Q2 2022 Essential Properties Realty Trust Inc Earnings Call
[music].
Good morning, ladies and gentlemen, and welcome to the essential properties Realty Trust second quarter 2022 earnings conference call at.
At this time all parties are in a listen only mode.
A question and answer session will follow the formal presentation, if you'd like to register a question. Please press star one on your telephone keypad. If you require operator assistance during the event. Please press star zero on your telephone Keypad. This conference call 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.
Dial in details for the replay can be found in yesterday's press release. Additionally, there will be an audio webcast available on our central properties website at www Dot a central properties Dot com, an archive of which will be available for 90 days. It is now my pleasure to turn the call over to Dan Donlan, Senior Vice President and head of capital markets.
Central properties. Thank you. Please go ahead.
Thank you operator and good.
Morning, everyone. We appreciate you joining us today for our central properties second quarter 2022 conference call.
Here with me today to discuss our operating results for people of what he is our president and CEO and Mark Patten, our CFO . During this conference call, we'll make certain statements that may be considered forward looking statements under federal Securities law. The company's actual future results may differ significantly from the matters discussed in these forward looking statements and we may not release revisions to those forward looking statements to reflect changes. After the statements were made Patterson and risks that could cause actual was.
<unk> 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 press release that Pete. Please go ahead.
Thank you Dan.
And thank you to everyone who is joining us today for your interest in essential properties.
As our second quarter results indicate our portfolio continues to perform at a high level with just two vacancies same store rent growth of one 9% and unit level rent coverage now at the highest level in our history.
Additionally, with the recent data, indicating a slowdown in demand for consumer discretionary goods.
Continued strength in the demand for services.
Our portfolio remains well positioned in the current economic environment as over 93% of our ABR is derived from service oriented and experience based businesses.
On the investment front, we remained active in support of our long standing tenant relationships, but we did deliberately slow our investment pace to allow seller expectations to better reset to the rapid changes that occurred in the capital markets This quarter.
Looking out to the back half of the year, we see our investment pace trending towards our a trailing eight quarter average at modestly higher cap rates, which along with the recent closing of our $400 million unsecured term loan supports our decision to increase our 2022 a S F.
<unk> per share guidance to a range of $1 52 to.
Two one dollar and 54 cents from a previous range of $1 50 to $1 53.
Turning to the portfolio.
We ended the quarter with investments in 1561 properties that were 99.9% leased to 322 tenants operating in 16 industries.
Our weighted average lease term stood at 13.8 years with only four 3% of ABR expiring through 2026.
Our weighted average unit level coverage ratio improved to 4.0 times from three eight times last quarter.
While our traditional credit statistics, which focuses on implied credit ratings and unit level coverage experienced strong sequential improvement this quarter.
These statistics are negatively skewed by one our trailing 12 month reporting convention, which lags our own reporting by one to two quarters and two the fact that various municipalities, we're still placing capacity restrictions on certain industries well into 2021.
We continue to expect these statistics to improve sequentially, particularly at the low end of the coverage spectrum.
As demand for the services and experiences that our tenants provide largely improved throughout 2021 and into the first half of this year.
During the second quarter, we invested $176 million through 'twenty three separate transactions at a weighted average cash yield of 7%.
These investments were made in 11 different industries with 70% of our activity coming from the quick service restaurant, Carwash and fare family Entertainment industries.
The weighted average lease term of our investments this quarter was 17.2 years.
The weighted average annual escalation was one 5%.
The weighted average unit level coverage was two seven times and the average investment per property was $3 9 million.
Consistent with our investment strategy, 100% of our quarterly investments were originated through direct sale leasebacks, which are subject to our lease form with ongoing financial reporting requirements.
And 86% contain master lease provisions.
From an industry perspective.
Early childhood education remains our largest industry at 13, 7% of ABR, followed by quick service restaurants at 12, 9%.
Car washes at 11, 7% and medical and dental at 11, 3%.
Of note unit level coverage for our early childhood education portfolio is now above pre pandemic levels as our operators have experience strong pricing power due to a favorable supply demand imbalance.
