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STORE Capital Corp (NYSE:STOR)
Q1 2020 Earnings Call
May 5, 2020, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to the STORE Capital First Quarter 2020 Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Ms. Lisa Mueller with Investor Relations. Please go ahead.

Lisa Mueller -- Investor Relations

Thank you, operator, and thank you all for joining us today to discuss STORE Capital's first quarter 2020 financial results. This afternoon, we issued our earnings release and quarterly investor presentation, which includes supplemental information for today's call. These documents are available in the Investor Relations section of our website at ir.storecapital.com under News and Results, Quarterly Results.

On today's call, management will provide prepared remarks, and then we will open the call up for your questions. [Operator Instructions]

Before we begin, I would like to remind you that today's comments will include forward-looking statements under the federal securities laws. Forward-looking statements by their nature involve estimates, projections, goals, forecasts and assumptions and are subject to risks and uncertainties, including those arising from the COVID-19 pandemic and its related impacts on us and our tenants that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statement. Discussion of the factors that could cause our results to differ materially from these forward-looking statements are contained in our SEC filings, including our reports on Form 10-K and 10-Q.

And with that, I would now like to turn the call over Christopher Volk, STORE's President and Chief Executive Officer. Chris, please go ahead.

Christopher H. Volk -- President, Chief Executive Officer and Director

Lisa, thank you, and good afternoon, everyone, and welcome to STORE Capital's first quarter 2020 earnings call. With me today are Mary Fedewa, our Chief Operating Officer; and Cathy Long, our Chief Financial Officer.

First things first, we welcome the opportunity to speak to you today and hope that you and your families are healthy and safe. While the journey through this unprecedented event has tested us all, we'll come to the other side together and we, at STORE, look forward to the opportunities that await us. Meanwhile, we're very fortunate to have a team made up of 97 experienced and talented employees, who have worked collectively to address the impact of the coronavirus pandemic upon our customers. This is also a time when our strategic investment in technology and systems allowed us to quickly gather the necessary information to address the needs of our customers. Technology has been instrumental in the ability of our collective team to work remotely from home over the past two months. Our direct origination strategy, which fosters long-term tenant relationships, also improves our ability to address moments of national business interruption like this.

With that said, let me discuss our achievements for the quarter. Even with the curtailment of our acquisition efforts, we had investment activity of over $260 million during the first quarter. At the same time, our portfolio remained extremely healthy with an occupancy rate of 99.5% and with continued stability in the percentage of net lease contracts rated investment-grade and quality based upon our STORE Score Methodology.

At quarter-end, our funded debt-to-EBITDA on a run rate basis was 5.4 times, which is slightly below the lower end of our target range and our pool of unencumbered assets stood at over $5.5 billion, or about 61% of our total investments. Leverage on this majority of our balance sheet stood at a sector low of 23% of cost, providing us with ample flexibility in our financing options to navigate this pandemic.

Now, as I do each quarter, here are some statistics relevant to our first quarter investment activity. Our weighted average lease rate during the quarter was approximately 7.5%, slightly lower than in late 2019. However, the average annual contractual lease escalations for investments made during the quarter was higher than normal at 2.5%, providing us with a gross rate of return, which you get by adding the lease escalations to the initial lease rate of about 10%. This is also above recent quarters. And with corporate leverage in the area of 40%, our levered investor return will approximate 14%, with net returns after operating cost in the 12% to 13% range.

Our investor returns from STORE and from predecessor public companies have been mostly driven by favorable property level rates of return. While we take the time to disclose the investment yields, contractual annual lease escalators, investment spread to our cost of long-term borrowings and our operating cost as a percentage of assets. These are the four essential variables that enable you to compute expected investment rates of return.

The weighted average primary lease term of our quarterly new investments continue to be long at approximately 16 years. The median post-overhead unit level of fixed charged coverage ratio for assets purchased during the quarter was 2.7:1. The median new tenant Moody's RiskCalc credit rating profile was B1. But if you incorporate the potent contract level of fixed charge coverages and the median new investment contract rating or STORE Score for our investments was far more favorable at Baa2. Our average new investment was made at approximately 77% of replacement cost, 90% of the multiunit net lease investments made during the quarter were subject to master leases. And all 57 new assets that we acquired during the quarter are required to deliver unit level financial statements, giving us unit level financial reporting from 98% of the properties within our portfolio. This is critical to our ability to evaluate contract seniority and real estate quality and has been really essential to our ability to quickly assess our tenant's ability to pay rents during this pandemic crisis.

And with that, I'll turn the call over to Mary.

Mary Fedewa -- Chief Operating Officer and Director

Thank you, Chris, and good afternoon, everyone. I'll start with a quick recap of our first quarter acquisition activity. We investment $264 million in real estate acquisitions at a weighted average cap rate of 7.5%. This included investments in 21 separate transactions at an average size of about $12.5 million. As Chris mentioned, our portfolio remained healthy in the first quarter and only 12 of our more than 2,500 property locations were vacant and not subject to a lease agreement at March 31, which is unchanged from year-end 2019. We sold nine properties in the first quarter. The majority of these properties were sold as part of our ongoing property management activities and resulted in a recovery compared to our original cost of just under 80%.

Our portfolio mix at the end of first quarter remained steady: 65% of our properties were in the service sector, 19% in experiential and service-driven retail businesses, and the remaining 16% were in manufacturing. Our top 10 customers were unchanged from last quarter. However, we continue to improve the diversity of our revenue and as a result, our top 10 customers accounted for well below 18% of annualized rents and interests for the quarter. Our portfolio remains diverse and granular and our single largest customer Fleet Farm, represented just 2.8% of annualized rents. Our second largest customer, Art Van, declared bankruptcy in early March. The bankruptcy process has experienced some temporary delays due to COVID-19. However, we continue to make good progress toward the resolution.

