Q2 2022 Netstreit Corp Earnings Call
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Greetings and welcome to the net Street Corp, second quarter 2022 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. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad as a reminder, this conference is being recorded.
Now my pleasure to introduce your host Cathy core Bullock.
The relations. Thank you Cathie you may begin.
We thank you for joining us for <unk> second quarter 'twenty to 'twenty two earnings conference call. In addition to the press release distributed yesterday after market close we posted a supplemental package and an updated investor presentation can be found in the Investor Relations section of the company's website at www.
Net dot com.
On today's call management's remarks, and answers to your questions may contain forward looking statements as defined in the private Securities Litigation Reform Act of 1995.
We're looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today.
More information about these risk factors, we encourage you to review our Form 10-K for the year ended December 31st 2021, and our other SEC filings.
All forward looking statements are made as of the day hereof and have street assumes no obligation to update any forward looking statements in the future.
In addition, certain financial information presenting on this call includes non-GAAP financial measures. Please refer to our earnings release and supplemental package for a definition GAAP reconciliation and an explanation of why we believe so.
Such non-GAAP financial measures are useful to investors.
Today's conference call is hosted by <unk>, Chief Executive Officer, Mark Manheimer, and Chief Financial Officer, Andy Blocher, They will make some prepared remarks, and then we will open the call for your questions now I'll turn the call over to Mark Mark.
Good morning, everyone and welcome to our second quarter 'twenty to 'twenty two earnings conference call before I discuss our investment activity for the quarter I want to take a moment and say how pleased I am with the team's ability to consistently source attractive investment opportunities and strong yields.
Continue to be nimble and creative in a dynamic market.
We have a unique and proven strategy and our performance demonstrates our continued ability to execute and drive strong and steady results.
With that I am pleased to report that we completed $122 $7 million of net investment activity for the quarter.
In a market that is evolving rapidly with higher interest rates and macroeconomic uncertainty we have remained disciplined and selective with opportunities with the opportunities we pursue.
As we started to see changes in the acquisitions market, we pivoted to higher quality and better priced acquisitions as shown by the higher yield for the quarter, which resulted in approximately $375000 in dead deal cost in the quarter we.
We believe this was the right strategy is there was a clear economic benefit to being nimble in an evolving market.
Since our IPO less than two years ago, we have more than doubled our portfolio size from 163 properties to 381 properties, our ABR from $334 $5 million to $84 $2 million and enhanced our diversification metrics, while maintaining the highest credit quality and stable portfolio and the net lease space increase.
Seeing investment grade and investment grade profile tenancy about 900 basis points to 81%.
Our portfolio is largely made up of tenants and the necessity discount and service industries, all of which are well insulated from recessionary <unk> inflationary pressures.
Despite uncertainty in the current economic environment, we believe that the defensive nature of our portfolio will allow us to continue to outperform as we did during the Covid pandemic, where we where we were the only public net lease retail REIT to collect 100% of our pre COVID-19 reps and.
In addition, we have a strong balance sheet with ample flexibility and liquidity to meet our investment goals for the year.
Now turning to our investment activities for the second quarter, we acquired 22 properties for $117 million at a weighted average initial cash capitalization rate of six 7% with a weighted average lease term of 10 nine years.
It is important to note that our second quarter acquisitions were on average at a higher going in cap rate better credit and with longer lease terms than prior quarters, which really demonstrates the strength of our team and ability to adapt and source high quality opportunities in an evolving market.
Rent commenced on three development projects that had total cost of $9 $8 million at a weighted average investment yield of six 5% and a lease term of 10 three years.
During the quarter, we entered into a $6 million convertible loan with a 12 month term and an interest rate of six 5%. We expect this loan to be converted into a fee simple ownership of two properties by the end of 2022 with a cash cap rate in line with the current interest rate.
We sold a kohl's for $9 $9 million at a 6% cap rate and we terminated a lease with a small auto parts retail store himself and sold the property, we expect to collect the remaining lease payments in a lump sum, which should result in a small gain in a future period.
Finally, we provided $4 $6 million of funding to support ongoing development projects at quarter end, we had six projects under development, where we have invested $12 $8 million to date.
You'll notice that our development activity is down from prior quarters due to recent completions and we have taken a more cautious approach as we expect a more challenging environment for developers to perform within their previously negotiated construction budgets, what tenants given rising construction costs rising labor cost and economic uncertainty.
At quarter end, our portfolio was comprised of 381 properties was 75 tenants contributing approximately $84 $2 million of annualized base rent of.
The portfolio had a weighted average lease term remaining of 9.5 years with 80, 181% of ABR represented by tenants with investment grade ratings Werent restaurant investment grade profiles and our portfolio remains 100% occupied.
