Q2 2023 Essential Properties Realty Trust Inc Earnings Call
Participants
Mark E. Patten; Executive VP, CFO, Treasurer & Secretary; Essential Properties Realty Trust, Inc.
Peter M. Mavoides; President, CEO & Director; Essential Properties Realty Trust, Inc.
Joshua Dennerlein; VP; BofA Securities, Research Division
Ki Bin Kim; MD; Truist Securities, Inc., Research Division
Nicholas Gregory Joseph; Director & Senior Analyst; Citigroup Inc., Research Division
Ravi Vijay Vaidya; VP; Mizuho Securities USA LLC, Research Division
Spenser Bowes Allaway; Senior Analyst of Net Lease, Gaming and Self-Storage; Green Street Advisors, LLC, Research Division
Unidentified Analyst
Presentation
Operator
Good morning, ladies and gentlemen, and welcome to Essential Properties Realty Trust Second Quarter 2023 Earnings Conference Call.
(Operator Instructions) This conferences call is being recorded. (Operator Instructions) Additionally, there will be an audio webcast available on Essential Properties Realty Trust's website at www.essentialproperties.com. An archive of which will be available for 90 days.
On the call this morning are Pete Mavoides, EPRT's President and Chief Executive Officer; and Mark Patten, EPRT's Executive Vice President and Chief Financial Officer.
It's now my pleasure to turn the call over to Mark Patton.
Mark E. Patten
Thank you, operator. Good morning, everyone. And thank you for joining us today for the second quarter 2023 earnings conference call of Essential Properties Realty Trust.
During this call, we will make certain statements that may be considered forward-looking statements under federal securities law. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to those forward-looking statements to reflect changes after the statements were made.
Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings press release.
With that, I'll turn the call over to Pete.
Peter M. Mavoides
Thanks, Mark. And thank you to everyone who is joining us today for your interest in EPRT. As our second quarter earnings release indicates, we are pleased to report another quarter of strong results, driven by the strength and stability of our portfolio that continues to perform exceptionally well and impacted favorably by our strong investment activity.
Our tenants continue to perform at a high level as reflected by our unit level rent coverage that increased to 4.1x. Our same-store rent growth, which remained favorable at 1.5% and just 2 vacant properties. The overall health of our portfolio is a testament to our disciplined underwriting process, the quality of our operators and the resiliency of our service oriented and experience based businesses.
In the second quarter, we acquired 78 properties in 29 separate transactions, that were 99% sale leaseback transactions with 66% of those opportunities generated from existing relationships. The initial cap on our second quarter investments was 7.4%, and the average annual escalation in those leases was 1.9% on 19.3 years of weighted average lease term, which results in an average yield over the primary lease term of 8.7%.
Our balance sheet remains conservatively positioned and our liquidity remains strong, with quarter-end leverage of 4.3x and pro forma leverage of 4.2x when taking into account our unsettled forward equity, and liquidity of approximately $634 million. As we've said, we're committed to maintaining a conservative balance sheet.
Based on our second quarter results, the visibility of our third quarter investment pipeline, and our anticipated capital markets activity, we have increased our guidance for 2023 AFFO per share to a range of $1.62 to $1.65.
Turning to the portfolio, we ended the quarter with 1,742 properties in our portfolio that were 99.9% leased to 360 tenants operating in 16 industries. Our weighted average lease term stood at 14 years with only 5.2% of our ABR expiring through 2027.
From a tenant health perspective, our unit level rent coverage ratio at quarter end was 4.1x and the percentage of our ABR that had less than 1x rent coverage level remained relatively consistent (technical difficulty) 2023, totaling just 3.1% at quarter end.
Regarding our second quarter investments, we invested $277 million in 29 separate transactions, and properties representing 12 of our 16 targeted industries. With approximately 77% of those investments in properties operated in the carwash, equipment rental, casual dining restaurants, grocery, entertainment, and medical industries.
The weighted average lease term of our investments this quarter was 19.3 years. As I mentioned earlier, the weighted average annual rent escalation remains strong at 1.9%. The weighted average unit level rent coverage of tenants at these properties was 3.9x, and our average investment per property was $3.4 million.
In the quarter, 99% of our investments were originated through direct sale leaseback transactions, completed on our lease form with ongoing financial reporting requirements. In addition, 57% of our investments were in a master lease structure.
Looking ahead to the third quarter, we remain active and our pipeline should support investment levels relatively consistent with our recent activity.
