STORE Capital (STOR) Q3 2021 Earnings Call Transcript

STORE Capital (STOR)
Q3 2021 Earnings Call
Nov 04, 2021, 12:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the STORE Capital's third quarter 2021 earnings conference call and webcast. All participants will be in a listen-only mode. [Operator instructions] Please note this event is being recorded. I would not like to turn the conference over to Ms.

Megan McGrath, investor relations for STORE Capital. Please go ahead, ma'am.

Megan McGrath -- Investor Relations

Thank you, operator, and thank you all for joining us today to discuss STORE Capital's third quarter 2021 financial results. This morning 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 results quarterly results. I'm here today with Mary Fedewa, president and chief executive officer of STORE; Cathy Long, chief financial officer; Sherry Rexroad, who will become our CFO on November 8th; Craig Barnett, EVP of underwriting and portfolio management; and Tyler Maertz, EVP of acquisitions.

On today's call, management will provide prepared remarks and then we will open up the call for your questions. In order to maximize participation while keeping our calls to an hour. We will be observing a two-question limit during the Q&A portion of the call. Participants can then reenter the queue if you have follow-up questions.

Before we begin I would like to remind you that today's comments will include forward-looking statements under federal securities law. Forward-looking statements are identified by words such as will, be, intend, believe, expect, anticipate, or other comparable words and phrases. Statements that are not historical facts such as statements about our expected acquisition, dispositions, or our AFFO per share guidance for 2021 are also forward-looking statements. Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements.

Discussion of the factors that could cause or result to differ materially from these forward-looking statements are contained in our SEC filings including our reports and Form 10-K and Form 10-Q. With that, I would now like to turn the call over to Mary Fedewa, STORE's chief executive officer. Mary, please go ahead.

Mary Fedewa -- Chief Executive Officer

Thank you, Megan. Good morning, everyone, and thank you for joining us today. I'll begin the call with an overview of our third quarter performance. Craig will provide an update on what we added to the portfolio and our portfolio management activities.

And Cathy who is retiring after this, her 28th quarterly call will review our third quarter financial results. Following our prepared remarks, we will open the call to questions. As you all know Cathy and I have worked closely together for many years. So this conference call feels a bit like the end of an era.

I want to thank Cathy for her wise counsel and many contributions to STORE and especially for building an outstanding finance department. On behalf of everyone at STORE. We wish Cathy all the best in her well-deserved retirement. An ending can also signal a new beginning and I am very excited to introduce you to Sherry Rexroade who will assume the role of CFO on November 8th.

Many of you know Sherry from her successful career at BlackRock and with her strong background in finance and capital markets, she will be a great asset to our team. Sherry was also one of BlackRock's top ambassadors and promoting sustainable business practices and we look forward to her help in advancing the ESG program at STORE. As you saw in our press release we had a very busy and productive third quarter. Business is back in full swing.

We reopened our office in October and I'm very proud of our team's outstanding execution that resulted in robust acquisition volume and strong growth in our pipeline of new opportunities. We saw a significant pickup in demand for our customized net lease financing solutions, as our customers and prospects resumed growth both organically and through M&A activity. During the quarter, we acquired more than $410 million in profit center real estate at a weighted average cap rate of 7.44%. Bringing our year-to-date weighted average cap rate to 7.7%.

We also delivered an AFFO of $0.52 per share reflecting our strong revenue growth and healthy portfolio operations. We also had strong prospecting activity and our pipeline grew to $13 billion since the end of last quarter. We believe this is a direct reflection of a healthy operating environment, our unique customer value proposition, and the results of our direct relationship approach. The net lease space has continued to attract new market participants.

So we are not surprised that we saw some cap rate compression in the quarter. That said, having been in the net lease financing business for several decades I've had the benefit of operating across many economic cycles and interest rate environments. This gives me confidence that our business model positions STORE to continue to deliver above-market cap rates and importantly to continue to deliver attractive returns in today's operating environment. For example, our most recent master funding debt issuance had a weighted average coupon of 2.8% resulting in a healthy third quarter investment spread of over 4%.

Now I'd like to touch on inflation, which is a current headline macroeconomic topic. For a few key reasons, we believe STORE is well-positioned to deliver strong AFFO growth even in an inflationary environment. First, as a triple net lease rate STORE does not incur property-related operating expenses. Second, we have an average annual contractual rent escalator of nearly 2% built into our leases, which provides a natural hedge against inflation.

