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Edited Transcript of SRC earnings conference call or presentation 23-Feb-17 4:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Spirit Realty Capital Inc Earnings Call

SCOTTSDALE Feb 23, 2017 (Thomson StreetEvents) -- Edited Transcript of Spirit Realty Capital Inc earnings conference call or presentation Thursday, February 23, 2017 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Pierre Revol

Spirit Realty Capital, Inc. - VP of IR

* Tom Nolan

Spirit Realty Capital, Inc. - Chairman and CEO

* Jackson Hsieh

Spirit Realty Capital, Inc. - President and COO

* Phil Joseph

Spirit Realty Capital, Inc. - CFO

* Boyd Messmann

Spirit Realty Capital, Inc. - EVP and Chief Acquisitions Officer

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Conference Call Participants

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* Anthony Paolone

JPMorgan - Analyst

* Alexander Goldfarb

Sandler O'Neill & Partners - Analyst

* David Corak

FBR Capital Markets - Analyst

* Haendel St. Juste

Mizuho Securities - Analyst

* Daniel Donlan

Ladenburg Thalmann & Company Inc. - Analyst

* Michael Knott

Green Street Advisors - Analyst

* Landon Park

Morgan Stanley - Analyst

* Ki Bin Kim

SunTrust Robinson Humphrey - Analyst

* Joshua Dennerlein

BofA Merrill Lynch - Analyst

* Rob Stevenson

Janney Capital Markets - Analyst

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Presentation

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Operator [1]

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Good morning ladies and gentlemen and welcome to the Spirit Realty Capital fourth-quarter and full-year earnings conference call. As a reminder this conference call is being recorded. I would like to turn the call over to your host for today's conference, Mr. Pierre Revol, Vice President, Investor Relations. Sir, you may begin.

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Pierre Revol, Spirit Realty Capital, Inc. - VP of IR [2]

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Thank you operator. Good morning and thank you everyone for joining us today. Presenting on today's call is Tom Nolan, Chairman and Chief Executive Officer; Jackson Hsieh, President and Chief Operating Officer; and Phil Joseph, Chief Financial Officer.

Before we get started I would like to remind everyone that this presentation contains forward-looking statements. Although we believe these forward looking statements are based upon reasonable assumptions, they are subject to known and unknown risks and uncertainties that can cause actual results to differ materially from those currently anticipated due to a number of factors. I refer you to the safe harbor statement in today's earnings release and supplemental information as well, as our most recent filings with the SEC for a detailed discussion of risk factors related to these forward looking statements.

This presentation also contains certain non-GAAP financial measures. Reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures are included in today's earnings release and supplemental information furnished to the SEC under Form 8-K. Both today's earnings release and supplemental information are also available on the investor relation section of our website. For our prepared remarks, I am pleased to introduce Tom Nolan.

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [3]

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Thank you, Pierre. Good morning and thanks everyone for joining our year-end 2016 earnings call. This morning I will start with an overview of our 2016 accomplishments. Jackson will provide more details on our portfolio, acquisitions and dispositions. And finally, Phil will provide more details on our financial results. We will then take your questions.

2016 was a pivotal year for Spirit. We made major strides towards our ambition of being recognized as a best-in-class REIT through active portfolio diversification, material balance sheet improvement, and building the right executive team that will create long-term value for our shareholders.

During the fourth quarter, we continued to focus on improving the quality of assets in our portfolio including the sale of the 84 Lumber portfolio and five Shopkos. We maintained our balance sheet leverage at 6.2 times debt to EBITDA, a material improvement from the same period last year.

We believe that smart acquisitions and continual portfolio management are key drivers to attractive long-term returns in the triple-net lease sector. Over the past year we acquired approximately $705 million of high-quality assets while selling $585 million of properties that were either accretive on a risk-adjusted basis to reinvestment opportunities or no longer core to our strategy. Our sales included 108 properties leased to 84 Lumber, as well as the monetization of certain of our Haggen and Shopko locations.

During the year we sold two of our former occupied Haggens for a 4.5% weighted average cap rate, which was 300 basis points lower than our acquisition cap rate. We lowered our Shopko concentration to 8.2% of normalized rental revenue, and our top 5 and top 10 tenets now comprise 17.5% and 25.8% of our normalized rental respectively, down from 19.4% and 26.5% respectively one year ago. These diversification improvements now position us as having one of the most diverse portfolios among our peer set.

In 2016 we grew revenue by 3% to $686 million and AFFO by 9% to $413 million. AFFO per share grew by a modest 1% as we did make the decision to forgo a higher potential near-term earnings growth rate in exchange for strengthening the balance sheet, and as such, position the Company for stronger growth in the years to come. This was principally accomplished through a $370 million equity capital raise in April.

Furthermore, having extinguished approximately $833 million of higher coupon debt as part of our liability management program, and achieving three investment-grade ratings, we accessed a new capital source with the completion of our Denovo $300 million unsecured bond issuance in August. As a result of this work, we reduced our cost of capital and ended the year at 6.2 times debt to adjusted EBITDA, versus 6.9 times at the beginning of the year.

Finally, we strengthened and deepened our management team providing leadership that will drive our next phase of growth. As we've stated in the past, we are committed to hiring best-in-class executives and team members in order to position Spirit as a leader in the net lease sector. Our moved to Dallas is complete, and with our experienced bench, we are benefiting from their innovative and forward-thinking approach to our business.

As you heard last quarter, Jackson spearheaded an effort to take a fresh look at each of our assets, which we're now utilizing to optimize our capital allocation and identify potential opportunities within the portfolio. We will continue to be prudent in our approach to acquisitions and incorporate these insights into future acquisitions or dispositions. We continue to see opportunities to accretively recycle assets, and given our enhanced process and methodology, we believe we can further improve the portfolio and deliver stronger growth.

Regarding our financial position, we entered 2017 with a solid and flexible balance sheet. We have very manageable debt maturities through 2018. We expect to continue to unencumber assets while keeping our leverage at levels consistent with our stated targets. Phil will provide further comments during his remarks.

Additionally, as part of our commitment to provide both long-term growth and income for our shareholders, I am pleased to report that we raised our dividend for the fourth year in a row to $0.18 per share, which represents a 2.9% increase over the prior year. Furthermore, let me note that in 2017 we plan to be even more proactive with meeting and speaking with the investment community while continuing to provide transparency into our business. We always welcome investors to visit us in Dallas and we are looking forward to our May 17 Investor Day in New York. We plan to provide more details around our strategy as well as new disclosures around our process and portfolio that we think our investors will appreciate.

