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Edited Transcript of NNN earnings conference call or presentation 12-Feb-19 3:30pm GMT

Q4 2018 National Retail Properties Inc Earnings Call

ORLANDO Feb 13, 2019 (Thomson StreetEvents) -- Edited Transcript of National Retail Properties Inc earnings conference call or presentation Tuesday, February 12, 2019 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Julian E. Whitehurst

National Retail Properties, Inc. - CEO, President & Director

* Kevin B. Habicht

National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director

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Conference Call Participants

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* Barry Paul Oxford

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Brian Michael Hawthorne

RBC Capital Markets, LLC, Research Division - Associate

* Christopher Ronald Lucas

Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst

* Collin Philip Mings

Raymond James & Associates, Inc., Research Division - Analyst

* John James Massocca

Ladenburg Thalmann & Co. Inc., Research Division - Associate

* Kathleen McConnell

Citigroup Inc, Research Division - Research Analyst

* Kevin Rich Egan

Morgan Stanley, Research Division - Research Associate

* Spenser Bowes Allaway

Green Street Advisors, LLC, Research Division - Analyst of Retail

* Todd Jakobsen Stender

Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to National Retail Properties' Fourth Quarter and Year-End 2018 Earnings Call. (Operator Instructions) At this time, it is my pleasure to turn the floor over to your host, CEO Jay Whitehurst. Sir, the floor is yours.

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [2]

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Thank you, Cat. Good morning, and welcome to the National Retail Properties' Fourth Quarter and Year-End 2018 Earnings Call. Joining me on this call is our Chief Financial Officer, Kevin Habicht. After some brief opening remarks, I'll turn the call over to Kevin for more detail on our results.

National Retail Properties had a very busy and productive fourth quarter, ending 2018 with annual core FFO per share growth of 5.2% over 2017 results while actually improving our already impressive leverage statistics. Our business model is designed and executed to deliver mid-single-digits per share growth on a multiyear leverage-neutral basis, and 2018 is another example of the power of that consistent strategy. Our total shareholder return for 2018 once again exceeded the REIT averages over 1, 3, 5, 10, 15, 20 and 25 years, respectively. We're not slow, but we are steady. And history shows that steady wins. Our broadly diversified portfolio of almost 3,000 single-tenant retail properties remained healthy with an occupancy rate of 98.2%, which is slightly higher than our long-term average of 98%.

The 400-plus tenants that lease our properties continue to operate businesses that are primarily focused on customer services, customer necessities and e-commerce-resistant consumer necessities. Every year, we assume we'll lose some rent due to struggling retailers. Currently, we have a minor exposure to 2 tenants, ShopKo and Virginia College, which are in default of their respective leases. Although these 2 tenants combined account for less than 1% of our total annual rent, we do expect these defaults to create some additional vacancies for us in 2019. I should note that these events are factored into our guidance for 2019.

Turning to new investments. Our acquisitions, due diligence, legal and asset management teams were very active in the fourth quarter as we invested almost $320 million in 136 new single-tenant retail properties at an initial cash yield of 6.7%. For the year 2018, we invested over $715 million in 265 new single-tenant retail properties at an initial cash yield of 6.8% and with an average lease term of 18.5 years. As has been typical for the past few years, our tenant relationships provided the majority of our acquisition opportunities.

In 2018, about 80% of our dollars invested were with a diversified pool of over 30 relationship tenants operating in 16 different lines of trade. We were also active on the disposition front, selling 15 properties in the fourth quarter. Year-to-date, we sold 61 properties at a blended cap rate of 5.1%, generating over $147 million in proceeds. The fact that our average disposition cap rate, in the low 5% range, was meaningfully below our average acquisition cap rate, in the upper 6% range, validates another one of the strategic advantages of our business model, namely the ability to recycle capital accretively. Kevin will provide more details on our capital markets activity, but I do want to highlight the early redemption of our $300 million debt maturity in 2021 and our issuance of almost $125 million of well-priced equity in the fourth quarter, all of which puts our balance sheet in excellent position for 2019 and beyond.