Third, we have flexible financing options and our existing portfolio is financed with well-laddered, fixed-rate debt, and no significant maturities until 2024. Finally, we have a strong pipeline of new opportunities and given our direct approach to acquisitions we have the flexibility to structure new lease contracts based on the current operating environment. Now turning to our recent dividend increase. On our last earnings call, I mentioned that our board would be evaluating our dividend and on a meaningful increase was likely based on our strong operational performance and positive outlook.

As expected, in September, our board approved a quarterly dividend increase of $2.5 per share, which brings our annual dividend to $1.54 per share. This represents a 6.9% increase and is the highest per share dividend increase in our history as a public company. Even with a significant increase, our dividend payout ratio remains conservative at 74% of AFFO for the quarter. Before I turn the call over to Craig, as you may have seen, S&P recently raised its outlook on STORE from stable to positive and affirmed their BBB rating.

Their report underscored the resilience of our portfolio during the pandemic and our healthy operating performance, credit metrics, and prudent financial policies. This rating validation is especially significant on the heels of a global pandemic that stress-tested our portfolio. S&P also cited other factors for raising their outlook including STORE's high occupancy and above-average embedded rent growth. As we have said before we attribute our outstanding portfolio performance during the pandemic to the strength of our customers who operate in vital industries, the size and diversity of our portfolio, and our portfolio management expertise.

With that, I'll turn the call over to Craig.

Craig Barnett -- Executive Vice President of Underwriting and Project Management

Thank you, Mary. I'll take a few minutes to cover our acquisitions and portfolio management activities for the third quarter. We originally had 412 million of acquisitions at a weighted average cap rate of 7.44 and a weighted average lease term of 16 years. This elevated level of activity was from both new and existing customers who selected STORE for our tailored financing solutions to address their capital needs.

More than half of our volume for the quarter was used to facilitate, M&A transactions, and the remainder was used for either balance sheet recapitalization or growth capital. In the quarter, about 75% of our acquisitions were from new customers highlighting not only pent-up demand in the broader economy. But also the strong new customer relationships our acquisitions team has been cultivating over the past several years. About a third of our acquisition volume each quarter is from existing customers.

Therefore each new customer represents an important source of future growth as we collaborate together to identify new opportunities for repeat engagements. Our transactions this quarter reflect our commitment to maintaining a diverse and granular portfolio, spanning a wide range of industries including restaurants, early childhood education, auto service, and food manufacturing. This quarter, the majority of our acquisitions were in the service sector consistent with our broader portfolio. Now turning to our portfolio.

Maintaining a diverse portfolio is one of the hallmarks of our business model and position STORE to deliver consistent and attractive risk-adjusted returns across all economic cycles. At quarter-end, our overall portfolio mix with 66% in the service sector, 19% in manufacturing, and 15% in service-oriented retail. Our portfolio consists of 538 national and regional customers across 2,788 properties operating in 119 industries. More than 85% of the portfolio was comprised of businesses that individually represent less than 1% of our annual base rent interest.

Taken together our top 10 customers account for only 19% of base rent interest. Overall or customers' financial performance remains strong and our portfolio continues to perform well. Our weighted average unit level fixed charge coverage ratio was 4.4 times slightly higher than last quarter. Our occupancy rate remains high at 99.4%.

Reflecting greater confidence in their near-term outlook many of our customers are focused on growing their businesses. They are seeing M&A opportunities created by valuation dislocations in their sectors and are taking advantage of opportunities to expand or vertically integrate. Our strong relationships with customers are strengthened through constant communication with them, as we review and monitor their financial health. Most recently our customers are focused on the changes in the macroeconomic environment such as labor pressures, supply chain disruptions, and inflation.

We are encouraged that they are telling us they are managing and adapting to these changes successfully. Moving on to our portfolio management activity. Dispositions are a source of operating cash flow that can be deployed toward a creative opportunity and they continue to play an important role in our portfolio management strategy. During the quarter we sold 25 properties that had an original cost of about 104 million.

This included one property we sold opportunistically for a 15% gain over cost, which equated to a gross sale cap rate of 6%. The remaining properties were sold either strategically or as part of our ongoing property management activities. The remaining 24 dispositions achieved net proceeds of 90% of our original cost. I'll now turn the call over to Cathy to discuss our financial results.