Finally, I started my remarks with a reference towards our ambition of establishing ourselves as a best-in-class REIT. As I've noted, I think the Company made substantial progress in 2016, particularly as it relates to our portfolio, balance sheet and people. There is one other area I would like to touch on and that is governance. Just like other elements of our business, we want best practices that are part and parcel of being a best-in-class REIT. As such, after a thoughtful and thorough review of our governance provisions, I am announcing that prior to our annual meeting in May, the Company intends to permanently opt-out of the so-called MUTA provision that would allow us to stagger our board.

With that, I will turn it over to Jackson.

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [4]

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Thanks, Tom, and good morning everyone. I will begin with an overview of our portfolio's operating results and then discuss our acquisitions and dispositions within the quarter, and provide additional color on our portfolio and capital allocation.

As of December 31, our portfolio was 98.2% occupied and had an average remaining lease term of 10.7 years. 45% of our normalized rental revenues were derived from national leases and 89% of our leases have built-in rent increases. Our unit level rent coverage remains healthy at 3.0 times on reporting tenants. During the fourth quarter we were net disposers of assets, acquiring $248 million and selling approximately $272 million of assets. We acquired 42 properties comprised of 23 tenants at a weighted average cap rate of 7.3%, which was a mix of existing and new customers.

We purchased a Mister Car Wash in St. Paul Minnesota from an existing tenant, which strengthened our master lease and furthered our relationship with them. We added a new customer with Sonny's BBQ where we bought seven properties in the Orlando area in an off-market transaction under a direct sale-leaseback subject to a master lease. This real estate ranked highly within our casual dining portfolio with strong coverage and a 15-year lease provided attractive annual bumps. We were pleased to partner with a franchisee that has a long operating history with Sonny's and we can partner with them to further their growth.

Regarding Shopko, we continue to be encouraged with investor interest in our Shopko locations. We also appreciate that from an overall operations and credit perspective, there is increased scrutiny concerning so-called big-box retailers. And while Shopko is not immune to these competitive challenges, we are encouraged with their performance, as Shopko's weighted average unit coverage for our portfolio base remains in excess of 2.5 times. In 2016 we sold nine operating units at a cap rate of 7.5% for proceeds of $78 million. Of the 116 Shopko and Pamida stores remaining in the portfolio, 72 of those are Shopko stores which comprise approximately 90% of the total Shopko rents.

Regarding the Haggens investment, we continue to work through the portfolio in order to maximize value. We sold four vacant stores for $25.2 million and two leased stores for $31.4 million at a blended cap rate of 4.5%. The remaining 14 stores include three vacant and 11 leased properties that generate $10.7 million in rent. We continue to participate in an unsecured creditor regarding our bankruptcy claim. The timing and certainty of the future payments related to our bankruptcy claim are not clear at this time.

As to asset pricing, with recent changes in interest rates, we saw some opportunistic increases in cap rates in the fourth quarter for larger assets. Smaller assets that are attractive to 1031 buyers continue to trade between 5 and to high 6 cap rates, but deal volume has been more choppy. We made a decision to reevaluate some of the potential acquisitions during the fourth quarter while committing to complete existing transactions already in process. At our current cost of capital, we're being very selective on new acquisitions and evaluating opportunities within the portfolio to generate earnings.

Finally, over the past few months, our team has completed a full review of our portfolio and implemented an asset ranking system with the goal of identifying new opportunities for growth. As Tom mentioned, we will provide additional insight into the composition of our portfolio, industry views, and targets during our Investor Day in May. With that I will turn the call over to Phil.

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [5]

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Thanks, Jackson. During the fourth quarter we maintained our disciplined capital allocation focus, while improving our portfolio and earnings quality. While we were position to be a modest net acquirer in the fourth quarter, investment discipline took precedent.

During the quarter we acquired $248.4 million of assets at a 7.3 % cap rate, and we disposed of $271.6 million of assets at a weighted average cap rate of 8.3%, including $205.7 million of assets sold to 84 Lumber at an 8.7% cap rate. While the 84 Lumber disposition creates a slight earnings headwind for 2017, our portfolio is now better positioned for durable and consistent earnings growth.

Before I address our financial results I would like to point you to some additional financial disclosure that we provided in our fourth-quarter supplemental. As we continue to listen to our stakeholders we have added incremental disclosure on our public bond financial covenants. We hope that you find this information helpful.

As Tom mentioned, last evening we reported AFFO of $0.21 per diluted share for the fourth quarter, including adjustments for restructuring charges and other expenses associated with our corporate relocation. This performance represents a decrease of approximately 5% compared to the fourth quarter of 2015. The decrease is primarily attributable to our balance sheet and portfolio management initiatives, most notably our transition to an investment grade balance sheet and our strategic 84 Lumber portfolio disposal.

In addition, moderate net acquisition activity and flat same-store rent growth were also contributing factors. As it relates to the 84 Lumber transaction, we received additional consideration of approximately $5 million for allowing 84 Lumber to exercise their purchase option early. This incremental consideration was recognized as a gain on sale, and hence, not included in AFFO.

Balance sheet progress that we made in 2016 has enabled us to improve our cost of and access to capital as we accretively grow and strengthen our portfolio. Vigilant balance sheet management, disciplined capital allocation and prudent earnings growth will continue to be key strategic objectives for 2017.

Total revenues for the fourth quarter of 2016 increased approximately 3% to $173.4 million compared to $168.7 million in the fourth quarter of 2015. Primary drivers were moderate net acquisition activity during the year-over-year period, higher fee related other income, and a non-cash straight-line rent adjustment for previously reserved rents. Offsetting the positive variance in revenues was lost rent related to lease restructurings and tenant credit loss.

Same-store rent growth for the quarter when compared to the prior-year fourth quarter was flat. Rent growth continued to be negatively impacted by an investment in the C-store category that has continued to underperform. This particular investment represents less than 1% of our annual in-place rents, excellent real estate and its impact on same-store results is temporary. As disclosed in our supplemental, if this tenant was excluded from our same-store portfolio, our reported same-store rent for the year would have been a positive 1.2%.

On the expense front, excluding restructuring charges and other expenses associated with our corporate relocation included in G&A, total expenses in the fourth quarter of 2016 increased to $184.6 million from $152 million in the same period of 2015. Primarily driving this result was higher property cost and non-cash impairments. Offsetting this was a decrease in cash interest expense, which notably decreased by approximately $10 million during the year-over-year period.

With respect to run rate G&A, excluding corporate relocation charges, represented 6.8% of total revenues for the quarter, in line with our targeted of at or below 7%. Going forward, we do not expect to recognize any further restructuring charges or costs related to our corporate relocation. As already mentioned, we continue to make great progress on lowering our debt cost to capital. [Cash] interest expense decreased by approximately 19% compared to the fourth quarter of 2015, solely as a result of our proactive secure debt liability management. In addition, our weighted average cash interest rate improved by approximately 35 basis points from the prior fourth quarter and now stands at 4.28%.

