Q1 2023 Four Corners Property Trust Inc Earnings Call
Participants
Gerald R. Morgan; CFO; Four Corners Property Trust, Inc.
Patrick L. Wernig; MD of Acquisitions; Four Corners Property Trust, Inc.
William Howard Lenehan; President, CEO & Director; Four Corners Property Trust, Inc.
John James Massocca; VP of Equity Research; Ladenburg Thalmann & Co. Inc., Research Division
Unidentified Analyst
Wesley Keith Golladay; Senior Research Analyst; Robert W. Baird & Co. Incorporated, Research Division
Presentation
Operator
Ladies and gentlemen, welcome to the FCPT First Quarter 2023 Financial Results Conference Call. My name is Glenn. I'll be the moderator for today's call.
(Operator Instructions) I will now hand you over to your host, Gerald Morgan, CFO of FCPT. Gerald, please go ahead.
Gerald R. Morgan
Thank you, Glenn. During the course of this call, we will make forward-looking statements, which are based on beliefs and assumptions made by us. Our actual results will be affected by known and unknown factors that are beyond our control or ability to predict. Our assumptions are not a guarantee of future performance and some will prove to be incorrect. For a more detailed description of some potential risks, please refer to our SEC filings, which can be found at fcpt.com.
All the information presented on this call is current as of today, May 2, 2023. In addition, reconciliation to non-GAAP financial measures presented on this call, such as FFO and AFFO, can be found in the company's supplemental report also available on our website.
With that, I'll turn the call over to Bill.
William Howard Lenehan
Good morning. Thank you for joining us to discuss our first quarter results. I'm going to make introductory remarks. Patrick will make further comments on acquisitions and the pipeline, and then Gerry will discuss the financial and capital raising results.
The existing portfolio continued to perform exceptionally well with 99.9% collections for the quarter and occupancy also at 99.9%. This is going to be an interesting year overall for the commercial real estate sector with transaction volume predicted to be down 50% or more, some REIT sectors unable to raise capital accretively and specific sectors like office, definitely out of favor. We contrast that with what FCPT, we believe, will be a year of business as usual. By that, I mean that we expect our portfolio to continue to perform well and benefit from the high tenant coverage our low rent levels allow. First quarter acquisition volumes were lower, which was in line with the overall market slowdown in our typical deal timing. However, we are currently working on very interesting investment opportunities in our pipeline, many of which are deals that may not have come our way in the past. We believe that 2023 will be a very healthy growth year.
Of course, capital costs have gone up, too, and we remain vigilant on comparing our investment yields against the cost of capital used to fund those acquisitions. In the quarter, we raised $52 million of equity at an average price of $27.73, and we began the second quarter with pricing locked on over $185 million of combined equity forwards and treasury locks to fund acquisitions at accretive rates.
We reported first-quarter AFFO of $0.41 per share. EBITDA grew 9% on a year-over-year basis. AFFO was flat prior quarter and year-over-year. This is due to the effects of higher interest rates on both our cost of debt and cost of equity.
Cash rental revenues grew 12.2% on a year-over-year basis, including the benefit of rental increases and $263 million of acquisitions in the last 12 months. This included the acquisition of 10 properties in the first quarter for $20 million at an initial cash yield of 6.9%, reflecting rents in place as of March 31.
Patrick will discuss the current investment environment in more detail. But just speaking at a high level, the first quarter continued to see attractive acquisition pricing with cap rates above historical levels, especially after the Silicon Valley Bank and Signature Bank collapses. The Q1 acquisitions average cap rate reflected that dynamic, improving 30 to 60 basis points versus the 6.6% and 6.3% in Q4 and Q3 of last year.
Of course, the news of the First Republic Bank is still being processed by the market. We anticipate investment opportunities for FCPT will emerge from the continued tightening of lending standards.
Moving on to our tenants' performance. Restaurant operators continue to have strong sales results in the first quarter with Baird estimating restaurants are operating at approximately 105% of 2022 weekly sales levels according to their survey on April 24. Restaurant operators are seeing moderation of cost increases in food and labor, but are still expecting some levels of margin pressure.
We continue to view the industry sales trend as a helpful data point, but we are also -- we also want to call out the very strong recent performance of our 2 largest tenants, Darden and Brinker. Darden, the parent company of Olive Garden and LongHorn, saw this brand same-store sales rise 12% and 11% for the most recent quarter. Olive Garden's margins rose 390 basis points from the prior quarter to 22.5%. LongHorn also showed significant improvement, rising 310 basis points from the prior quarter to 17.4%. Brinker, the parent company of Chili's saw brand same-store sales rise by 8% and restaurant margins improved by 450 basis points to 10.3%. All 3 of our anchor brands are benefiting from moderating labor and commodity costs while continuing to leverage rising sales volumes.