Cathy Long -- Chief Financial Officer

Thank you, Craig. I'll begin by discussing our financial results for the third quarter followed by a review of our capital markets activity and balance sheet. Then I'll provide our updated guidance for 2021 and I'll introduce our 2022 guidance. All comparisons, our year over year unless otherwise noted.

Beginning with our income statement, third-quarter revenues increased 14% from the year-ago quarter to $199 million primarily reflecting the growth in our real estate portfolio. Revenue for the third quarter of 2021 includes $1.8 million of lease termination fees collected in connection with properties we sold. Interest expense increased by $1.3 million from the year-ago quarter. Reflecting higher average debt outstanding, as well as a non-cash charge of approximately $550,000 for accelerated amortization of deferred financing costs related to the prepayment of debt in July.

Property costs totaled $4.3 million for the third quarter and $14.1 million year-to-date. Excluding amounts reimbursed by our tenants. Property costs represented about 13 basis points of our average portfolio assets during the first three quarters of the year down from 16 basis points for the same period a year ago. We expect that G&A expenses will rise in some measure as our real estate investment portfolio grows.

However, G&A expenses as a percentage of the portfolio will generally decrease somewhat over time due to efficiencies and economies of scale. Excluding the non-cash stock-based compensation and the severance expenses recognized last year, G&A expenses as a percentage of average portfolio assets were relatively flat quarter over quarter at about 43 basis points. During the third quarter, we recognized an aggregate $3.4 million impairment provision on properties that were likely to sell. This amount was more than offset by a $10.7 million gain recognized on properties sold during the quarter.

Third quarter AFFO on a per-share basis increased 13% to $0.52 diluted share from 46% a year ago. And total AFFO increased to $140 million from $119 million. The increase in AFFO primarily reflects higher revenue from our real estate portfolio growth. Now turning to the balance sheet and our capital markets activity.

We collected $8 million of rent receivables during the quarter that was originally deferred under our COVID rent relief program. As of September 30th, we had just $34 million remaining in net COVID receivables and we continue to expect the vast majority of this to be collected by the end of 2022 as scheduled. We funded our third quarter acquisitions with cash from operations, borrowings on our revolving credit facility, proceeds from dispositions of real estate, and proceeds from the sale of equity through our ATM program. During the quarter, we issued approximately 500,000 shares of common stock under our ATM program at an average price of $35 and $0.98 per share raising net equity proceeds of $19 million.

In July as planned to be prepaid without penalty $83 million in STORE master funding debt that had a coupon of 5.33%. Using proceeds from our June issuance of STORE master funding debt. This latest issuance of master funding debt bears a weighted average coupon of 2.8%. So we were able to take advantage of an opportunity to lower the cost of capital with this prepayment.

Our debt maturities are intentionally well-laddered and we have no significant maturities until 2024. Another series of master funding notes will be available for prepayment without penalty later this month. These notes bear an interest rate of 5.2% giving us another opportunity to further lower our debt costs. With the flexible prepayment windows under our master funding program, we will have the opportunity to prepay additional series during 2022 and in future years.

At September 30th, we had approximately $4 billion of long-term fixed-rate debt outstanding with a weighted average interest rate of about 4% and a weighted average maturity of about 7 years. Leverage is at the low end of our target range at 5.6 times net debt to EBITDA on a run-rate basis or around 39% on a net debt to portfolio cost basis. Approximately 63% of our gross real estate portfolio was unencumbered and the ratio of net operating income to interest expense on our unencumbered portfolio remains exceptional at more than seven times. We closed the quarter with a strong balance sheet.

We have ample access to a variety of favorably priced debt and equity options to finance our growing pipeline of acquisition opportunities at very attractive spreads. At quarter-end, we had $37 million in cash. Approximately $600 million is available under our ATM program and nearly $500 million of borrowing capacity is available under our revolving credit facility. Now turning to the guidance, we are raising our 2021 AFFO per share guidance from a range of $1.94 to $1.97 to a range of $1 98 to $2.

An increase at the midpoint of 8.7% over 2020's AFFO. We're maintaining our 2021 annual real estate acquisition volume guidance net of projected property sales at $1 billion to $1.2 billion. Based on our 2021 acquisition activity to date and the overall cap rate compression we're seeing in the net lease sector, we expect the weighted average cap rate on new acquisitions for the year to be closer to 7.5%. Finally, I'll turn to our initial guidance for 2022.