We added four new tenants in the quarter, which includes a sprouts grocery store with solar panels on its roof augmenting our ESG efforts and Ulta store are most restaurants and in N T be automotive service store.
Subsequent to quarter end, we acquired seven properties for $45 $4 million, including closing cost with the recent acquisitions, we've completed $304 million and net investment activity year to date, which is over 60% of our full year $500 million targeted net investment activity.
This level of activity is a testament to the experienced team we have in place and our focus to grow the portfolio with high quality tenants. We believe we are well positioned to maintain our momentum for the remainder of the year and beyond with that I'll turn the call over to Andy to go over our second quarter financial results and 2022 guidance.
Thank you Mark and once again, thank you all for joining us on today's call and.
In our earnings release published yesterday after market close we reported net income of <unk> <unk>.
<unk> 26 cents and a F O 28 cents per diluted share for the second quarter.
The portfolio's annualized base rent grew to over 84 million in the second quarter up 52% from June 32021, driven by a 114 acquisitions seven developments and two mortgage loan receivables since the end of the prior year second quarter.
Interest expense increased 600000 to $1 $5 million from 900000 in second quarter 2021, due principally to a higher average balance outstanding on the revolver and increase base rates compared to second quarter 2021.
G&A increased to $4 9 million in the second quarter compared to 4 million second quarter 2021, primarily due to an increase in the number of employees from 24 to 30 to support our growing portfolio.
In addition, as Mark referenced we had approximately $375000 of dead deal costs in the quarter, but we do not expect this increased level of dead deal costs in the future quarters.
Turning to our balance sheet at quarter end, we had over $39 million in escrow to facilitate acquisitions that closed on July one and total debt of 412 million outstanding.
Which $175 million is from our fully hedged term loan with the remaining balance from our revolving line of credit.
We launched a recast of our credit facility on July 11th to expand our review of our revolver from 250 million to $400 million and to add a 200 million dollar long five year term loan towards debt structure.
The new term loan is expected to be freely pre payable at any time, providing optionality to access the private placement market or to seek other capital markets alternatives for refinancing if we see attractive longer term opportunities.
The $600 million recast is already fully committed and is expected to close in mid August at which time, our all of our liquidity will increase by $350 million.
We intend to leave our existing $175 million term loan outstanding which has a fixed all in rate of 136% and matures in December 2024.
On June 20, <unk>, we settled two 4 million shares receiving net proceeds of $50 million under our forward sales agreement associated with our January offering.
We have until January 10th 2023 to settle the remaining $4 5 million shares associated with our forward sales agreement.
During the quarter, we did not make any sales under our ATM program.
At June 32022, our net debt to annualized adjusted EBITDA ratio was three seven times after giving consideration after giving consideration to the remaining shares outstanding under the forward sales agreement from our January offering well below our target range of four and a half to five five times.
With regard to our dividend earlier this week the board declared a <unk> 20 regular quarterly cash dividend to be payable on September 15th to shareholders of record as of September 1st our payout ratio for the quarter was 71%.
For 2022 <unk> per share guidance, we're maintaining our previous guidance range at $1 14 to $1 17, but due to market volatility have widened some of what the expectations and our underlying assumptions our guidance includes the following assumptions.
<unk> activity in the year, including developments, where rent has commenced and mortgage loan receivables net of dispositions to remain at least $500 million cash G&A is expected to remain in the range of $14 5 million to $15 million, which is inclusive of transaction costs noncash compensation expense is expected to remain in the range of <unk>.
Five to $5 5 million.
Due to a combination of increased borrowings and a significant increase in the forward curve. Since we most recently provided guidance our cash interest expense expectation has been increased and widened from our previously stated five five to six and a half million dollars to $7 million to $9 million.
Noncash deferred financing fee amortization, which is not included in our cash interest expense is increased from 600000 to the range of 800 to $900000 to reflect the pending credit facility recast.
And lastly, a decrease to full year 2022 diluted weighted average shares outstanding which includes the impact of O. P units from our previously stated 52 to 54 billion shares to now be in the range of 50 to 52 million shares as a result of higher projected debt balances for the remainder of 2022.
These changes will not impact our targeted leverage as we continue to expect our net debt to EBITDA to be between four and a half to five and a half times.
To wrap up we're confident in the ability of our portfolio to offer stable and predictable cash flow during a time of economic uncertainty and we appreciate the support of our bank group as we finalized our largest round of debt financing.
During our tenure as a public company, we have demonstrated our ability to execute and build our best in class portfolio.
Our team remains focused and diligent as we as we look forward to meeting our investment goals for the remainder of the year.
