Q3 2023 Essential Properties Realty Trust Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to essential properties Realty Trust third quarter 2023 earnings Conference call.
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. Additionally, there'll be an audio webcast available on essential properties Realty Trust's website at www Dot central properties dotcom.
An archive of which will be available for 90 days.
On the call. This morning are Pete My voice E T. Our Ts President and Chief Executive Officer, Mark Patten E. P. Our cheese executive Vice President and Chief Financial Officer, and Rob Salisbury E. P. Our Ts senior Vice President and head of capital markets and it is now my pleasure to turn the call over to Rob Salisbury. Thank.
Sir you may begin.
Thank you operator, good morning, everyone and thank you for joining us today for the third quarter 'twenty to 'twenty three earnings conference call for essential properties Realty Trust.
During this 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 FCC and in yesterday's earnings press release with that I'll turn the call over to Pete.
Thanks, Rob.
And thank you to everyone who is joining us today for your interest in essential properties.
As our third quarter earnings release indicates we are pleased to report another quarter of strong results.
Driven by the strength and stability of our portfolio that continues to perform well.
And was impacted favorably by our solid investment activity.
Despite some areas of the broader consumer sector note, noting a slowdown in recent months our growth oriented middle market tenants continued to perform well.
As reflected by our unit level rent coverage that remains strong at 4.0 times.
Our same store rent growth, which remained favorable at one 2% and just three vacant properties.
The overall health of our portfolio is a testament to our disciplined underwriting process, which focuses on growing operators and durable service and experience based industries.
And owning granular and fungible properties that generate strong cash flow for these operators.
Our tenants provide a strong value proposition to their customers with generally low average tickets that do not rely on consumer financing and therefore do not experienced demand headwinds from a rising rate environment.
In the third quarter, we acquired 65 properties in 30 separate transactions that we're 100% sale leaseback transactions with 86% of those opportunities generated from existing relationships.
Our third quarter investments reflect an improving pricing environment for our business with an initial cash cap rate of seven 6%.
And.
Average annual rent escalation in those leases up 2%.
And our weighted average lease term of 17.6 years.
Which results in an average GAAP yield over the primary lease term of eight 7%.
With limited active competitors in the middle market sale leaseback arena today.
And higher base rates driving up the cost of private credit alternatives for these operators, we expect the favorable cap rate environment to persist in the near term.
Our balance sheet remains in great shape as Mark will discuss shortly as.
As we remain committed to maintaining a conservative leverage profile and strong liquidity position.
We are establishing our 2024 <unk> per share guidance at $1.71 to one dollar and 75 cents, which implies a 5% growth rate midpoint to midpoint.
Our guidance for 2020 for flex continued healthy portfolio performance.
In an improving pricing on new investments.
[noise] tempered by an expectation of a higher cost of capital and a generally volatile capital markets backdrop backdrop, continuing in the near term.
Importantly, I am pleased to note that supported by our conservative leverage profile and our low dividend payout ratio.
The company is nearly $100 million of forecasted retained free cash flow can be accretive really deployed into our investment pipeline.
Without any additional reliance on the capital markets.
Combining the reinvestment of our retained cash flow.
Our strong capital deployment year to date.
And our healthy rent escalators.
Tenant credit assumptions, we estimate our <unk> per share and grow nearly 4% and 2024 without requiring any additional external capital.
Notably favor.
Favorable developments in the capital markets could provide the opportunity to achieve a higher growth rate than what is implied at our midpoint of guidance.
Turning to the portfolio.
We ended the quarter with 1793 properties in our portfolio that were 99.8% waste just 363 tenants operating in 16 industries.
Our weighted average lease term stood at 13.9 years with only 5% of our ABR expiring through 2027.
From a tenant health perspective.
Our unit level rent coverage ratio at quarter end was 4.0 times.
And the percentage of our ABR that had a less than one times rent coverage level.
Level remain consistent from the second quarter of 2023 totaling just three 1% at quarter's end.