Now, turning to our response to the pandemic. First, I'd like to say, we could not be more proud of our entire team at STORE and the efforts they have collectively made to step into action for our clients since the abrupt onset of COVID-19. You heard us say before that our focus on delivering value to our customers beyond real estate financing solutions has resulted in close customer relationships and significant repeat business. As you might imagine, we have been in active dialogue with our customers over the past several weeks on many topics, from rent collections to government stimulus programs that might help them. We also launched a COVID-19 website as a resource to help our customers understand and access the various government relief programs. As you know, the middle market has always been an especially vibrant part of the economy and a key driver of economic wealth and job creation in the US. So it makes a lot of sense that the government is focused on helping middle market companies through CARES Act programs, such as Paycheck Protection Program for smaller companies, and the Main Street Lending Program, which is expected to launch in May for larger companies. Many of our tenants are well positioned to benefit from these stimulus programs, and our team will continue to educate them about the options and help them through the process.

Now, turning to April rents. We have made good progress on rent collection since our last update just a couple weeks ago. Our cash collections for April rent now represents 68% of our base rent and interest. Including these cash payments, we have reached agreements for over 97% of our April rents. For the rents that were deferred, we negotiated short-term agreement that included, for example, interest, higher lease escalations and/or longer lease terms. And for the rents we agreed to defer for April, more than 75% were concentrated and only six of our -- more than 100 industries represented in our diverse portfolio. These include industries like fitness clubs, theaters, early childhood education centers, restaurants and family entertainment centers that have high mandated closure rates across the country.

Going into the pandemic, our portfolio was performing well with strong corporate and unit level coverages. And in addition, there was no discernable difference in April rent payments as it relates to company size or whether they were backed by private equity. What was clear is that, tenants looking for rent release are in businesses that have been temporarily disrupted or closed due to COVID-19 rather than experiencing a credit event. We are, therefore, optimistic that these tenants will rebound nicely as the economy opens up. Again, these are essential businesses that people value, need and depend on. We also believe that geographic diversity is an important factor in evaluating the impact of COVID-19 on STORE given that certain regions of the country are opening sooner than others. Based on recent news announcements, at least 17 states have eased restriction sso far, and together, they makeup nearly 50% of stores base rents and interests. So, we are now talking to many of our customers who are preparing to reopen their businesses in these select states.

While overall, our tenants view the coronavirus as a temporary disruption and believe that their businesses will open and recover. They realize that reopening will not happen overnight but will be more of a phased-in approach over time. In the meantime, our acquisition team continues to cultivate new and existing relationship to ensure that we continue to have a strong pipeline of opportunities.

And in closing, I'd like to reiterate our strategy. We invest in profit center real estate. It was profitable going into COVID-19, and we believe these locations will be profitable after COVID-19. Our team is focused each and every day on delivering the best outcomes for our customers, our employees and our shareholders. And that is what we will continue to do.

And now, I'll turn the call to Cathy to discuss our financial results.

Catherine Long -- Chief Financial Officer, Executive Vice President and Treasurer

Thank you, Mary. I'll begin by discussing our financial results for the first quarter, followed by an update on our balance sheet and the steps we've taken to increase our financial flexibility in response to the pandemic.

Beginning with the interim statement. First quarter revenues increased 14% from the year-ago quarter to $178 million, and the annualized base rent and interest generated by our portfolio in place at March 31 was $730 million, an increase of 13% from a year-ago.

Total expenses for the first quarter were $118 million, as compared to $109 million in the first quarter of 2019. During the first quarter, we derecognized $6.7 million of non-cash equity compensation expense related to certain performance-based restricted stock unit awards that are no longer expected to be earned. Excluding this adjustment, the increase in total expenses was primarily due to higher depreciation and amortization expense related to our larger real estate portfolio, as well as increased interest expense and property costs.

Interest expense increased by $3.6 million to $41.7 million, primarily due to additional long-term debt we issued in 2019 to fund investment activity.

Property costs for the first quarter increased by $3.4 million year-over-year, primarily due to property tax accruals related to non-performing properties leased to tenants that may not be able to pay these expenses. Nearly half of this amount was related to the Art Van bankruptcy in Q1. As a result of the derecognition of the non-cash equity compensation expense, G&A expenses for the first quarter were $7.9 million, down from $12 million a year ago, and included a minor amount of expenses related to our COVID-19 response. Excluding the impact of non-cash equity compensation, G&A expenses as a percentage of our average portfolio assets decreased to 51 basis points during the quarter from 53 basis points a year ago. During the quarter, we recognized a $2.9 million impairment provision related to our real estate portfolio, primarily for properties we are likely to sell.

AFFO increased over 11% to $120 million from $108 million a year ago. On a per share basis, AFFO was $0.49 per diluted share, a 2.1% increase from $0.48 per diluted share a year ago.

Now, turning to our balance sheet. We funded our first quarter acquisitions with a combination of cash flow from operations and $150 million of borrowings on our revolving credit facility along with proceeds from property sales and our ATM equity program. In early January, we issued about 4 million shares of common stock under our ATM program at an average price of $36.22 per share, raising net equity proceeds of approximately $149 million.

At March 31, we had approximately $3.6 billion of long-term debt. The year-over-year weighted average maturity of that debt rose to seven years, and the weighted average interest rate decrease slightly to 4.3%. In the first quarter, we extended the maturity of one of our $100 million bank term notes into 2021 and that note has two more one year extension options available. We have no significant debt maturities for the remainder of this year. We continue to be in compliance with all of our debt covenants and we expect to remain in compliance going forward.

We took steps in the latter half of the first quarter to augment our balance sheet and liquidity position in response to the pandemic. As previously announced, at the end of March, we drew down the remaining amount on our $600 million credit facility as a precautionary measure to increase our liquidity. We have an additional $800 million of capacity available under the accordion feature of our facility. We've not yet requested access to that from our banks and the term debt markets remain open to us.

At the end of April, we had over $550 million in cash after payment of the first quarter dividend and funding approximately $15 million in ongoing construction commitments. To put that amount of cash in perspective, it's over 2.5 times of our full-year 2019 operating costs, plus annual cash interest expense for the year combined. We believe our conservative leverage profile and this higher than normal cash balance position will serve us well to navigate the pandemic.

Now, turning to our outlook for the rest of 2020. As previously announced, in mid-April, we withdrew our 2020 guidance based upon decisions we made to respond to the pandemic. These include curtailing near-term acquisition activity, maintaining higher than normal liquidity levels and deferring a portion of our rent and interest income. We will reinstate guidance where we have more clarity around the path and timeline for states and businesses to reopen.

And now, I'll turn the call back to Chris.