As we take one last look back at 2018, no word better describes National Retail Properties than consistent: consistent investment focus on single-tenant retail properties, consistency of people and culture, consistently increasing the annual dividend for 29 consecutive years, consistent conservative balance sheet philosophy that maintains flexibility and dry powder, consistently delivering mid-single-digits per share growth on a multiyear basis. The disciplined execution of our business plan on a steady, recurring, consistent, multiyear basis has rewarded our shareholders with total returns that exceed the REIT averages.

Before I turn the call over to Kevin, I want to welcome Betsy Holden to the Board of Directors of National Retail Properties. Betsy's depth and breadth of background as the former co-CEO of Kraft Foods and currently as a senior adviser at McKinsey & Company, coupled with her experience on other major public company boards, will be invaluable in the areas of strategy, governance and consumer retailing.

Over the last few years, we've refreshed our board with 4 new high-quality directors. Much like the rest of National Retail Properties, our board is very well positioned as we look ahead to the future.

With that, let me ask Kevin to provide his additional comments on our fourth quarter and year-end results.

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [3]

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Thanks, Jay, and I'll start with my usual cautionary statement that 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 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 this morning's press release.

With that, headlines from this morning's press release report quarterly core FFO results of $0.63 per share for the fourth quarter of 2018 and $2.65 per share for the full year 2018. That represents a 5.2% increase over prior year results, and that's consistent with the increased 2018 guidance we gave back in November. We left 2019 core FFO guidance unchanged at $2.71 to $2.76 per share, which implies 3.2% growth to the midpoint. We do this while maintaining a strong and liquid balance sheet and not relying on large amounts of short-term and/or floating rate debt. Details of our 2019 guidance is on the bottom of Page 6 of today's press release.

Our AFFO dividend payout ratio was 72.4% for 2018. That's down slightly from 2017. Occupancy ticked down to 98.2% at December 31 as a result of several seasonal leases expiring and the tenant vacancies Jay noted in his comments. We continue to drive additional operating efficiencies, with G&A expense decreasing to 5.5% of revenues for 2018, and that compares with 5.8% a year ago. Just a quick side note here is that our G&A expense line item includes state and local corporate taxes that we pay in various municipalities; some REITs exclude that from G&A and put that on a separate line item.

For purposes of modeling 2018 results, the annual base rent for all leases in place as of December 31, 2018, was $626.5 million, so this allows you to take some of the guesswork or estimation out on timing of Q4 acquisitions and dispositions for projections starting January 1, 2019.

We issued 2.6 million shares of common equity in the fourth quarter via our ATM. Common equity issuance for the full year totaled $341 million. So combining this equity issuance with $148 million of property disposition proceeds, plus approximately $116 million of free operating cash flow -- that's after all dividend payments -- that combination has provided a total of $605 million of equity in 2018, which is 84.5% of the $716 million we invested in new acquisition investments during the year. So this leaves us in very good leverage and liquidity position to maintain an active acquisition effort into 2019, albeit it does weigh a bit on near-term per share growth a bit.

But again, this is consistent with our long-held strategy of maintaining a conservative leverage profile and getting capital when it's available and well priced. Additionally, as we previously announced in the fourth quarter of 2018, we paid off $300 million of 5.5% notes that were not due until July 2021. We were using some of the proceeds from the $700 million of 10- and 30-year unsecured notes that we issued in the third quarter. The $18.2 million make-whole prepayment penalty charge in the fourth quarter was excluded from our 2018 core FFO and AFFO results.

Just a quick side note; in terms of the capital markets activity and its impact on fourth quarter results, really had 3 notable impacts: one, we had additional debt outstanding pending the payoff of a 2021 notes, so that pushed interest expense up a bit; additionally, secondly, interest expense increased due to the 2021 note redemption from the note cost, the note discount and the treasury lock write-off that we -- that ran through interest expense in the fourth quarter, and that was not added back to core FFO or AFFO; and then lastly, as I just mentioned, we had an increased share count of 2.6 million shares. So all 3 of those items and the capital markets activity weighed on fourth quarter results a bit.

We ended the year with no outstanding -- amounts outstanding on our $900 million bank line, and we had $100 million in cash. Leverage metrics remained very strong. We've been inclined to keep a balance sheet with notable financial capacity and flexibility, and more so when the markets are volatile. Again, this may cost per share results a bit in the short run, but good defense will allow more effective offense. Capital structure and undrawn lines of credit are an asset.

