Q2 2023 Broadstone Net Lease Inc Earnings Call
Today's call is being recorded.
I'll now turn the call over to Mike Russo Senior Vice President of corporate strategy and Investor Relations at broad Stone. Please go ahead.
Operator, and thank you everyone for joining us today for <unk> second quarter 2023 earnings call.
On today's call you will hear prepared remarks from CEO , Jon Marino, President and COO, Ryan Albano, and CFO , Kevin funnel, all three will be available for the Q&A portion of this call.
Before we begin I would like to remind everyone that the following presentation contains forward looking statements, which are subject to risks and uncertainties that can cause actual results to differ materially due to a variety of factors.
Should you not to place undue reliance on these forward looking statements and refer you to our SEC filings, including our Form 10-K for the year ended December 31, 2022 for a more detailed discussion of the risk factors that may cause such differences.
Any forward looking statements provided during this conference call are only made as of the date of this call.
I'll now turn the call over to John .
Thank you, Mike and good morning, everyone.
Thank you all for joining today's call.
As we detailed in last night's earnings release, I am pleased to report another strong quarter of results and thoughtful capital allocation as we turned the page on the first half of 2023.
Our mission is to deliver sustainable long term growth and value creation for <unk> shareholders, and we believe that the prudent and selective approach. We have chosen to employ this year has laid the foundation for that our second quarter results were driven by solid same store portfolio performance and accretive capital recycling efforts.
<unk> is positioned to continue to provide predictable results for our shareholders in the second half of the year and beyond because of our solid and diversified portfolio, our patient and disciplined execution strategy, our growing pipeline of accretive opportunities to invest capital in our flexible and fortified balance sheet.
Starting with our existing portfolio of 221 unique tenants who operate across 54 different industries are best in class diversification is defensively positioned us to provide durable and consistent cash flow across all market cycles.
We continue to view, our tenant and industry diversification is a key differentiator for broad stone, which when combined with top tier annual rent escalations of 2% provide significant downside risk mitigation benefits.
Especially in difficult or uncertain markets are.
Our real estate portfolio, which is predominantly leased to industrial and defense of retail and restaurant tenants continues to perform exceptionally well as evidenced by 99, 9% rent collections during the second quarter and 99, 4% occupancy as of June 30.
As of quarter end only two of our 801 properties were vacant and not subject to a lease.
As always we are closely monitoring the health of all our tenants, but especially those who may be more susceptible to the evolving challenges of operating in today's environment.
We have experienced tremendous success in our capital recycling efforts this year generating $168 3 million of gross proceeds at a weighted average cash cap rate of five 9% on tentative properties, which Ryan will provide additional detail on in just a few moments.
Our proactive approach to asset management and corresponding disposition efforts have helped to mitigate both credit and residual risk within our current portfolio. While also providing additional dry powder to be accretively deployed at attractive spreads.
With the stock price well below where we would be comfortable raising equity capital. We intend to continue to control our own destiny as we have done through the first half of this year and will rely on disciplined capital recycling is a core pillar of our near term strategy and we will look to opportunistically execute additional accretive asset sales during the second half of the year.
On an external growth front, we remain committed to our patient and disciplined approach and have found creative ways to accretively deploy capital during the second quarter, which included a healthy mix of new property acquisitions revenue generating investments in our existing assets and development fundings.
While we have sourced and evaluated over $17 billion of new investment opportunities year to date we.
We have employed a selective approach to external growth.
Our belief that cap rates market dynamics and risk reward trade offs are not properly calibrated for many assets currently on the market.
We are focused intensely on making investments that create long term value for our shareholders and.
And have successfully capitalized on several unique opportunities that have emerged as a direct result of the current market.
Of note, we have opportunistically partnered with many of our current tenants and developers as financing conditions remained challenging for both.
By establishing new partnerships and strengthening existing relationships, we have found ways to add value for our shareholders that supplement our more traditional acquisition sourcing efforts.