From a tenant concentration perspective, our largest tenant represents only three 2% of our ABR at quarter end.
Our top 10 tenants account for just 19% of ABR.
Which was down 20 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 unrated tenants and middle market operators, which offers an expansive opportunity set.
In terms of dispositions, we sold eight properties this quarter for $26 1 million in net proceeds.
At a six 2% weighted average cash yield with.
With a weighted average unit level coverage ratio of one one times.
As we have mentioned in the past owning liquid properties is an important aspect of our investment discipline as it allows us to proactively manage industries tenants and unit level risks within the portfolio.
We.
Specced, our level of dispositions to remain elevated in the back half of the year as cap rates for individual granular properties remain near historic lows.
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 second quarter Mark.
Thanks, Pete and good morning, everyone.
The second quarter was another strong quarter for us, which was certainly an output of the performance of our portfolio.
The notable elements of our reported operating results for the second quarter of 2022 are as follows.
Total revenue was up $14 4 million or 25, 2% versus the same period in 2021 totaling $71 4 million for Q2, 2022, which reflects the impact of our net investment activity and the performance of our tenant base.
I mentioned that in contrast to last quarter, our investment activity. This quarter was heavily weighted towards the back end of the quarter.
While our asset dispositions occurred more towards the beginning of the quarter.
Total G&A was just over $7 million in Q2, 2022 versus $6 5 million for the same period in 2021.
Which primarily was reflective of higher noncash stock compensation expense.
Our cash G&A move lower sequentially from Q1, 2022 by approximately $400000, which included the impact of lower payroll related costs, which as I mentioned in our Q1 2022 conference call were elevated in Q1 2022.
And the adjustment to our incentive compensation accrual in Q2 2022.
Our cash basis G&A continues to scale favorably as a percentage of total revenue coming in at just six 8% for Q2, 2022 versus eight 1% for Q2 2021.
Net income was $35 8 million in the quarter.
Our F F O totaled 54 million for the quarter or 41 cents per fully diluted share a 28% increase over the same period in 2021.
Our nominal F O totaled $56 million for the quarter up $10 $7 million over the same period in 2021, which on a fully diluted per share basis was 38 cents, an increase of 12% versus Q2 2021.
Turning to our balance sheet I'll highlight the following.
With another solid quarter of investments are income producing gross assets reached $3 $7 billion at quarter end.
From an equity perspective, we generated approximately $32 million of net proceeds during the second quarter on our ATM program.
Our ATM activity was lighter than recent quarters in part due to the challenging dynamics in the equity markets, but also as we generated liquidity through recycling capital from asset sales and loan repayments.
Subsequent to quarter end, we closed a $400 million five and a half year term loan we completed the term loan through an amendment of our $800 million credit facility.
The rate on the term loan is floating at one month term so for plus 95 basis points.
At closing $250 million of the term loan was funded with the remaining $150 million available on a delayed draw basis.
We greatly appreciate the support of our lender group and partnering with a company to get this fully pre payable term loan executed at attractive rates.
Our net debt to annualized adjusted EBITDA was four seven times at quarter end, and our total liquidity, including the remaining $150 million available to us on the term loan is approximately $808 billion we.
We utilize the $250 million funding from the term loan to effectively pay off the outstanding balance on our revolver.
Our conservative leverage position strong balance sheet and significant liquidity position.
Continues to be supportive of our investment pipeline and future growth plans.
Lastly, I'll reiterate that our current investment pipeline outlook for the core portfolio and strong performance. This quarter provided us with a basis to increase our 2022 <unk> per share guidance range to $1 50 to $2 54 that Pete mentioned, which implies a 14% year over year growth rate at the midpoint.
With that I'll turn the call back over to Pete.
Great. Thanks, Mark.
Operator, please open the call for questions.
Thank you the floor is now open for questions. If you would like to ask a question. Please press star one on your telephone keypad at this time.
