Q4 2022 Essential Properties Realty Trust Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to the essential properties Realty Trust fourth 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.
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.
The dial in details for the replay can be found in yesterday's press release.
Surely there will be an audio webcast available on essential properties website at www dot essential properties Dot com, an archive of which will be available for 90 days.
It is now my pleasure to turn the call over to Don Don Dan Donlan, Senior Vice President and head of.
Capital markets and portfolio management and essential property.
Thank you operator, and good morning, everyone. We appreciate you joining us today for our central properties fourth 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 will 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 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 press release with that Pete. Please go ahead.
You, Dan and thank you to everyone who is joining us today for your interest in essential properties.
We finished 2022 on a strong note with a record $328 million of investments in the fourth quarter and $937 million invested for the full year.
This translated into year over year, a S. F O per share growth of 14% in 2022, which we are extremely proud of given the unprecedented volatility in the capital markets and the rapid rise in interest rates.
Our fourth quarter results indicate our portfolio continues to perform at a high level with unit level coverage of four times.
Supremacy of 99, 9% and same store rent growth of one 6%, which speaks to the de Minimis credit losses that we experienced in 2022 as our weighted average contractual rent escalations are approximately one 6% per annum.
This strong performance is a testament to our granular fungible properties, the resiliency of our service oriented and experience based Tennessee, which represents 93% of our a b R.
And our proven ability to accretively recycle out of our weaker performing properties.
The investment front, we remained active in support of our long standing tenant relationships as they are increasingly turning to us as a reliable capital provider to grow their footprints given the limited funding available in the bank market and.
In private leverage buyers largely being sidelined due to the dislocation in the debt markets.
With quarter end pro forma leverage of four five times and liquidity of nearly 700 million our balance sheet continues to be well capitalized for our investment activity.
We are reaffirming our 2023 F F O per share guidance of $1.58 to $1.64, which implies year over year growth of 5% at midpoint.
Turning to the portfolio.
We ended the quarter with investments in 1653 properties that were 99, 9% leased to 350 tenants operating in 16 industries.
Our weighted average lease term stood at 13.9 years with only six 1% of our ABR expiring through 2027.
From a tenant health perspective, our weighted average unit level coverage ratio was four times this quarter, which was expected given the lagging impact of inflationary pressures flowing through our tenant financials.
Our percentage of ABR under one times coverage continue to moderate from pandemic pressures experienced during the reporting period and now stands at a more normalized level of three times, 3% of ABR.
During the fourth quarter, we invested $328 million through 39 separate transactions at a weighted average cash yield of seven 5%.
Which was up 40 basis points versus the prior quarter.
These investments were made in 13 different industries with 75% of our activity coming from the Carwash casual dining auto service and entertainment industries.
The weighted average lease term of our investments this quarter was $18 seven years, the weighted average annual rent escalation was one 8%.
The weighted average unit level coverage was three two times and the average investment per property was $2 8 million.
Consistent with our investment strategy, 99% of our quarterly investments were originated through direct sale leasebacks, which are subject to our lease form with ongoing financial reporting requirements.
90% contained master lease provisions and 95% were generated from existing relationships looking.
Looking ahead first quarter of 2023, we have closed $65 7 million of investments to date at a 7.6 kashyap.
Our investment pipeline remains robust as an increasing number of middle market companies are seeking sale leaseback capital as a financing alternative as other sources of capital have become unavailable or on economics.
We see this trend continuing to bet benefit essential properties as 97% of our 2022 investments were sale leaseback transactions and we remain well positioned to reliably deliver capital to our relationships.
From an industry perspective car washes are our largest industry at 13, 2% of ABR followed by early childhood education.
<unk>, 8%.
Service restaurants at 11, 6% and medical dental at 11, 1%.
Of note unit level coverage for our early childhood education portfolio continues to increase above pre pandemic levels as our operators are seeing strong pricing power and a better labor environment, which has allowed our facilities to further increase their enrollment.
From a tenant concentration perspective, our largest tenant represents three 4% of ABR at quarter end and our top 10 tenants now account for only 18% of ABR.
Tenant diversity is an important risk mitigation tool and differentiator for us 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 26 properties this quarter for $75 5 million in net proceeds at a six 9% weighted average cash yield.
Our weighted average unit level coverage ratio of two one times.
As we have mentioned in the past owning fungible and 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.
This record level of disposition activity was in response to the capital markets volatility experienced in the back half of 2022 and our desire to lower our reliance on new raising new capital.
While we do not anticipate our elevated level of quarterly dispositions to persist we do expect our disposition activity to remain well above our trailing eight quarter average of $27 million or at least the first half of 2023.