Our estimated EBITDA rent coverage was 4.6% for the 72% of our portfolio that reported the statistic, driven mainly by large improvements in margins in Darden's last quarter. This remains among the strongest coverage within the net lease industry and provides a cushion versus inflationary impacts on input prices and moderating consumer demand.
One item that we've been tracking is how much Darden brand sales have risen since the FCPT spin-off in 2015 versus how much rents have risen. Olive Garden and LongHorn same-store sales have risen 23% and 45%, respectively, over the past 7 years, while rent has only risen 11%.
With that, I'll turn it over to Patrick.
Patrick L. Wernig
Thanks, Bill. I'd like to pick up on the comments you made around the shift in cap rates. After years of being in a seller's market, we're seeing significantly more opportunities for well-capitalized investors to acquire high-quality real estate net leased to strong operators. The cap rate improvement is a direct result of less competition and tighter lending standards. Specifically, we attribute the current buyers market to 4 factors, which are somewhat circularly impacted by one another.
First, less institutional competition with fewer private equity sponsors pursuing retail net lease. Second, tighter bank lending standards have raised borrowing rates and lower loan leverage as a percentage of property value. As Bill mentioned, this shift has been particularly acute, following recent turmoil in the banking sector. Third, reduced 1031 exchange transactions. For example, in recent years, the tight valuations of multifamily apartment buildings have driven property sales and subsequent 1031 exchanges into retail net lease. The valuation is down, there's less motivation for owners to exchange into net lease today. And finally, net lease and sale leaseback transactions are more attractive on a relative basis for operators evaluating the financing options than in recent years, even as cap rates rise.
Shifting to the pipeline. We expect more new or newly constructed properties in our Q2 acquisitions and for the rest of the year. We've largely been outpriced for developer projects in prior years. But in 2023, we have been more successful in engaging with developers. They have been more eager to sell their completed inventory or to arrange forward commitment to purchase properties that are yet to be completed. Those same developers were selling properties 100 basis points inside of our pricing a year ago.
Regarding the property mix, our Q1 acquisitions were more heavily anchored to medical retail than typical. 71% of our property is leased to medical tenants, 24% to auto service and 5% to casual dining. Looking at the forward pipeline, we'd expect the mix to even out over the course of the year, the medical retail may comprise a higher percentage of full year volume than in prior years. We've been very focused on building out our pipeline and capabilities in that sector and expect it to be a core part of our portfolio in the future.
As we stated in the past, Q1 is typically our lowest deal volume quarter for the year. For example, in 2021 and 2022, Q1 is 15% of acquisition volume for the year. This year, we saw a slow start to sourcing in January and February, which we attribute to market volatility. That said, after February, our closings have picked up speed. We closed over $25 million of volume in the month of April, outpacing all of Q1.
Looking at our pipeline, we expect to have a robust Q2 and Q3. We expect to continue recycling capital opportunistically into new acquisitions, particularly where we can also improve portfolio quality. In the quarter, we sold 3 properties for a sales price of $12.1 million, representing a combined gain of $1.6 million. These were 2 Red Lobsters and 1 Burger King and the sales were previously disclosed. These stores were specifically selected as disposition candidates based on relative underperformance versus their respective brands.
Now turning to Gerry for a discussion of our portfolio and financial results.
Gerald R. Morgan
We generated $51.4 million in cash rental income for the first quarter after excluding $0.8 million of straight line and other noncash rental adjustments. We collected 99.9% of base rent for the quarter. There were no material changes to our collectibility or credit reserves nor any balance sheet impairments in the quarter.
On a run rate basis, our current annual cash base rent for leases in place as of March 31 is $195.7 million, and our weighted average 5-year annual cash rent escalator remained at 1.4%. Cash G&A expense for the quarter was $4.3 million, representing 8.3% of cash rental income for the quarter. We continue to expect cash G&A will be approximately $16 million for the year, although we trended slightly higher in the quarter due to higher payroll taxes given the timing of prior year stock grants that vested in January.
Turning to the balance sheet. As Bill highlighted, we are well capitalized to fund growth. On March 31, we held $31 million of cash and 4.1 million shares under forward sales agreements with anticipated net proceeds of $111 million upon settlement. Including our undrawn revolver of $250 million, we start the quarter with $392 million of available liquidity.