With that we'll now open the line for questions operator.
Thank you we will now be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate that your line is in the question queue.
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Thank you. Our first question is from Todd Thomas with Keybanc Capital markets. Please proceed with your question.
Okay.
Hi, Good morning first question in terms of funding investments throughout the balance of the year yeah. The the.
The remaining shares to settle from the forward equity in January and Andy you you just discussed.
Little bit of the AR in the revised guidance you know the the your expectation for the weighted average shares but.
I was just wondering if you could just talk about plans to permanently finance our line balance from here and also discuss thoughts on raising equity capital.
In the back half of the year as you.
Look towards the $500 million net investment guidance that you maintained.
Yeah. Thanks, Tom Yeah, so from our perspective.
We're taking a big step.
Funding line balance with the recast that we just talked about.
It's a $600 million recast where we stand right now we've got about $900 million of current in place commitments. We're waiting on another $170 million more we would anticipate that that would close in the next couple of weeks, but it is fully committed.
That's like I said, it's a long five year, a new five year term loan that goes along with the existing term loans that comes to maturity.
But at the end of 2024, so we feel like from a debt perspective.
We're pretty locked up and we're adding as I said in my remarks, we're adding another.
$350 million worth of liquidity to the balance sheet on the equity side, Yeah. We've got 95 million up $95 million roughly of equity that remains undrawn under the forward.
From a leverage and lowering the share count expectation the real key there is we just wanted to get greater certainty on the debt financing before we decided to be more efficient.
On the funding mix right. So if you recall, we started off the year, we were talking about a private placement private placement market closed very very quickly.
That's why we moved to the debt market.
Really thankful for the support that we have we still have access to.
It's roughly $160 million worth of equity through the ATM.
And just feel very confident with where we stand as we look at the opportunity set that mark and his team is looking at on the asset side.
Okay does the does the current budget have any additional equity capital being raised throughout the balance of the year. It looks like you'd be in sort of the high five times range on a net debt to EBITDA basis.
Pro forma the remaining $250 million of of acquisitions or so.
You mentioned, the four and a half to five five times target leverage level I realize you've been below that by a wide margin for many quarters and you know it may bounce around a little bit above that in the near term, but where would you expect to be at year end.
Yes, I mean, I would think that we'd probably be at more efficient leverage probably around five and like I said, we're never going to talk about specifically.
The specific methods that we have available to us but.
We have not been active on the ATM and we do have that as a as a tool at our disposal.
To take advantage on a go forward basis.
Okay, and then in terms of.
Asset pricing and and an acquisition cap rates.
I was just curious if you could talk about pricing trends.
There you are seeing cap rates widen a bit as our buyers and sellers begin to adjust to the higher interest rate environment and sort of what your what youre seeing in the pipeline today.
Yeah, absolutely so.
Yeah.
You saw a pretty big pivot from us.
Early on in the quarter, which resulted in a little bit of dead deal costs, which we always like to try to avoid but yeah. The increase in pricing will just see a lot of the typical buyers falling out of the market. You know I think a lot of the 10 31 buyers that use leverage the ones that were locked in on exchange needed to close on those transactions, but once those kind of really flowed through.
The market, we've really seen less activity with 10 31 buyers they are still there but.
Any of them that use a decent amount of leverage are not going to be we don't anticipate being as active.
And then certainly the larger private equity firms that are using a lot of leverage are you know more or less completely out of the market. So.
We pivoted during the quarter and I think you know.
Shouldn't be lost on everybody that not only did we get a six 7% cash cap rate on acquisitions, but then when you look at the quality of what we what we acquired during the quarter.
From a credit standpoint, you know our weighted average lease term et cetera. We are really excited about the opportunities that we saw during the quarter, which is why we pivoted and so you know certainly in my view are our highest quality.
Portfolio.
Acquisitions during that during the quarter. So are we.
We hope that continues to be the case, but you know I think you know certainly we've seen in the neighborhood of 25 basis points on average increase in the in the areas that we're looking at that we're looking for.
Okay.
Great and one last one Andy if I could just go back to the the recast and the term loan.
It is the term loan fixed or variable and do you plan to put hedges in place.
Yes, I mean, so when we talk about the interest expense guidance expectations.
So for the forward surfer curve has just been like literally all over the place right.
We had shown.
Our rate to our board recently occurred market as well inside of that.
So we're going to evaluate.
I think our our thought at this point is while it has a delayed draw feature we would likely fully draw down at closing and then the question is going to be what is the forward curve looks like at that point.
How do we think about fixing that.
And either in full or in part.
Based on market conditions at that point in time, but.