We currently anticipate 2022 AFFO per share to be within a range of $2.15 to $2.20. That represents a 9.3% increase over 2021 projected results using the guidance midpoint for both years. This AFFO guidance is based on our current projections for net real estate acquisitions for the remainder of 2021 plus projected 2022 annual real estate volume net of projected property sales of approximately $1.1 billion to $1.3 billion. Before turning the call back to Mary, I want to take a minute to thank the many investors and analysts I've met over the past seven years since STORE went public.

Your thoughtful questions and observations gave me an important perspective on what it takes to drive value for our shareholders. While it's hard to step away from decades of working side by side with many talented colleagues, I can confidently retire knowing that I'm passing the baton to Sherry Rexroad, an experienced results-oriented leader with financial foresight and a deep understanding of the REIT space. I wish her every success. And finally, I want to express my sincere thanks to Mary.

It has been a great privilege to work with you these past years in helping to build STORE into the powerhouse company it is today. And I'm proud to call you both friend and colleague. I'm confident that your strong leadership and vision combined with the talents of Sherry and our outstanding team will lead the next chapter in STORE Capital's success. With that, I'll turn the call back to Mary.

Mary Fedewa -- Chief Executive Officer

Thank you, Cathy. We are excited about the momentum in our business. Our customers are healthy and growing and so is our pipeline. Our cap rates remain at attractive levels supported by our unique business model.

Our cost of capital is low and spreads are wide allowing us to deliver excellent AFFO growth and returns. So it's a great time to be in the net lease business. Our team remains focused on executing the three-pronged growth strategy I outlined last quarter and we look forward to updating you on our progress in the coming quarters. Finally, I want to mention that plans are well underway for our sixth annual customer conference, the Inside track forum in February.

This much-anticipated event provides an opportunity for us to come together with our customers to network, share ideas, and draw inspiration from many success stories. Our customers are valued stakeholders and our conference is one of the ways we thank them for their trust and collaboration. This year we're excited for the event to be back in person. And with that, I would like to turn the call over for your questions.

Questions & Answers:

Operator

[Operator instructions] And the first question will come from Sheila McGrath with Evercore ISI. Please go ahead.

Sheila McGrath -- Evercore ISI -- Analyst

Yes. Good morning. You mentioned 16 new customer relationships. I was wondering if you could give us a little bit more detail on what type of tenants these are? And is it the result of adding new acquisition personnel or perhaps widening the funnel of types of tenants that you would consider?

Tyler Maertz

Hi, there. Yeah, this is Tyler. I'll take that one. Yes.

So first of all our Q3 volume, you have the mix of that was a craft service in manufacturing about 80% service or 20% manufacturing. And on the service side, it was in typical industries like restaurants, auto service, car washes, early childhood education, and specialty medical. Manufacturing side tends to be a wide range of industries. But in Q3 was for food processing and manufacturers of specialty medical products.

So that's kind of the span of it. And it was the result of the continued relationships that we're cultivating in the pipeline that we're --  that we have been building since the beginning of the year and prior.

Mary Fedewa -- Chief Executive Officer

We didn't get any new salespeople Sheila in this quarter.

Sheila McGrath -- Evercore ISI -- Analyst

OK. Great. And then, a question for Cathy. Congratulations Cathy and Sherry also.

But I just question you mentioned an upgrade from the rating agency to positive. If you were to get upgraded to BBB positive or plus, should -- would -- how would that impact financing cost?

Cathy Long -- Chief Financial Officer

First of all thank you, Sheila. So for financing costs, if you recall on our revolver there is an investment grade pricing grid. So if you do pop up to BBB plus that would pull your rate down a little bit on the revolver. Plus we are issuing every year debt in both the senior unsecured market as well as the ABS market and the ratings there on the senior unsecured side would certainly allow our spreads to come in and lower cost of capital keeps those spreads wide.

So even though you may see -- you may have seen cap rate compression this quarter being able to lower our cost to capital maintains the spreads. And we put a chart in fact in our deck this quarter on Page 10 that talks about how spreads have been able to maintain over all the many years we've been in this business. So that's kind of how we think about it.

Sheila McGrath -- Evercore ISI -- Analyst

That's great. Thank you.

Operator

The next question will come from Caitlin Burrows with Goldman Sachs. Please go ahead.