This creative approach to navigating the current market environment demonstrates our differentiated our relationship driven approach to investing that is a core component of our success.
With the difficulties the entire real estate industry faces in 2023, our investment strategy has been focused on being patient and disciplined and maximizing long term shareholder value in 2024 and beyond.
Our flexible balance sheet and conservative leverage profile.
With proceeds from dispositions at attractive cap rates in the high five to low 6% range will support our growth strategy in the second half of the year and into 2024.
As I've said in the past P&L.
<unk> is currently in a position to make decisions that we want to not decisions that we have to and especially important distinction in today's real estate market.
And with that I will now turn the call over to Ryan who will provide additional details on the status of our portfolio, our accretive capital recycling efforts second quarter investment activity and our growing pipeline of investment opportunities.
Thanks, John .
Thank you to all of our listeners who have joined us today.
Again with the status of our existing portfolio, our tenant base remains highly resilient. Despite many of the challenging macroeconomic headwinds they have faced year to date.
While we closely monitor our entire tenant roster on a routine basis. There are no overarching somatic trends of note at this time.
From an individual tenant standpoint, I am pleased to provide an update regarding a few tenants on our watch list that we have been closely monitoring for several quarters.
First red Lobster's turnaround continues to gain momentum as the company returned to profitability during the first quarter of the year as a result of Red Lobster's concerted effort to grow same store sales invigorate customer interest cut unnecessary overhead and lower labor costs.
Titan remains fully committed to red lobster and as publicly communicated its support of the business.
We will look to confirm these trends over the next several quarters, beginning with timing and second quarter results, which will be released in the coming days.
As for our individual sites, we continue to monitor site level performance.
Encouraged by what we're seeing at the property level.
As we have discussed on previous calls we remain confident in our investment in the underlying value of the real estate, capturing low double digit unlevered IRR and properties sold to date.
Have recouped over 75% of our initial investment even with 19 remaining locations that are currently earning and cash yield north of seven 5% on invested capital.
Our remaining sites represent one 6% of total ABR as of quarter end.
Second we are encouraged by the recent steps taken by Carvana to increase the company's financial flexibility as it pursues profitability and a return to growth.
Carvana second quarter results set company records for adjusted EBITDA and gross profit per unit.
Which was up 94% year over year.
While carvana also lower expenses and reduce its long term debt burden.
We are encouraged by the recent news and also remain confident in our investments defensive positioning driven by both the mission critical nature of our industrial sites as well as the fundamentals in the Submarket in which they are located.
As of quarter end Carvana represented one 2% of our total ABR.
Finally, we are closely monitoring progress towards the reopening of Green Valley Medical Center.
We are in regular contact with the current tenant and are receiving a routine progress updates.
To date, the tenant has failed to achieve certain milestones is defined by our agreement. However, they remain hopeful the operations will commence at the property during Q4 of this year.
While we are working closely with the tenant towards the reopening of the hospital. We are evaluating all potential alternatives at this time and we will continue to provide updates as more clarity is achieved.
These three tenants coupled with a handful of other smaller tenants measured as a percentage of ABR comprised the individualized tenant specific portion of our watch list, which is largely consistent quarter over quarter.
As John previously mentioned, we successfully executed on our accretive capital recycling initiatives during the second quarter.
During the quarter, we sold four properties for gross proceeds of $69 4 million.
At a weighted average cash cap rate of five 6% on tentative properties.
Together with our Q1 dispositions and asset sales closed since quarter end, we sold eight properties for gross proceeds of $168 3 million.
At a weighted average cash cap rate of five 9% on tentative properties.
These asset sales have mitigated both credit and residual risk in our portfolio, while also providing dry powder to be accretively redeployed at attractive investment spreads.
We intend to Opportunistically execute on asset sales in the second half of the year.
On an external growth front cap rates remained relatively consistent quarter over quarter and is largely leveled off across our core property types.
While we continue to selectively pursue opportunities with strong real estate fundamentals that augment the risk return profile of our investments. We have also had success finding more creative ways to bolster our traditional sourcing efforts.