Our next debt maturity is in 2022 and our weighted average debt maturity is now 9.3 years. All of our outstanding debt is fixed rate, and our balance sheet remains in good position to fund future acquisitions and weather potential economic and capital market turmoil.

Looking at our quarter-end leverage metrics. Net debt to gross booked assets was 34.6%. That's down slightly from a year ago. As you know, we've not been -- found that market cap-based leverage metrics are particularly relevant, and therefore, don't manage our balance sheet around them. More relevant, we believe, is net debt to EBITDA, and that was 4.8x at December 31. Interest coverage was 4.8x for 2018 and fixed charge coverage was 3.7x for 2018. Only 5 of our 2,969 properties are encumbered by mortgages, totaling $12.7 million.

In conclusion, we believe 2019 will be another good year of solid growth and operating results, and the comps for multiple prior years are not easy. When sourcing capital and making capital allocation and investment decisions, driving per share results on a multiyear basis is at the forefront of our minds. Our investment strategy in terms of property type, tenant type, and our balance sheet strategy have been very consistent for many years.

And with that, we will open it up to any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Kevin Egan from Morgan Stanley.

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Kevin Rich Egan, Morgan Stanley, Research Division - Research Associate [2]

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Just a quick question. I noticed that in terms of the assets held for sale, it seems like it ticked up a little bit this quarter. Could you give any color just around what those assets are and when you're looking to dispose of them?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [3]

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Yes. Nothing to read into that. As you will have noted, disposition activity for 2018 was increased as well. We've sold $148 million of properties, which is a little bit higher than normal for us, but you shouldn't really read anything into that number. That's what's for sale.

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Kevin Rich Egan, Morgan Stanley, Research Division - Research Associate [4]

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And then just one more. I noticed that Camping World, it seems like it ticked up about 7 properties between 3Q and 4Q. Were those additional properties that you acquired? Or were those Camping World locations that start paying rent again? Or what was the nature of that?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [5]

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Yes. Kevin, those were some additional acquisitions of Camping World dealership properties that we closed on in the fourth quarter. They were unrelated to the Gander Outdoor properties. These are brand-new Camping World sites.

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Operator [6]

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Our next question comes from Brian Hawthorne from RBC Capital.

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Brian Michael Hawthorne, RBC Capital Markets, LLC, Research Division - Associate [7]

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My first question is on the Flynn Restaurant Group. What happened there? Was that just an acquisition or a merger, I guess?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [8]

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Yes. We acquired in the fourth quarter a portfolio of QSR restaurants operated by Flynn Restaurant Group. They are one of the largest franchisees of a number of different restaurant concepts, including Taco Bell. So we've had a relationship with the Flynn Group for a number of years and have acquired various Taco Bell properties that have been under their umbrella. And in the fourth quarter, they did a transaction to become a franchisee of Arby's, and we did a sale leaseback as part of their acquisition of that Arby's franchise business.

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Brian Michael Hawthorne, RBC Capital Markets, LLC, Research Division - Associate [9]

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Are they the same as Bell American?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [10]

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Yes. They're the parent company of Bell American. Yes.

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Brian Michael Hawthorne, RBC Capital Markets, LLC, Research Division - Associate [11]

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Okay. And then, I guess, what are your plans for the vacant properties, for ShopKo and Virginia College?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [12]

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Right. Just to put some color on that, we own 3 Virginia College properties, which are technically -- not to get in the weeds -- technically in receivership, but it's effectively the same as if they were in bankruptcy and rejected. So those are back in our portfolio. They're part of our -- the vacancies we had in 2018. Our leasing team is working on those properties. It's too early to report any results. There may be some other schools that are interested in those. But those are just properties that our very excellent leasing team is working on getting re-leased. We also -- we sold 1 ShopKo in the fourth quarter, so we entered 2019 with 3 ShopKos, and -- they have filed bankruptcy. Our properties are listed on the store closure list. But right now, they're still open. They're going through the going-out-of-business sale. And again, those are properties that our leasing team is working to find retenanting opportunities out there for those properties as well. All of that, as we mentioned in our comments, is factored into our guidance for 2019.

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Operator [13]

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The next question comes from Christy McElroy from Citi.