From an industry perspective, at quarter end, carwashes was our largest industry at 15.6% of ABR, followed by early childhood education at 12%, quick service restaurants at 10.8%, medical dental office at 10.6%.
From a diversity perspective, our largest tenant, EquipmentShare, represented 3.6% of ABR at quarter end, and our top 10 tenants continue to demonstrate the diversity in our portfolio, accounting for 17.5% of ABR.
As we've consistently stated, tenant diversity is an important risk mitigation tool for us and a product of our differentiated investment strategy. A direct benefit of our focus on noncredit rated tenants and middle market operators, which offers an expansive opportunity sets, and in our view generate superior risk adjusted returns.
In terms of dispositions, we sold 16 properties this quarter for $41.7 million in net proceeds at a weighted average cash yield of 6.2%. The weighted average unit level rent coverage ratio for the properties we sold was 2.2x.
Owning fungible and liquid properties and capitalizing on that liquidity is an important aspect of our investment discipline. And it allows us to proactively manage our industries, tenants and unit level risks within our portfolio.
For the remainder of 2023, we expect our level of quarterly investments to align with our 8 quarter average, as we selectively take advantage of favorable market pricing to accretively recycle capital away from identifiable risks, reduce our industry concentrations, and importantly support our tenant relationships.
With that, I'd like to turn the call over to Mark, who will take you through our operating results and the balance sheet for the second quarter and discuss our capital markets activity. Mark?
Mark E. Patten
Thanks Pete. Echoing Pete's remarks, the second quarter of 2023 was certainly a strong quarter for us, evidenced by our reported results last night and represented by our increase in the top and bottom end of our guidance range for AFFO per share for the full year of 2023.
Performance of our portfolio and our investment results for the quarter continue to reflect the high quality of our tenancy, consistent internal rent growth, and benefits of our differentiated investment platform. As I'll cover in a moment, our consistently conservative balance sheet and strong liquidity position, continue to support our aspirations for external growth in 2023.
Among the headlines last night was our AFFO per share for the second quarter, which on a fully diluted per share basis was $0.41, that's an increase of 8% versus Q2 of 2022. On a nominal basis, our AFFO totaled $61.9 million for the second quarter of 2023, that's up $11.3 million over the same period in 2022, an increase of 22%, and up over 6% compared to the preceding first quarter of 2023.
We also reported core AFFO per share on a fully diluted per share basis of $0.44 for the second quarter, an increase of 7% versus Q2, 2022.
Total G&A was approximately $7.6 million in Q2 2023, while recurring cash G&A, excluding approximately $360,000 of costs associated with the departure of one of our junior executives totaled $5.3 million in Q2 2023. We adjusted our core AFFO by approximately $172,000, which reflects the impact of this non-recurring expense, net of the impact of stock compensation forfeitures.
Importantly, our recurring cash basis G&A as a percentage of total revenue, decreased to 6.1% in Q2 2023. We continue to have the expectation that our recurring cash G&A as a percentage of total revenue will continue to rationalize quarterly and on a full year basis.
Turning to our balance sheet, I'll highlight the following. With our $236 million of net investments in 2Q, 2023, our income producing gross assets reached nearly $4.5 billion at quarter end. From a capital markets perspective, we had a solid quarter from an equity perspective.
In mid-May, we settled the second half of our forward equity that we issued through an overnight offering in February of this year that generated approximately $104.5 million in net proceeds. We also generated approximately $66 million of gross proceeds in the latter part of the second quarter from our ATM program, that was all on a forward basis. We settled approximately $45 million of those ATM sales prior to the close of the quarter.
Turning the leverage, I'd like to personally announce that we have received commitments from our bank group for an unsecured $450 million term loan with a tenure including extension options of 5.5 years.
A new term loan will have a 6 month delayed draw feature and at closing $200 million will be utilized to retire our $200 million term loan that's due to mature in April of 2024. Although the 2024 term loan will be paid off, we will retain the favorable swaps we have on that term loan through April of next year.
As part of executing the new term loan, we are estimating that the impact of potential swaps on each of the draws and the April 2024 swap extension will be at a fixed rate ranging between 4.5% to 5%.
We intend to close the new term loan in the third quarter of this year. Although, let me note that closing of the new term loan is subject to customary closing conditions. We're very appreciative of the continued support of our bank group and very pleased to have the opportunity to address the near term debt maturity and further bolster our balance sheet with attractively priced debt capital, which not only provides us with dry powder to address our near term investment opportunities, but also favorably impacts the interest costs, we estimated for the remainder of 2023.