Christopher H. Volk -- President, Chief Executive Officer and Director

Thank you so much, Cathy. As is usual and before turning this call over to the operator for your questions, I'd like to make a few comments. We've included in our regular quarterly investor presentation a handful of slides pertaining to the impact of COVID-19, including a slide that addresses our current share valuation. We believe that the value of STORE stays more compelling than when we started this Company in 2011. It should be, since investors at the end of April could buy in at roughly 15% discount to the actual cost of the equity we have deployed. That discounted even more as I speak today.

Before our share purchase window expired and well after the extent of the pandemic was evident, much of STORE's leadership and several Board members purchased shares at prices close to $30. By April 3, our shares have fallen 61% before recovering to a still material drop of around 45% by the end of April.

I have a reason for this belief in our compelling valuation that comes in two parts. First part is that, our current share price implies a permanent base rent and interest income loss equating to about 70% of our tenants paying half their contracted rents. We do not believe that this will happen, which leads me to a second part of the reasoning, which is also evident from the supplemental slides. As Mary mentioned, virtually all the COVID-related lease deferrals granted by STORE emanated from closed sectors of the economy. And six of these sectors alone accounted for about three quarters of the rents deferred.

Our nation is replete with restaurants, education facilities, health clubs, movie theaters, home furnishings retailers and family entertainment facilities. In our view, these and more closed sectors represented within the STORE portfolio are central for a past and future way of life. We take heart in this because we absolutely believe in the ability of our tenants, non-rated, middle market and larger companies that fully comprise these largely closed sectors to successfully emerge from this pandemic. This leads to a clear lesson about a pandemic like this. Closures and lease deferral requests did not pertain to tenant credit quality, revenues or balance sheet size. It resulted from a sensitivity to this black swan event that mandated a broad, albeit temporary cessation of commerce. Surveying the wider landscape beyond the net lease arena, this notion becomes even more clearer, given the limited payments of rents from retailers of all sizes and credit ratings.

With this said and evaluation of STORE at this moment cannot rest on static benchmarks such as percentage of rents collected or percentage of investment-grade tenants or occupancy rate, everything is relative, and our approach to investing begins with an integrated business model that we pioneered in 1980 and refined over the past four decades across three separate and successful public investment platforms. Viewed in this light, I believe STORE's non-rated tenant April rent collections led in that leased sector. We chose both to our work and to the diversity of our portfolio, which, fortunately for us, included a number of sectors less impacted by the pandemic. And given the general spread between lease rates attainable from investment-grade to non-rated tenant, I would also posit that STORE's April cash yield on investment impacted as it was by lease deferrals, lay near the very top of our net lease peer group.

We've always stated that we succeed if our tenant succeed. In the case of this COVID-19 event, much of our ability to rebound is not tied simply to our tenants but to entire essential sectors of the US economy. STORE will emerge from this pandemic in a strong position. We fully expect to be proud of our tenants and how they perform, and we will continue our devotion to this market that really needs us. Companies like STORE are essential for real estate capital formation among middle market and larger non-rated companies and will help this country as we emerge from this pandemic.

I'll close with a few comments about our plans for investor communication going forward. Since our last earnings call, I wrote a letter in March, we have conducted two webcasts to update the investment community. In a time of national business upheaval, frequent communication has become essential. So, we plan to hold three webcasts prior to the release of our second quarter financial results. The market calendar for the first of these calls, which will occur on May 27. On that call, we expect to provide you with an updated on May rent collections and comment on the broader status of our tenants as various states begin the very hard task of reopening. Because our annual shareholder meeting is scheduled for the very next day, we will not be providing a general business update at that meeting. We look forward to providing these future monthly updates and to making ourselves available to answer your questions.

And now, I'd like to turn the call over to the operator for any questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question today will come from Nathan Crossett with Berenberg. Please go ahead.

Nathan Crossett -- Berenberg Capital Markets -- Analyst

Hey. Good afternoon, guys. Hope everybody is doing well. So just a question. I appreciate the slide on the COVID-19 impact. 68% of the rent was paid in April. You mentioned 98% of that -- or 98% you came to an agreement on. Are these agreements for April rent only or do they include future months? And then how should we think about kind of the mechanics of the deferrals? How long are the payback period, etc?

Mary Fedewa -- Chief Operating Officer and Director

Yeah. Hey, Nate, this is Mary. Before we start the Q&A, if you don't mind, I'd like to just provide a brief update on Art Van.

Nathan Crossett -- Berenberg Capital Markets -- Analyst

Okay. Yeah.

Mary Fedewa -- Chief Operating Officer and Director

The Delaware -- yeah, sure, OK. The Delaware Bankruptcy Court just approved the sale of certain Art Van assets, including existing inventory and this approval has actually cleared the way for the releasing of all of STORE's 23 Art Van Wolf and Levin locations. STORE has entered into four master leases for all 23 STORE-owned locations with an existing customer of ours. And so, therefore, no STORE-owned former Art Van location will be vacant. Estimated recovery is in line with the rest of our portfolio at approximately 70% of base rent with potential upside actually written in these leases. So I just want to give a quick update on that for everyone.

So to go back to your question -- go ahead.

Nathan Crossett -- Berenberg Capital Markets -- Analyst

No. I was going to say that's helpful. Do you want me to repeat my question or...

Mary Fedewa -- Chief Operating Officer and Director

No. I think I've got it. So, actually you asked about the April rent collections at 68% and is that for just one month? So, our average deferral agreement was for two months on average. And so, I would say that, from that perspective, and we expect to be paid back within -- the majority of it within the next 12 months. So that kind of hopefully answers your question there.

Nathan Crossett -- Berenberg Capital Markets -- Analyst

Okay. And that 68%, how many of those kind of accessed the PPP? Or if you include the PPP and some of these Fed programs, like where do you kind of taken out?

Mary Fedewa -- Chief Operating Officer and Director

You bet. So, actually, great question, 98% of the cash received in April was paid without PPP help. So, we just started, as you know, to come in toward the end of April and 1st of May here.

Nathan Crossett -- Berenberg Capital Markets -- Analyst

Okay. So, like what percentage of your tenants are saying that they can and will access the PPP in some way, shape or form?