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Kathleen McConnell, Citigroup Inc, Research Division - Research Analyst [14]

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This is Katy McConnell on with Christy. Just regarding the same-store footnote on the impact of bankruptcies and SunTrust on 2018 rental income. Can you specify how much of this impacted Q4 occupancy and same-store growth? And then how much of a drag do you expect these names and the others on the watch list that you mentioned could be in 2018 as far as rental growth?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [15]

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Yes. This is Kevin, Katy. Yes, in terms of the supplemental disclosure, I think you're looking at -- the biggest impact on 2018 same-store rent was really the Gander Mountain, which we've talked about for a number of quarters actually. And so that kind of played through in 2018, which impacted those numbers. Virginia College is a lesser amount. But both of those -- ShopKo is a 0.3% tenant right now. So that would be the potential impact on 2019. That had no impact in '18, so you won't see anything related to that until later this year for ShopKo. The Virginia Colleges were vacant at 12/31/18. So that will have about a $2 million impact on 2019 delta between '18 and '19, and the Gander Mountain will -- played itself out. So I don't know if that answers your question. So there's about $2 million of ShopKo rent, there's about $2 million of Virginia College delta between 2018 and 2019.

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [16]

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Katy, let me make one other point there. I think this is -- just to take a step back and talk -- think about the strategy for a moment with us, as Kevin pointed out, a big part of the impact for that same-store sales number was Gander Mountain and SunTrust. And in both of those instances, they were part of structured settlements that were in the best interest of the long-term business for us. In the case of Gander Mountain, we elected to quickly re-lease all of those stores to a very creditworthy tenant for a long-term 20-year lease with good rent bumps at the expense of trying to hold on to those properties and do -- hold on to those vacancies and try to increase what we might get if we waited for longer. It was a mathematical decision that was easy to make to quickly take the bird in the hand and get the rent started again on those Gander Mountain properties. And that might have -- that does have some impact on 2018 same-store sales numbers. But it was an important thing to do. And similarly, with SunTrust, we structured the renewal of the vast majority of those leases almost 2 years ago now. And the -- those properties where the leases are not renewed just became vacant in 2018. But as part of an overall structured settlement, it was the right thing to do.

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [17]

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And this is Kevin. I'll just take a macro step back, I guess. The way we have talked about with investors over the years is we typically have about a 1.5% increase in our leases built into the rent growth over time. Offsetting that, which we are usually quick to point out, is that, in my mind, as investors think about our company, they should always assume we're going to have 1% of our rent go dark during a given year. And we're never certain which tenant that might be or when it might be or whether it's 0.8% or 1.2%. But we lease properties to retailers. They go out of business. So in our minds, it's always prudent to factor that in. Having said that, we've been able to maintain occupancy at 98%, plus or minus 1% for many, many years. And at the moment, we don't see any reason to kind of change that outlook.

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Kathleen McConnell, Citigroup Inc, Research Division - Research Analyst [18]

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Okay, great. And then maybe just a quick follow-up. Can you update us on the 8 remaining SunTrust leases that you have?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [19]

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Yes. We entered 2019 with 8 of those properties still vacant. Four of those are -- have pending resolution, and then the remaining 4, our leasing team is still working on. I did want to point out something I've mentioned in previous calls. These remaining SunTrust properties are some of the better real estate locations for that group of vacancies. And that's partly why you're seeing us continue to work those hard. We really want to maximize our -- the impact to us from those remaining vacancies of some of the better real estate.

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [20]

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And again, one side note on SunTrust. At the bottom of Page 9 of the supplement, we gave a recap or an update on that whole transaction, not just the 8 but the whole transaction. At the end of the day, it's played out pretty well for us. So we're dealing with some of the last few properties in that process. But it's worked out largely as we had expected and have been pleased with that investment.