Caitlin Burrows -- Goldman Sachs -- Analyst

Hi team and yes, congrats, Cathy, and welcome Sherri. Maybe we'll start with Mary earlier this year you mentioned the possibility of doing larger deals in the future, but looking at the '21 net acquisition guidance in the 2022 guide. It looks like the acquisition guidance does not assume meaningfully higher volumes next year or maybe even a deceleration. So just wondering if you could discuss your pipeline today and also whether there's anything different about its composition versus maybe a normal pre-COVID time.

Mary Fedewa -- Chief Executive Officer

Yeah. You bet, Caitlin. So I would say that actually when we get guidance for volume for 2021 this year last November. We actually came out really with 2019 sorts of guidance and that included acceleration throughout the year and we're on track to achieve that.

We have -- I talked a lot about the three-pronged approach and years specifically probably talking about the portfolios, although we've been active in evaluating a couple of portfolios is nothing really to report right now. We're not in any hurry. We're going to be selective and we're going to continue to look at things. But you're correct the 2022 guidance does not specifically include any portfolio acquisitions.

Caitlin Burrows -- Goldman Sachs -- Analyst

OK. Got it. And then Cathy mentioned that you have master funding available to prepay and 4Q. So just wondering if you were to move forward with prepaying that and or other debt in '22.

What do you think it could be replaced with. Would that be new master funding unsecured, some of both?

Mary Fedewa -- Chief Executive Officer

Could be both. We are committed to both markets. So on the master funding side, as you recall, we can issue AAA debt on that side and the pricing there is usually quite tight. And then in the senior unsecured market, we are still seeing attractive rates.

If we were to issue debt today on a 10-year basis you could be talking 125 basis points over the 10 years so still a sub-three rate.

Caitlin Burrows -- Goldman Sachs -- Analyst

Got it. Thank you.

Operator

The next question will come from Todd Thomas with KeyBanc Capital Markets. Please go ahead.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Hi. Thanks. Good morning out there. Cathy, best of luck in retirement and congratulations Sherry.

First question, just about the investment yields and the cap rates that you discussed that came in a little bit in the quarter at 7.4%. It sounds like you're anticipating that yield to compress a little bit further in the fourth quarter based on the full-year cap rate expectation. Is that right? And then can you speak to what we should expect in terms of investment yields moving forward in '22 and what's embedded in the guidance?

Mary Fedewa -- Chief Executive Officer

So this is Mary. I'll start, Todd. First of all, yes, you're correct. We've seen some -- Cathy just mentioned some initial pressure -- pressure on our initial cap rates.

But as Cathy mentioned, we worked really hard to reduce our weighted average cost of capital and our spreads have actually widened. So -- and we would also encourage you, I would encourage you to you to look at Page 10 in the corporate presentation. We are expecting that cap rates may compress a little bit more in the fourth quarter and maybe even early into 2022. Although I would say that's a concern and a general consensus out in the marketplace from our perspective on what we're out the front lines are telling us our front line is telling us is that we could be seen the bottom of our cap rate compression right now the cost of capital is at an all-time low and more or less that is probably the lowest cap the interest rate could go that would make sense for most buyers.

So we think that we'll see a little bit more, you're correct, but we could be getting toward the bottom as Cathy guided. We guided to 750 for 2021 and maybe in that range 2022 -- as the '22 that guidance as well.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

OK. Great. And then in terms of the guidance for '21, which was revised higher and thinking about '22. So year-to-date AFFO you're at $1.49 that implies $0.50 in the fourth quarter at the midpoint so a $0.2 decrease from the third quarter.

I realize there was about a half a penny or so at least term fee income realized in the quarter, but can you just provide some detail around the drivers of the sequential decrease before revamping to I guess $0.54 per quarter in '22?

Cathy Long -- Chief Financial Officer

It's Cathy. So fourth quarter sometimes you have seasonality and expenses. So that could take up a little bit in the fourth quarter. So that be part of it.

Also, fourth quarter volume, as you remember, gosh, at year-end. Everybody wants to close deals on the last minute year-end and so the revenue impact that you have at fourth quarter acquisitions is generally very small in the fourth quarter. It will provide a lot of boost into 2022, but we won't read a lot of revenue generally in the fourth quarter from fourth quarter acquisitions just because year-end is when people sort of look at doing real estate transactions whether they're tax-motivated or M&A motivated. And so, I think that's part of what you're going to see is not having that necessarily big revenue lift timing-wise.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

OK. All right. That's helpful. Thank you.