Our results this quarter were impacted by higher short-term borrowing rates. 92% of our $1 billion of debt is fixed, currently at a rate of 3.44%. However, the interest rate on the remaining 8% of our debt is variable and pricing increased on average by approximately 90 basis points versus the fourth quarter. A reminder to investors that we think a 90% fixed, 10% variable rate debt mix is appropriate for our business, benefits us in some quarters, impacts us and others. Our current all-in cash interest rate at quarter end is 3.64%.
With respect to overall leverage, our net debt to adjusted EBITDA in the quarter was 5.6x. Our fixed charge coverage ratio is a healthy 4.6x. Pro forma for settling and deploying the remaining equity, we estimate our leverage is approximately 5.3x, well below our target of 6x leverage. As of March, we also have $75 million of forward starting swaps in place, effectively fixing the 10-year treasury base rate at 2.6% for our next long-term private note issuance later this year.
And with that, I'll turn it back over to Glenn to open up for investor Q&A.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from Wes Golladay from Baird.
Wesley Keith Golladay
Maybe I'll just start with Gerry, since he just finished up. How should we think about settling the forwards or issuing the debt, any priority there?
Gerald R. Morgan
Yes. The forwards are already issued. So I think they get priority. But as mentioned, we'll also look to access the debt markets at some point this year and obviously, use the revolver as needed to smooth out between. The great news is in the current capital markets, we have options, both with the equity forwards and with delayed funding on private notes to time the issuance of our capital to meet acquisitions.
Wesley Keith Golladay
Okay. And then Bill, you made the comment about seeing more types of deals this part of -- due to the bank turmoil. Was this specific to the developments you highlighted in the prepared remarks? Or are you talking about more sale leasebacks or other types of deals as well?
William Howard Lenehan
I think it's across the board, Wes. We've seen opportunities from regional banks that owned net lease properties, restaurant properties, their balance sheets are shrinking and they're looking for liquidity. We've seen developers who historically would have been selling properties one by one at very high prices to the 1031 exchange market, look to us to buy forward their pipeline really across the board. And if you look at the relative attractiveness of net lease versus high yield versus JV equity versus preferred versus bank debt, I think net lease now is the most attractive. It's been on a relative basis versus other kinds of capital since our inception.
Wesley Keith Golladay
Yes. So am I to read that correctly, you may have a little bit more chunky portfolios, maybe small portfolios? And would you get a discount on that?
William Howard Lenehan
Yes, I think that's a fair read. Pricing is one part of it, and there are circumstances where we feel like we're getting better pricing. Other factors might be getting longer lease terms, not having such high premium investment-grade properties. But certainly, pricing is one of the many factors.
Operator
We have our next question comes from [Jim Cambridge from Apical].
Unidentified Analyst
Building off the developer commentary, are you sort of looking towards building more of a relationship type or programmatic acquisition pipeline with these folks? Or still too early for that?
William Howard Lenehan
It really is evolving in real time if you look at even yesterday and today, what's happening in the capital markets. But I would say our ICSC schedule, if this is a proxy, is far more weighted towards developers than it has any other year. And we've made a real concerted effort to explore that avenue for acquisitions. And it's just historically, there was such a strong bid from folks who sold their apartment building for a 4 cap and wanted to turn around and buy properties that didn't have any landlord responsibilities. And because their proceeds were so tax advantaged and that they sold their down leg property for such a high value, they were willing to pay up for net lease, especially the kind of high-quality net lease that we buy. And with the sales of apartments down so substantially and banks are not very willing, local banks, not very willing to extend credit, I think we are in a really good situation.
Unidentified Analyst
Terrific. Again, I appreciate your 4-point commentary regarding sort of the less competitive environment. Do you have any sense -- I think it's hard to do, but on the less institutional capital, in your mind -- you've been in the business for years -- were they really just sort of tourists in this industry? Or they're just maybe not as competitive on the cost of capital today. And unfortunately, they'll come back in volume in future periods? I'm just curious what your thoughts are on their tenacity and staying power, institutional funds and like PE?
William Howard Lenehan
Yes. Let me just maybe take the question more broadly. You had, on one hand, a buyer, 1031 exchange buyer who wasn't super sophisticated, was buying locally. But it's unusual that as a $3 billion company, we were competing against, in many cases, literally individuals. And they were less focused on pricing, used more leverage than we were willing to use. And then on the other hand, you had an influx of private equity funds and private equity funds on behalf of insurance captives, now they were less interested in buying the $2 million buildings, $3 million buildings that we are often buying, but they provided liquidity in other places. They have largely exited the market. So it's both the individual and the private equity funds.