During the second quarter, we invested $64 9 million at a weighted average initial cash cap rate of seven 3%, which included three industrial new property acquisitions for $24 million.
Additionally.
We have also invested $7 million in revenue generating capex projects with existing tenants, we view partnering with existing tenants as a differentiated way to accretively deploy capital, while bolstering the underlying value of our assets.
<unk> seen an increase in these types of opportunities as financing conditions have become more challenging and we currently have 13 million of unfunded commitments towards future investments in our existing properties along with a growing pipeline of additional future projects currently under active consideration.
Additionally, we closed and we began funding development on a previously announced $204 $8 million build to suit transaction.
During the second quarter, we closed on the acquisition of the land and have funded a total of $37 $5 million through June 30.
We expect to fund an additional $69 $3 million through the remainder of the year.
The build to suit transaction.
As for a new 1 million square foot try climate distribution facility in Sarasota, Florida leased to United Natural Foods, Inc. A leading publicly traded distributor of health and specialty food in the United States and Canada.
The facility is projected to open in the third quarter of 2024 with rent commencing no later than October of next year.
During the 18 months construction period, we will earn capitalized interest at customary rates and once completed the facility will be leased to UNFI pursuant to a 15 year lease with multiple renewal options and two 5% annual rent escalations.
The stabilized yield upon completion will be approximately seven 3% and together with rent escalations will translate into a GAAP cap rate of approximately eight 3%.
We are excited to add this state of the art industrial facility to our portfolio.
This transaction is expected to drive significant growth in earnings for years to come.
We continue to see similar opportunities to partner with developers, who have had difficulty securing financing in today's market and while we remain opportunistic we are focused on acquiring current yielding assets as the predominant source of external growth.
Year to date, we have completed investments totaling $85 million, including $25 $6 million in new property acquisitions.
One $8 million in revenue generating capex.
$37 5 million in development fundings.
The new property acquisitions and revenue generating Capex had a weighted average initial cash cap rate of seven 2% and included $79 $8 million and industrial properties and $5 $2 million and a retail property and with that I will now turn the call over to Kevin.
Thank you Ryan and good morning, everyone.
Turning to our financial results during the quarter, we generated <unk> of $69 million or <unk> 35 per share an increase of two 9% per share results quarter over quarter.
Results were largely driven by same store portfolio growth and performance.
During Q2, we incurred $7 $9 million of cash G&A, which tracks in line with our guidance for the year.
We're always focused on maintaining financial flexibility to support our ability to be opportunistic when appropriate.
We ended the quarter at 5.0 times leverage on a net debt to annualized adjusted EBITDA basis, the decrease quarter over quarter.
As of quarter end, our revolving line of credit was largely under utilized just over 10% with over $875 million of remaining capacity.
As a reminder, our substantially fixed rate debt capital structure has insulated us from many of the upward pressures associated with the string of rate hikes and higher for longer interest rate expectations.
Moving forward in the near term, we will evaluate the potential opportunity to swap portions of our outstanding revolver balance to fixed rates as we gain additional visibility into our acquisition and disposition pipeline for the second half of the year.
Our ATM remains a core component of our overall capital market strategy that allows us to opportunistically consider raising equity alongside investment volume.
Given the activity in the quarter, we maintained approximately $145 million of capacity on the current program.
At our quarterly meeting our board of directors approved a dividend of 28 per common share and op unit consistent with the prior quarter and is payable on or before October 13th 2023.
The dividend is well covered aligns with our targeted <unk> payout ratio in the mid to high 70% range and represents an attractive dividend yield relative to many of our peers.
Finally, we are maintaining our 2023 per share guidance today with an <unk> range of $1 40 to $1 42 per share.
We are also maintaining our acquisition disposition and G&A guidance ranges that we previously communicated.
Please reference last night's earnings release for additional detail and we will evaluate guidance revisions as we progressed further into the second half of the year.
We will now open the call up for questions.