With that I'd like to turn it over to Mark Patten, our CFO , who will take you through the financials and balance sheet for the second quarter.
Thanks, Pete and good morning, everyone.
We had a fantastic fourth quarter with as Pete noted a record level of $328 million in new investments.
Notably at a seven 5% cash cap rate.
Our portfolio continues to produce consistent internal rent growth as evidenced by our same store rent growth coming in at one 6%.
Our balance sheet liquidity remains highly supportive of our growth for 2023.
Among the headlines last night was our <unk> per share, which on a fully diluted per share basis reached 39 cents in the quarter, that's an increase of 5% versus the fourth quarter of 2020 one.
On a nominal basis, our F O totaled $55 8 million for the quarter.
Up $10 4 million over the same period in 2021.
That's an increase of nearly 23% and up over 4% compared to the third quarter of 2022.
For the full year ended 12, 31, 22 <unk> per share totaled $1 53 per share on a fully diluted per share basis, which is a 14% increase over 2020 one.
On a nominal basis, our full year 2022 way flow increased by 32% over 'twenty, 'twenty, one or $58 million totaling $208.8 million.
Total G&A was just $6 5 million in Q4, 2022 versus $5 8 million for the same period in 2021 with.
With the majority of the increase relating to an increase in noncash stock compensation expense.
Our Q4, 2022 cash G&A was approximately $4 3 million.
And was sequentially lower to Q3, 2022 by approximately $1.3 million, which was impacted by the absence of the 250 Grand we expensed in Q3, representing the costs, we incurred to amend our 'twenty 'twenty seven term loan to reduce the rate grid on that borrowing and a reduction of our 2022 bonus accrual in the.
The fourth quarter.
Our cash G&A as a percentage of total revenue was five 8% for the quarter and 7% for the full year 2022 which compares favorably to the 9% and 10, 6% respectively for the quarter and full year of 2021.
On an annual basis, we continue to expect our cash G&A as a percentage of total revenue to rationalize in 'twenty twenty-three.
Turning to our balance sheet I'll highlight the following.
With our $328 million in <unk> 2022 investments.
Our income producing gross assets reached $4 1 billion at year end.
From a capital markets perspective in the fourth quarter, we completed the sale of approximately $22 $2 million of stock on a forward basis on our ATM program.
We settled that forward in early January of 2023, along with the shares that we sold in January 20th twenty-three generating total net proceeds of approximately $39 $2 million.
From a debt perspective, I'll reaffirm that during the quarter, we swapped to fixed all of the remaining $150 million that we drew in October under the $400 million 2028 term loan.
Our net debt to annualized adjusted EBITDA R. E was four six times at quarter end.
Adjusting for the proceeds from the forward sale, we completed in the quarter, our net debt to annualized adjusted EBITDA. Our EBITDA was four five times.
We are committed to maintaining a conservative balance sheet and investors should expect us to remain well within our historical leverage range of four five times to five five times.
At quarter end, our total liquidity stood at nearly $700 million.
Our conservative leverage position strong balance sheet and significant liquidity position continues to be supportive of our current investment pipeline and sufficient to fund our growth plans in 2020 three.
Lastly, I'll mention that our current investment pipeline the outlook for our core portfolio and our continued strong performance at the end of 2022 provided us with the basis to maintain our 2023 if a vote per share guidance range of $1 58 to $1 64, which as Pete mentioned implies more than.
5% year over year growth at the midpoint.
With that I'll turn the call back over to Pete.
Thanks Mark.
Please open the call for questions.
Thank you we will now be conducting a question and answer session.
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One moment, please while we poll for questions.
Thank you and our first question is from Hendel St. Just with Mizuho. Please proceed with your question.
Yeah.
Hi, Good morning. This is Ravi gave you on the line for Ron do I Hope you guys are doing well.
Understanding that once you you know what.
The transaction activity that's occurred in <unk>. So far is not necessarily the run rate for the whole year can you talk about your perception of the transaction market today, and how that feels compared to prior years and the first quarter.
Yeah.
Yeah, I think you know listen I wouldn't read too much into the quarter to date activity normally the cadence in the first quarter is a slow January I'm, given sort of the hangover effect from what you typically as a a very active fourth quarter, but.
The.
The transaction market is pretty interesting in that.
There is a slightly diminished level of transaction activity, giving whats gone given what's going on in the capital markets.
But that's also offset by a severe.
Diminish severely diminished a set of our competitive set and such that those balancing factors make us feel really good about the pipeline, we're seeing and and the opportunities that we're working on.
Great. That's helpful. Just one more here given the portfolio mix a you know a number of private equity backed tenants can you comment on your watch list right now and how.