Mary Fedewa -- Chief Operating Officer and Director

So we're estimating about half of our tenants, maybe a little over, that will be able to do the PPP program. And, obviously, that doesn't include the Main Street program. We're talking about just the Paycheck Protection...

Christopher H. Volk -- President, Chief Executive Officer and Director

If you're looking at it, we have four 491 tenants and in surveying the tenants we think about 350 of them are eligible, which is about 71% of the tenants but it works out to about half the rents. And then if sort of you further break it down and say, of that half, how much -- how many of them could actually get enough PPP to really help on the rent? Which is not to say that the other half won't help on the rent because that PPP money, I think, is sort of helpful. But of that half about 175, which is about 25% of rents and interests will actually help out -- have enough money to help out on the rent. So, it's possible that in May we'll benefit from that. Certainly, we would like to hope so. And June -- and in April, it wasn't really an effect. They had no impact.

Nathan Crossett -- Berenberg Capital Markets -- Analyst

Okay. Thanks. I'll back into queue.

Operator

The next question comes from Craig Mailman with KeyBanc Capital Markets. Please go ahead.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Thanks, everyone. Mary just may be on Art Van, the 70% recovery rate, when does that kick in and what's the drag on a dollar basis?

Mary Fedewa -- Chief Operating Officer and Director

Yeah. So, just you know that the new operator will take possession by May 8 and the 70% is a total solution for these guys. So, quickly they'll take possession. They've already got management in place.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

So, how much...

Christopher H. Volk -- President, Chief Executive Officer and Director

The 70% includes all the costs and all the drag. So it's a net number coming up. But the rent could start as early as July. But it may -- obviously, you have COVID-19 thing, so it just depends.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

But I just -- when it starts, like what would the new rent be versus the previous rent on just a dollar kind of drop?

Mary Fedewa -- Chief Operating Officer and Director

70% of our original leases with Art Van is the rent to start.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Okay. And then, on the deferrals, can you just kind of go through if at all any of that was abatement versus just kind of deferral loans? And whether any of these agreements kind of go back and recut the leases maybe you're extending term or getting some other benefits?

Mary Fedewa -- Chief Operating Officer and Director

Sure. So, as I mentioned in the prepared remarks, so essentially there were no -- there was no forgiveness or abatement, all agreements that were made we got an economic benefit for here at STORE. So, that could have been -- it could have been anything from interest on the deferral, as I mentioned, to longer lease terms, higher escalations, stronger contracts, but there was no pure forgiveness of rent.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Is anyone going on non-accrual?

Mary Fedewa -- Chief Operating Officer and Director

No.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Thank you.

Operator

The next question will come from Rob Stevenson with Janney. Please go ahead.

Robert Stevenson -- Janney Montgomery Scott LLC -- Analyst

Hi. Good afternoon, guys. At this point, are you guys looking to, I mean, is acquisitions cut to zero at this point? Are you still selectively buying stuff? And if so, are you going to be buying anything where the tenants deferring or not paying rents?

Mary Fedewa -- Chief Operating Officer and Director

Okay. Hey, Rob. This is Mary. So we're honoring our construction commitments that we have outstanding and we've made a few small acquisitions, very small under -- where we had contracts in place -- purchase and sale agreements in place when it made sense but not without an update on -- of course, an update on the credit and the COVID environment. And so, we would not be funding anybody who is asking -- who could not pay the rent or was really impacted by COVID.

Robert Stevenson -- Janney Montgomery Scott LLC -- Analyst

Okay. And then, I guess, the other one would wind up being like, were any -- did you guys require -- in order to even have the deferral discussions, did you guys require people to be current as of that point in time? And so, is there likely to be a great -- a significantly greater percentage of people that don't wind up paying May rent versus April? Or are the people that are not likely to pay May the same as that were like that didn't pay April?

Christopher H. Volk -- President, Chief Executive Officer and Director

The May rent -- well, you're sort of intertwining, Rob, and this is Chris. So, you may have to correct me here, but you shouldn't be intertwining the notion of doing new investments with May rent and what impact that's going to have on May rent. I think the general consensus -- if you're talking about May, the general consensus of the community that I've listened to is that, May is more difficult month potentially just because with April people had, at least a half a month of operations in March. So they had some steam going into April and May, of course, people were fully closed down. So there's an increased pressure on people in May. The offsetting part to that, from our perspective is that, since we only got 2% of our payments in April from the PPP that could be upside for us, which might be an equalizer. So we'll see how that works. And...

Mary Fedewa -- Chief Operating Officer and Director

Reopening.

Christopher H. Volk -- President, Chief Executive Officer and Director

Yeah. Nobody is reopening too.

Mary Fedewa -- Chief Operating Officer and Director

Reopening that were...

Christopher H. Volk -- President, Chief Executive Officer and Director

Right. Assume gradual reopenings. And we'll keep tabs on that. So when we do our conference call at -- on May 27, we'll kind of give you an update as to who's open, who's not. I mean, what was interesting -- and Mary can elaborate on this, but if you -- there are handful of states out there that have actually not shut down, I mean. And so, if you're just looking sort of state-by-state, the recoveries or the rent payments that we've had from those states that are open tend to be closer in the 80% range, right? And so, that would suggest that as states open, there's an absolute upside, if we were to look at the states that are open today.

Robert Stevenson -- Janney Montgomery Scott LLC -- Analyst

Okay. So, I mean, for the states that were -- that never really closed, there was still a decent amount of revenue collected on those people just didn't stay home automatically?

Mary Fedewa -- Chief Operating Officer and Director

Yeah. That's correct. For the handful of states that did not have a government declared stay-in-place order. From our rent collections, we saw substantial and materially better collections in those states, as Chris mentioned, about 80-plus percent.

Robert Stevenson -- Janney Montgomery Scott LLC -- Analyst

Okay. Thanks, guys. Appreciate it.

Operator

The next question is from Vikram Malhotra with Morgan Stanley. Please go ahead.

Vikram Malhotra -- Morgan Stanley -- Analyst

Thanks for taking the questions. So, I just want to clarify the difference between deferral and then interest. Can you clarify what sort of interest is this? How are the mechanics on that?