As a reminder, if you'd like to register a question. Please press star followed by one of your telephone keypad. If you change your mind. Please press star followed by two am please ensure you're on mute when speaking.
We would also ask participants to limit themselves to one question with an additional follow up.
Our first question comes from keeping Kim of <unk> Securities. Please go ahead.
Thanks, Tom Good morning.
Can you given where your equity prices price today can you just talk about your capital sources, and what you're thinking for how to grow the company over the next year.
Yes, sure keeping I think it's been consistent this year, so far I would point you to our dispositions and the success. We've had there is our source of capital and you marry that with.
Where our leverage has been sitting around that five times leverage or theres, a lot of capacity to meet <unk> exceed our investment targets for this year and get us into next year pretty comfortably.
And for your dispositions.
What does that kind of approximate cap rate that we can assume in our models going forward.
I think you should continue to assume high fives low success I mean, we've had a lot of successful far this year as you heard in our remarks in the release Thats $968 million at a $5 nine on tentative properties.
The focus we've had throughout this year and going into next year is going to be continuing to control, our destiny and providing ourselves with the type of spread that we want for the investments that we are executing on even though we are being selective and disciplined about where we are deploying capital. So we will be focused on trying to make sure that on the opportunistic dispositions. We do pursue that we can maintain that spread.
Okay, and if I can squeeze.
Everyone here.
Green Valley Medical Center can you just talk about what were some of the milestones that werent met and from a financial impact standpoint, let's say that milestone isn't Matt.
This year.
Does the downside impact to that.
From a financial standpoint.
Yes, So finance standpoint for this year isn't huge I mean, we have been collecting rent on that property for the entirety of the year.
The difficulty with getting into some specifics as this private Senate. This is information thats publicly available in the same way as a public bankruptcy or things like that but.
The types of operational hurdles that you can expect from trying to open up a new hospital, particularly up a hospital, particularly opening up a new hospital that had to shut its doors and so not only do you have all of the hurdles you would expect to have there, but working through trying to purchase assets and work through the Medicare reimbursement process with the prior operator.
As well as looking at current financing conditions. It takes a lot of money to open up a new hospital in with financing conditions changing over the course of the last 12 to 18 months, it's been incrementally more difficult for them.
Okay. Thank you.
Our next question comes from Michael Coleman of BT.
Michael Please go ahead.
Yes. Thanks, Good morning, maybe you could spend a little bit more time talking about the revenue generating capex side of the opportunity set and just give us a sense for as you are seeing these new opportunities come in maybe.
What's the scale of the opportunity and how do you approach the underwriting and understanding these are already tenants that exist in the portfolio, but how do you approach.
Underwriting, adding new Capex here.
Is there a potential.
In terms of changing some of the in place lease terms to make them more favorable and then also kind of the duration of the average project.
Yes, great question, it's something that we're spending a lot of time focused on we think that that's a clear differentiator for us in this space as an industrial focused diversified net lease REIT with 52% of our ABR tied to our industrial assets. We think we have a unique opportunity to use revenue generating capex tenant improvement projects building expansions.
As a way to add additional return for our shareholders and differentiate ourselves from the rest of the net lease space because there are more opportunities to do this in industrial than you would see in retail and restaurant for example.
The length of these projects is it varies there are some of these that are a few months depending on what they're trying to do and then if you look at some of the build to suits or some of the larger expansion. They can last up to 12 months to 18 months or so.
We look at that from an underwriting standpoint, similar to any time that we're going to be deploying new capital. There is a whole process that we have internally that we have to work through to make sure that we still feel comfortable with the overall tenant credit that we feel comfortable with the real estate, where we sit relative to rents on a mark to market basis.
All of those things still have to check the box. The nice thing with you. So that you then are not only deploying capital in a place where we feel good about the overall risk reward trade off but you are now improving the quality of assets already in our portfolio, which in the net lease business, sometimes with the long nature of our leases it's difficult to do.