As I noted.
Our same store rent growth remained favorable at one 2%.
Although that represents a 30 basis points decrease from last quarter.
Rent growth in the third quarter was impacted by a 30 basis point headwind from the bankruptcy of a gym operator in Oregon.
Like many other businesses in Oregon. This particular, operator experienced significant operating challenges due to the longer imposition of pandemic operating restrictions in Oregon.
Which was somewhat unique in the context of our broader portfolio of health and fitness properties.
Specifically, we did not collect rents on two properties operated by this tenant.
Which totaled only $8 million of net book value.
We expect to find a replacement tenant and recruit a meaningful amount of the economics.
We view this as a tenant specific event given that our portfolio of health and fitness properties continues to perform well as evidenced by industry unit level rent coverage to one times.
Regarding our third quarter investments, we invested $213 million and 30 separate transactions and properties, representing 12 of our 16 targeted industry.
In the quarter, 100% of our investments were originated through direct sale leaseback transactions completed on our lease form with ongoing financial reporting requirements.
In addition, 60% of our investments were in a master lease structure.
The weighted average unit level rent coverage of the tenants at these properties was three three times and our average investment per property was $2 8 million.
Looking ahead to the fourth quarter, we remain active and our pipeline should support investment levels relatively consistent with our recent activity.
With the potential for further improvement in initial cash cap rate as our capital is becoming increasingly attractive against the capital constrained backdrop for middle market businesses today.
Specifically, we expect initial investment cap rates in the high 7% range with strong underlying lease terms.
Looking at our portfolio industry breakdown at quarter end car washes remained our largest industry at 15, 3% of ABR, which is down 30 basis points from last quarter.
Our next largest industries, where early childhood education.
Medical dental and quick service restaurants.
Our largest tenant equipment share represented 3.3% of ABR at quarter end and.
And our top 10 tenants continue to demonstrate the diversity in our portfolio accounting for just 17, 8% of our ABR.
As we've consistently stated portfolio diversity is an important risk mitigation tool for us and a product of our differentiated investment strategy.
A direct benefit of our focus on non credit rated tenants and middle market operators, which offers an expansive opportunity set.
And in our view generate superior risk adjusted returns.
In terms of dispositions, we sold 10 properties this quarter for $28 5 million in net proceeds.
At a weighted average cash yield of six 5%.
The weighted average unit level rent coverage for the properties, we sold three six times.
Owning fungible and liquid properties and capitalizing on that liquidity is an important aspect of our investment discipline and it allows us to proactively manage our industry tenant and unit level risks within our portfolio.
Heading into the fourth quarter, we expect to selectively take advantage of favorable market pricing to accretively recycle capital away from identifiable risks reduce our industry concentrations and importantly support our tenant relationships.
With that I'd like to turn the call over to Mark who will take you through the operating results and balance sheet for the third quarter and discuss our capital markets activities.
Thanks Pete.
Pizza remarks, the third quarter of 2023 was certainly a strong quarter for us evidenced by our reported results last night and represented by an increase in our guidance for 2023 F O per share to a range of $1 64 to $1 65.
Performance of our portfolio and our investment results for the quarter continue to reflect the high quality of our tenancy our favorable capital market transactions consistent internal rent growth and the benefits of our differentiated investment platform.
As I'll cover in a moment, our consistently conservative balance sheet and strong liquidity position continue to support at our aspirations for external growth in 2023 and beyond.
Among the headlines last night was our <unk> per share for the third quarter, which on a fully diluted per share basis was 42 cents, an increase of 11% versus Q3 of 2022.
On a nominal basis, our F O totaled $66 $3 million for the third quarter of 2023 up $12 $8 million over the same period in 2022, that's an increase of 24% and up over 7% compared to the preceding second quarter of 2023.
We also reported core <unk> per share on a fully diluted per share basis, a 45 cents for the third quarter, an increase of 18% versus Q3 of 2022.