Christopher H. Volk -- President, Chief Executive Officer and Director

So, Vikram, the way it works is that, there are a variety of solutions. In some cases, you're doing lease modifications, and you're building escalated payments into the lease modifications. And in some cases, you're doing it in the form of notes that actually have an interest rate better than the note. And so, it's just a combination of those things. And if you look at the deferrals and the expected cash flows, substantial majority of the amount of rent that will be deferred should be collected by the end of 2021.

Vikram Malhotra -- Morgan Stanley -- Analyst

And so, these -- when you say notes, are these -- like you're providing funds to tenants and they're giving you interest on those loans?

Christopher H. Volk -- President, Chief Executive Officer and Director

We're not providing -- we're not writing anybody a check. What we're doing is, if they can't pay us the rent, we just make them execute a note for that amount of rent. We're not actually writing anybody a check or anything.

Mary Fedewa -- Chief Operating Officer and Director

It's not a business loan?

Christopher H. Volk -- President, Chief Executive Officer and Director

There's no business loan here.

Vikram Malhotra -- Morgan Stanley -- Analyst

Okay. And then just on the covenants, Cathy, you mentioned sort of compliance with covenants, specifically related to the Master Funding kind of level in terms of the DSR coverage at 1.8. If you take that 1.8 and the deferrals, the 30-ish percent deferral that you've seen today, you sort of get to a level that's close to the 1.3, where certain things could trigger. I'm just sort of wondering how do you bridge that -- those two numbers.

Catherine Long -- Chief Financial Officer, Executive Vice President and Treasurer

Okay. Would it be helpful if I walk through some of the math on the master planning and how it would work?

Vikram Malhotra -- Morgan Stanley -- Analyst

Sure.

Catherine Long -- Chief Financial Officer, Executive Vice President and Treasurer

So, as you know, like at the beginning of the year, I'll start with the beginning of the year because it's easier to go back to the 10-K and be able to pull numbers out of the management discussion and analysis section. Our annualized base rent and interest was $714 million for the whole portfolio. And about 37% of the revenue comes from those assets that are in Master Funding. So that's about $264 million a year would be going into Master Funding. So, if you -- in a normal time frame, that $264 million covers principle and interest on the outside debt that we have. And about $140 million comes to the bottom of the waterfall back to STORE Capital. Does that makes sense so far? So that's in a normal time when you're covering 1.8 or 1.9.

If you take the $264 million of revenue coming in and you say what if I only got 60% of that? That's $158 million. When you compare that to the $122 million or so of debt service, that's a 1.295 coverage, which gets you below that cash sweep trigger that you're talking about, which is at 1.3. But at that point, if you're getting a $158 million of revenue and you're covering $122 million of debt service, what would flow through the bottom of the waterfall is about $36 million a year, and that's what gets trapped. So that's about $3 million a month.

Christopher H. Volk -- President, Chief Executive Officer and Director

And that's the most it could be by the way.

Catherine Long -- Chief Financial Officer, Executive Vice President and Treasurer

Yeah.

Christopher H. Volk -- President, Chief Executive Officer and Director

It's the worst-case scenario and everything else is nothing. And I would say this to you, I mean, the master trust for April was well north of 1.30 coverage. So, from a -- we're not close to cash sweep, so I just want to point this out to you. And there are a lot of ways -- there were a lot of reasons why we're not close to them but we're not close to them. If we ever got close to them, it's not a big money amount. And I want to make it extremely clear, and happy to discuss it but that our leverage corporately is 40%, which is right in the strike zone -- and 40% costs. It's right in the strike zone of where pretty much every BBB company was. And in fact, Realty Income, at the end of last year before they did their equity offering, again this year, was right around 48%, plus or minus. And the only difference is that, we're not relying solely on unsecured money, we're relying on the master trust as well.

The master trust has two-thirds of our debt, it only has one-third of our assets, I mean, less than that. And so, what ends up happening is that, the unencumbered net leverage is 23%. It's the lowest in the space, there's no one that could come close to it. And so, the question was, in a real downside scenario, and Vikram you've mentioned that the Master Funding is, it poses some sort of risk to us. Given that we have this non-recourse debt on the balance sheet and in a total downside scenario, master trust does a much better job of protecting our investors than it would be if we were just unsecured debt-only. So, you're in a much better position than any other REIT would be, both from a diversity of capital and from a protection of shareholders and unencumbered noteholders because -- or unsecured noteholders, because leverage is 23%.

Vikram Malhotra -- Morgan Stanley -- Analyst

Okay. That makes sense. I just want to clarify, get the leverage aspect and the unencumbered portfolio. But I'm just -- I'm not -- maybe I'm not understanding it, when you have had deferrals of 30%. How are you -- what are the reasons for not being close to the 1.3, if like unless the deferrals are really different in the Master Funding vehicle versus like how is it not cloe to 1.3?

Christopher H. Volk -- President, Chief Executive Officer and Director

Fundamentally, it comes down to the fact that we're the servicer. And because we're the servicer, all the waterfalls come to us, this is not like CMBS where you have cash sweeps and you have a servicer. We are the servicer. So, if we choose to waive fees for example, then obviously it changes the waterfall. I mean, so there are things that we can do that are in our power to do that essentially allow us to not be subject to cash sweeps. And at the end of the day, if you're looking at us versus National Retail and Realty Income, both of which are reliant on unsecured debt virtually completely. They look at the same, I mean, there's -- the cash flow comes in, it goes out. The only difference is that, we have a chunk of assets that are in a non-recourse vehicle, which at the end of the day prepare -- create some protection for investors but basically because we're the servicer, we can manage the cash flows in such a way that we don't trigger any cash sweeps.

Vikram Malhotra -- Morgan Stanley -- Analyst

Okay. Fair enough. I'll probably take it offline. Thank you so much.

Operator

And our next question will come from Haendel St. Juste with Mizuho. Please go ahead.

Haendel St. Juste -- Mizuho Securities USA LLC -- Analyst

Hey. Good afternoon up there. I hope you guys are all well. Thank you for taking my question. So, Chris, I guess, first one for you. Certainly, understanding that this is all happening so quickly. But just curious how COVID and your portfolio performance and what you've seen in the marketplace in terms of other peers portfolio, exposures and performance. It's impacting your portfolio allocation theory at all, you could just make favorite yields, more middle market tenants versus high-grade. So just curious on your observations, how they might be impacting your thoughts or strategies. Are you willing to do a bit more high-grade deal that you'll get a bit more attractive here? And then, also can you sprinkle in some thoughts on how you're feeling about your exposures to the movie theaters, restaurants, gyms? And what do you think that road to recovery for those rents look like? Thanks.

