Q1 2023 National Properties Inc Earnings Call
Speaker 1: Greetings and welcome to the NNNREIT First Quarter 2023 Earnings Call. At this time all participants are in a listen-only mode and a question and answer session will follow the form of presentation.
Speaker 1: If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded.
Speaker 1: I will now turn the conference over to your host, Mr. Steve Horne, CEO of NN-Enri's. Sir, you may begin.
Speaker 2: Thanks Ali. Good morning and welcome to the inaugural NNN REIT first quarter 2023 earnings call. Joining me on this call is Chief Financial Officer Kevin Hobbitt.
Speaker 2: As this morning's press release reflects, NNN's performance in the first quarter produced 3.9% core FFO growth along with acquisitions slightly over $155 million with a 7% initial cash yield.
Speaker 2: In addition, our portfolio retained the high occupancy of 99.4, which I attribute to the upfront due diligence on property acquisitions and the continuous portfolio management that M&N does every day. But before we continue with the operational performance, I want to address the name change, which I'm excited about. First, as I stated in the press release, the change does not signal a strategy shift with acquisitions.
Speaker 2: Balance Sheet Management with deliberate and consistent NNN.
Speaker 2: We felt it was time to take advantage of the NNN brand. The reality is NNN is what we are called with our circle of investors, peers, clients every day. In addition, our website and emails use the NNN REIT brand.
Speaker 2: Therefore, the change is making NNN even more consistent within our sector. Turning to the highlights of the first quarter financial results, our portfolio of 3,449 freestanding single-tenant retail properties continue to perform exceedingly well. As I stated earlier, occupancy ended at 99.4 for the quarter, which is above our long-term average of 98%. occupancy remained flat from year-end, at the quarter-end NNN only had 20 vacant assets.
Speaker 2: which is one less than the year end, which is a product of our leasing department enjoying a high level of interest by a number of strong national and regional tenants in our vacancies. In addition, 91% of our leases that were up for renewal during the quarter exercised an extension.
Speaker 2: I'm sure we'll cover more of the credit watch list in the Q&A, but I just want to get a little bit more color. There are some large names that file bankruptcy.
Speaker 2: One of the recent filings of Bed Bath & Beyond, which NNN currently owns three of their assets with an average rent of $13 per square foot.
Speaker 2: We've been getting a lot of inbound interest on the assets because of the quality of real estate, so I expect when the time comes to release the assets, we'll have superior recovery rates in a timely manner. Remember, as I stated earlier, the average occupancy from NNN since 2003 is 98%.
Speaker 2: So in a portfolio I stood to test the time through GFC and COVID.
Speaker 2: Turning to acquisitions, we'll continue to be prudent in our underwriting and NNN is afforded the luxury to continue to be selective.
Speaker 2: We acquired 43 new properties in the quarter for approximately 155 million, the initial cap rate of 7%, with an average lease duration of 19 years.
Speaker 2: Almost all of our acquisitions this past quarter were sale leaseback transactions.
Speaker 2: That is a result of the calling effort of our M&M Acquisitions Department.
Speaker 2: And then prides itself on maintaining the relationship business model, which we do repeat programmatic business.
Speaker 2: With regard to the acquisition pricing environment, the last quarter of initial cap rate of 7% is approximately 40 basis points wider than the fourth quarter of 2022.
Speaker 2: As I mentioned during the February call, we were seeing cap rates steadily increase.
Speaker 2: But now as we sit here at the beginning of May, the cap rate increases are starting to plateau some.
Speaker 2: What I mean, the rate of increase is definitely slowing down, so I'm not expecting another 40 basis points for the second quarter of 2023.
Speaker 2: This is resulting on NNN feeling that cap rates are starting to hit the glass ceiling assuming the macroeconomic environment settles down.
Speaker 2: During the quarter, we also sold six properties that generated nearly $12 million of proceeds to be reinvested in new acquisitions.
Speaker 2: The disposition consisted of three vacant assets and three income producing assets at a 6.6 cap rate. I do expect disposition activity to be greater in the second quarter and we are keeping our disposition guidance unchanged for the year.
Speaker 2: As I finish up and to remain consistent as past calls, Kevin and his team keep the balance sheet rock solid. We ended the first quarter with $209 million out on our $1.1 billion line of credit. No materials debt maturities until 2024. Thus, M&N is in terrific position to fund the remaining of our 2023 acquisition guidance.
Speaker 2: reasonable rest while maintaining a strong and flexible balance sheet.