Our liability management activities [in position] to the investment grade corporate bond market have enabled us to access capital more efficiently. During 2016, we extinguished approximately $883 million of high coupon secured debt with a weighted average interest rate of 6%. Total cost related to this early retirement of debt approximated $31.7 million or 3.6% of the principal amount of the debt that was retired. More importantly, our unencumbered asset-base currently stands at $4.8 billion, has increased by approximately $1.7 billion year-over-year, and represents almost 60% of our total real estate investment. As of today, we only have $345 million of debt coming due through the end of 2018, excluding our $420 million unsecured term loan, which is extendable at our option pursuant to two one-year extension options.

In terms of our financial standing, our cash flow and leverage metrics continue to trend favorably. Mixed charge coverage notably improved at 3.6 times versus 2.9 times in the prior fourth quarter. In addition, our fourth quarter reported leverage at 6.2 times improved by 0.7 turns from the prior fourth quarter period. We continue to expect to end the year at or below 6.3 turns; however, leverage may tick up slightly during the intervening period depending on the timing of capital allocation activity, most notably the timing of asset sales.

Our corporate liquidity remains strong and positions us well for accretive growth. As of December 31, we had $86 million drawn on our $800 million unsecured line of credit. Currently we have approximately $12 million in unrestricted cash and cash equivalents on our balance sheet, and approximately $640 million available under our line of credit. In addition, we have approximately $26 million of liquidity available in our 1031 exchange and master trust notes release accounts that are available to fund real estate investments.

From a liquidity perspective, we are positioning the balance sheet so we are not reliant on the public equity and debt capital markets during 2017. During the quarter we declared dividends to common stockholders of $87 million, which represented an AFFO payout ratio of 85% compared to $77.3 million representing an AFFO payout ratio of 78% in the comparable period a year ago.

In conclusion, we are affirming our 2017 AFFO guidance range of $0.89 to $0.91 per common share. Key drivers of our 2017 guidance range will be disciplined external growth, accretive capital recycling, as well as harvesting the organic rent growth in our portfolio. Outlier drivers to keep in mind are the Haggen settlement proceed and our continual focus on G&A cost reduction, specifically related to the internalization of certain services currently provided by third parties.

On the Haggen settlement, we want to be clear that the timing and amount of any payment is uncertain at this time. More succinctly, all of this [delated] damages related to lost rent, when and if received, will go through AFFO, even for those stores that were retenanted. As it relates to the lost rent on vacated stores, from an AFFO-per-share perspective this could approximate $0.01 for FY17, if damage claim proceeds are received in 2017.

As with prior quarters, the timing of our capital allocation activities will directionally drive our earnings throughout the year. We will continually maintain a focus on improving our cost of capital by maintaining moderate leverage, delivering durable and consistent earnings growth, as well as continual stakeholder engagement. With that, we will be happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Anthony Paolone, JPMorgan.

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Anthony Paolone, JPMorgan - Analyst [2]

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Thanks. Good morning. First question is can you touch on the fourth quarter acquisition activity and how it split up between things like investment-grade and noninvestment grade?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [3]

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Sure. This is Jackson. We didn't have a huge amount of investment grade transactions. I would tell you that if you looked at our disclosure, the majority were sale leaseback transactions as opposed to master lease. So we acquired, for instance, a Regal Cinemas, for instance. a couple Camping World assets, as I talked about, the sale leaseback with Sonny's BBQ.

I think the biggest thing that we saw, and I referenced this in a my comments, pre-election, post-election we saw a shift in cap rates of at least 25 basis points, plus or minus. We saw them both basically on the sell side and on the buy side. So we had a number of transactions that we were marketing that had gotten tied up, and if they weren't really buttoned up, buyers came back and widened on us. And I will tell you we did the same thing on transactions post-election opportunistically, and we walked away from a number of transactions. So there was definitely a different break right after the election.

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Anthony Paolone, JPMorgan - Analyst [4]

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Okay. And then I guess on that thought, with you all having paused a bit because of that, does it change the timing or how you think about acquisitions and dispositions in 2017? So for instance, do we see acquisitions maybe delayed a bit as you guys reset, but the dispositions are more front-end loaded? How do we think about that?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [5]

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I think it would be cooked similar to the level you saw in the fourth quarter, because we've seen a big pickup in acquisition -- it's very interesting, the market, in our view, especially in the early part of this year, has sort of stabilized. And I will break it down the acquisition market in the following terms: 1031 market is completely non-changed. We've been continually finding buyers for the individual small assets that have lined up in that market. I would put bigger portfolios where public companies were acquiring them, generally they haven't changed their point of view, I would think, for the larger quality opportunities.

The area where I think it's still price discovery is if you have a private buyer that's using debt capital to buy a medium-sized single property, like $20 million and plus range, (inaudible) costs have widened, so I think time will tell where those assets land. But to follow back on your question on investment-grade, we locked in -- we just closed a Home Depot this week that we had committed to prior to the election and post, to just give you some sense, we widened that transaction by 25 basis points on that particular asset. It closed, it's investment-grade, obviously. Home Depot is a focused tenant of ours. They've moved to number 12 on our list right now.

We locked in to another one that is -- presumably we are expecting to close very shortly, and the cap rate will widen more substantially than 25 basis points. I think the takeaway is that our pipeline in the first quarter and second, I think, will be very robust, and similar to the way we were approaching business in the third quarter.

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Anthony Paolone, JPMorgan - Analyst [6]

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Okay. Does the comment about just maybe the larger boxes requiring a bit more price discovery, does that inhibit you from putting anymore Shopkos into the market or doing anything on that front right now?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [7]

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As a stated goal you've heard us talk about Shopko, or any tenant, having a tenant larger than 5% of our overall tenant roster, in our mind doesn't makes sense. The buyer base for Shopko continues to be -- we are constructively very positive about it. I think you will continue to see us selectively monetize those assets. The one thing I will tell you is that we are selling Shopkos that are generally lower coverage than our current master lease coverage. So we are very specific as to the type of Shopko assets that we're selling right now versus the ones that were remaining in the national lease.

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Anthony Paolone, JPMorgan - Analyst [8]

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Okay. And last thing for me, just on 2017 NOI, or central revenue, if you will, what does that look like when you anniversary the matters around that C-store investment?

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [9]

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Say again?