Christopher H. Volk -- President, Chief Executive Officer and Director

Sure. So, thinking about where we want to start here. I think that modern portfolio theory -- when Eugene Fama came up with modern portfolio theory and won a Nobel Prize for it, he wasn't thinking about COVID-19. And COVID-19 is something that hasn't affected the United States for over a century. And what we're seeing is that, companies that can pay rent are those companies -- the companies that are best able to pay rent today, are those companies that are in positions that are somewhat immune to COVID-19. So, it could be anybody from Amazon to grocery stores, to drugstores, dollar stores had done well. And those would be sort of at the very best and then pretty much everybody else has done badly. And even if you look at retailers, I mean, you're looking at a company like LVMH, which is owned by one of the richest people in the world and that's a single A rated company. To my knowledge, they didn't pay any rent for the month of April. And so, that the COVID pandemic has caused the cessation of business where companies of any rating aren't really designed to have a cessation of business.

So, my outlook on this going forward is a couple things, and then we'll have to wait and see what happens. But the first thing is, this illness has caused a huge cost on our society and our federal government. I mean, it's cost $3 trillion plus, most likely, from the federal government and maybe more. And just a 30 million unemployed. So it's been an enormous cost to just everybody. And so, with such a cost, my guess is that, the US government and every other government is going to do their very level best to make sure this doesn't happen again. And so, the likelihood of COVID being something that we need to worry about next year or the year after I think it's going to be pretty slim. It really needs to be pretty slim because it's so ubiquitous, you can't just go around and chase COVID proof businesses and have those businesses have a lower cost of capital than other businesses.

And so, in that case, we're going to be going after a broad market of businesses, middle market and larger non-rated companies which constitute the plurality of companies in the United States. And we're going to go after those companies and fulfill a very important need for them for efficient real estate capital. And we're going to do what we do best, as to whether we go into movie theaters or whatever, we're only 4% in the theaters anyway. So, we're pretty light in the movie theater sector anyway. Fitness centers were a little bit heavier. I think that you'll see us evaluating what the long-term implications of COVID-19 are there will be some societal impacts on COVID-19. Clearly, you've seen that with air transit, hotels, hospitality industries. There'll be certain industries that could potentially be permanently impacted by this. I don't believe, for example, the early child education, which was a big sector for us, is going to be permanently impacted. I think that fitness clubs long-term aren't that hugely impacted but the jury is out. I think the theaters will probably come back stronger than people think just because they're so content related. I mean, if you bring in content and people have the ability to go to a theater and they can watch a new blockbuster release, I think they're going to want to go out and do that. And this could be really tied to content.

So, I think that a lot of these industries are coming back. And one of things that we said in our prepared remarks was that 75% of our lost rents for April or deferred rents was tied to six sectors. I mean, it's just nothing, it's not tied to middle market tenants or unrated tenants, I mean, one of the things that you often get comments about or we get comments about is that, somehow middle market tenants are riskier than big tenants. I mean, COVID basically takes no prisoners. I mean, it doesn't matter whether you're a middle-market or a larger, or whether you're a BBB company or a BB company. If you're in a COVID-sensitive business, you're going to be really, really hurt by this. And if you let it go on long enough with 30 million people, the rest of the people are going to be really hurt by it, because it's going to impact just the overall economy if we keep on going long enough for this.

So, we're going to do what we do best and we're going to stick to our strategy and we're going to evaluate these sectors closely and take measured steps as we get through this. And what we always do is make bets and one of the things that we do when we make bets is, we diversify, which gets you to another Nobel laureate, which is Harry Markowitz, who talked about getting efficient portfolio theory and having huge amounts of diversification, which by the way is why if you look at STORE today, STORE among all the net lease REITs, probably collected a higher percentage of rents from non-rated companies than anybody else. And we did that because we had such diversity apart from the fact that we had a lot of people working hard on this.

Haendel St. Juste -- Mizuho Securities USA LLC -- Analyst

I appreciate that. So, certainly, it doesn't sound like there's a near-term imminent shift in strategy but certainly that your commitment to middle market remains. Just a couple quick follow-ups here. Did you guys talk about what's driving the bump in the annual contractual lease bumps here that the jump from up to 2.5%? Is there any single tenant industry? Can you talk a little bit more about that? And then maybe share what the rent collection was for assets within the trust during the month of April versus those outside the trust? Thank you.

Christopher H. Volk -- President, Chief Executive Officer and Director

Yeah. I'm happy to answer that. I wanted to like make a small addendum to my last comment, which is that when you talk about risk, one of your questions was will you go after investment-grade tenants? And implicit in that discussion or that question is that, somehow these are less risky that -- and we would be just, wouldn't we better -- be better off there? And I would say that you cannot measure risk without measuring time. You can't actually discuss a risk without discussing time.

Now, in the market like we're in today, candidly like, long-term it's lunch for most people. So they're just trying to figure out what's happening today, that's why we're having to do once a month conference calls with people. But -- so really like over a 10-year period of time if a BBB company is going to be unrated 60% of the time, then you can't treat it like a BBB company. And that's really the credit migration statistics for a BBB company. So, we're running this Company not for tomorrow, we're running this Company for 10 years from now. And we're thinking about risk and comparative risk, we're thinking about risk in the span of the decade, of years. And we know that risk adjusted returns have to be measured accordingly.

I would say that in terms of the transactions this quarter, what happened was we got cut off or honestly, I mean, we were on a roll to do a decent quarter worth of acquisitions. We curtailed them. When we curtailed them, we had sort of a small sample which makes you look like cap rates went down and bunks went up. It was due to a handful of transactions where we had higher bumps and lower cap rates and really most of those bumps were really elevated in the short term. So -- but in my prepared remarks, I tend not to go into like a lot of details, so that's why we didn't discuss it.

Operator

The next question will come from Shivani Sood with Deutsche Bank. Please go ahead.