<unk> 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 the handset before pressing the star keys once again Thats Star One to register a question at this time.
First question is coming from Greg Mcginniss Scotiabank. Please go ahead.
Mr. Mckenna, Please make sure your phone is not on mute.
Definitely on mute. Thank you very much operator.
Good morning.
Pete you mentioned in your opening remarks that cap rates remain near historic lows. Just curious what do you think may change that I could we potentially see.
Expanding cap rates in the back half of the year and that causes obviously gone up. So just curious what you think holding the cap rates and whether that might change.
Yes, Greg Thanks for that I made that comment really in the context of our our dispositions and in the market for our individual assets. So you know kind of granular.
Other properties being sold into the retail investor in 10, 31 market that market remains very tight and and I think that market is driven by a different dynamic that's not necessarily entirely correlated to.
Interest rates.
Yeah, it's really a hunt for yield and tax deferrals and other things I also made commentary around our forward pipeline and obviously we closed.
Our pipeline at a 7% cap rate and our expectation for the back half of the year is to see some some modest increase in expansion in cap rates there.
And so it's an interesting market. We are one of the reasons, we deliberately slowed our pipeline and in the quarter was to allow the pricing of assets, where we buy to catch up to the movements in rate and we would expect to see that flow through in the back half.
Okay. Thanks, and then in thinking about current environment, you know whether or not we're in a recession right. Now are you starting to see any impact to your tenants I mean, the tenant credit metrics, all look pretty strong and continue to improve on that trailing 12 month basis.
But are you having to look at some of your tenants in terms of potential credit losses, this year or those that might be on your watchlist.
No, we really haven't seen any of the weakness flow through and in fact, you know the.
The coverages are at all time high levels and you know that.
Portfolio is really and we said this a number of times in the prepared remarks portfolio is in great shape, and performing well and I think one of the thing. That's underappreciated is the stress test that these tenants went through with Covid and the right sizing of their operations and rebounding from that and so.
We're not seeing any cracks nor do we anticipate them and you know.
Our tenants are really doing a great job.
Okay, and then just a comment not a question, but the chicken in pickle concept looks amazing and I want one in New York.
[laughter].
Those guys are great operators, they've got a great concept, that's really resonating in and.
I don't know that we would.
I want the basis that would cost to put it in New York.
If youre talking about the city, but.
They are definitely expanding and that concept has some good legs to it.
Thank you.
Thanks, Greg I appreciate it.
Thank you. The next question is coming from Nicholas Joseph with Citi. Please go ahead.
Hey, it's very odd, but that's that could.
We have a question on production pipeline I'm. Just curious is that with rising rates are you seeing hockey and Bob and al could.
Could you just comment on like how that buyer ship.
Looked at by market some markets disproportionately impacted by the buyers back.
Right.
I had a tough time at that question you really broke up.
Dan.
Now did you say I'll repeat the question it felt like cap rates, yeah, I cannot eat it but.
But just curious any occupied on rising rates for buyers.
Okay.
Yeah, No I mean.
It's much the retail investor in 10, 31 market that we sell in as a national market and.
Really haven't seen much of that flow through in and.
Pretty wide dispersion in rates based upon the asset class as well as the part of the purchase price of the assets, but I haven't seen material changes in that market certainly not by.
Geography.
Got it and then are there any changes to lease escalations and some of your newly signed deals.
The impact of inflation or maybe a tougher macro macro backdrop has that impacted you know conversations around lease escalators.
It really has and if you think about how we operate our business, where 80 plus percent of what we're doing in any quarter is repeat business with guys, where we already have on negotiated lease.
It's really not.
Creeping into the narrative and.
So.
We're doing 20 year leases and.
This recent spate of inflation for the first time in 30 years, it really hasnt changed that negotiating dynamic.
Got it thank you.
Thank you.
Thank you. The next question is coming from Handel St. Juste of Mizuho. Please go ahead.
Hey, guys good morning.
So.
And maybe you had I think $330 million under contract or LOI.