Regarding our debt maturities, utilizing all the extension options, and the new term loan was a result in a maturity date in 2029, which would result in us having no debt maturities until 2026.
Specifically, regarding the second quarter 2023 results, our net debt to annualized adjusted EBITDAre was 4.3x at quarter end, when factoring in the proceeds that we'll generate by physically settling the remaining $20 million of the equity we issued on a forward basis in the second quarter that we have not yet settled. Our leverage at quarter end would equal 4.2x.
Our total liquidity at the end of Q2, 2023, totaled approximately $634 million. Our conservative leverage, strong balance sheet and significantly liquidity position continues to be supportive of our current investment pipeline and sufficient to fund our external growth plans for the remainder of 2023.
Lastly as our release indicated, and Pete mentioned, we raised our AFFO per share guidance range for the full year of 2023 to $1.62 to $1.65 per share, which reflects not only our 2Q investment performance, our visibility into our investment pipeline, and our performance expectations for the core portfolio.
But importantly, the strength of our middle market tendency which experienced no material credit losses in the first half of the year. The midpoint of our increased guidance range implies a year-over-year growth rate of nearly 7%.
With that, I'll turn the call back over to Pete.
Peter M. Mavoides
Thanks Mark. In our view, the current landscape for investing remains very positive as operators seeking to grow their businesses face the challenges of a constrained capital markets environment, which leads them to seek long-term capital by executing sale-leaseback transactions on the real estate.
Additionally, the challenging market environment, particularly the availability and pricing of debt capital has curtailed the number of market participants that can fill demand of these operators. We're excited about the opportunities we see to invest in the second half of the year.
Operator, please open the call for questions.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from the line of Spenser Allaway with Green Street Advisors.
Spenser Bowes Allaway
I was just wondering, if you guys could provide some commentary just on any cap rate trends you might have observed across the different industries in the second quarter?
Peter M. Mavoides
Yes. I would say, in general, cap rates were pretty static across the second quarter. Obviously, our -- the cap rate on our investments was down 20 basis points, which is really a mix of a result of the industry mix. We did a number of restaurants and grocery deals that tend to trade at the tighter end of the cap rate range that we invest that brought that down. But generally, the market is pretty stable, and I would expect cap rates to kind of be in that mid-7% range in the back half of the year.
Spenser Bowes Allaway
Okay. And I mean, you kind of just alluded to what you're kind of expecting for the back half of the year, but can you just provide any color on what you've observed as from 3Q in terms of cap rates? Is it kind of static as you saw through the second quarter or any color there?
Peter M. Mavoides
Yes. It's static to slightly up. Our 3Q pipeline is a little -- currently, a little higher than what we posted in the 2Q -- second quarter, but obviously, that can change depending upon what actually closes and future deals that come in. But, overall, it's a pretty healthy investing market, and it's pretty stable. We haven't seen pricing pressures creep in and driving cap rates down. So it's just -- it's been pretty consistent kind of throughout the year.
Operator
Our next question comes from the line of Josh Dennerlein with Bank of America.
Joshua Dennerlein
Maybe a big picture question for you. Just kind of curious what your conversations like have been with tenants and kind of how they're feeling about their expansion opportunities, just any pain points they're seeing? Just kind of curious what you're hearing?
Peter M. Mavoides
Yes. Listen, I would say overall transaction volumes are down as the capital markets and the availability of capital is somewhat constrained. That said, the guys who are transacting are finding good opportunities and leaning on relationships and their partners to continue to grow. Really driving the underlying desire to grow is stable operations, and I think you see that rippling through the portfolio's performance and lack of credit issues.
So overall, the operators are feeling good about their prospects, there's always sort of transitional companies and growth aggregators that are driving investment volumes and it feels pretty healthy.
Joshua Dennerlein
Appreciate that. Any particular segment that's more active in expansion mode?
Peter M. Mavoides
Yes. I mean, in the quarter, we invested in, I think, 12 of our 16 industries. So we're really seeing investments across the spectrum. In the quarter about 1/3 of our opportunities were in the carwash space, and you'll see that our carwash industry concentration has grown. And I would say there's a lot of consolidation and a lot of opportunities coming from that in the carwash space. We certainly have seen that over the last kind of 3, 4 quarters.