I think the private equity funds really had few other alternatives when high yield was 4% or 5%, bank loans were only a couple of percent and net lease seemed at a moment in time to be more attractive. So we think that there's less competition across the board.
I'd also make a quick comment that it's unusual that in times of dislocation like we're in now, it's very typical for real estate opportunity funds, Blackstone, KKR, TPG, Carlyle, that sort of thing, to be very active. And those funds right now, while they are flush with liquidity and investable cash have been less active than in other environments and the kinds of buildings that they very often would buy office, in particular, are particularly out of favor.
Operator
We have our next question comes from John Massocca from Ladenburg Thalmann.
John James Massocca
So maybe as you look at the pipeline, particularly kind of near term for the rest of 2Q and 3Q, what are you seeing in terms of cap rate trends? The cap rate expansion we've seen over the last couple of quarters starting to moderate? Or is it kind of continuing at pace?
William Howard Lenehan
I think we were a little early or certainly earlier than some of our peers in talking about a 50 to 75 basis point cap rate increase. I think that's probably because we look at a lot of individual properties, and we're not waiting for portfolios. That pricing has been wide. We can be quite active at a 7 cap or above today. But I also would remind people that pricing is only just one of the variables. And to the extent that we find long-term investment grade, high credit quality portfolios, we certainly are willing to pay more for that. But we'll see -- I think that the turmoil over the last couple of days in the lending market and the focus on real estate, on regional banks' balance sheets bodes well for us competitively.
John James Massocca
Okay. And then given it made up such a big portion of 1Q acquisition activity, how are you thinking about the underwriting for the specialty medical properties, urgent care properties? And how does that underwriting maybe differ versus some of your traditional restaurant property investments?
William Howard Lenehan
Sure. I think the thing that's important to remember with specialty medical is it's just how significant the investment is in the space, whether that's specialty HVAC units, whether that's sinks and other water uses in each room. So it's a similar underwriting things like location leverage, lease term, rent growth all matter, but it's also making sure that you're thoughtful about what your basis is and making sure that you're aligning with creditworthy tenants. But it's -- the medical space is a broad one. We have done quite a bit of research on it in the last couple of years. But I think it's probably something like an 85% overlap to the other kinds of net lease that we buy.
John James Massocca
Is there any difference in how you have to view the credit versus in the restaurant space, either because of fungibility or the types of credits that tend to be backing these operations?
William Howard Lenehan
Not really. I mean there's very similar dynamics, private equity involvement, people executing roll-up strategies, benefits of scale, some very similar dynamics at the high level. But obviously, every credit underwriting we do has a component that's top down, how is the industry, what are the demographics; and then bottoms up, which is what's the balance sheet of the guarantor and the lease, what are their sources of funds, how are they performing. So there's both components. But I would say, overall, relatively similar and a subsector that's long-term trends are pretty positive with the aging of America. And to the extent that we're going to bend the cost curve in health care, I feel pretty strongly is going to happen outside the hospital.
Operator
(Operator Instructions) We have a follow-up question from Wes Golladay from Baird.
Wesley Keith Golladay
You guys have been more active with Cooper's Hawk, which I see as being a little bit weaker credit than you normally go after. So how are you getting comfortable with these deals?
William Howard Lenehan
Yes. Cooper's Hawk is probably a little bit below median for what we would look at, and the build-out cost can be pretty high. So we've looked at a lot of them. And I think -- well, we've done one. We've done one. It's an interesting brand. It has ancillary revenue from its wine club, quite popular in Midwest markets. We looked at a bunch of them, and we got comfortable with the one that we've done. But we have largely stayed away from the brands that have a very significant build out, but we're looking -- we're turning over a lot of rocks, right? So I would say that, that's an example of one where we got comfortable that the submarket that it's in was quite strong, brand-new build and actually despite a pretty elevated basis for what we typically buy, much below the average Cooper's Hawk.
Operator
(Operator Instructions) We have no further questions on the line.
William Howard Lenehan
Okay. Great. Well, thank you, everyone, for joining the call. Again, a much more interesting environment to be a buyer of real estate. We have ample capital to execute our business plan. Our team is as strong as ever, and we're really looking forward to the next few quarters.
With that, we'll adjourn the call. But anyone who would like to meet at NAREIT, please reach out to Drake and look forward to seeing you in New York. Thanks.
Operator
Thank you. Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.