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Anthony Paolone, JPMorgan - Analyst [10]

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You had flat core growth in 4Q and the C-store investments seem to be the drag. Just wondering about 2017, and when you anniversary that, and what core growth should look like in 2017?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [11]

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I will just take the C-store thing right on -- I'll just tell you right now and describe what the situation there is. And I want to characterize it with, I'm going to be very specific and limited in what we can say about it, but first and foremost, this is a C-store portfolio that's first of all under a master lease. It's 30-plus stores, it's really [struggled] real estate. The assets are primarily in southern California. The average household income is about, five-mile pop, is about $358,000, and household income is about $62,000. Locations are Los Angeles, Huntington Beach, Ontario, Long Beach, Pomona, San Francisco, Vallejo, Ventura and Portland.

It is really great real estate. The issue we have is the operator. We are in the process of removing the operator. Actually, they haven't paid rent since August. We have some recourse for the operator and we also have multiple operators and potential buyers that have approached us on the asset. So the bottom line is we're trying to resolve it as quickly as we can.

We're very confident in the value and the rentability of those stores. But we just have to work through it, so I can't really give you a time as to when it's going to come back online, but obviously, we're moving posthaste as quickly as we can to resolve it. But we are very confident about the portfolio.

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Anthony Paolone, JPMorgan - Analyst [12]

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Okay. Got it. Thank you.

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Operator [13]

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Alexander Goldfarb, Sandler O'Neill.

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Alexander Goldfarb, Sandler O'Neill & Partners - Analyst [14]

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Good morning down there. Jackson, just continuing on the C-store tenant. You said they haven't paid rent since August of 2016, so you guys haven't been booking any revenue from them since then, or you have for GAAP purposes on the presumption that you will get paid back?

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [15]

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No. Alex, it's Phil. From a GAAP perspective, we've offset -- we've taken a reserve as it relates to the straight-line rent, so we haven't been recognizing revenue on that, I would say, for the fourth quarter. And realistically, as it relates to go-forward strategy, our focus on that tenancy is obviously making sure that we are focused on getting that retenanted with a new operator and have income going forward, but from that perspective, no.

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [16]

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And look, I don't want to make light of it, it's less than 1% of our total rent. We don't like the fact that they're not paying, but again, I sleep well at night to know that these are really very, very attractive C-store locations on really visible four-corners in the right market. So we've already been proactively approached by a number of different operators and potential buyers of the asset. And we are going to methodically do the best we can to maximum value and actually get these things back online, basically, because it's very good real estate.

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Alexander Goldfarb, Sandler O'Neill & Partners - Analyst [17]

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Okay. So if we look at it from the perspective of backfilling boxes, I think in total you have 46 empty boxes plus this chain of 30 C-stores that you're looking to replace with a different operator. If we heard from the strips when they're looking to backfill some of their vacancies, Golfsmith or Sports Authority or whatever, it seems to be a 9 to 12 month process in total. In your view as you look at your available space, should we think about something similar where it's almost about a year between when you have a store not renewing go dark, or you're trying to replace an operator, that it's sort of a 12-month timeframe? Or is it longer, shorter, just how do we think about the time to backfill some of these spaces and the drag on the portfolio?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [18]

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I will tell you one thing -- and this is just something with me coming in nil. I think we're going to be more efficient at dealing with vacancy because there's kind of a push-pull. You can hang on too long and try to get that extra dollar or extra $0.10, and there's a cost implicit in just holding it vacant. So there's a trade-off, right?

There's a quick fix and then there's one that's longer trend that may create more value. The vacancy in this particular C-store location is really a different circumstance than what I will call, maybe some of the vacancy we have in some of the other locations where it might be a single location you're trying to retenant something. This is sort of an operating portfolio that's, candidly, (inaudible). And so it is just a question of -- I can't get too specific on that particular portfolio because, like I said, we're in the process of removing the operator, but I feel very confident that these will get resolved very quickly, at least as it relates to that portfolio if it is vacant. It's currently not on our vacancy list right now because the lease is still in effect right now.

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Alexander Goldfarb, Sandler O'Neill & Partners - Analyst [19]

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Right, but as far as the remaining 46, are those spaces that we should expect to be filled as we look to 2017 or we should think about that's NOI that will remain absent from 2017?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [20]

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I think you could expect those to resolve, those vacancies, probably from a historical standpoint, much faster. Either sold or leased. It's a high priority that I've put on the asset management team because I think that there's obviously a lot of different things people can do with their time, blend and extend, sell property, vacancy is like a real KPI in that group right now. And so, they are -- even though it's a very small portion of the portfolio, there's a lot of effort being put into resolving those matters in a more expeditious fashion.

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Alexander Goldfarb, Sandler O'Neill & Partners - Analyst [21]

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Okay, and my second question is, Jackson, it sounded like from your comments on the transaction market, cap rates are -- things have settled back down and that you expect at least the first half to almost be a catch-up period. But I think, Phil, you mentioned not planning to access either the debt or equity markets this year. As we think about you guys funding from dispositions, you guys have long spoken about that investment grade bucket, the drugstore type, the flat leases that you look to harvest at low cap rates. Can you just update us on how much of that product is available so as we think about your ability to acquire, we can think about how much that you potentially have to sell in order to fund acquisitions this year.

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [22]

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Let me just start. Jackson can talk about the assets that we would be targeting for disposition in 2017. But one thing to keep in mind, and one thing I referred to on our call is that the timing of capital allocation activities, as well as the fact that leverage is expected to moderately increase during the first half of the year, that's directionally going to drive our earnings and capital allocation plan. So I would not be looking at it from the perspective of having asset sales and accretive capital recycling being the sole driver of our external growth. We will moderately leverage into the year. But as I mentioned in my prepared remarks as well, we are totally comfortable with our leverage guidance at our below 6.3 turns.

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [23]

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Alex, the other thing, too, is we are a new team down here, and as you know, if you buy -- timing of your acquisitions has a big impact, obviously, on earnings for the year. We are very cognizant of it. I would tell you that our first -- we took a bit of a pause, like post-election, we were very aggressive on deals that were not signed up that we wanted to buy, we were prepared to move forward, but it had to be at revised pricing.

And I would tell you that on things that we were selling, what we were getting retraded -- and I'll be specifically, there were a couple of Haggens assets that were locked in at very attractive prices, the guys came back, retraded us, we said no. So we only ended up selling one at the end of the year which was Eugene. We think that the markets have begun to stabilize for those high-quality investment grade type assets. We caught a couple of them pretty attractively that are going to transpire early in January and February closes that we picked up. But there were a number of deals that we walked away from as well, just so you know.

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Alexander Goldfarb, Sandler O'Neill & Partners - Analyst [24]

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Okay. Listen, I appreciate it. Thank you.

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Operator [25]

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(Operator Instructions)

David Corak, FBR Capital Markets.

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David Corak, FBR Capital Markets - Analyst [26]

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Good morning, guys. Just a quick one for Phil. In terms of your leverage position today, how are you balancing potentially repurchasing shares given the stock price with maintaining your position with the ratings agencies? And then maybe just some color on the metrics and the math that you guys are focused on right now, if and when you are considering buybacks?