The childcare space remains pretty robust for us with opportunities. Certainly, the restaurant space is a little more mature from that perspective. But overall, I would expect our portfolio to grow ratably.
Operator
Our next question comes from the line of Greg McGinniss with Scotiabank.
Unidentified Analyst
This is [Elmer] on with Greg. You touched on this in your remarks earlier a little bit. But how is buyer competition for the smaller asset size that you're acquiring a $3 million to $5 million, regarding private cash and leveraged buyers and cost of debt retracting slightly, but still elevated, and regional banking turmoil subsiding. How has that changed in year-to-date acquisitions? And has that kept normal course capital recycling opportunities still attractive in Q3 so far, given disposition volumes up a little bit over 10% over the Q2?
Peter M. Mavoides
Got you.
Mark E. Patten
That's long and lot of -- you got that?
Peter M. Mavoides
I'll dig into it. First, I would say, by design, we do not compete with the $3 million to $5 million retail investor by doing sale-leasebacks. The sale-leaseback transaction is a more sophisticated transaction with an operator that requires execution certainty that the retail investor generally can't provide.
Certainly, the retail investor that is dependent on financing or a leverage bid, and I would say that leverage bid has become even more suspect in the current market. So that's not a segment of the market that we compete against on our investment.
That said, as I said on the call, we do compete with larger leverage buyers who were struggling to get debt capital. And on more organizational, more portfolio basis that's allowed us to be a little more competitive and aggressive in our investments.
In terms of the flip side of that coin, which is when we sell our assets into those markets and the leverage that our buyers get, certainly, that is a challenge. And that market is -- the investment volumes are down materially, but that's a huge market, and we're able to sell into it, because we're not as price sensitive as many sellers, given the -- our basis and our ability to move some of the riskier assets at of our portfolio. So that market has dried up a bit, but it's still robust and allowing us to recycle capital and keep the portfolio fresh.
Unidentified Analyst
Got it. And I guess as a follow-up, you mentioned last month seeing more potential deal volumes that are meeting our investment criteria, right, due to the attractive environment for sale-leaseback capital. Of course, investment flowing was up above the 8 quarter average. And I think you touched on it a little bit in your prepared remarks about G&A, rationalizing a little bit. I think it was down quarter-over-quarter. Do you expect -- do you anticipate any headwinds on G&A in the balance of 2023, given the level of investment of investment volume that you're seeing thus far?
Peter M. Mavoides
Yes. We -- the short answer is, no. We continue to staff in the organization, but generally, the vast majority of our staff and the executives are in their seats and trained and executing. And investments we're making in G&A are really more for like as we look at next year, and so I wouldn't expect anything out of the norm on G&A.
Mark, would you add anything on that?
Mark E. Patten
I think that's right. I think that trend is -- and like you said, our headcount is pretty stable. So I wouldn't expect anything different.
Operator
Our next question comes from the line of Eric Wolfe from Citi.
Nicholas Gregory Joseph
It's actually Nick Joseph here with Eric. We saw the uptick in new relationships in terms of acquisition opportunities versus the recent quarters. Can you just walk through the typical cadence of the opportunity and how the conversations typically go in terms of growing these relationships from here?
Peter M. Mavoides
Yes. Listen, as we said in some of the prior quarters, we were really focusing our capital on servicing existing relationships that were bringing us opportunities. And we generally like to lean into our relationships, because when we have the relationships, it gives us an inherent competitive advantage, because we've underwritten the credit, we have negotiated documents and we're able to perform reliably against those opportunities.
That said, we've always wanted to maintain a balance and strike relationships with new operators and they become the growth engine down the road. And so in the quarter, we were able to strike some new relationships. There's some guys who are in the market doing deals. Some of them are in the market for the first time, because the capital markets constraints and other alternative financing have drove them to sale-leasebacks. And some of the relationships we're, quite frankly, transacting with other people, and those counterparties are no longer active and so they're source to find a new counterparty.
But we make it clear at the outset. We're in a relationship for a long term, and we want to help our operators grow their businesses, and the underwriting process is an investment that we make into those relationships such that we can continue to transact with these guys kind of going forward.
Nicholas Gregory Joseph
Appreciate that. And then just maybe on the other side in terms of sales, obviously, some dispositions in the quarter. How does that impact kind of the relationship with the growth with those tenants where you have exist -- where you have continued assets with one that maybe sold a handful of their properties?