Total G&A was approximately $7 $2 million in Q3, 2023, while cash G&A totaled $5 million in the third quarter importantly, our cash basis G&A as a percentage of total revenue decreased to five 5% in the third quarter, which further supports our expectation that our G&A growth rate will.
Be outpaced by the growth in our assets and earnings as our platform generates operating leverage through the benefits of scale.
Turning to our balance sheet I'll first highlight the following with our $185 million of net investments in the third quarter are income producing gross assets reached nearly $4 $6 billion at quarter end.
From a capital markets perspective, we had an excellent quarter firstly on the personnel front. We're pleased is unfortunate to have hired Rob Salisbury as our head of capital markets. Rob brings an extensive real estate finance and investing background, including experience on top ranked equity research teams large buy side equity and credit sick.
Curious platforms and most recently as a senior leader at a leading real estate private equity firm.
We're excited to have Rob help us continue to build long term value for our shareholders.
On the equity side, we successfully executed in an overnight follow on offering in September that we were able to upsize by 20% pricing approximately 12 million shares at $23 per share and generating approximately $276 million of gross proceeds.
Similar to our February 2023, offering this transaction was completed a 100% on a forward sale basis, which affords us the flexibility to draw down the capital on an as needed basis.
On the ATM program. This quarter, we settled approximately 836000 shares in July for proceeds of $20 million and we sold an additional $11 million during the quarter, which remains unsettled as of quarter end.
On the debt side, we closed on the previously announced $450 million delayed draw term loan in August we are very appreciative of the continued support of our entire bank group all of whom participated in this execution we.
We utilized $200 million at closing to retire the 'twenty 'twenty four.
Term loan, which was our only near term debt maturity set to expire in April of next year.
Assuming we exercise the extension options available to us the $450 million term loan would mature in February of 2029.
And we had $375 million drawn on the term loan and we subsequently drew the remaining $75 million in October.
Consistent with our interest rate hedging program, we fully swapped 100% of the amounts drawn for the fully extended term of the dead commitment at a weighted average fixed rate of five 4%.
As we noted on our last earnings call. We retained the favorable swap on the $200 million linked to the 'twenty 'twenty four term loan that we repaid which currently has an effective fixed rate of just under 3%.
Subsequent to quarter end, we executed new forward, starting swaps to extend the $200 million hedge through the remaining term of the 'twenty 'twenty nine term loan, which will go into effect in April of 'twenty 'twenty, four and an all in fixed rate of approximately five 5% we.
We have incorporated this within our 'twenty 'twenty four guidance rigor.
Regarding our debt maturities utilizing all the extension options and the new term loan what as I mentioned result, and a maturity date in 2029, which would result in us having no debt maturities until 'twenty 'twenty seven.
From a leverage perspective, our net debt to annualized adjusted EBITDAR was four five times at quarter end.
When factoring in the net proceeds that we generate by settling the $273 million of equity we issued on a forward basis in the quarter, our leverage at quarter end would equal three seven times.
Our total liquidity at the end of the third quarter totaled approximately $989 $6 million up $356 million from 634 million last quarter.
Again, our conservative leverage strong balance sheet and significant liquidity position continues to be supportive of our current investment pipeline and sufficient to fund our external growth plans for the remainder of the year.
With that I'll turn the call back over to Pete.
Thanks Mark.
Operator, please open the call for questions.
Thank you Sir we will now be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate that your line is in the question queue. You May press star two to remove a question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys.
One moment please poll for questions.
And the first question comes from the line of Han Dallas St. Jude with Mizuho. Please proceed with your question.
Hi, Good morning. This is Ravi gave you on the line for on Dal I Hope you guys are doing well I just wanted to touch a bit on the 24 guide well.
Well what gives you a.
The confidence to provide 24 died in the current environment.
I know you guys have a strong liquidity position your balance sheets have been shaped, but how are you thinking about volume and spreads.
Going forward, especially when they were expecting slower volumes and shifting capital costs.