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [27]

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Look, from a share buyback perspective, that's clearly based on facts and circumstances at that point in time. We are no different than any other REIT from the standpoint that there's a number of REITs out there that have share repurchase programs in place, and as you know, the large majority of the REITs do not use those programs. Obviously, directionally I can't talk about the math in terms of when we would consider buying back shares, but we as a management team obviously look at our Company from an NAV perspective continually, and we have a very good grasp of when we would consider entering into the market, and now is not that point in time.

Your question as it relates to leverage, I think when we're talking about it with the agencies, one thing to keep in mind is that we speak with the rating agencies very frequently on a quarterly basis. We as a management team are going out there in the first quarter, which we always do, to show them our capital plan for the year. And in connection with that, the agencies are aware of the fact that we anticipate ending the year at or below 6.3 turns. Directionally, we are going to be obviously speaking with them in terms of, yes, leverage may moderately tick up throughout the year, but on the back half of the year we do see leverage coming down, again, to at or below 6.3 turns.

And when you look at leverage today, I think some of what people lose sight of -- and again, when we look at leverage we're looking at debt plus preferred to EBITDA, and I think people are coming around to that view on leverage. We compare very favorably with our peer set. We're all in the same zip code right now.

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David Corak, FBR Capital Markets - Analyst [28]

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Okay. Great. Thanks, guys.

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Operator [29]

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Haendel St. Juste, Mizuho.

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Haendel St. Juste, Mizuho Securities - Analyst [30]

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Good morning, guys. My question is, understanding your plan here to focus on selling some of your lower cap rate, lower growth assets, and acquiring higher yielding assets, which will certainly help your earnings in the short run, just curious how you're balancing that earnings benefit versus the risk of these high-yielding assets, the lower credit tenants generally involved, and also to the impact on your pro forma NAV as part of your investment calculus or capital allocation decision here?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [31]

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I will start. When you talk about higher yielding assets, when we're looking at higher yielding assets they're generally not investment grade, right? So if you buy an investment-grade unit, you don't get a master lease generally, you don't get unit coverage, you don't get really great sales visibility potentially on that particular property because the tenants don't need to do that.

If you're dealing with a noninvestment grade tenant, and it's under a national lease and a critical essential asset like restaurant portfolio or a gym portfolio, you're going to get things that structurally will help you quite a bit. And so, the question for us is, is it the right location, is it the right operator, is at the right rent per square foot, is it the right concept? And that's what we look at when we balance investment-grade versus noninvestment grade because, look, the noninvestment grade assets if they are bought properly with the right underwriting criteria, the structural benefits you get from visibility and national leases, very, very powerful as it relates to if something goes wrong.

Case in point, there were a lot of investment-grade big-box retailers that, quite honestly, have gone through a lot of change where if you're out ahead of that and they're not going to tell you, it's challenging.

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [32]

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I would just want to embellish on that. This is Tom speaking. This something we talk about internally all the time. I'm not here to suggest the laws of investing don't apply, in other words, higher yield and higher alpha does not mean higher beta. We're not suggesting that. But on an episodic basis, and on a one-off basis, we're looking at some of the assets that we are selling and one of the ones that we're buying and we are prepared to make that trade, and believe we're actually enhancing the portfolio characteristics and yet we're making a lower cap rate sale for a higher cap rate buy. Again, in general, that's not the laws of investing and I understand that, but for certain of the assets that we're selling, we believe that that is in fact the case.

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [33]

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One of the things to think about in that regard as well is that, as Jackson mentioned, the 1031 market is very vibrant right now. Case in point, if we just talk about Walgreens for example, we could have a Walgreens in our portfolio that's coming up on 10 years remaining left on the lease term. It's a flat lease and there's a very strong bid in the 1031 market for that. Obviously, if that's not a core asset for us from that perspective, rather a flat lease, we're not really comfortable with the renewal process for that tenancy yet. Somebody's going to pay us an attractive cap rate. That's a good trade for us well.

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Haendel St. Juste, Mizuho Securities - Analyst [34]

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Appreciate the comment. One more follow-up, if I may. As part of your underwriting these newer tenants, these higher yielding tenants we're just discussing, are you acquiring, are you getting unit level coverage? And maybe you could share with us perhaps some additional things you are requiring here and if you're able to get -- compare and contrast perhaps the rent bumps you're getting on these versus the older assets you are selling?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [35]

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I'll use Sonny's as a good example. And I put that in the category of not super high-yielding, but directionally things that we look at. This was a situation where really good real estate -- four of the locations were in Orlando, a couple -- two were in Gainesville, the other was in Florida as well. This particular franchise that was buying this property that we had bought from the COO of Sonny's was joining up with this particular existing franchisee. Five of the seven assets that we're buying are getting renovated. The new facelift that Sonny's is putting out there.

So we bought this deal that's basically 2 times coverage; old units. This was basically company-owned stores being sold to a new franchisee which was the former COO and existing 17-year franchisee. So they're going to put, call it, a couple million dollars face lifting five of the seven. That coverage just anecdotally on rebrands that the existing franchise had experienced was like 10% to 13% uplift post facelift.

To us, that has bumps, a master lease, it's got a renovation going on, it's got very, very high VPDs and population -- good population demographic growth around those units. And that will be north of a 7%-plus cap rate and get improving coverage as time goes on. Those are the kinds of deals that we will probably -- you'll see us do more of. And as this particular franchisee is rolling out more locations for Sonny's, we'll on a case-by-case, look at bringing more of those into the master lease.

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Haendel St. Juste, Mizuho Securities - Analyst [36]

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Thank you.

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Operator [37]

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Daniel Donlon, Ladenburg Thalmann.

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Daniel Donlan, Ladenburg Thalmann & Company Inc. - Analyst [38]

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Thank you and good morning. I just have three quick housekeeping questions and one structural question. It will take very quick to answer. The coverage for Shopko, you said about 2.5 times. Is that as of the third quarter or fourth quarter on a trailing 12 basis?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [39]

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That's of the third quarter because they are on a fiscal fourth, we haven't seen their fourth-quarter numbers, so that's third quarter.

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Daniel Donlan, Ladenburg Thalmann & Company Inc. - Analyst [40]

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Okay. Thanks. As far as guidance goes, what's embedded in terms of other income and interest from real estate transactions?

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [41]

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Dan, for that I would assume 1% of cash rent is typically a good proxy. Anywhere from $6 million to $7 million

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Daniel Donlan, Ladenburg Thalmann & Company Inc. - Analyst [42]

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Okay. And then Shopko, do you get a 6% bump starting in September, is that correct? Am I remembering that right?