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Operator [21]

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Our next question comes from Collin Mings from Raymond James.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [22]

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Collin Mings here. Guys, just 2 questions for me. First, just on the automotive service category. That continues to rise, up about, call it about 100 basis points sequentially. Jay, can you just maybe talk a little bit about the specific opportunities in that bucket that you're having the most success sourcing as well as just the competition on that front, especially given that this automotive bucket has gotten a lot of attention recently as being viewed as e-commerce resistant?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [23]

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Yes. Thanks, Collin. We -- as you know -- to take a step back, in the big picture, what we try to do is build relationships with growing operators and do repeat programmatic business on a multiyear basis with those relationship tenants. And our acquisition teams have done a very good job of building some relationships with tire retailers and auto repair and auto service companies. And we've always had great relationships in the car wash business, which is part of auto service for us. And so what you're seeing is the fruits of our acquisition efforts in building repeat business relationships with new tenants in -- where we're happy with the real estate locations and we're happy with the tenants' business and the tenants' strength.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [24]

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Okay. So a lot of the growth there we should think about just being, again, tied to carwashes, specifically?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [25]

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No, I think carwashes are a smaller part of that. It is more tied to tires and auto service.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [26]

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Okay, all right. That's helpful. And then just really quickly, going back to SunTrust, I appreciate again the update that was provided in the supplemental. But just curious, bigger picture, just on the proposed BB&T transaction as well as thinking about just your bank exposure overall -- I think it's only 1.7% of rents now -- but just any initial thoughts on that proposed deal and your portfolio?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [27]

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Sure. First off, our bank branch exposure is almost entirely SunTrust. We have, I believe, it's 67 SunTrust leased bank branches in the portfolio. These are leased for 9.5 years remaining with SunTrust at very low average rents. The average rent for our SunTrust bank branch portfolio is $140,000 per year. So when we look at the BB&T transaction -- and we have looked at our properties, and it appears to us that about 44% of our properties are within 2 miles of a BB&T property -- but when we look at that, what I see, Collin, is opportunity. SunTrust has been a relationship tenant with us. We have long-term lease remaining at very low rent, and all of that is great opportunity to have a conversation with your relationship tenant about what the tenant would like to do going forward in that situation. It's too early to have that conversation right now. They need to get through their transaction and decide what they want to do. But I feel like we're in very good position as it relates to our SunTrust portfolio in that merger. One other point to make, I think, on the SunTrust properties, unrelated to BB&T, is that they -- we have been able to sell a number of those properties -- sold a number of them in 2018 for 6% cap rates or lower. And it has been part of that capital recycling process that I talked about in my comments, where we're able to dispose of properties where we are -- we think that someone else could be a good long-term owner at cap rates below what our acquisition yields are. So those properties have been very good for recycling as well.

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [28]

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And again, just a reminder, it's obvious, but maybe the worst-case scenario is they have to pay us rent for the next 9 years. So we feel pretty good about that in the near and intermediate term.

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Operator [29]

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Our next question comes from Barry Oxford from D.A. Davidson.

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Barry Paul Oxford, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [30]

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Real quick, guys, when I'm looking at your numbers, I saw that tenant recovery sort of jumped up this quarter but also expenses kind of jumped up, but that caused your margins to be down about 1%. Is that kind of an anomaly of what's going on in the quarter? Or is that how it's going to look kind of going forward?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [31]

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You're talking about property expenses?

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Barry Paul Oxford, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [32]

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Yes. Property expenses along with the tenant recoveries, Kevin, both of those combined. They both kind of jumped up, but yet your margin kind of overall went down. And this is how many angels can dance on a pin of a head, I get it.

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [33]

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Yes. And that's the way we think about it. We think about property expenses net of tenant reimbursements. So for the quarter, it was $2.5 million, which was about 1.6% of revenues, and that compares to $2.1 million for the year before, that was about 1.4%. If you look at the full year -- so there's always a little noise in the quarter -- you look at full year 2018, we had net property expenses of $8.3 million, and that was 1.3% of revenues. That compares with $7.6 million of net property expenses in 2017, and that happened to be exactly 1.3% as well. So year-over-year, as a percent of revenues, net property expenses did move. The absolute number drifted a little higher just because we're a bigger company, have a little bit more vacancy today than we did a year ago, but nothing notable or I don't think the trends are really changing there.