Cathy Long -- Chief Financial Officer

Yeah.

Operator

The next question will come from Ki Bin Kim with Truist. Please go ahead.

Ki Bin Kim -- Truist Securities -- Analyst

Thank you and congratulations, Cathy. 

Cathy Long -- Chief Financial Officer

Thank you.

Ki Bin Kim -- Truist Securities -- Analyst

Just a quick question. You're welcome. So a quick question on your fixed charge coverage ratio. I noticed that you got an improvement on the average fixed charge coverage ratio, but the median stayed the same.

Can you just help me understand what's driving those two differences?

Craig Barnett -- Executive Vice President of Underwriting and Project Management

Are you speaking of the weighted average in the median?

Ki Bin Kim -- Truist Securities -- Analyst

Yeah. You're -- that's right. The median fixed charge coverage ratio was a flat quarter over quarter. Your average increased, just I understand what's happening there.

Tyler Maertz

Yeah. So the calculation on the median -- it's a median. So that pretty much stayed the same. When you think about quarter-to-quarter.

The weighted average is just a function of -- just our coverages with some larger investments pulling that up. So it's a weighted average.

Ki Bin Kim -- Truist Securities -- Analyst

Right. But I guess what I'm getting to is that was there a certain group of tenants is doing better. That's driving the weighted average higher, but the median being flat.

Craig Barnett -- Executive Vice President of Underwriting and Project Management

Right. OK. So in regards to just the composition or the industries that might be pulling that up, I mean it -- our tenants are really in very good financial health. They have a strong balance sheet.

They've adjusted their operation. So they're reducing expenses by introducing technology and automation. So overall coverages are improving across the board. So there's always a wide dispersion across industries.

Movie theaters are continuing to lag. But we are seeing a lot of improvement in industries like pet care, especially medical, restaurants. So those are kind of dragging or pulling the coverages up.

Ki Bin Kim -- Truist Securities -- Analyst

OK. And just a question on guidance. Your 2022 guidance was fairly above consensus numbers and I don't pretend to know, but everyone who our models. But given your commentary about net acquisition volume being pretty similar to 2021 and cap rate compression.

I'm just curious, what are the -- is it interest expenses that you're assuming that you're going to save some money on, or whether are there any other line items that we should just be aware of?

Cathy Long -- Chief Financial Officer

Sure. Yes, that is true. We are going to reap the benefits of lowering our cost to capital because we were able to do that starting mid-year this year. And so we didn't really get a full year's worth of the lower interest rates and we're talking quite a bit lower, right.

Because the master funding transactions that were done many years ago were at greater than 5% interest rates and we've replaced that with interest rates that are sub-3%. So that impact is quite large and you'll get a full year of that impact next year, as well as just earlier this year we had thought that coming out of the pandemic, we would have a lift in the second half of the year. And then last quarter we had talked about seeing the lift a little faster than we expected to. But we're still getting a lift in the second half of the year from people for example who were paying a percentage of their sales while their sales have increased quite a bit.

And so you're getting higher rents. We were able to move more people off of cash basis accounting. So whereas last quarter, it was about 4% of our annualized base written rent and interest are now under 2.5%. That would set out the cash basis group.

So you're seeing all of those lifts that we were expecting happening and that's going to push into 2022 and as well as that all give you a growing free cash flow after dividends. And remember with a payout ratio right now that's 74%, but that will trend lower as we go along. All that excess cash flow is being able to be reinvested in new properties for internal growth. And so you're not having to raise as much equity as by having stronger free cash flows.

So that provides an additional boost to AFFO. Does that help?

Ki Bin Kim -- Truist Securities -- Analyst

Yeah. That's helpful. Thank you. And just a quick one here.

Are you -- how much equity are you assuming in your 2022 guidance?

Cathy Long -- Chief Financial Officer

We're keeping the same leverage target. So as a reminder we do fund debt to EBITDA at five and a half to six times in that range and we're going to continue to do that. But remember a big part of what you do you're using debt financing and that free cash flow, which is reducing how much equity you need.

Ki Bin Kim -- Truist Securities -- Analyst

OK. Thank you. 

Cathy Long -- Chief Financial Officer

Yup.

Operator

The next question will come from Ronald Kamdem with Morgan Stanley. Please go ahead.