Speaker 2: As I stated earlier, M&M is in solid footing as we are a quarter to 2023.
Speaker 2: With that, let me turn the call over to Kevin for more color and detail on our quarterly numbers.
Speaker 2: Okay, Steve, thank you. And as usual, I'll start with a cautionary statement. We will make certain statements that may be considered to be 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 these forward-looking statements.
Speaker 2: to reflect changes after the statements were made, factors and risks that could cause actual results to differ materially from expectations or disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release. Okay, with that out of the way, headlines from this morning's press release report quarterly core FFO results of 80 cents per share for the first quarter of 2020.
Speaker 2: over Q1 2022 results.
Speaker 2: As can be seen in the footnote on page 1 of the press release, as well as the detailed deferred rent repayment schedule on page 13, the
Speaker 2: The accrual basis deferred rent repayments have now been virtually fully repaid and will not create any real noise in our
Speaker 2: rent repayments have now been virtually fully repaid and will not create any real noise in our community.
Speaker 2: AFFO number going forward. The scheduled cash basis deferred rent repayments continue to taper off materially in 2023 as can be seen again in the details provided on page 13 of the press release. And that slowdown produces a...
Speaker 2: about a $5.8 million or three cents per share headwind for the full year, which we obviously, previously I should say, noted and is baked into our 2023 guidance.
Speaker 2: One last note on first quarter results, we did receive $1.7 million of lease termination income, and that's higher than normal, and compares with $1.0 million in Q1 of 2022. But overall, a good quarter in line with our expectations. Moving on, our AFFO dividend payout ratio.
Speaker 2: total acquisitions in the first quarter. And that's about half of the equity needed for those acquisitions. This is for specific residential property.
Speaker 2: Assuming we write a balance sheet at roughly 60% equity and 40% debt on a gross book value basis.
Speaker 2: Occupancy was 99.4% as Steve mentioned at quarter end and that's flat with the year end of 2022. G&A expense was $12.25 million for the quarter and that represents about 6% of revenues. But our midpoint guidance for this line item is still $44 million for the full year.
Speaker 3: 2021-2023.
Speaker 2: Today, we did not change our 2023 guidance, which we introduced in February .
Speaker 2: First quarter results might suggest we have the opportunity to be at the higher end of the guidance range, but we will revisit any guidance changes when we report second quarter results.
Speaker 2: The 2023 guidance and the key supporting assumptions are on page 7 of today's press release. Switching over to the balance sheet, we maintain a good leverage and liquidity profile of roughly $900 million of liquidity. The first quarter was fairly quiet in terms of capital markets activity.
Speaker 2: and that was part of our plan to navigate this rockier interest rate and capital market environment. Our weighted average debt maturity is about 13 years including that bank line.
Speaker 2: All of our debt outstanding is fixed rate with the exception of the $209 million on our bank line which represents about 5% of our total debt.
Speaker 2: A couple metrics, net debt to gross book assets was 40.4%, which is flat with year-end. Net debt to EBITDA was 5.3 times at March 31st.
Speaker 2: interest coverage and fixed charge coverage was 4.7 times for the first quarter of 2023.
Speaker 2: So, we're in very good shape to navigate the elevated economic and capital market uncertainties and to continue to grow per share results which we view as the primary measure of success. And with that, we will open it up to any questions.
Speaker 2: very good shape to navigate the elevated economic and capital market uncertainties and to continue to grow per share results which we view as the primary measure of success. And with that, we will open it up to any questions. Ali. Let's see here's another place where we we take a higher look for success or greater desires.
Speaker 1: Thank you. At this time we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please, before we poll for questions. Thank you.
Speaker 4: Our first question is coming from Spencer Alaway with Green Street. You may proceed. Thank you. You mentioned in your prepared remarks that the rate of cap rate increases has slowed, but can you just comment broadly on the different retail industries or are there any segments that stand out as continuing to have a wider bid-ask spread? So cap rates haven't moved as quickly and then to the contrary, any industries that have seen...
Speaker 2: Just think of whatever our portfolio is, that's the segment I'm really speaking of. If it's QSR, convenience store, auto service specifically, where we've done the most volume recently. And the large regional operators, non-investment grade tenants. But we're seeing a little bit of a plateau in the cap rates.