What portion of this Ah I guess its still in the pipeline for the third quarter I guess trying to understand whats in the pipeline the type of deals.
Volume for the second quarter, and obviously, a little bit below the historical trend. So I'm curious if any of these deals are not part of the pipeline for the second half as we're looking at it.
So maybe you can give us some color on what's in that pipeline they need new categories.
Yes.
As we say that the pipeline is very dynamic and usually represents.
A 90 day forward look.
And can some deals can even extend well beyond that given the M&A nature of some of our investments where we're supporting a transaction that has uncertain timing.
And so it's impossible to say exactly what the percentage.
The commentary in the call was that we expect our investment levels to return to the eight quarter average.
In the back half of the year and so.
That would suggest that 200 ish.
Sort of number.
And the pipeline certainly supports that the commentary.
And then in terms of comp composition of the pipeline, there's really nothing new in it and again I would reiterate when you're doing 80% repeat business and relationship business. It's.
The deals are coming from your portfolio and the deals that you've done in the past and those relationships. So by design. The pipeline is going to look a lot like what we own and Theres really nothing noteworthy but for some some expansion in the cap rates at the margin.
Great.
Maybe one on on dispositions I wanted to understand the cap rate there.
A bit lower than we expected the volumes a bit more understand it's the incremental sources of capital. These days, but maybe you can talk about.
The level of cap rates is that a level, we should expect maybe the decision to sell after till late in the quarter did that influence.
You know what you sold in the cap rates at all.
Yeah listen I think the timing of dispositions.
Is reflective.
Reflective of our decision to kind of lean into capital recycling as a result of the movements in rates that we saw in <unk>.
During the quarter and that sales cycle is just by by design, but puts it towards the end of the quarter.
And we.
We anticipate staying on our front foot.
In terms of dispositions in the back half of the year.
The cap rates on dispositions are going to vary wildly in and.
It's not a material part of the financial picture. So I Wouldnt guide much lower than than you saw printed but I would.
We would generally transact.
Kind of around that 6% range or below.
I did make the commentary.
Citi asked about at the beginning that that market remains pretty robust and it's somewhat disconnected from the movements in rate and so there's a real.
Disconnect for us to sell into that and realize those rates despite the movements in and cap rates and interest rates as well as selling off.
Kind of the assets that we don't want to hold on a long term basis. So.
The liquidity, we've built into the portfolio as an important risk mitigated for us in this important.
Source of capital and you should expect us to tap that as we look at the back half of the year.
Thank you.
Thank you Phil.
Thank you. The next question is coming from Sheila Mcgrath of Evercore. Please go ahead.
Hi, Yes, good morning Pete.
Pete.
<unk> costs are up you know depending on the company's 5100 basis points or more I just wonder based on your experience in that in the net lease sector. If you think that cap rates could move in lock step with borrowing costs. It costs rise or do you expect a lag here.
Yeah.
Well I think there is certainly always a lag right as you kind of clear through your pipeline, which I made the commentary that usually about a 90 day pipeline. So I think that's one of the reasons why.
You look at our second quarter print at 176 seven cap.
Those were largely deals that we were committed to prior to the movements in rates and.
Why we're guiding to low sevens and above that here in the back half so.
Certainly lagging the movement in cap rates.
And generally there is not a lockstep movement in cap rates to interest rates.
And but.
They do move.
In the same direction, just it takes a little while and it's a little muted.
Okay, and then the GAAP cap rate for acquisitions tweaked back to 8% it hasn't been at that level, you know for a couple of years.
Just wondering were you able to originate current product with higher annual escalation.
Yes, that's what that would that would.
That's that would indicate and it also goes lockstep with our wall being so long at $17 two years.
So we are originating deals that were a little longer as well.
Okay. Thank you.
Alright, Thank you Sheila.
Thank you. The next question is coming from Josh <unk> of Bank of America. Please go ahead.
Hi, good morning.
On for Josh.
A question on tenant credit quality.
I was wondering if you could explain why rent coverage ticked down at two seven times.
About three three last quarter.
Could you explain the trend a lot.