How has that changed over the last few quarters are you noticing any margin bidding for any of the company was labor. It gets more expensive or is demand come in for many retailers from consumers as well.
Yeah I would.
Our watch list is and you know related to private equity ownership and in any way. The vast majority of our portfolio is privately held and and you know that could be private equity owned or you know individual private individuals, but overall the watch list as we define it which is at the intersection.
Section of the single B minus credit and coverage less than one time, one and a half times.
Is that 50 basis points, which is as low as it's been and you know overall the portfolio is in great health you see that in our same store sales number that we reported as well as our occupancy, which you know at 99% and one 6% or is or are pretty healthy. So portfolio is in great shape.
Coverage moderated a little bit as I said in the prepared remarks, which we think is a result of.
You know kind of in the inflationary pressures and the lagging effect of our tenant's ability to push that through but at four times is really nothing that gives us concern.
Yeah.
Thank you and our next question is from RJ Milligan with Raymond James. Please proceed with your question.
Hey, good morning, a couple of questions. My first is it looked like.
<unk> became a top tenant.
This quarter and I'm, just curious because it does seem like a slight deviation from no buying fungible boxes I'm curious if you could give any more color on that incremental investment.
How much was it in <unk> and sort of the thought process there.
Yeah. So five star really what had been in our portfolio for a while as they were formerly tracks and and you know they.
And they rebranded them as they did another add on investment you know, we think those assets are pretty fungible and and in several of them are kind of in the family and entertainment space, you know with high land value and I'm, you know a long operating history of great.
Unit level economic and coverage.
And you know a great operator with great assets and you know we're happy to have them in the top 10.
Okay, and then a question for Mark most of the forwards here have been used up and I'm just curious in the short term.
How do you anticipate funding our growth just say over the next few quarters do you anticipate using the line for that or could we anticipate additional potential for what's coming.
No I appreciate that question I think we keep what you could anticipate is that are you know sort of embedded in our guidance is not needing to access incremental debt, but rather use the revolver.
In terms of equity I think you know if it was a T. M. If it was equity activity, mostly it would probably be opportunistic under the ATM, but we really don't need to do anything.
Of a material nature to hit our midpoint. So in the next two quarters certainly nothing of significance.
Great. That's it for me thanks, guys. Thanks.
Thanks, RJ and we appreciate it.
Thank you and our next question is from Josh Josh Dan Your line with Bank of America. Please proceed with your question.
Yeah, Hey, guys I was just curious if your.
In your own underwriting or what you're seeing a kind of competitors for assets kind of changing their IRR hurdles at all just given the.
Changes in the cost of capital today.
Yeah listen I I can't really speak to what other people are doing.
You know, obviously I think you know that.
Leverage buyer who's seen debt costs rise materially and and you know you.
You know I have severely you are challenged in the current market environment with with the curve.
Availability and cost of underlying financing.
As we look at opportunities you can see our cap rates have moved to 40 basis points sequentially in the quarter mm ENT and our you know we feel good about.
The opportunities, we're seeing and our ability to kind of move rates.
I would also point out.
You know in the quarter our lease.
At least 10 or was it was high it was higher at $18 seven years versus $16 five years than in the third quarter and our Escalations were higher so overall, where we're getting a more favorable economic package and the deals that we're doing.
The deals in the quarter, where you know 95% repeat business. So guys that we have dealt with in the past and so that would clearly indicate.
Higher embedded irr's inherent in those deals, which kind of goes along with the cost of capital.
Yeah I appreciate that that's good color and then within like the industry verticals that you like.
To acquire are there kind of better opportunities out there like as far as like where you're seeing the most steel volume coming coming through.
Yeah, you know.
We yeah.
We tend to invest and we tend to tell people to that we will invest ratably largely because that's where our relationships.
And that's where our sourcing activity is conducted in across the 16.
Verticals and end it may ebb and flow them, you know in any given quarter or the fourth quarter.
Was very heavy in carwash activity for us quite frankly for the first couple of quarters of the years. Those that sector was was was pretty hot from a cap perspective, and many deals where pricing away from us and we are choosing to trance transact and other sectors, but for whatever.
The reason I'm you know those operators.
Didn't have as many capital opportunities in the fourth quarter, and we were able to strikes a nice balance there, but overall you know over a longer period of time, Josh I would expect it to the portfolio grow ratably.
Thank you.
Okay.
Thank you and our next question is from Greg Mcginniss with Deutsche Bank. Please proceed with your question.
Hey, good morning, with Scotiabank I'm trying to reconcile between comments made last quarter regarding.