Speaker 2: They're acceptable cap rates, but we picked up the 40 basis points. I'm kind of thinking more in the range of 20, 30 basis points for the second quarter. And then as we move out into third quarter, it's a little bit too early on the pricing. But assuming the economy stays where it is, I think we're kind of getting near the top of it right now currently. Okay, that's helpful. And then the cap rates on the dispositions. That's all I have time for.
Speaker 2: issue, you know, lower in the fourth quarter and the first quarter, but the stars are starting to align where I'm expecting the second quarter to pick up pace a little bit. As far as our disposition this quarter and the three vacancies.
Speaker 2: And the 6.6 cap rate was a result of really two defensive sales, meaning one was a dark cocaine rent asset we sold, and the other was an obsolete, I'll call it a gas station, not a convenience store. And then the third one was an opportunistic sale, where somebody liked the property more than we did. And the third one was an unresponsive sale, where somebody liked the property more than we did. And the third one was an unresponsive sale, where somebody liked the property more than
Speaker 5: Thank you guys.
Speaker 1: Thank you. Our next question is coming from Joshua Steneline with Bank of America. You may proceed.
Speaker 6: Hey guys, it's Josh Detterline here.
Speaker 6: Could you remind us what the bad data amount is assumed in guidance and how the bed bath and beyond BK falls within that range?
Speaker 2: Yeah, sure this Kevin. Yeah, so we assumed in our guidance as we have for a number of years 100 basis points of rent loss in our guidance and didn't really use any of that in the first quarter and as it specifically relates to bed, bath, and beyond.
Speaker 3: Our stores have not been closed or on the rejection list, and so we anticipate they will continue to pay rent up until that changes, if and when that changes. So at the moment, we're not experiencing any notable level of bad debt.
Speaker 7: one.
Speaker 6: OK.
Speaker 3: Interesting. So they're not on the closure list? Correct. Yeah, they've announced, I think, 480 total stores, 360 bed baths, 120 buy buy baby, and our stores are not on that list.
Speaker 6: Okay, good call. And then I think just reading the 10Q that came out this morning, there's another tenant in bankruptcy. Can you hear me?
Speaker 3: Can you update us on that tenant, the assets, and maybe what the rents are? We really only have two in bankruptcy. One is Bed Bath, which we talked about, and the other is Regal Cinema, which we've talked about in the past, which is just one property.
Speaker 3: We'll see where that goes. They're still paying rent, but we'll negotiate that as that goes along, whether that survives or does not survive, time will tell. But very small in the scheme of things. Okay. Appreciate that. Thank you guys.
Speaker 1: Thank you. Our next question is coming from Eric Wolf with Citi. You may proceed.
Speaker 4: Thanks, good morning. Just starting with the guidance question, you know, what takes you sort of from that run rate of 82 cents in the first quarter down to 80 cents for the rest of the year? I think you brought up some least termination income, but it would seem like there's something else that gets you down there other than the least termination income.
Speaker 3: Yeah, nothing really. I mean, I think, you know, as I noted in my prepared remarks, you know, we're clearly tracking for the high end of our guidance range. It was, you know, a little bit of a discussion, you know, or thought process here internally and whether we would.
Speaker 3: think about revisiting our guidance, but we're just kind of measured and deliberate kind of people and so we deferred that to the second quarter. I did note, like I say, yeah, to your point, there's a penny of
Speaker 3: unusual one-time kind of income, lease term income in the first quarter that helped results. So we're not expecting that to continue. But yeah, we like where we stand and hopefully with time we'll be able to let the guidance drift higher which is... Thank you.
Speaker 3: has occurred from time to time over the years.
Speaker 3: But yeah, that's just the way we went at it this time.
Speaker 4: Okay. And then you mentioned that cap rate here hitting the glass ceiling around 7%, although I think you said that might expand about 20, 30 basis points further. But just curious at that level, sort of call it the low seven type cap rate. You know, how are you feeling about your ability to create value at that level given your cost of capital?
Speaker 2: cap rate and kind of what I said in the opening remarks. Third quarter is a little bit too early, but we're gonna, we'll deploy money at that seven and a quarter, seven, three range. And Kevin can talk about kind of the relationship or cost of capital.
Speaker 3: Yeah, I mean, and we've talked about this over the years, how we think about our cost of capital. I don't want to go into all the details.
Speaker 3: at the moment, but it's in our pitch book. And we try to burden our cost of equity today at around an 8.5% kind of cost. For purposes of deploying capital, that's the kind of return hurdle we've set up internally as we think about deploying capital into new investments.