Peter M. Mavoides
Yes. I think that is a process that there is some sensitivity to, but as long as you're open and transparent and making -- EquipmentShare is a great example, as we're able to sell those sites and really free up capital capacity to continue to invest with them and continue to help them grow their business. And so they recognize that it's mutually beneficial, and it's generally a collaborative process to kind of manage those relationships and manage those exposures.
Operator
(Operator Instructions) And our next question comes from the line of Ki Bin Kim with Truist Securities.
Ki Bin Kim
Mark, it seems like the bank debt market is a little more available for certain triple-net lease. Can you just discuss your refinancing plans? And what kind of pricing you're seeing? And if starting forward swaps is in the cards in the near future?
Mark E. Patten
Thanks Ki Bin. I mean, look, your note, what 2 days ago, I think, it was probably a pretty good analysis for us. We are fortunate our bank group is very supportive. I think the way you sort of pose that dynamic in your piece was probably appropriate. But for us, the pricing really was pretty consistent with what we've seen before from the term loan side of things. And then in terms of the forward swaps or frankly, just even swaps as we do the draws. You could do either, but certainly, the forward swap, I think, is (technical difficulty) in my remarks, which is kind of that 4.5% to 5% range. It all depends.
So I think if you look at the renewal swap or the extension swap in April '24, that's probably a 4%, 6% kind of number. If you look at when we do the draw, if we do more than just paying off the 2024 term loan, when we close that tranche, the swap probably prices higher, but within the range I was mentioning. That's where I think the mix of the draws relative to doing a forward swap to match it, that's why that 4.5% to 5% is probably a pretty good range.
Ki Bin Kim
Great. And in terms of your unit level coverage, there was a slight migration for some tenants moving to the below 1x covered or below 1.5x covered. And on the flip side, some actually improved. I'm not sure how much acquisition has changed that dynamic, but if you can just comment on high level, what type of tenants have maybe migrated south a little bit?
Peter M. Mavoides
Yes. Certainly. And I would start with only 2 vacant properties, a strong same-store sales number and growth in the portfolio, and de minimis to negligent, to no credit loss. But the migration there, I think what you're seeing is some of the industries that are more sensitive to wage pressures and have lacked the ability to increase price on a real-time basis, like the early childhood education guys. They can push price, but you're not going to do it kind of 5, 6 times a year. And so we've seen some decrease there.
The restaurants have also seen some slight margin pressures with wages and cost of goods. But overall, nothing that's giving us a concern, and we would expect those guys to migrate back to a more healthy level.
Operator
Our next question comes from the line of Haendel St. Juste with Mizuho.
Ravi Vijay Vaidya
This is Ravi Vaidya in the line for Haendel . Just as a -- the question. As we see the financing and liquidity in the bank and we're starting -- I feel like we're starting to see a more of an improvement there going forward? Do you feel that tenants will be incrementally less reliant on the sale-leaseback of the pro forma capital going forward? Or would you say that since rates are still so high that you would still see that being incremental source of capital?
Peter M. Mavoides
Yes. I would think it's more of the latter. If you think about a middle market borrower and borrowing unsecured in the 9%, 10%, 11% range, sale-leaseback capital is still accretive to that. And I think there's a long way to go in kind of normalizing of that market to before it becomes -- reverts to a more normalized level that is inside of what sale leaseback pricing that they say. So I don't think that's changed materially. And I think it's going to be a while before we see that.
Ravi Vijay Vaidya
Okay. Just one more. What's your watch list today as a percentage of ABR?
Peter M. Mavoides
Our watch list as a percent of ABR is 90 basis points. And just to refresh, we define that as the intersection of the unit level coverage risk of 1.5x or below and credit risk of B or below. And so that's currently 90 basis points, which is the level.
Ravi Vijay Vaidya
Okay. I believe your theater exposure is north of that. So are those theaters, are all -- or are theater not included in those metrics?
Peter M. Mavoides
There'll be some theaters in those -- in that -- in those numbers, certainly. I think a couple of our theaters are still kind of below that 1.5x level. Yes. So all of that 90 basis, more than half is in our theaters.
Great. Any more questions, operator?
Operator
No. This concludes question and answer session. Pete, back to you.
Peter M. Mavoides
Awesome. Well, then that concludes the call. Thank you all for your time today, and we appreciate it.
Operator
This concludes today's conference. Thank you for your participation. You may now disconnect your lines.