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [43]

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No, Dan. When we restructured the lease with Shopko, as you may recall, we did that in order to facilitate the sales that were ongoing. We converted the 6% every three years to effectively 2% every year. So we went from every three years to every year. So for this year, we've got a 2% bump, I think it's 1.95%. And it was effective January 1.

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Daniel Donlan, Ladenburg Thalmann & Company Inc. - Analyst [44]

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Okay. Very helpful. Last one for me, just looking at your acquisitions in the fourth quarter relative to prior quarters, your cap rate came down from about 8.1% in the first quarter down to 7.35%. Your sale leaseback transactions and master leases as a percentage of rents also came down versus historical metrics that we could find. So just curious -- I think maybe you alluded to it a little bit in your prepared remarks, but is this a shift in strategy or was this fourth quarter an aberration and you would expect not only cap rates to move back up but percentage of sale leasebacks and master leases to move back up as well?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [45]

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I think the fourth quarter was an unusual quarter for us. We saw real direct visibility because we are a big seller of property, obviously. The market changed. We obviously had a decline in our cost of capital as well. We took the course that things that were not buttoned down before election, had a certain kind of price reaction from us. I would say also, I think, without getting specific in terms of the things that we bought, I think we bought actually better quality single-unit opportunities.

And I think you're going to see us have a balance of focusing on that as well as our core strength of enhancing the noninvestment grade portions of our portfolio. For instance, Home Depot, we just closed it last week, that transaction was buttoned up two days after the election. The one that we just closed on. We think we got a very attractive price relative to the way these things trade. We're going to be very moderate as to how we think about that, but they will become one of our top 10 tenants very shortly.

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Daniel Donlan, Ladenburg Thalmann & Company Inc. - Analyst [46]

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Okay. I appreciate the color.

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Operator [47]

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Michael Knott, Green Street Advisors.

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Michael Knott, Green Street Advisors - Analyst [48]

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Tom, thanks for the MUTA announcement. I appreciate that and I just wanted to ask if you cared to elaborate on your thought process on that decision any more beyond what you already said, just in terms of how you thought about reaching that conclusion?

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [49]

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No, I'm happy. I don't think there's too much to elaborate. I guess I would offer two thoughts. I think the first thought is, when we been asked about this before, I think one of my responses is we take governance exceptionally seriously. We think we have terrific board of directors, nine members, eight independent. We think we have excellent governance and it's something that we pride ourselves on.

What we said was this is something we look at annually. We look at all of our governance provisions annually. And while I realize there isn't unanimity on this particular topic as to the benefits or costs associated with this, I think our view in discussions internally, and this was, again, purely an internal process on our part. Our view was the prevailing wisdom is that this shift is more towards better and more transparent and more accountable governance. That was where we want to be held in the REIT industry, so that was the judgement our nominating and governance and board reached, and we were happy to do so.

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Michael Knott, Green Street Advisors - Analyst [50]

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Okay, thanks. And just curious how you're thinking about your cost of capital today, and how that is influencing how you think about your acquisition/disposition activity in 2017. I think commentary today has touched on this question a little bit here and there, but I just wanted to ask you in that particular manner. Thanks.

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [51]

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I would hope that when history judges us over the last couple of years, I think we've gotten good grades for how we've allocated capital, when we've accessed the market, how we've accessed the market, both on a debt and equity standpoint, how we've recycled capital. We obviously study our cost of capital. We also understand that that's a spot analysis. Your cost of capital today could be dramatically different two months from now.

We believe that we have an opportunity to dramatically improve our cost of capital with all of the enhancements that the Company has gone through over the last year. I touched on them in my remarks, balance sheets, the investment grade, the fact that, as Phil pointed out, we're right on top of our peers. We weren't in the same zip code with our peers over a year ago.

The portfolio changes, again, I would suggest people look at our top 20 tenancy today versus our top 20 tenancy two years ago, and it's a dramatic improvement in the relative quality of the portfolio. So this Company has a real opportunity to improve its cost of capital. I would point to the fact that we did our first Denovo bond offering. At that time we paid -- the entry fee came out a little bit wider because you're a Denovo operator. We've seen those spreads tighten as companies and as the folks who own that debt have gotten to know the Company better.

I realize equity multiples and debt spreads are different constituencies, but there's a lesson learned there in terms of the fact that as people get to see the changes and improvements that were made to the Company, that we think that it's a real opportunity for cost of capital improvement. And that's what we're going to be driving toward in 2017. In the meantime, we are going to be very prudent about how we use our capital and how we access the capital markets. And when we see opportunities to grow AFFO, we're going to do it. And again, I think that's what we've been doing successfully for the last three years.

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Michael Knott, Green Street Advisors - Analyst [52]

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Thanks. And just a quick follow-up to your comments there would be if you do achieve a better cost of capital going forward, particularly on the equity side, do you feel like that would cause you to be more aggressive on acquisitions or do feel like you're confident enough to go ahead and incorporate that type of thought process into your acquisition activity today?

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [53]

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I think you always need to be studying your cost of capital. It's one of the elements that goes into the thought process of both how aggressive you want to be, any element, whether it be acquisitions, dispositions. I don't think it pays to be dogmatic, I think it pays to be looking at it constantly and making the right decisions at the right time. With both your cost of capital and the opportunities that you have to acquire property and the enhancements that you have to make to the portfolio. Jackson talks about these Home Depot's. That's a nice upgrade in terms of our top 10 tenancy, and we're going to continue to do that and we can do that easily with our existing cost of capital. We can continue to improve this portfolio with our existing cost of capital.

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [54]

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Yes, just to reiterate, we sold a couple of the Haggens assets. And we think about selling Haggens, how do you want to redeploy? Do you want to buy a noninvestment grade casual diner on a master lease, or do you want to focus on a critical tenant that you believe has legs? We very strongly believe in Home Depot right now. So when we were thinking about that calculus we knew we had a certain number of Haggens properties that we're focused on selling. They are going to be very aggressive cap rates, and so we looked at that as an accretive idea of opportunity.

And I would just put out my little two cents on cost of capital. Almost 6 months into the opportunity, this Company has more opportunity, in my opinion, of relative -- and I would look at our peer set in terms of their differential in cost of capital. I hope that when we have a chance to really take people through our business plan in May, I'm very confident that we're going to be able to close the gap on the cost of capital, and you'll see us correspondingly increase our acquisition volume aggressively in tow.

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [55]

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One thing that I will just add on cost of capital is -- and again, if you just look at our debt cost of capital, and as Tom was mentioning, in our Denovo bond offering. Since we did that offering our spreads have come in about 50 basis points. The other thing to mention is that Tom, Jackson and I were on a non-deal road show, we met with 24 fixed income investors in April -- I'm sorry January. Just post those meetings, our spreads came in another 25 basis points. From that perspective when you're looking at our overall cost of capital, and alluding to what Jackson was talking about here, the opportunities that we have in terms of improving our cost of capital I think sometimes is not really taken into consideration by the Street. We have a tremendous opportunity here to continually improve our cost of capital, more so than our peers I think.