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Barry Paul Oxford, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [34]

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Okay, great. And then just one follow-up question, kind of switching gears. You guys are carrying very low debt, which, again, is great and very conservative. But some investors might argue that you're in an over-equitized position. You did a great job raising money off of the ATM or AMT -- ATM. But in '19, what can we expect, given the fact that you have your debt really in a very low position?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [35]

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Yes, a good fair question. And yes, I think it's accurate to note that we are very well capitalized and, as I alluded to in my notes, we really have virtually pre-funded, if you will, all of 2019's acquisition volume in a large degree, not totally. But to your point, we have no meaningful need for additional equity to carry on our game plan, which is a position we'd like to be in, generally. And again, as a reminder to folks, even if we don't raise another dollar via the ATM or the equity markets, we have about $120 million a year of retained earnings, if you will, after all dividends are paid, and then, call it $100 million of property dispositions that provides -- the combination of those 2 things provide over $200 million. So, to your point, Barry, we're in very, very good shape. We really have no need to raise capital. We don't have any real plans to do so at the moment. But I will caution that, historically, we have raised capital, as I've said, when it's available and well priced. And so we've done that. Will we do any more? It doesn't feel like that today, but it depends what the capital markets brings our way. And so that will drive some of that decision process. But yes, point well taken.

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [36]

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Yes. Barry, just to reiterate Kevin's point. One man's over-equitization is another man's dry powder and prudent balance sheet. We -- Kevin did a very, very good job for us at the end of the fourth quarter obtaining some well-priced equity, even though we knew it was going to drag on the short-term results. That's just part of our core DNA and the philosophy that we operate by.

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Barry Paul Oxford, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [37]

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Right. So is it fair to say we'll at least be -- '19 will be lower than '18, more than likely?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [38]

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It feels that way at the moment.

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Operator [39]

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And our next question comes from Todd Stender from Wells Fargo.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [40]

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Just on acquisitions. We saw the average initial lease yield edge lower. So maybe just if you can provide comments on what you're seeing in the market for 2019, and then just across your acquisitions in the quarter, maybe the range of cap rates from lowest to highest.

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [41]

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Yes. If you look at 2018, Todd -- I don't have the precise numbers. But I would say the cap rates ranged from low 6%s to low 7%s in -- for a bandwidth for 2018. The pipeline for 2019 looks good. As usual, we try to source -- we do source the majority of our acquisitions from relationship tenants. And so our acquisition officers are having those conversations, and we're continuing to grow that relationship pipeline. We're also looking at the portfolios that are out there. It feels very kind of normal and typical for this kind of year when you look at the pipelines that are out there. As it relates to cap rates, what we've said for a long time is that they feel like they are remaining flat. I will say, if anything, cap rates may be trending down just a little bit, as opposed to trending up. But generally, we feel like they're pretty close to flat from prior -- from last year.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [42]

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And how about when you're looking at -- you guys have more of an appetite for either below investment-grade or not-rated tenants. Any comments there and where cap rates are? If cap rates are coming in a little bit, you're still willing to get a lower cap rate but maybe not get the credit.

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [43]

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Yes. What we look for are -- primarily -- are what we think are good, safe real estate locations where we're getting things for a reasonable price at a reasonable rent. And our portfolio of regional and national relationship tenants are still out there finding deals that work for us. So it just feels like kind of business as usual when it comes to that.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [44]

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Okay. And then just the last question. Can you talk -- you addressed it at the beginning of the call. But can you talk a little bit more about the addition of Betsy Holden to the board? Her background is very impressive, co-CEO of Kraft, but it also may speak to the credibility that you guys have, to attract someone of her caliber. So it's encouraging news, maybe just on the REIT side, for someone like her to join a REIT's board.

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [45]

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Thank you. I hope she feels the same way you do. But we were introduced to Betsy through one of the other board members at our company who had served with her in another capacity, and we were so pleased when she said yes. She's a very smart, savvy, experienced businessperson. And I agree with you, Todd, it is nice to get that kind of validation from somebody that's outside of REIT world that seems to be excited to join our board.

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Operator [46]

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And our next question comes from John Massocca from Ladenburg Thalmann.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [47]

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So your convenience store exposure came down a little bit in -- kind of quarter-over-quarter. But 7-Eleven exposure stayed the same. I mean, what drove that decline?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [48]

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The decline in the overall convenience store exposure was really just growth of other areas, John. I'm trying to remember. I don't think we sold any convenience stores or had anything else change about that.