Shivani Sood -- Deutsche Bank -- Analyst

Hi. Thanks for taking the question. Chris, you just sort of touched on the investment activity and Cathy, you mentioned it in your opening remarks that the team curtails near-term investment activity when 2020 guidance was pulled. So just curious what your team would need to see in the market or sort of the operating environment to get comfortable with dipping a toe back in the market again. And could we see your team do something opportunistically if there were sort of an arbitrage opportunity to be had?

Catherine Long -- Chief Financial Officer, Executive Vice President and Treasurer

It's Cathy, I'll start and then Mary can talk about what plans are for going forward. So, yeah, we had expected to have a bare quarter as Chris had mentioned. And very, very early when COVID hit the US, we decided to curtail investment activity. So most of March was less curtailed. Now, we've got about a $100 million of construction commitments that Mary had talked about earlier, that we will be doing. And those are kind of spread out over the rest of the year. So, when I mentioned things about the construction that's what I'm talking about.

And then -- and I think in Mary's prepared remarks, she did mention that our relationship managers continued to keep the relationships going on the deals that we were working on and on new deals for example, and maybe you could talk to that Mary.

Mary Fedewa -- Chief Operating Officer and Director

Yeah. I would say that, Shivani, our pipeline -- our front-end is, they've been helping a lot with the COVID-19 activity but pipeline is still very robust. We have many, many long-term relationship here. As you know, a lot of our business is repeat. We have a lot of growing customers that are really on the edge of their seats and anxious to do something again. So, we're keeping the front-end very warm. And as soon as we can get back out there, we will do that for sure. So I think we're warm on the front-end still.

Shivani Sood -- Deutsche Bank -- Analyst

Great. Thanks for that color. And then, Mary, sorry. I think you had mentioned Mary that the 17 states that are starting to reopen represents about half of the Company's annualized base rent. So, I appreciate that it's still very early on but any commentary that you guys can share there about demand and how quickly it may or may not be returning?

Mary Fedewa -- Chief Operating Officer and Director

So, it's a great question but also a tough one as Chris has mentioned, it's just -- it's anybody's guess right now as to how quickly these will reopen and in what fashion they'll reopen. I think our customers are cautiously optimistic that they'll be able to get going. But reopen doesn't really mean reopen right now, there is a lot of phased in approaches. They're doing industry by industry, there's a lot of precautions that need to be put in place whether it's masks or taking temperatures or putting some spacing in between seats and movie theaters and so on. So, there are some things to do. And then the consumer behavior has yet to show itself. So, that's kind of the last piece of the puzzle, so we'll see what consumers, if they start to jump out there or not. So I just think that it's really early, Shivani, but there is excitement definitely to get going.

Christopher H. Volk -- President, Chief Executive Officer and Director

If you look at some of the rules on a state-by-state basis, though, they'll tell people on the restaurant business or in the early child education business, they could be 25% capacity. But if you're a business person running a restaurant or early child education facility, 25% is not going to excite you enough to want to open. So mathematically, you just need more room than that. And so, I think that we're going to see this happen gradually. Somebody from the New York Times did suggest that that we were in the second inning of this. I don't know whether it's a second or third inning, but this could take a while, right? I mean, and I think that we have to be prepared to be patient with this and work through it, which we will.

Operator

The next question comes from Jeremy Metz with BMO. Please go ahead.

Jeremy Metz -- BMO Capital Markets -- Analyst

Hey. Thanks. I guess, I just want to go back to the Master Funding, you mentioned having well north of the 1.3 coverage here, being able to waive some fees to help avoid any of this potential cash sweep. I guess, just given the composition of the property pool that supports it, it's nearly 25% restaurants, that's a lot more than what's in the unencumbered pool, you have another 16% in retail. You outlined that collections there have been pretty low for industries like restaurants. So, I guess, just wondering what else is at your disposal here to help keep it so far above that 1.3? Is it just your ability to swap properties in? Is that something you're able to do or is that something you're considering? Any color there?

Christopher H. Volk -- President, Chief Executive Officer and Director

So, Jeremy, we don't swap properties into or out of Master Funding. So, we don't swap between the unencumbered pool and Master Funding. We can, but we don't. And as far as the coverages are concerned, one way to -- another way to get the coverage, one way is obviously the subordinate fees. And we have, by the way the BBB note interest income. So, the 1.90 coverage that people talk about is actually after paying us for our interest on the BBB notes and the fees, right? So you can basically subordinate all that stuff if you want to, right?

The other thing is that, if you take a rent deferral and you do it in the form of a note. So, if we make a note to a tenant and we do it, a rent deferral, in that fashion, then the Master Funding will look like it's been paid. I mean -- and so, there's no -- there's -- you don't get to a cash sweep at all. And so, you'll see that happen as well. So, there are number things at our disposal to be able to manage the Master Funding portfolio. And if you're an investor in that Master Funding portfolio, you actually want us to do all these things. I mean, this is not something you don't want us to do, you want us to support it. I mean, going to cash sweeps is easy, as Cathy said, I mean, if we were -- essentially, a cash sweep is only going to happen if we decide to abandon Master Funding to be -- I mean, I think it's to be sort of clear about it. I mean, if we were to say we don't really care about these assets. And then maybe you might get into a sweep but it's assuming that you really care about these assets, that the situation is temporary and these tenants are going to rebound. You're going to feel pretty good about it.

I mean, under normal circumstances, by the way, the difference between 1.90 and 1.30 is something like 45 -- 35% to 45% of your tenants have to default simultaneously, which is happening in a COVID environment, to your point, but that's like also having 80% of your tenants defaulting and having a 50% recovery rate, right? I mean, it's something that would have been really unthinkable. And it's candidly unthinkable to me that we're not going to be able to get those that 35% or 40% of our tenants to be active again because it's -- the risk isn't really a tenant risk, it's a sector risk. And I, for one, don't think that the early child education sector is not going to exist. So, hope that helps you.

Jeremy Metz -- BMO Capital Markets -- Analyst

Okay. Yeah. And then the second for us is, can you just give us your latest thinking around the dividend here just in light of what's going on, in light of some the rent collections you've noted and some of the pressures across some of these industries? Just wondering how and what the latest is there. Thanks.