Okay.
Yes.
I would say is.
More important trend to focus on is the trend of the overall portfolio not our individual.
Not our overall.
<unk>.
In quarterly investments and so that that number is for the investments that we made during the quarter and those investments are heavily influenced by the mix of industries and property types that vary widely from quarter to quarter. The bigger trend is our portfolios.
We're all coverage expanding to four times, which is the highest its been.
Now that two seven is very small percentage of the overall portfolio and really heavily influenced by the specific deals that we do.
Okay. Thank you.
<unk>.
And.
For my second question I'm, just wondering if you all have changed your thinking around underwriting new acquisition.
<unk>.
Stay on track and you haven't changed your outlook for that for that quarter.
Quarter trailing average.
I cannot give any condition.
Has there been any change in how you're thinking about underwriting.
Well I guess, there's really there's two questions inherent in that is one is underwriting risk and two is managing the business and the growth within the business.
Our evaluation and underwriting of risk in our tenants has evolved over.
Decades of investing in this asset class and that does not has not changed nor is it likely to change in.
In terms of our pace of acquisitions.
While our cost of capital isn't where it has been.
It's still attractive and there is a lot of opportunities with less competition quite frankly as you.
This market volatility has shaken out a lot of the competition that we were seeing formed earlier in the year.
And we have great relationships that continue to bring us opportunities to invest in and build the portfolio and grow earnings and so we feel good about what we're seeing here in the back half of the year and where we.
To continue to deploy capital.
Towards that.
Great. Thank you.
Thank you.
Once again, ladies and gentlemen that is star one if you would like to register a question at this time.
The next question is coming from Keybank of choice Securities. Please go ahead.
Thanks, Tom and good morning.
Can you talk about the debt raise the guys just did I believe is still floating.
If you have any plans can slop, it and what that cost could look like.
Yes, thanks for that question.
I'll start with saying what we've.
<unk> consistently said before that our philosophy is really to match fund our leverage to our long dated leases, which we certainly plan to do.
But it just strikes us that.
Is that an opportunity opportune time to lock in that long term funding.
Given the dislocation that we see in the public unsecured debt market. So.
Not swapping a long five term loan are really sort of preserves our optionality around prepayment capability.
And that's really that's really why we were there.
If you can just kind of.
I'll help me satisfy my curiosity, though what would the swap rate be if you. If you did it in this type of market.
Alright, Dan what are you guys yeah. Its around two 3% right now Kevin on a five year basis.
Okay.
And if cap rates do tick up higher im guessing its not going to be for all types of assets in all categories together right.
What do you think it shakes loose first and.
With those types of assets being things that you'd be interested in so.
So I guess I'm asking.
So the things that you're typically looking to buy.
Those cap rates move.
Upwards as well.
Yeah listen it's.
Remember the way, we invest is providing.
Sale leaseback capital.
Two growing operators within our targeted 16 industries largely relying on relationships that we know and have done deals within the past.
Our.
Competition in.
The price of those deals really are paid based on two factors. One is the level of competition and two is our competition with competing capital sources.
And so.
We largely compete against other forms of capital, whether it would be unsecured financing or mortgage financing or or what have you and to the extent that that capital becomes more expensive or less available R. R.
Sellers are counterparties are tenants or are less price sensitive and so we're seeing.
<unk> ability to move cap rates across the entire spectrum of opportunities that we invest in all our industries.
Yeah.
We remain.
We continue to avoid highly auctioned.
Competitive situations, where there's a competitive dynamic that forces a cap rate down.
Like in the investment grade existing lease deals.
But we're seeing the ability to move cap rates.
Across all our opportunity sets.
You know at a modest rate.
Okay. Thank you.
Alright, Thank you Kevin Thanks, Kevin.
Thank you. The next question is coming from John Mascara of Ladenburg Thalmann. Please go ahead.
Good morning.
Oh not Jonathan.
Just on the disposition front it seems like a lot of the capital recycling was kind of based on loan receivable prepayments just curious what the outlook for more of these kind of tenant prepayments is in the near to medium term given kind of.