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [56]

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And look, I think with cost of capital, you earn it, right? So I think what we will share with you soon is a new leadership direction focus, and I will tell you intensity that has been brought to this organization and rigor, I hope it's very clear to you when you see us in May. And like I said, we've got to prove to people that we deserve it. I think we will prove it. So we're going to continue to march on.

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Michael Knott, Green Street Advisors - Analyst [57]

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Thank you.

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Operator [58]

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Vikram Malhotra, Morgan Stanley.

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Landon Park, Morgan Stanley - Analyst [59]

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Hi guys, this is Landon Park on for Vikram. Just wanted to touch base on the impairment that you guys took in the quarter. It was fairly large. Just wondering the details on that and if it relates in any way to the portfolio review that Jackson had undertaken.

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [60]

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Landon, it's Phil. I would say, part and parcel, it was part of the portfolio review that Jackson went through. I would say that the impairment that we recognized this quarter, we would not expect this to be a run rate trend. We did have a very deliberate focus on property cost leakage and getting underperforming assets out of our portfolio.

That was clearly what was driving the majority of these impairments that we recognized in Q4. But I think as you're looking forward to 2017, as Jackson alluded to, in terms of the disposals that we will be looking to do in 2017, some of them are going to be these underperforming assets that are contributors to this property cost leakage. We're very vigilant on reducing that leakage, and then also, some of the dispos that we're looking at this year are just accretive dispositions as well.

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [61]

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And I think people know the process for impairments, but when you take an asset from held for lease to held for sale, that almost always triggers an impairment. We did, as part of this portfolio review process, and Jackson has alluded to this already, we're trying to be more aggressive in terms of dealing with vacant properties because they contribute negative AFFO. We've got carry costs associated with them and they have been vacant for a long period of time.

So we have been more aggressive on this, and as a result of that aggressiveness, the irony is it creates an impairment, but it's an impairment on an AFFO negative asset. So from our perspective it's certainly not a negative on the business. It's really a reflection on us being more aggressive from a portfolio management standpoint.

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Landon Park, Morgan Stanley - Analyst [62]

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Okay, great. And then just a quick follow up on those comments. Is there anything, any single tenant or single asset that makes up a large chunk of the impairment? And then just going forward, maybe can you provide a bit of the size of the opportunity on the asset recycling portfolio repositioning side? Maybe a multi-year potential target for the portfolio.

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [63]

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On the impairment side of things, there is not one outlier that is driving the impairment that we recognized in the quarter. I guess, personally I didn't understand your second question.

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Landon Park, Morgan Stanley - Analyst [64]

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What is the planned disposition asset recycling program over the next several years? In terms of size.

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [65]

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I think, look, the way we're going to look at it -- and look, these assets, you can't [sort] up, as you guys know. I'll give you anecdotally, I just approved the sale yesterday of a Red Lobster, Oakridge Tennessee, at a 5.85% cap rate. It's part of a master lease. For our reason it made sense to sell that property, not just because it's a 5.85% cap rate, but given some of the dynamics around that property within the master lease.

There are there opportunities. We're in the process of doing a blend and extend right now with Walgreens. There are some stores that when we get that extension we will probably monetize. But it's not a wholesale decision that we do right now. So part of it is, I would say, improvement within the portfolio. Some of it's defensive, some of it's opportunistic, and there's lead time that's involved in all of these decisions.

So I think we do have a plan on these dispositions, but we're also mindful of not being a churn shop because it has impact on earnings. But all of these decisions on dispo, in some ways, the third-quarter dispositions and the fourth quarter dispositions, a lot of those decisions were made in the first, second quarter of last year. So we're really trying to -- with the new scheme and focus that we have, really -- you will see more of that disposition activity really come to life probably in the third, fourth quarter, to the extent we pursue some of this stuff.

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Landon Park, Morgan Stanley - Analyst [66]

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Okay. Thanks for that color.

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Operator [67]

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Ki Bin Kim, SunTrust.

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Ki Bin Kim, SunTrust Robinson Humphrey - Analyst [68]

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Thanks. Good morning everyone. Just a broader question for Jackson. What are some of things that you are trying to change or improve at Spirit, whether it deals with how you deal with tenants or how you look through buying and selling things? Just trying to get a larger sense of what might be forthcoming from Spirit Realty.

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [69]

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Look, my background, obviously, coming from the banking side, is very data-driven, customer driven. I've dealt all my career with dealing with customers and boards and giving advise. I would say that what I would like to see improved in this organization, much more customer engagement, number one. Much more analytical rigor as it relates to how we analyze things. And just much more intensity. I came from a pretty intense place. Much more intensity as it relates to buying, selling, just doing our job, basically.

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Ki Bin Kim, SunTrust Robinson Humphrey - Analyst [70]

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I didn't think Morgan Stanley was that intense of a place. (laughter)

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [71]

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As they say, always be closing. (laughter) Whether we're buying, selling or trying to create value.

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [72]

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Speaking as the CEO working with Jackson on this, I can say I think Jackson has brought a wonderful perspective of portfolio management and engagement. Not to suggest that the Company wasn't a portfolio management Company. You've heard me talk about it for years. But what you'll see I think at the main meeting is far better analytics, far better presentation capability, far better, both internal capability for us to see forward and to see around corners and to make decisions about the portfolio, I think in a more informed fashion and a more analytical fashion. Jackson has done, from my perspective, really a wonderful job working with the team here to put us in a position and I think we're going to showcase that in May, and I expect and hope that it will be well received by investors.

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Ki Bin Kim, SunTrust Robinson Humphrey - Analyst [73]

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Okay. And how are the duties or responsibilities split between you, Tom, and Jackson? And what happens in terms of if there's disagreements in terms of what you're buying or selling or how to do things? How do those things get navigated around?

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [74]

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I think one of the things that I've encouraged is a robust investment committee process. And again, the changes that I've made, Jackson is not the only addition to the executive management team here over the last 18 months. I think there has been substantial additions through the work that I've done in terms of attracting talent to the organization. We have a robust investment committee discussion and people's perspective, and our investment committee operates in a way that you would expect through attempting to reach a consensus. But I do have the discretion as the CEO, I do have a veto if that's what you would want to call it. I don't tend to look at it that way.

What I tend to look at as is it is my job to set the investment strategy and direction of this Company. That is my job. Working with Jackson very closely, and we spend a tremendous amount of time together, he and I look at that strategy and we talk about it, and then Jackson and his team are working with me to implement it.