Speaker 3: And so what that ends up producing is a weighted average cost of capital, including debt in the low sevens. And so we feel like today that's what we need to earn to generate the sufficient and appropriate return for NNN shareholders. And so I know other people take different views around their cost of equity and all that kind of thing.
Speaker 3: But like I said, I won't go into all the details there. But the good news is, you know, for us, you know, and that's why I kind of highlighted, you know.
Speaker 3: our free cash flow funded half of our equity need, if you will, in the first quarter, just from operations. And so we really have a, in terms of raising additional capital, and that's before property dispositions, which would be another 10, 15% of our equity needs.
Speaker 3: acquisition, equity funding for acquisitions. So at the end of the day we need precious little new equity capital to kind of on a cash flow basis to kind of run the data. So that's kind of the new data that we're looking at. So we're looking at the new data,
Speaker 3: or achieve the guidance, acquisition guidance we're thinking of for the year.
Speaker 3: Having said that, the free cash flow we generated, the property disposition proceeds, in our minds, we continue, we burden that at an 8.5% cost as well. It's not free cash flow, it costs 8.5% and if we can't earn that kind of return on equity, then we...
Speaker 3: we probably are doing a disservice in our opinion to shareholders and we might send it back to shareholders if we don't think it has a sufficient kind of...
Speaker 3: cost to it. So that's just the way we think about it. Like I say, it's a little different than I think a lot of folks, but...
Speaker 3: I think it's helped us being a little more disciplined over the years and we like that approach. Thanks for the detail.
Speaker 1: Thank you. Our next question is coming from Rob Stevenson with Jani. You may proceed.
Speaker 8: Good morning guys. Steve, back to the cap rate commentary that you were making before. How much does that differ, you know, the movement between sale lease backs versus the one-off and small portfolios that may be more sensitive to all these issues with the banks these days?
Speaker 2: So Rob, good question. You know we don't play in, we call it 1031 market where there's the one-off. We have a dedicated acquisition guy that's always trying to find the diamond in the rough. But as day-to-day operations, we do the sale leaseback. The sale leaseback market. path.
Speaker 2: the sophisticated clients have understood the capital markets or just the overall lending environment is a little more difficult for the middle market. So, if they migrated to the sale-leaseback and they've allowed for the cap rate expansion, the 1031 market where there's even more competition, if it's just doing the 1031 exchange, it's a little more difficult for the middle market to get into the market.
Speaker 2: at high fours, low fives, you've seen a significant cap rate movement because they started off so low historically in the last couple years. But the sale leaseback market, we're still seeing an increase for the second quarter, just not as fast of a rate. Okay. And how deep is that buyer pool today? I mean-
Speaker 8: and other issues.
Speaker 2: Kind of the same storyline, I've been in the business here at M&N REIT for 20 years and we've been highly competitive market from day one. Just the names have changed over the course of the years. Yeah, there's a few less buyers in the market currently that relied on the kind of secured loans.
Speaker 2: But it's still highly competitive. Nobody's stealing assets, it's market pricing currently. If somebody doesn't like my pricing, there's somebody right behind me that's willing to do it.
Speaker 8: Okay, that's helpful. And then Kevin, given all that's gone on with the bank term loan market as well as interest rate hedge pricing, where is your best debt access today and what is that costing you today?
Speaker 3: Well, Rob, it's funny today, everything pretty much costs the same roughly, or at least in the scheme of things. And so bank lines are close to five and a half, ten year debt is close to five and a half, and thirty year debt is not a whole lot more than that. And
Speaker 3: Today, you know, it's really any decision around the term of debt you might be using or issuing is a bit of a bet on where rates will be two years or four years from now. Like I said, we chopped a lot of wood on long-term debt.
Speaker 3: you know, prior years, particularly in 2021, and pushed our weighted average debt maturity pretty far out and for the last several years really have not used our bank line. So we've, we, our approach has been to pivot somewhat to use our bank line, which has been virtually unused.
Speaker 3: interest rate direction. So that's the way we're kind of playing it at the moment. And having said that, I'll say A, we don't typically, we don't give guidance on our capital markets activity. And B, I reserve the right to change my mind. And so hopefully I've been sufficiently elusive.
Speaker 9: Hey, good morning, everyone. Are you seeing any signs that the tennis will pause expansion due to the macro uncertainty?
Speaker 9: Are you seeing any signs that your current tenant roster, the ones that you're growing with will pause their expansion plans due to the macro uncertainty?
