range.
Got it Okay and then could you also go through maybe some more of the thought process process of completing dispositions in the quarter. Obviously, you have a variety of ways to raise capital, but what made you go that route for those properties.
Yeah listen as we said the disposition activity is really.
Largely drew.
Driven from a risk management perspective, not a generation of capital perspective, so the $10 million in assets, we sold during the quarter were up.
We're really getting out of assets that we didn't feel met our long term investment criteria in more centers.
Moving those out of the portfolio and freeing up that capital to invest with into other assets. So that's generally our view on selling assets.
Got it thanks.
Thank you. Our next question comes from the line of Katy Mcconnell with Citi. Please proceed with your question.
Thanks.
So just going back John Graff coupon St. Charles I'm, sorry experience small tenants and drink here can you touch on the key drivers of that improvement.
With that any update on how you're seeing your tenants have been performing.
Yeah listen I would say in terms of theaters.
No.
Majority of our theaters are the five or six of our theaters to be specific as AMC and you know I think everyone AMC as a public company with with very clear disclosure and so I think you know.
People can get a good sense of what's going on there.
As we said during the pandemic, we think we have good theaters that work worked for for the tenant and.
Certainly I think coming out where we're seeing that in the numbers.
In terms of the improvement in the experiential tenants are they experiential sector.
As I told Sheila that was specifically related to some asset level repositioning.
You think back a year ago, when we work through our town sports bankruptcy those sites would have been offline for a period of time in that peer in the reported period that would a highly impacted that number.
Got it Okay and then for your service based tenants I'm curious how much of an impact labor shortages are having there and are there any categories in particular that you're more concerned about within your portfolio today.
We're not going to see that.
We were getting the.
Financials to us on a on a trailing 12 basis anecdotally, we're hearing that.
But I'd point to the fact that coverage is up across the board in and.
And generally everyone's doing well and certainly everyone's paying so it is only anecdotal at this point.
We're hearing about labor challenges in the restaurant space is in the early childhood education space, but not seeing it impact our collections at this point in time.
Got it okay. Thank you.
Thank you.
Thank you as a reminder, ladies and gentlemen, if you would like to ask a question. Please press star one on your telephone keypad. Our next question comes from the line of keeping Kim with trailer. Please proceed with your question.
Thanks, and good morning, So just a follow up on that previous question.
When you talk to your tenants and what is your kind of real time sense of what is happening to their kind of overall profit scenario given that they're probably getting good topline growth, but facing higher cost structures.
Yeah, you know I think you kind of see that in the numbers and the coverage right.
Rents aren't growing that fast, but our coverages are improving.
So you know as we said, it's anecdotal and we Havent really dissected the numbers on you know.
For that and generally I think the the recovery that we're seeing in the pickups and benefit from recovering from the pandemic is outweighing the headline pressure to margins that you know labor and other things.
Would create all that said.
That's not a static analysis and I think as we think out theres going to be continued pressure to margins and continued.
Both to cost of goods sold as well as our.
Labor and we'll watch that closely.
You know.
With with coverage of three five times and real estate as a rent you know one of the first line items to be paid.
Really that's more of an operator risk then enlarge risk.
Got it and so I guess, thus far have you have you seen that impact the willingness for some of your tenants to open new stores.
Yeah listen the vast majority of our.
Incremental investment activity is with tenants.
Opening buying or or emerging into new stores and and.
As we've said, it's a heightened level of activity and there's there's a lot of capital.
Feeding that and.
We have not seen any reluctance to for our tenants to continue to grow.
And just last quick one here I'm talking about the same thing that cap rate compression environment and competition.
On the flip side I mean, you could buy.
Probably a good time to sell additional assets that might not meet your criteria. As we look forward is it reasonable to expect a higher level of disposition activity and what we see.
Listen I think generally we've we've tried to transact.
Somewhere around 10% of what we bought in that.
Somewhere between 10 and $20 million a quarter.
Certainly.
We're trading.
That becomes dilutive for us.
From them.
And so we're really going to sell to mitigate risks and I would say.
If anything it disposition activity is going to moderate in the coming quarters.
Okay. Thank you.
Thank you Kevin.
Thank you. Our next question comes from the line of Joshua <unk> with Bank of America. Please proceed with your question.
Yeah, Hey, good morning, everyone I'm curious on your comments on the potential.
Potential tax law changes driving M&A activity was there any specific area with and where.
You know, where you would work where you're seeing like a lot of extra activity, where it might slow into 2022 or just kind of curious.
If there's any more color you guys can provide there.
Yeah, I think it's a couple of things.
As the threat of repeal of 10 31 that leads people with investment properties.
So I'm more inclined to sell I would say that that's less of an impact the bigger impact as you know potential increase in capital gains and taxes on wealthy.
Motivating people to sell.
Businesses and business investments, so if euro four unit childcare, operator on the cusp of retirement and Youre going to sell your business in the next three years to five years.
The threat of the tax change will really accelerate that and and really overall that would result in the heightened M&A activity that we're seeing.
Interesting.
These potential tax law changes or maybe specifically the 10 30 ones going away impact cap rates at all.
Yes.
Yes.
And I don't think so.
The business seller.
The business not sell a scenario that's not really a cap rate play that's more of a business valuation play and that's driven by the overall macro capital markets environment.
And so I think theres not going to be a direct impact of cap rates, there and as we've said in the past.
When we invest in sale leasebacks.
It's generally not a 10 31 10 31 motivated.
Scenario.
It's helping to capitalize the business and we're not competing on cap rates.
When we sell we will sell into the 10 31 market.
But that's.
That's not a driver and to be clear. This is just the threat of changes in tax laws.
That you know.
It is not as actionable as you know when it becomes apparent that something's going to change.
Got it I appreciate the color.
Thank you.
Thank you there are no further questions at this time I'd like to turn the floor over to Pete for closing comments.
Great well. Thank you all for your attendance today and thank you for your questions and we look forward to engaging with everyone in the upcoming NAREIT meetings.
Have a great day. Thank you.
This does conclude today's teleconference. You may disconnect. Your lines at this time. Thank you for your participation and have a wonderful day.
Okay.
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