Yeah listen I, you know, we run a very predictable business, we have a very stable portfolio of long dated leases that provide us a great operating base.
Also generate significant free cash flow to invest and we have you know.
A large amount of well priced capital available to us that's on our balance sheet and so.
You know given the factors that you know our businesses, so predictable and we have largely baked in our capital needs and the cost of those that capital for 2024, or we felt it was appropriate and timely to provide guidance.
Yeah.
Got it and if we just assume a worst case scenario in transaction markets are completely shut down how much do you think you can grow next year.
My question to take that how much we can grow <unk> next year at a baseline.
So I think the way yeah. The way I'd answer that is if you take a look at you know what you might refer to kind of doing nothing else other than us.
Kind of the run rate activity in the fourth quarter, which is really going to have the most significant impact on 2024.
So what we do in the fourth quarter of 'twenty three is going to be the biggest component of our embedded rent bumps would be the second secondary element and then obviously redeploying our retained capital, which Pete mentioned as nearing $100 million, which is a pretty significant milestone for us.
So those three components are and really just the other things you'd build into like the headwinds around our swap that we've got forward, starting you'd probably be just under a 4% growth.
Yeah, and listen I would add you know, we see a great market to invest and we've been driving cap rates up and we are actively engaged with our relationships to deploy capital at accretive spreads and so you.
Now by no means sitting on our hands and.
Not taking advantage of the dislocation in the capital markets on the contrary, we see a great opportunity for us to to to put capital to work at accretive spreads.
Got it. Thank you I appreciate it guys.
Thank you.
And the next question comes from the line of Eric Wolfe with Citi. Please proceed with your question.
It's actually Nick Joseph here with Eric maybe just following up on that in terms of 'twenty 'twenty four guidance assumptions.
What's the investment spread assumption embedded there.
Are you thinking in terms of cap rates to get to the midpoint.
I want to wait for guidance.
Yeah, listen where we one as we generally kind of pumped on the specifics of that question in that there is a wide range of assumptions supporting guidance generally what we're seeing today is investment cap rates in the high Sevens.
And we assume that that persists and our ability to put capital to work at that level of persist through at least the first half of 'twenty 'twenty four and you know as I said earlier, a large part of the capital that is complete we're putting to work is already priced in in the form of the term loan that we did in.
And that we swapped and we get the rates on that and in the forward equity that's already priced in and and and so you know I think you can do the math on those components, but that's kind of how we're thinking about it.
Okay. That's helpful. Thanks, and then just going back you mentioned kind of the desirability of sale leasebacks with some of these middle market tenants can you talk about those conversations that are going on today.
How they're thinking about doing those deals versus other capital sources that they may be looking at.
Yeah, and this is Ben.
And evolving and improving theme for us over the last couple of quarters, but you know the the bank market is is one you know costly and too challenging to access and so when you think about so for plus 456.
You're talking about rates that are that are wide of where we're getting getting deals on a 20 year basis today.
If you can even get that and then you look at the unsecured.
Sub investment grade market that that's even wider and so.
These these middle market operators.
Are struggling with capital alternatives and largely focused on.
Long term permanent capital against the real estate with the equity.
The owners to capitalize new investments and growth and grow their businesses.
Okay.
Thank you very much.
Thanks, Nick.
And the next question comes from the line of Greg Mcginniss with Scotiabank. Please proceed with your question.
Okay.
Hi, good morning. Thanks for the time. This is there's actually an orange hang on with Greg.
So.
You've grown exposure to the car Washington history.
From 10% of ABR to 15% in the last five years.
Primarily due to as you've talked about the cash flow stability and drawing credit quality they provide.
With having to be more selective on these types of deals in recent quarters. What other types of businesses do you see drawing with you you're going with in the portfolio in the near term.
That offer similar attributes.
But maybe don't require you to have to be selective.
Yeah listen I would say are our investment discipline.
It is designed to be very selective and in source and opportunity set that.
That allows us to be selective amongst the mix of transactions that we're seeing.