Right.
With the fed increasing rates by 75 basis points with GDP read yes.
Yesterday, I said <unk> seen a little bit better better forward curve recently that we've seen.
Not like a week or two ago right. So that's an evaluation that we'll make and we'll certainly make you aware of that at that point in time.
Okay, Great alright, thank you.
Okay.
Thank you. Our next question is from Nicholas Joseph with Citi. Please proceed with your question.
Hey, it's Chris can carry on with Nick Joseph.
Are you seeing any I just want to fall back up on the transaction market.
Are you seeing any buyers pull out of certain markets more so than other markets and has there been a differences in buyer appetite across different qualities.
That's the quality spectrum for different assets.
Yeah, and I would say, it's a good question and I think really where we started to see.
More buyers pull out it really had to do with more of the leverage buyers at lower cap rates. So yeah. There are higher quality transactions that were in many cases, well below the cap rates that were acquiring assets at all.
A lot of those deals started it up we start to get a lot more calls on those types of transactions as you know I've got all the euro lower four cap rate range a.
Transactions people relying on that you know you start getting to leverage a lot more quickly on those types of transactions. So as you start moving up the cap rate scale, that's starting to creep in more and more as interest rates continued to rise. So I think it's really been much more of the buyer that's relying on leverage you.
You saw it really in industrial which we're not really active there at all.
Yeah.
Our cap rates, you've seen like Amazon distribution centers kind of you know that we're trading in the three years kind of trading up and kind of the higher for us up to a five cap so really pretty big displacement.
Displacement in that market.
And then as you start creeping up into retail and some of the lower cap rate deals just the the debt doesn't pencil for that part of the higher leverage buyers. So that's really where we've seen.
The biggest impact and so we've certainly seen a massive increase in our opportunity set which allowed us to be significantly more selective on the quality as well as on pricing. This particular quarter and we're seeing that into the end of the third quarter. So we're pretty excited about what we're seeing in the third quarter as well.
Got it and then with a tougher macro backdrop today. How are you guys thinking about the watch list or are there any tenants on the watch list that maybe youre, keeping a closer eye on or or how is the watch list a ball.
Yeah sure Yeah, and it's pretty similar to what we were starting to see last quarter as it relates to the consumer, especially on the lower and they're really starting to get under more and more pressure.
Savings for the consumer are back to pre pandemic levels youre, starting to see consumers relying more on credit cards.
And Walmart and target results I think illustrate necessity products are selling in discretionary is not.
So we took a pretty deep dive into our portfolio.
Really good about the defensive nature about what's in our portfolio I think if we have one tenant in particular that I think has seen.
Poor results, most recently that'd be best buy.
They've had a bit of a rough year. It was really just the health and the preferences of the consumer have shifted but their sales are above pre pandemic levels and we're very confident in the Turner and the tenants resilience than the assets that we own. So we don't feel like there's any any rest of the rent or anything like that but you know I think we need to be pretty cautious on that on that particular tenant.
But you know we do it you know I think we do a pretty good job of underwriting not only in the tenant health, but the cyclicality and predictability of tenant health and various different economic environments and you know we certainly have.
A pretty volatile market out there and then I think we also do a pretty good job of applying Oh, an appropriate asset management plan. After we acquired the assets if you recall last year.
Yeah, we sold an RV asset, which was you know that was kind of at the peak of its cyclicality doing are starting to really well last year.
Turning to see Keystone and Winnebago and the news with you know not so positive news. So we're really happy that we moved out of that asset last year. So I think that speaks to how we're thinking about when we can opportunistically move out of certain assets and you know really trying to focus on assets that we feel like are going to do very well in any economic environment.
Thank you.
As a reminder, if you would 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.
Yes.
Our next question comes from Connor Seversky with Bahrenburg. Please proceed with your question.
Okay.
Thanks for having me on the call.
Just quickly on the development pipeline notice the spend this quarter was around $5 million and again in the context of kind of these heightened risk factors and maybe seeing some of your developers pulling back from activities can you provide any expectation for what that run rate spend might look like through the end of the year and possibly into 2023.
Yeah sure I mean, it's going to be pretty dependent on what's going on with construction costs labor costs et cetera.
A typical development deal for us is where we're partnering with a developer they cut a deal with you know they've got their construction budget and they've got whatever they paid for the land or whatever they are signed up to.
Got it got the land under contract for and then they negotiate what the rent is going to be with a tenant in that kind of locks and what their what their yield should be and what they can flip the asset so we.
We've been very active and having conversations with the developers that we work with and they're really just getting squeezed. So you know the construction costs being higher labor costs being you know you know being higher as well as more difficulty difficult to even really getting labor. So are.