Essentially moderating acquisitions and maintain guidance this quarter. Despite a record Q4 on transactions significant liquidity and a healthy sale leaseback environment guidance being maintained due to the level of anticipated dispositions in the first half of the year or any color you can provide on the puts and takes would be appreciate it also around what <unk>.
Rates do you anticipate on those asset sales.
Yeah listen I think in the asset sales just tackle that one I would expect you know something in the mid to high sixes and you know if you are conservative you know underwrite a seven.
But clearly we think theres good liquidity for our properties on.
On an individual basis and continue to sell into that market as it relates to guidance you know, it's it's early in the year end and there.
There remains a lot of.
Turmoil in the capital markets and we feel I would say, we feel incrementally much better today than we did when we first issued guidance based upon some of the factors you mentioned you know our execution in the fourth quarter the dynamics in the sale leaseback market.
And and quite frankly, the first quarter pipeline that we see.
But it's still early in the year, and we'll certainly continue to evaluate guidance and and as.
As the year progresses, but.
You know at this point, we're just affirming our guidance.
Okay. Thank you and on the dispositions are there any I mean, what types of assets that you're looking to offload or doesn't it.
No particular industry particular tenants or are you just kind of finding the ones where you can get this this good cat, there's good cap rate to help fund future growth.
Yeah. It's it's certainly not that you know, we're not cherry picking and trying to.
Sell the assets to garner the most attractive cap rates if that were the case I would expect you know you know our best assets to sell in the fives, we're really looking at assets with coverage levels or our trends at the unit level that would.
<unk> indicated it's not going to be the healthiest asset over a long period of time and oftentimes, we're selling assets out of a master lease.
So that we can improve our hold position so by and large it's it's derisking sales you know getting rid of assets that you know.
We don't think are going to be as durable for the 20 year period as we would like.
Okay. Thank you.
Thank you.
As a reminder, it is star one if you would like to ask a question. Our next question is from Nick Joseph with Citi. Please proceed with your question.
Hey, good morning, it's Nick on for Nick Joseph.
So a bit of a follow up but you all decided the 228 million that's been activity per quarter, our previous presentations and obviously Q4 is about that so I just curious how we should sort of run rate that as a baseline going forward, because it's going to be north of that 228 or similar.
Yeah, well listen we as as we always do kind of guide people towards the eight quarter average is a good indicator of what to expect.
As but you know we rarely have visibility on our pipeline out past 90 days such that you know what.
Uncomfortable, giving you a more precise investment guidance around that historically and in one of the reasons, we provide historical quarter over quarter guidance quarter over quarter activity. The fourth quarter is heavy and I think this fourth quarter is consistent with that.
And you know I think the first as we look at the first quarter, we feel pretty good about what we see.
But you know I think as we said in the context of providing guidance.
We would expect a more moderated level in the back half of this year.
And that May change as the year.
You know plays out but as we sit today, we feel good about the first half and we'll see what comes in the second half.
Yeah.
That's really helpful. Thank you and then on guidance. So how do you see the economic environment affecting the tenant base and how much credit loss, if any is baked into those numbers right now.
Yeah.
Yeah actually so what I'd tell you just from.
From a modeling standpoint, if you look at the range you could just assume that there's a healthy level of credit loss at the bottom end of the range. So we've incorporated that and effectively as you move up that range are really moving up towards our more historical loss experience, which is probably.
30 basis points, but.
You know candidly as you discovered in 2022, certainly as you saw on our same store growth, we had limited credit loss and so oftentimes that can be a pretty good tailwind.
For us as we move through the year to kind of.
Ability to adjust our guidance.
Awesome. Thank you and I'm looking forward to seeing you guys at the conference.
Yeah, Thanks for hosting and we're looking forward to it.
Thank you and our next question is from John Michel <unk> with Ladenburg Thalmann. Please proceed with your question.
Good morning.
Oh, Yeah, Hey, John .
So maybe going back to dispositions a little bit.
As we think about loan repayments from from the loan book is that something that could moderate over the course of 'twenty three versus what was done in 'twenty two given the you know.
Cap rate environment, that's out there for those those.
[noise] tenants and or was it kind of for Q3 Q to <unk> shift just kind of the inherent lumpiness in repayments.
Yeah, I think it's just the inherent lumpiness of repayments.
I would.
The loan books pretty small and it's not material part of our asset base and those those repayments tend to be episodic.
I would suggest.
We have some loans that are repaid through the sale of individual assets and that kind of tends to dribble in and so I would expect that dribble in sort of repayment to persist throughout the year because that market remains open and attractive with 10 31 buyers continuing to to transact in.
In sell in and which results in those loans being repaid to us.