But you are also strengthening the relationship with that tenant for future potential business opportunities and strengthening the relationship with the tenant has with that site. So the likelihood that they're going to stay for the long term and renew and.
And be a long term partner with US goes up so it's an area that we like a lot and we're pretty excited about for the future.
Yes, I agree that's great and one follow up John maybe on the acquisition side I think you mentioned the $17 billion of opportunities that you reviewed can you just give us a little bit of flavor in terms of kind of where the disconnect is in the marketplace is it still predominantly the bid ask spread on the pricing is it that some of these assets that are coming through.
<unk> don't fit the quality kind of where where is the disconnect there.
Most of the opportunities that you are underwriting.
You can only speak for us I think.
Depending on which company you're speaking to today.
The views are different but I think everything you just said and more as we said in our prepared remarks, we still are struggling with a number of the opportunities that are out of the market today and sort of our view of the sort of triangulation among cap rates risk reward tradeoff underwriting views.
We use on the overall financing market and how we should be thinking about spread investing and how we should be thinking about where our cost of capital is and for that reason and just the general overall uncertainty in the real estate market.
The economy overall appears to be doing well relatively speaking, but real estate is experiencing its own sort of focused issues relative to rising interest rates and whatever else, where we've taken that selective disciplined approach. This year, we intend to continue with that now all that being said we have issued guidance at the beginning of the year and we remain absolutely confident in our ability.
To hit our pipeline is bigger than it was in the first half of the year.
There are a number of larger advanced stage opportunities that are in the pipeline that we're pretty excited about and we will hope will come to fruition as we work through the rest of it and as we came into this year, we always plan to be back half weighted and that's what we're seeing as Ryan said in his remarks cap rates feel like they've plateaued a bit into that high six low seven range in terms of the places where we feel most comfortable.
<unk> capital, but.
Just because we came into the year planning to be back half weighted and that is what we're seeing doesn't mean, we're going to start chasing deals or we've been patient and disciplined the whole year and thats, what well continue to do.
Great. Thanks for the time.
Thank you.
Our next question comes from John Kim of BMO capital markets Jo Malone issues.
Good morning.
On your disposition achieved high six cap rate this quarter driven by industrial.
Should we expect.
Sales to be weighted towards the industrial in the back half of the year, just given the expected yield.
And within your disposition pool, how many red lobster.
Yes, there is a handful of red lobsters in there we talked about this a number of times and Ryan mentioned it again, we started with 25 of those were down to 2019, we will continue to look to decrease that exposure for obvious reasons, but we're very comfortable with where red lobster sits today I mean on a rent coverage ratio a full turn higher than they were at this point last year or so.
We need to hold those assets for the long term, we feel very comfortable with that.
Overall weight for the back half of the year, we will certainly continue to look for those opportunities that are a little chunkier that are going to give us the spread were looking for well look to continue to do some risk mitigation either on sort of where we think rents are on a mark to market basis, or where we have some credit concerns.
Certainly some of those sit in the industrial bucket, but I mean that would be natural because more than half of our portfolio is industrial but we are absolutely looking at where we can find opportunities in the healthcare space retail and restaurant is not a spot other than sort of red lobster and a handful of things that we are particularly interested in what those cap rates arent that attractive to us from a disposition standpoint, particularly the top 30.
One buyer sort of pulling back a little bit, but youll see it in industrial Youll see some health care. So I think that's where the balance would be for the rest of the year.
Do you expect that the mix of your appetite to shift meaningfully over the next 12 months.
Not necessarily in a trend other than what you've seen in the last five years.
When we look at how we have adjusted since 2018, we were 31% industrial five years ago.
Since then we've acquired about $2 billion worth of assets, a little bit north of 70% of that has been on the industrial side for all the reasons that.
We talked about with respect to the opportunity and revenue generating capex.
The way that we're thinking about broader macroeconomic trends.
Success of recent industrial policy in the U S with a massive amount of new investment on the private side, which is something north of $450 billion spreads.