When you run a business that is focused on.
Prior relationships and and relying on those prior relationships such that 80% to 90% of your business is coming from those relationships. Your incremental investment activity is going to look a whole lot like your portfolio and so generally what we tell people is to expect our portfolio to grow ratably.
Which means you will continue to invest in car washes and that'll be in.
That kind of 12% to 15% range and we will continue to invest in early childhood education that'll be in that 12% to 15% range.
Quick serve restaurants automotive service casual dining all these are industries with inherent real estate characteristics that we like and as a result, we conduct our sourcing activity and have relationships to generate opportunities out of those industries.
Okay got it.
And maybe if I can touch on your watch list I mean, it seems that improved incrementally during the quarter or at least was stable.
As you look ahead to next year could you give us a sense of which tenants are in industries. You believe would be most impacted if theres a weaker consumer.
Yeah, you know a lot of our.
Not a lot of our industries R. R.
Cause consumer discretionary by design and.
What we see is and we've seen this through a number of cycles now as these industries tend to perform.
Pretty stable through consumer stress and I would say really the only.
Area.
Usually see it the hardest and fastest is in casual dining.
But it's never really that deep but.
But we would expect the portfolio to perform stable through a period of a consumer distress.
Okay got it thank you.
Thank you.
Okay.
Hi, Good morning, Thanks for taking my question. So I just wanted to understand.
Get some color around our new tailored agitation exposure in the portfolio like how many different tenants in that and then what is that maybe we've got exposure there.
And then funding trends youre seeing from the PPE side in that particular sector.
And also any particular clarity she was quite delayed by Canadian <unk> sector.
Yes generally.
We have we currently own about 186 early childhood education centers, you can see in the quarter that.
Busy bees.
Came into our top 10.
Actually busy bees is the local brands.
What's the name of the.
Bright path kids is the corporate.
Which is which is a large operator that purchased a smaller operator that we had already done the sale leaseback with.
Generally we see good trends and that's in that sector with improving coverage and P/e control.
Continues to.
You know roll up a lot of the smaller localized and regional operators.
Such that we see improving credit trends in our investments.
Thank you.
And the next question comes from the line of Keybanc Kim with Chewy Securities. Please proceed with your question.
Thanks, Good morning.
When you talked about higher yields that you expect going into 2024 I was just curious if that's a if you're noticing that in a broad spectrum or is it more concentrated to a couple of key industries.
I think the our ability to drive pricing is more effect factor of the dislocation in the broad capital markets.
<unk>, all our industries equally and so it's really across the board of our opportunity set.
And in terms of your 2020 forward guidance.
What are you what are you assuming for credit losses, I think in the past you've said, 25% to 40 basis points as normal for the portfolio just curious how 2020 for comparison.
Yeah. We've said what we have said is that 25 to 40 basis points as a.
Kind of historical.
Loss experience.
Generally when we build a guide, particularly this far in advance.
And in a market backdrop that we're seeing where a little bit more conservative than that as.
As we go through it.
And take a real deep dive into our individual exposures and tenants and what maybe what may happen there.
So you can assume baked into guide is a range of scenarios is probably a little wider than that.
And but you know historically.
The tailwind to our guidance throughout the year as a lack of manifestation of those losses.
Okay. Thank you.
Kevin.
Yeah.
Ladies and gentlemen, as a reminder, if you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate that your line is in the queue for participants using speaker equipment and may be necessary to pick up your handset before pressing the star keys.
Excellent question comes from the line of Conor at Seversky with Wells Fargo. Please proceed with your question.
Hi, Thanks for taking my question guys, Hey, Suzanne for Conor This morning.
Context of a weakening consumer metrics, how should we be thinking about tenant credit specifically here. So he prt's portfolio exhibited resiliency during the Covid environment, how can we feel comfortable they expect the same kind of performance if consumer spending drops off.
Yes, listen I would it's hard to imagine a scenario, where you see a larger drop off in consumer spending than we saw during COVID-19 and if you start with the premise that the portfolio performed well through that period of time.