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [49]

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It didn't move much, and that might just be kind of a rounding issue. But I'm not sure there's much to read into that.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [50]

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Okay. And then with regards to the Virginia College properties, can you maybe give us a little more color on the size and locations of those boxes and kind of how fungible they are, particularly if they're not going to get re-leased to another education operator?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [51]

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Yes. Their boxes are 45,000 to 60,000 square feet, John, and they're in pretty good locations. One's in the Denver area, one's in Austin, Texas, area and one is in Knoxville. And to the extent they had to be retenanted for something else, we would just run the numbers on that and see what made sense. Our first -- job 1 for us is re-leasing. And job 2 is to try to re-lease as is, if at all possible. We will accept lower rent on properties if we can lease them as is, as opposed to putting in TI dollars and then announcing a better rent spread. But our leasing team is working on that, and we'll have more to report later. But right now, we're trying to see if we could find some other users that fit those types of properties.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [52]

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Understood. And then, maybe now switching to maybe the balance sheet. Excluding the loss on extinguishment of debt, what, roughly, was the onetime impact to interest expense of all the noise in 4Q around the debt prepayment? And is anything potentially going to carry over into 1Q '19?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [53]

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No, nothing will carry over. It was about $4.2 million of noise connected to the 2021 note redemption in 4Q that flowed through interest expense that, like I say, weighed on results. So yes, but nothing will find its way going into 2019.

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Operator [54]

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(Operator Instructions) Our next question comes from Spenser Allaway from Green Street Advisors.

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Spenser Bowes Allaway, Green Street Advisors, LLC, Research Division - Analyst of Retail [55]

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Your dispositions of vacant properties seemed to trend up this year, and I know part of that was a function of you guys working through the SunTrust properties. But then in your prepared remarks, you noted that we should expect -- you to be working through the ShopKo and Virginia College vacancies. So understanding that vacancies are hard to forecast, but should we expect this to go back to normalized levels? Or do you think that the more overall kind of challenged retail environment is going to present more elevated levels of vacancies moving forward?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [56]

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Well, Spenser, there's always going to be -- as Kevin mentioned, we're going to always have some vacant properties. We may well be around 98% occupied for the foreseeable future, if I'm understanding your question correctly. As it relates to the sale of vacant properties, as I've mentioned before, job 1 is to re-lease those vacancies. And so we work very hard to look for other tenants before we decide to sell any properties. If you look at the vacant properties that we sold in 2018, I looked back, and our average hold period for those vacant properties before we sold them was more than 2 years. So we worked very hard to restart rent before we decided to sell those properties. But in the end, it's just a mathematical calculation for us as to what we could rent properties for on an as-is basis, what we might get if we put in TI dollars or what we could get from a disposition and then reinvest those proceeds, and calculate what's the best -- the better decision based on those alternatives.

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [57]

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Yes. And I just would point out, Page 9 of the supplement gives a little bit of detail as it relates to property dispositions. And to your point, a good chunk of 2018, so we had -- we list 24 properties as vacant sales, which is an elevated number for us. The footnote notes that 13 of those were SunTrust and 5 of those are land parcels. So we can quibble -- I'm not sure if everybody would call that a vacant property or not, excess land, but we do in this case, and so -- but clearly, 13 of them were SunTrust properties, and that number, obviously, will decline notably in the coming quarters. And so, if I'm betting, I'd say the number of vacant properties we've sold will drift lower from where we are today. But we'll see. We'll play that out. To Jay's point, our job is to work it hard on the leasing front. And there comes a time a handful of properties where selling it makes more sense, and so we'll see. But if I was betting, I'd say the number of vacant properties sold probably drifts lower in 2019.

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Spenser Bowes Allaway, Green Street Advisors, LLC, Research Division - Analyst of Retail [58]

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Okay, that's helpful. Yes, I guess my point was really just kind of alluding to the fact that -- could we see more of those footnotes moving forward, just given the fact that retail in general is so challenged and maybe net lease won't be as insulated as it has been in years prior? If you'll end up seeing some more tenants either close unforeseen properties or whatnot?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [59]

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Yes. We try to keep the market abreast of kind of what we're seeing and what's going on and what we're buying and what we're selling. So we'll continue to do that.