Speaker 2: I think what we're seeing out there right now, our development pipeline is, you know,
Speaker 2: really high, you know, compared to historical basis. So we're not seeing a slowdown as far as, you know, them picking and choosing.
Speaker 2: expansion as far as individual sites. What we're seeing is, and it's more not really the economic uncertainty of their customer, it's more the debt lending side of things that the M&A activity we're seeing slow down. There's not many doubles or home runs in the M&A market that we're seeing that our tenants are picking up. It's got to be, we're seeing a trend in the market. It's got to be, there's not many doubles or home runs in the M&A market that we're seeing slow down. There's not many doubles or home runs in the M&A market.
Speaker 9: Kevin, I want to go back to your comments about how you view your weighted average cost of capital. I think you said it was in the low sevens and in your currently where you're buying. Have you historically tried to target a spread over that? Or do you just view that, hey, we're buying better quality and the overall quality mix is being transacted at our weighted average cost capital? Yeah, and I know I'm swimming upstream on this because that's the...
Speaker 3: In our pitch book, we use that example. If you think your cost of equity is 5.5% to pick a number, then you come out with a weighted average cost of capital today, close to 5.5% because that's not far from that. You think your cost of capital is very cheap. Again, this is not...
Speaker 3: We divorced sourcing capital from deploying capital. And look, I understand those two things get connected eventually, but we try to layer on a level of extra discipline, if you will, of burdening our cost of equity for purposes of deploying capital at about an 8.5% percent.
Speaker 3: And if you fully burden your cost of equity, you don't really need to spread above that because you're earning enough. You're justifying, that's what the hurdle rate's there for, is to say what do we need to earn to sufficiently compensate NNN shareholders. And so,
Speaker 3: a higher rate than most other companies do. And we've set that hurdle there. And I think it leads to the better outcomes in the long run. In the past, call it two years ago, when the world was awash with money, we burden our cost of equity at about an 8% return. And our cost of debt was a whole lot lower. And our weighted average cost is
Speaker 3: capital in our minds was about a 6% level. That's what we said was the return requirement for an NNN shareholder then. And so you didn't see us do virtually any sub-6 cap rate deals. I call it two years ago.
And now the world's changed, interest rates are up, we've raised our return on equity hurdle, and so now we're targeting kind of a low sevens kind of return, and we think that fully and sufficiently compensates our shareholders. And again, this is for purposes of deploying capital. When it comes to sourcing.
consistently for a long time, but we do go about it a little differently. And so we never really get into the vernacular of a spread over our cost of capital because we really we put an extra burden on our equity return hurdles that I think
compensates for that. Anyway, sorry that was a long-winded answer to your question. No, I appreciate it. Thanks for the detailed answer Kevin. Thank you. Once again, if there are any remaining questions please press star 1 on your phone at this time.
Our next question is coming from John Masotta with Ladenburg-Thalman. You may proceed. Good morning. Maybe building a little on Wes's first question, if you kind of think about what your tenants are using, you know, new dollars or investing with them for, what's kind of the broad, the broad breakdown between expansion and maybe refinancing. It's definitely...
skewed towards expansion currently. Our tenants haven't, it's still early on, we're a year into it, that we're not seeing our tenants having to refinance debt. Most of our tenants, it's a business model decision to do sale-leaseback financing. They believe in not owning real estate because they understand they can take that equity, put it into operations, and then make it higher margin selling a service or a good that they're selling opposed to the increased value of real estate.
So we don't do a lot of refinancing. Historically, we've done a lot of M&A financing and bolt-on acquisitions and new store development is the vast majority of where we deploy capital. Okay. And then you talked about it a little bit in terms of bed bath and beyond, but maybe more generally, what's the demand like out there for vacant assets, you know, vacant
We don't get that back. But yeah, there's definitely some movement of the smaller regional or even the mom and pop operators taking our vacant assets.
How does that activity number compare to pre-pandemic or earlier years? It's definitely elevated right now that we're seeing more activity with our vacant. First and foremost, we always try to release our vacant, but after a certain amount of time.
It's not realistic to hold on to vacancies. You can just get the overhead drag, and we'd rather just sell them, even though it might not be top dollar, and then redeploy that money accretively into acquisitions. Okay. That's it for me. Thank you very much. Thanks. Thank you. Here's where we have reached the end of our question and answer session, so I will now turn the call back over to Mr. Horne for closing remarks. Thank you, Ali. M&M's in a great position here.