You should assume that it should continue to perform well.
Going forward I would say.
We are ultimately landlords to these businesses and we are owning the cash flow.
Assets that.
These business that comprise these businesses and ultimately.
Weakening consumer is going to have impact on on the equity values of these companies, but not the obligations to landlords and I think we very deliberately invest in a very specific set of industries and.
An investor can it can easily take a look at the sectors that we're in and understand that many of them are.
Not really discretionary or subject to a weakening consumer.
Yes.
I appreciate the color just a quick follow up if you just if you had to choose one area, where do you think the highest risks of consumer behavior is within your portfolio.
Yeah, as I said, the casual dining tends to get there.
The earliest and hardest when you see a recession as consumers.
Consumers eat out less and will trade down to <unk> our options.
That would probably be the biggest hit that said, we have great coverage in that space in good assets as I said I would not expect to have any material credit losses.
I appreciate the color thanks, guys.
Thank you.
And the next question comes from the line of Josh <unk> with Bank of America. Please proceed with your question.
Hi, this is.
Josh.
I wanted to touch on again for 2024 capital sourcing.
Kind of what the assumption is acquisitions are expected to stay largely in line with historic trends.
What is your maybe strategy capital sourcing and perhaps.
Thought process on pre funding going into 'twenty four.
Yeah, I mean, our capital sourcing I think what we started with was really the bottom end of our range is.
Utilizing the liquidity that we have available to us now.
Otherwise sourcing as you move through kind of a range.
The capital sourcing is number one the availability on our revolver.
And that's really probably the biggest component of anything that we do relative to the 'twenty 'twenty four guide.
Yeah, and I would.
Would add given.
Settled forwards the term loan and you know the capacity with them.
But we had built into the balance sheet, we have almost.
800 to a $1 billion of investable capital without exceeding our leverage targets.
Great. Thank you.
Thank you.
And the next question comes from the line of Spenser <unk> with Green Street Advisors. Please proceed with your question.
Thank you.
Thank you guys for all the great color on 'twenty guidance, maybe just one more as it relates to that so can you just talk about how far acquisition.
Spreads could compress before you ultimately decided to perhaps pump the brakes or just not grow next year.
Yeah.
I I'd stop short of putting a hard number on that.
You know and it really we take a forward look we expect markets.
Markets to improve.
Good.
I would more say you're unlikely to see us.
It would be more come down to managing our balance sheet, such that leverage gets out of out of whack and we get into a spot where we're uncomfortable relative to the balance sheet and our ability to access capital and you know historically.
Our behavior around leverage is pretty predictable.
<unk> seen us crest, 5% or five times net debt to <unk>.
Ari I think a couple of times.
So.
Think I would look at it that way Spencer.
I think Spencer the other thing I might mention is just you know.
Depending on where you land on on a weighted average cost of capital for us.
Our net spread today is in a pretty good spot and we.
Right.
Uh huh.
Incredibly favorable and underpinning compression in cap rates would probably be.
A market backdrop that would make our weighted average cost of capital and get favorable and I think that means our spreads.
Constructive.
Okay, Yes fair enough and then can you just remind us if you currently have a share buyback program in place and if we did enter an environment, where external growth was off the table and should that be expected to be like a use of capital.
Listen I think if we got to that point than we thought.
Thing for shareholders was to for us to invest in our shares then the board would consider that.
But we do not have one in place as we sit today.
Thank you guys.
Alright, Thanks Spencer.
There are no further questions at this time I would like to turn the floor back over to Peter <unk> for any closing comments.
Great well I'd like to congratulate the team on a great quarter.
As we've said, we're pretty optimistic about what we're seeing going forward and we're happy to have our 2024 guidance out there and look forward to meet and one in the coming weeks.
The conference schedules, Thank you and have a great day.
Okay.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
Yeah.
Yeah.
Hum.
Okay.
Yeah.