That's really the relationship and I think this Company has benefited from the talent, the executive talent that we've drawn to this Company in the last 18 months is a big reason that we are in the position that we're in today. It's why we all sense the opportunity that we have here. Again, I think looking -- and I point people to the -- it's not as if we haven't been making progress along the way. I point to the balance sheet, I point to the portfolio. But now, with this talent in place, we are in a position to take it somewhere.

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Ki Bin Kim, SunTrust Robinson Humphrey - Analyst [75]

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Okay. Thank you.

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Operator [76]

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Joshua Dennerlein, Bank of America Merrill Lynch.

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Joshua Dennerlein, BofA Merrill Lynch - Analyst [77]

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Good morning, guys. I saw that you purchased three office assets in the fourth quarter. Talk about the rationale behind that and then what's your appetite for more? Do you have a limit on how much of the total portfolio could be office?

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Boyd Messmann, Spirit Realty Capital, Inc. - EVP and Chief Acquisitions Officer [78]

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Yes, this is Boyd. Historically, Spirit has always had medical office, industrial, along with retail and other concepts. We look at the opportunities as they come available and make decisions what's best for the portfolio. I think we will always continue to look at medical ops opportunities, we will certainly look at industrial, retail and segments that are accretive to the portfolio, both from an AFFO standpoint and from a diversification standpoint.

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Joshua Dennerlein, BofA Merrill Lynch - Analyst [79]

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So those office buildings were medical and emergency centers that were in the fourth quarter? Not traditional offices?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [80]

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Yes, and just to be clear, although we've said this before, I know in the triple net sector some folks do categorize suburban office that happens to be leased long-term to a -- long-term 15-year lease, they consider that triple net investing. That is not a priority for this investment strategy. It never has been. I view that as suburban office that happens to have a longer lease. So when you hear office from us, it generally refers to some sort of specialty. In this case it's medical office.

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Joshua Dennerlein, BofA Merrill Lynch - Analyst [81]

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Okay. Thanks for clarifying that. On the C-stores, just a question, where are the in-place rents versus the current market rents for that portfolio? Is the in-place rent a bit too high compared to the market? Does that have something to do with the difficulties of the operator?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [82]

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No, it's not really a rent issue. Like I said, I don't want to get -- we've sort of said as much as I think we can say as it relates to that portfolio. What I will tell you is given those locations, urban end-fill, high density, high population areas, rents for C-stores are very high for those relative to rural. I don't think it's a question of the rent necessarily, but operations. That's really what -- that's the issue.

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Joshua Dennerlein, BofA Merrill Lynch - Analyst [83]

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Okay. Thanks for that. I'm good.

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Operator [84]

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Rob Stevenson, Janney.

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Rob Stevenson, Janney Capital Markets - Analyst [85]

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Good morning, guys. Can you talk a little bit about, given your comments earlier, understanding that it's under a master lease, but what is the level of the 116 Shopko assets that are meaningful below the 2.5 times average coverage ratio?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [86]

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First of all, we have a master lease so as you kind of think about a master lease, we have rents allocated, but it's one big rent.

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [87]

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We have made this comment before relative to this question and we can't give out individual store performance given the requirements of confidentiality in the lease. What we have said, and it remains consistent today, is that the Shopko performance within these boxes, given their locations, midwest locations, they tend to be on a relatively tight bell curve. There aren't a lot of weak performers and there aren't a lot of rock star performers. There tends to be a pretty steady state portfolio around a relatively tight bell curve around the general average for the --

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [88]

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The biggest thing we have going for us, too, is rents are low. The rents are really low. We're going to talk when we get to Investor Day more about Shopko. There are some opportunities there, let's just leave it at that. We are very comfortable -- we've talked to Shopko a lot, just so you know. And they are doing very well and the locations that we are continuing to maintain are very, very good real estate locations. Good access, a lot of retailers near by, they're profitable. So I think to Tom's point, the coverage range is very moderate. It's very, very close to the medium.

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Rob Stevenson, Janney Capital Markets - Analyst [89]

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Okay. And then, the 46 vacant assets as of December 31, what is the thought process in terms of today, in terms of percentage, in terms of release versus wind up selling? And, Phil, what's the implied drag on earnings from taxes, utilities, maintenance, et cetera for having to have vacancy on those units right now.

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Phil Joseph, Spirit Realty Capital, Inc. - CFO [90]

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Let me just take the leakage aspect of things. What I've always told people is that -- and I tend to just triangulate to cash rents. Kind of what we show on our NAV page. When I look at property cost leakage, I always say it can approximate anywhere from 1.5% to 2% of cash rents. As I said earlier, part of the exercise that Jackson went through in terms of going through the portfolio is that we're definitely going to be more vigilant in terms of reducing that property cost leakage numbers. I do see us -- that's the range I will give you in terms of property cost leakage. Rest assured that our goal is to get to the lower end of that, but it could be as high as the 2% number.

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Rob Stevenson, Janney Capital Markets - Analyst [91]

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Okay. Today, what's the thought in terms of that 46 or whatever it is today, how much are likely to be released versus more likely to be sold?

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Jackson Hsieh, Spirit Realty Capital, Inc. - President and COO [92]

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It's hard to say, to give you a really good percentage. Generally, what we are looking at mitigating a vacancy at that point. Look, if we could have worked with the existing tenant, there's a lot of different ways we could do that and not make it go vacant, but once they have made the decision to go vacant, we look at releasing as an option potentially, we look at sales and -- it just really depends on the net present value between those two opportunities. So it's hard to give a real straight percentage.

What I would tell you is there generally wasn't a KPI as it relates to vacancy greater than 12 months. I'll just leave it at that. And there is now. I think there's a trade-off when a vacancy goes beyond 12 months, I think that has -- you've got to balance short-term, a quick fix, versus having something hang on the hoop for 24 months and try to hold out for maximum value. So there is a trade-off there. It's hard to give a percentage. We do have vacancy. We don't just go to punt it right away. And we try to give -- I would just say there's a lot more attention right now being put on trying to get the best alternative from the net present value for us, whether it be a sale or release.

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Rob Stevenson, Janney Capital Markets - Analyst [93]

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Okay. Thanks, guys.

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Operator [94]

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There are no additional questions at this time. This concludes our question and answer session. I would like to turn the conference back over to Tom Nolan for closing remarks.

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Tom Nolan, Spirit Realty Capital, Inc. - Chairman and CEO [95]

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Thank you. Thank you all for your time this morning, and as always, for your interest in Spirit Realty. We are pleased with our progress over the past year and we're very excited by the opportunities we see ahead for us in 2017. We look forward to speaking with you all again soon. Thank you.

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Operator [96]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.