Seeing that pressure that they're under and knowing that the tenants are typically not willing to renegotiate the rents that they've agreed to we don't want to be put on a situation, where the developers coming back to us and asking us to take the pain. So we're like we just see a lot of opportunity in other areas right now, where we think it's prudent for us to kind of take a step back.
And really see where that how that plays out and take a cautious approach in.
Especially in an environment, where we have ample acquisition opportunities.
Got it understood and then maybe just a bit of a modeling question on the 26 investments included completed during the quarter.
Can you give us any sense of time waiting is to win is to win those 26 were completed.
Yeah, Conor I think that are from bringing them on to the portfolio. I think we had an average of about 20 days.
Sorry say it one more time on that.
2020 days and that was somewhat influenced by early in the quarter, where we started to see cap rates start to move and seeing better opportunities are where we.
Pushback on some other transactions anything that we saw in diligence, we pushed back pretty aggressively on on on some of the sellers and so we ended up with more of a back end weighted.
Quarter, which I think will likely reverse reverse itself in the third quarter.
Paul.
Yes, we obviously, we closed roughly $40 million on the first day of the quarter in the third quarter. So we're well ahead of that pace.
Okay. So for the second quarter, we're looking at just for clarification 20 days after March 30th or 20 days before June 30th.
Yes, 20 days before 20 days average outstandings the way with it I got it got it.
Okay. Thank you that's all for me.
Thank you. Our next question is from Josh Federline with Bank of America. Please proceed with your question.
Hello, This is Dan.
Thank you Caroline.
I was hoping to see if you can elaborate more.
Where do you see the best opportunities for capital recycling within the portfolio.
Yes, sure I mean, what we're always kind of taking a look at the portfolio, where we see potential risk.
Fortunately, we took such a deep nice to the portfolio before going public that there really isn't much if anything that we know that that has.
Theres any concern now that being said.
We do keep relationships with various other counterparties in the in the marketplace, whether they'd be DSD operators or 10, 31 buyers or even brokers that have some relationships where somebody may.
Find themselves in a trade and need to close on something quickly. So you know, we'll take advantage of those types of opportunities and sell assets here and there I think you know like our seven elevens and some other assets within the portfolio Oftentimes you know.
We get pretty aggressive offers on those you know it was sub five cap range and so you know in the event that we can sell some of those assets and you know at pretty aggressive cap rates and we feel like we can redeploy the capital.
Efficiently and Accretively, we're always wanted to do that but we also don't want to be out in the market selling $50 million to $60 million and not be able to replace it in the quarter because that you know that puts some pressure on earnings.
Great. Thank you and then also could you.
Right.
Yeah.
Could you also remind us on what the mix between the fixed rent bumps and inflation linked bumps within your portfolio as well.
Yeah sure I mean, you know we have a few assets in the portfolio that have.
CPI bumps, but you know I think oftentimes people think of that as inflation protection.
But the reality is almost all of the CPI rent bumps in the net lease retail space are.
Three times CPI, you know the the lesser of three times, CPI, or 2% or 1% or whatever the whatever that transaction as you know depending on how that lease is structured.
We would rather just have one or 2% fixed rate bumps for the periods of time, where there isn't inflation to make sure that we're getting the maximum rent.
Our rent growth so yeah.
Having a few a few leases in the portfolio with CPI.
With caps well, yeah, we kind of view those is inferior to the to the fixed rate bumps, but maybe two thirds of the portfolio has some level of rental increases.
Thank you.
Okay.
Thank you. Our next question is from Conor Seversky with Bahrenburg. Please proceed with your question.
Just one more from me here I'm just looking at the provision for impairment recognized in Q2 was that any was that related at all to any assets that were maybe slated for sale and then moved back onto your operating portfolio once once a mark to market.
Yes, we kind of had a.
Hey, kind of odd situation related to the advance auto auto parts store that we sold in the quarter, where we terminated the lease and then sold the property during the quarter. So I and then we're expecting to get a lump sum of the remaining lease payments in the third quarter. So just that timing led to.
What would be an impairment and then likely again after that or.
Revenue that is a little bit unusual, but all in all if you put all those pieces together it actually would result in a slight gains. So it's just a little bit of a funky.
Accounting scenario.
Got it can you quantify what that gain would be at all.
I mean, we're talking about.
$100000 something like that is a pretty good okay.
Understood. Thank you.
Thank you there are no further questions at this time I would like to turn the floor back over to Mark Manheimer for any closing comments.
Well, thanks, everybody for joining us today, and we certainly look forward to continuing the dialogue in the future.
Take care.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
Okay.
Okay.