On occasion, those loans are refinanced out and that becomes a little more chunky I would expect that to be a little more challenged in the current market environment, where the big.
Hunks of of repayment coming back to us or a little.
A little less probable.
But again, it's not a big part of our book and I wouldn't expect it to have a material impact on our numbers.
As you think about the impact on NOI or are those typically repaid right at the same rate that they were issued at or.
Is there some kind of I guess.
Economic benefit that accrues to <unk>.
<unk> on the sale in terms of like you know that.
Bonus or additional debt.
LTE stuff.
Yeah, I mean on occasion, we have prepayment penalties and you see that flowing through our numbers on it.
It happens.
Not on all of the loans and it tends not to be material. We've always said that our loan book tends to carry the same.
Rate as are our investments so you know they they.
That money probably went out the door.
Like our investment capital and I'll call. It in the low sevens and if we're getting it back today, we're able to redeploy that kind of in the mid to high sevens. So there could be some economic impact there.
Okay, and then apologize if I missed this earlier in the call, but how are you seeing a yoga pipeline not you gave the cap rate on acquisitions closed to date, but looking out in the pipeline, maybe whats under LOI as well.
Are you seeing kind of additional cap rate expansion versus what was seen in <unk> or things.
<unk>, a little bit given maybe the interest rate environment.
It feels like they're stabilizing and so you know our first quarter pipeline is not materially different than that.
Fourth quarter.
And so it doesn't it doesn't.
Our cap rates arent going to eight mm, but I'm certainly not back to seven and so I think that the mid sevens a good good.
Cater.
And then one last question on acquisitions. The competitive set you mentioned it was kind of smaller than it had historically been.
I guess, maybe just in terms of what Youre seeing at the table as you kind of look at deals in and negotiate with potential tenants.
Our people potentially drifting more in your space that historically played in the investment grade or is it more kind of publicly traded names.
On a sale leaseback basis or is that.
I guess not happening.
Yeah.
I would first off encourage you to think about the competitive set not only as sale leaseback buyers, but alternative sources.
Sources of capital and that's the much bigger impact is that.
<unk> financing leverage to leverage lenders in an asset back lenders there, they're all challenged and our tenants you just have fewer capital alternatives to capitalize their growth, which is making more and more of them turned to sale leaseback.
Capital that as an alternative and it's really a very unique window in time.
Where there is such a dislocation in the overall capital markets that allow us to kind of lock in these attractive returns for 20 plus years.
As it relates to the sale leaseback competitors.
You know clearly as I said in the prepared remarks, some of the leveraged buyers are less aggressive and we are seeing some incremental.
Competition from some of the public peers.
But really that's at the margin and the bigger factor is that financing.
As challenging all over the place and more and more people are forced to look to sell leaseback capital as a means of financing their growth.
That's very helpful and that's it for me. Thank you very much.
Thanks, John .
Yeah.
Yeah.
Thank you and our next question is from Tayo Okusanya with Credit Suisse. Please proceed with your question.
Hi, Yes. Good morning, everyone I just wanted to go back to the commentary you guys made about Neil.
You know uncertainty in the credit market.
And specifically I'm trying to understand.
What's happening with your middle market cannot be.
To access the capital.
Whether that causing any kind of financial distress.
Which could have impact on you know on rents or whether again to financial distress.
You can create opportunities for you guys to do.
A new spot transactions.
With some of these tenants on a going forward basis.
Yeah.
Most of our tenants.
You know the vast majority of our tenants have long capital that's locked in and form of debt equity and in real estate capital.
And really the financial stress really comes from you know operating stress that are operating under performance, which we are not seeing.
And so as we said our our our portfolio is in great shape. Our tenant watch list is as low as it's been in a long time, our coverages are very high and.
Our tenants are doing very well and we feel good about that to the extent that there were any issues as mark indicated that would be baked into our guidance and and.
But overall, we feel really good about the underlying credits in the portfolio and their operating performance, which in owning their operating real estate is our primary concern and you can see our coverages are very strong our occupancy is 99, 9% and more flow through of rent escalations in 'twenty two.
92 was virtually 100%.
All good indicators of solid credit performance.
Lack of capital availability.
And the capital markets more pertains to their incremental growth and financing their M&A ability, which at the margin is creating incrementally.
More opportunities for us to deploy capital at attractive rates.
Yeah.
Yeah.
Okay.
Thank you as there are no further questions 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 time today, we look forward to seeing everyone at the upcoming conferences and please feel free to reach out if you have any questions have a great.
Yeah.
Ladies and gentlemen. This concludes today's teleconference. You may disconnect. Your lines at this time. Thank you for your participation.
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