Is that kind of big lumpy.
Floods of that in the last two of the last three quarters.
Yeah, I would start our loan book is pretty modest at two.
202 hundred ish million.
So it's.
There is.
There's not a ton.
I would expect that we continue to get some loan payoffs in the back half of the year.
Yeah.
Probably.
Not as big as we saw in this quarter, but.
<unk>.
At some level.
Okay.
Right.
We don't control those and it really depends on the borrower when they source alternative capital or decided to repay so.
It's it comes out is when it comes out.
Okay.
And then maybe bigger picture kind of with recession in an economic pullback.
At least in People's minds are kind of outlooks going forward.
Yes, you kind of look back and you are experiencing kind of the sale leaseback market with the middle market credits.
In prior cycles, maybe and maybe as you look forward if there is an economic slowdown.
Correlated Dean feel.
Deal flow is to economic activity essentially.
The tenant either arent confidant are in a position to expand or consolidate I mean, how do you think that flows through your transactions or do you think it's kind of immune to that but take care.
Liable source of capital.
Yeah.
I would say.
Are somewhat immune to that because.
Our opportunity set is so large and our investment volumes are so modest relative to the opportunity set and we go to market with.
Great cost of capital relative to a lot of alternatives.
I would also point out that our 16 industries and our service experience based.
<unk>.
The industry focus is.
One of the one of the bright spots in the economy, and really fighting the trend and services and experiences are.
We're doing pretty well.
Our tenants within those industries continue to do well.
So that's one of the reasons why we are maintaining our kind of guidance and raising our guidance. Despite what is not a completely sunny outlook.
Okay.
So for me. Thank you very much thanks John .
Thank you. The next question is coming from Chris Lucas of capital One. Please go ahead.
Hey, good morning, everybody.
Pete just kind of going back through the disposition pool that you guys are thinking about and just reviewing the last trailing eight quarters is sort of a mix of what appears to be sort of risk mitigation in terms of low coverage type assets being sold as well as maybe some more medium.
Credit issues. So I'm just curious as to when I think when you guys think about the disposition pool that youre looking at to sort of fund acquisitions is it risk mitigation or is relative value that drives what goes into that pool.
I would say it's more.
And not to be cute, but it's more relative value around risk mitigation and.
And selling assets that just.
Just don't meet our long term.
Investment horizon.
And.
Just moving them out in and remember there's an interesting dynamic that goes on when we're selling assets out of the master lease that.
We are establishing a rent on a specific asset.
And.
Really and that affects the hold position on the overall position, but by and large it's risk mitigation on occasion, we will get a inbound offer unsolicited offer for assets, where the prices just.
Way off the charts relative to our thinking on value and we will hit that bid but for the most part it's the risk mitigation.
Okay. Thanks for that and then as it relates to I guess I'm just trying to.
Understand when we talk about interest rates and its impact on.
Cap rates I guess I, just want to make sure that there was specific.
Rate benchmark that Youre looking at obviously with the increased concerns about a recession, you've seen a sort of a flight to the 10 year has come down quite a bit just in the last couple of weeks.
Just just kind of curious when you think about what what drives that.
Move in cap rates.
What rate are we really talking about.
I think that I think the 10 year really becomes the best proxy given the long dated nature of this asset class.
And then just the liquid nature of the 10 year.
Most investors in this space are looking to match fund and term debt similar to the underlying lease lease term and so.
I think the 10 year becomes the best proxy.
Okay. That's great. Thank you that's all I had this morning.
Alright, Thank you very much Chris we appreciate it.
Thank you at this time I would like to turn the floor back over to Mr. <unk> for closing comments.
Great well. Thank you all for your participation today and your questions. We appreciate your interest.
And our company and.
Everyone have a great summer thank you.
Ladies and gentlemen, thank you for your participation. This concludes today's event you may disconnect. Your lines at this time and enjoy the rest of your day.
Yes.
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Okay.
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Sure.
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