Spread throughout the country in the last two years, you've got new industrial construction and the way that people are thinking about near shoring and onshoring with close to $200 million. This year in new construction. This is an area that we will continue to leg into we think it's a great differentiator for us and it's also the place where we feel most comfortable with those tenant relationships and the opportunity to really.
<unk> value for the long term for our shareholders. So.
Nothing altogether that different from the trend line that you've seen with continuing to put the focus on industrial.
Okay.
Steve I appreciate the additional disclosure you provided.
How long will it take to get the stabilized yield of seven three I realize its a 1 million square foot project I'm not sure if it takes a while.
To get to that level.
Okay.
Yes that should it comes online.
Rent commencement date in October of next year.
703 year one yield.
Yes, correct.
Got it would tie in place rent commencing at that time, the rent level translates into.
Yes.
Ineffective stabilized yield of seven three.
Hey, Juan.
Got it.
Thanks.
Thank you.
Our next question comes from Ronald Camden of Morgan Stanley . Please go ahead.
Hey, just staying on that build to suit.
Maybe can you talk about maybe a little bit more color.
Yes.
If there is more of those deals down the pipe even with this tenant.
Or any other tenants as youre thinking about the pipeline away from acquisition.
Like there is.
You are leaning a little bit more towards this construction, maybe just just trying to get a sense of if this one off.
Or was there a couple tens of $104 million to be had here.
Yes, Thanks, Ron absolutely, we think Theres a great opportunity here this was.
A big jump in for us to start with in terms of the size of this deal, but I think thats been paying off and paying dividends for us in terms of.
Getting us comfortable with the space overall trying to find what the right balances between the longer term nature of the development side of this taking on the capitalized yield over the next 18 months before it comes online at that 703 initial year, one cash yield as Brian was just talking about.
But with the comfort level that we have here with the building set of expertise and experience that we are evident we think theres a real opportunity to do more whether it's with this tenant or others remains to be seen whether it's with this developer or others remains to be seen but we're having a lot of good discussions with people and theres a handful of things in the pipeline right now that stage opportunities that would fit or similar.
Built in terms of a build to suit opportunities. So we feel pretty good about it and we hope that we're going to be able to see more and working hard towards that.
Great.
I guess my second question was just if.
If I think about.
He started to take a little bit of a bigger step back.
On the business, obviously youre doing.
I saw the disposition.
Come in through the quarter and so forth.
Maybe can you talk about your willingness to maybe do more on that front and its funding until the equity comes back.
And so forth.
Yes, I mean thats the plan.
<unk>.
We're not happy with where the stock is currently trading in terms of where we would be comfortable.
Raising equity the short answer is higher.
And so we will be looking to control our destiny.
For as long as we need to and we think we've built up a portfolio and an internal process and ability to do that for as long as we need to and so at this point we came into this year with where we were trading and where we believe the markets. We're going to go with the belief that we weren't going to be raising $1 of equity throughout 2023.
We still believe that and we're gonna be looking the first time will hopefully be in a place where will be comfortable with where the stock prices and we will be looking to do that as sometime in 'twenty 'twenty four and we'll be using additional dispositions and strategic work around that to fund the rest of our growth until that point.
Great and then if I could just sneak one more just on.
Bad bad debt, maybe can you remind us how much are you budgeting this year.
Have you sort of gone through already.
I appreciate the opening comments about red lobster, and so forth, but just on a holistic basis, how do I think about that.
Yes, we are still holding the call it 75 basis points against against revenue for bad debt and year to date, we're in something I think on single digit basis points that we've experienced just recently.
Awesome. Thanks, so much.
Okay.
We have no further questions on the phone line, so I'll hand back to Jones for closing remarks.
Thank you Jordan and thank you everyone for joining us today and for your continued interest and support of BMO.
Seeing many of you over the past several months and look forward to connecting in the second half of the year. Thanks, all have a great day.
This concludes today's call. Thank you for joining you may now disconnect your lines.
[music].
Yes.