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Operator [60]

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(Operator Instructions) And our next question comes from Chris Lucas from Capital One.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [61]

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Just a panful of housekeeping items, Kevin. So on the annualized rent that you give for -- as of December 31, the $626 million plus, is the Virginia College rent included in that number or excluded from that number?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [62]

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Yes, they were vacant as of year-end. That is excluded from that number.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [63]

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And then ShopKo, was that in or out?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [64]

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That was in, because they're still current and still paying rent and have been rejected the leases. So that's still leased and occupied and paying rent. So that was in at 12/31/18.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [65]

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Okay, great. And then, do you have the renewal rate for 2018? You provided it last year for '17. I was just curious as to what the number was this year and if there was anything that impacted it specifically.

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [66]

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Chris, the SunTrust bank branches -- the renewal and the lease expirations occurred 18 months apart. So if you normalize SunTrust by either putting all of those 18 months ago or all of those currently, the renewals and the expirations, it works out to be right on top of our long-term average of 80% to 90% renewals at 95% to 100% of the prior rent.

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [67]

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I think it was, what, 83% if you normalize SunTrust. So it was right in where we typically operate.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [68]

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Okay. And then just on the leasing activity. It was weaker year-over-year if you sort of -- if you adjust out last year for Gander. But more interestingly for me was just the TI numbers were higher on the re-leasing. Was there specific deals there that caused the TI numbers higher?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [69]

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Chris, the vast majority of that TI dollars on the re-leasing was for one of our relationship tenants who took over one of our vacant properties, and we funded the renovations and got a return on all of those dollars. So it falls into this bucket as TI. But it -- but we look at it more like the types of properties where we will buy the land and then fund the building for one of our relationship tenants. In this case, we'd leased them a building that we already had and then funded their renovations and got a return on those dollars that's comparable with our return on our other investments. And Chris, while we're on that point, I think there's also some dollars included in the renewals where there was less than $1 million, I think. And I do just want to point out that those dollars -- because typically, we get renewals with next to $0 involved. And even though that's not a big number, that -- in both of the instances where we put in dollars for renewals, we've got 10-year or longer lease renewals. So it was not for the standard 5-year renewal in order to -- we got some additional value for those dollars invested.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [70]

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Okay, that's helpful. And then, I guess, my last question, just on the topic of the balance sheet and capital funding. Kevin, what would you be able to price 10-year debt at? And is the preferred market at all open at this point?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [71]

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10-year debt for us today is probably in the low 4%s, meaning 4.2%. So that's about treasuries plus 1.45 or so: 4.1%, 4.2%. The preferred -- I don't think it's open enough for us to pursue, A. B, I don't think it's probably -- because of that, I don't think it's particularly well priced. But -- and C, I at the moment feel like we have that piece of the capital stack kind of where we probably want it. So probably not inclined to go there today. We have 2 outstanding preferreds, one at a 5.7% coupon and one at a 5.2% coupon and like that capital, which we do view as perpetual capital.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [72]

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And I guess, while I'm on the topic, I guess, 30-year debt, have you looked at how that's priced out today?

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [73]

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To be honest, I have not. I think it might be close to where we issued last September, where we had a 4.8% coupon. It's probably come in a little bit from there but not a lot. But I'd call it the mid- to high 4%s is where that would probably be today.

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Christopher Ronald Lucas, Capital One Securities, Inc., Research Division - Senior VP & Lead Equity Research Analyst [74]

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So plenty of attractive choices.

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Kevin B. Habicht, National Retail Properties, Inc. - CFO, Executive VP, Assistant Secretary, Treasurer & Director [75]

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Yes, plenty of choices there, which, obviously, to the extent that that's where the 30-year is priced, if in fact that is where it would pencil out, preferred may not be the most attractive option, regardless.

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Operator [76]

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And our last question comes from John Massocca from Ladenburg Thalmann.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [77]

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Just a quick follow-up one for me. Is the Virginia College, was that your only education tenant exposure in the portfolio? Or are there any other education operators in your tenant base?

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [78]

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John, I'm thinking quickly. I believe it is our only exposure. And it is just for those 3 properties.

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Operator [79]

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There appears to be no further questions. I'd now like to turn this back to you, management. Thank you.

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Julian E. Whitehurst, National Retail Properties, Inc. - CEO, President & Director [80]

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Thank you. We thank you all for joining us this morning, and we look forward to visiting with you -- with many of you as the spring conference season approaches. Have a good day.

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Operator [81]

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Thank you. This does conclude today's conference. We thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.