Christopher H. Volk -- President, Chief Executive Officer and Director

Yeah. I mean, I think we expect to be able to answer that in June for you. I mean, I think our Board of Directors is going to evaluate the dividend closely and they're going to do what they should do. I mean, and as you're looking -- as you're in June and you have transparency on June collections. And as you've seen May and April collections, and as you -- more important than that or just as important as you can look forward and have some predictability of where you think the world is heading. Then I think boards are going to be in a very good position to make cogent and clear policy. And, of course, the stuff changes every day, as you know. So, one day things are closed, the next, things are open and so on and so forth. So, that's what's going to happen. And, of course, we're going to give you monthly calls, WebExs before the next earnings call. So, that means that you'll have an update, you should expect one in June. And so, when we do the one in June we'll be able to talk about it, dividend policy as well and then we'll have another update in July.

Operator

The next question will come from Todd Stender with Wells Fargo. Please go ahead.

Todd Stender -- Wells Fargo Securities -- Analyst

Hi, thanks. Obviously, it's very early in May, you gave us the indications for April and may be May if deteriorates, I guess, from a rent collection standpoint. Looking out, maybe it's too early, but if we're in June and heading into July, what kind of data points or indicators that we can keep an eye on for you guys that would give us an indication that you could start to reinstate guidance? Is it collections, is it having every state reopen? How do you guys look about providing visibility on guidance?

Christopher H. Volk -- President, Chief Executive Officer and Director

I think -- Todd, it's a good question. I think it's a macro issue. I think it's states being open and then knowing what's happening in the restaurant space and early child education space and the industry -- that the risk to STORE today from a deferred rent perspective, as I said before on this call, are not a -- are not tenant-specific. They tend to be much more sector-specific, right? And when you got 75% of the risk or the deferred rents tied to six sectors, then it's -- then for you, as an analyst, looking out there those six sectors are important. I mean -- and if -- and they're showing no signs of opening or if consumers are cautious or if unemployment staying super high, I mean, I think that these are all things to be worried about.

Todd Stender -- Wells Fargo Securities -- Analyst

And then when it comes to number of months, so far we're in the month -- one month, two month, three month ballpark of maybe rent deferrals. At what point, how many months you have to get to for a tenant not paying the rent before it becomes a rent default?

Christopher H. Volk -- President, Chief Executive Officer and Director

Well, rent default doesn't happen unless we actually send a default notice. So, I mean, our tenants started calling us up in mid-March. And so, we started having dialogues with our tenants. By the time April came around, we pretty much had a very clear idea before April 1 came around who was not going to pay. And there are always some people that come out of left field, but we had a pretty good idea before April 1 happened. And so, our tenants work with us partly because we have a good relationship with them, and they're -- we originated them well directly. I mean -- so I expect that if our tenants need more assistance than what we've already agreed upon, then we're going to have the exact same types of dialogues. And when you have those dialogues and you're working with a tenant and the tenant is part of the solution not part of the problem, you're going to work with them.

Operator

Thank you. And our last question today will come from John Massocca with Ladenburg Thalmann. Please go ahead.

John Massocca -- Ladenburg Thalmann & Co. -- Analyst

Good afternoon.

Mary Fedewa -- Chief Operating Officer and Director

Hey, John.

John Massocca -- Ladenburg Thalmann & Co. -- Analyst

So, what percentage of your kind of pre-COVID contractual rent kind of roughly came from leases that had some kind of modification in April? I know you gave the 68% cash payment number but I would imagine that included partial deferrals and maybe some other kinds of modification or support you provided where rent was kind of paid in April. So, I just wanted to get a general feel for how many tenants reached out to you.

Christopher H. Volk -- President, Chief Executive Officer and Director

So the 68% is cash, as a percentage of rent and income. And so, basically we were short 32% of rent collections for the month of April. We did not really disclose how many tenants actually called us up and asked for things and what the negotiation was. And I don't expect that's really right for us to give that disclosure. I mean, obviously, there's back and forth and you're working on is getting a mutually -- agreeable, mutually acceptable relationship because all this is just painful, frankly, for both -- for all of us.

John Massocca -- Ladenburg Thalmann & Co. -- Analyst

But was there any kind of significant number of modifications that didn't turn out to be kind of monetary or where it didn't really impact the cash payment in April?

Christopher H. Volk -- President, Chief Executive Officer and Director

All of the modifications that were made to leases had to do with lease deferral agreements. There was nothing that was done outside of that.

John Massocca -- Ladenburg Thalmann & Co. -- Analyst

Okay. And then just a quick one. What was -- there was a kind of -- you mentioned Art Van drove some of the elevated operating costs in 1Q, what was the other half? Was it just a broad group of things or was there any other kind of specific tenants that were maybe impacted in the quarter?

Catherine Long -- Chief Financial Officer, Executive Vice President and Treasurer

Yeah. This is Cathy. Art Van was the only one that was big enough to point out separately. The rest were just a handful of minor stuff.

John Massocca -- Ladenburg Thalmann & Co. -- Analyst

Okay. That's it from me. Thank you, guys, very much for the time.

Catherine Long -- Chief Financial Officer, Executive Vice President and Treasurer

Thank you.

Christopher H. Volk -- President, Chief Executive Officer and Director

Thanks.

Operator

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the call back over to Chris Volk for any closing remarks.

Christopher H. Volk -- President, Chief Executive Officer and Director

Well, thank you, all. And it's been a pleasure doing this Q&A and talking with you. And we look forward to talking to you again on May 27 when we do a follow-up call. Until then, have a great day.

Operator

[Operator Closing Remarks]

Duration: 64 minutes

Call participants:

Lisa Mueller -- Investor Relations

Christopher H. Volk -- President, Chief Executive Officer and Director

Mary Fedewa -- Chief Operating Officer and Director

Catherine Long -- Chief Financial Officer, Executive Vice President and Treasurer

Nathan Crossett -- Berenberg Capital Markets -- Analyst

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Robert Stevenson -- Janney Montgomery Scott LLC -- Analyst

Vikram Malhotra -- Morgan Stanley -- Analyst

Haendel St. Juste -- Mizuho Securities USA LLC -- Analyst

Shivani Sood -- Deutsche Bank -- Analyst

Jeremy Metz -- BMO Capital Markets -- Analyst

Todd Stender -- Wells Fargo Securities -- Analyst

John Massocca -- Ladenburg Thalmann & Co. -- Analyst

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