Ronald Kamdem -- Morgan Stanley -- Analyst

Thanks and congrats, Cathy, and Sherry. Appreciate providing the guidance, which is just great transparency. Just sticking on that line of questioning, your mind is -- what you're assuming or where does 2022 assume for bad debt may be relative to 2021 and also maybe relative to the pre-COVID?. Thanks.

Mary Fedewa -- Chief Executive Officer

We are pretty much at pre-COVID levels now. So if you would look at cash collections and things like that where we're back to pre-COVID levels. So we're probably looking at maybe 1.5% today that we're not reporting revenue on. People who are in process of being relet or things like that and that will probably come down some.

So that so you could think about it that way.

Ronald Kamdem -- Morgan Stanley -- Analyst

Got it. So 1.5% is sort of a right ballpark.

Mary Fedewa -- Chief Executive Officer

Or less.

Ronald Kamdem -- Morgan Stanley -- Analyst

Or less. Got it. And then just switching gears a little bit. Just the pipeline obviously grew.

Just we're looking for more color on that. Is that strictly because of the new tenant relationships and adding some of their some of the opportunities there? Is there any specific sectors or industries that we can call? Just any color on a pipeline that hit $13 billion this quarter? Thanks.

Tyler Maertz

Sure. Yeah. Hey, this is Tyler. So yeah, so generally, I'd say the pipeline is an evolving thing.

It's a result of our acquisitions team out there kind of cultivating relationships and all of the industries that we address. Generally, the composition it's consistent with where it's been in terms of industry composition. There was an uptick in that in the family entertainment industry in particular. But overall that's consistent with the businesses.

Returning to growth due to business reopening and pursuing M&A opportunities. So it's really just continued like now business is back, as Mary mentioned and in the pipeline as dynamic, our acquisition teams as always out there cultivating those relationships and fluctuations can be driven by timing not necessarily because of anything beyond that. But it's really just that our teams out there trying to find opportunities for us to pursue.

Ronald Kamdem -- Morgan Stanley -- Analyst

Right. And then last one for me if I may. And it's a small one. Just the equity and income that came in through the quarter.

I think you guys have taken equity in a bit in a tenant maybe can you just remind us of what that is that came in through the quarter and how we should think about that?

Mary Fedewa -- Chief Executive Officer

Sure. I believe you're talking about the equity investment that we got. Like it was last year, wasn't it? So what that is. We have a mortgage outstanding with a tenant and was able to as additional collateral basically for that mortgage we were able to get an equity interest in an affiliate of theirs that is in the amusement industry or water parks and things like that.

We value it last year based on discounted cash flows and things like that. It was about $3.5million of value that we put on our books as an asset. We're maintaining that now on equity method accounting. At the end of last year, they had some small losses and we picked up our share of those losses, but this year they are actually ahead of budget and are reporting income and we're picking up our share of income.

We did see a small amount of cash distribution during the quarter, but it was only a couple hundred thousand. So we didn't really mention it but that appears to be doing really well. We did not include that by the way, in AFFO that's -- we just subtract that from AFFO.

Operator

The next question will come from John Massocca with Ladenburg Thalmann. Please go ahead. 

John Massocca -- Ladenburg Thalmann and Company Inc. -- Analyst

Good morning.

Mary Fedewa -- Chief Executive Officer

Hey, John.

John Massocca -- Ladenburg Thalmann and Company Inc. -- Analyst

First off, congratulations, Cathy. And congratulations, Sherry. It is the first question, on the guidance should we assume disposition activity is going to kind of run in about that 25% of investment volume, or is there acquisition volume? That it kind of passed historically? Or could there be some variation from that as we look out to 2022? 

Cathy Long -- Chief Financial Officer

It's Cathy. So baked into guidance how we think about it is looking at the beginning balance of the portfolio and then assuming anywhere from 3% to 5% of that would be the amount we would dispose of in any year. 

John Massocca -- Ladenburg Thalmann and Company Inc. -- Analyst

OK. But so it's not really going to be related to the actual deal volume or just the inflation?

Cathy Long -- Chief Financial Officer

That's correct. That's correct.

John Massocca -- Ladenburg Thalmann and Company Inc. -- Analyst

And in terms of pipeline, it was kind of notable. Obviously, there's a movement within the pipeline every quarter, but entertainment releasing the jump up as a percentage of the pipeline. Can you remind us maybe what type of assets is in that bucket? And then also just any color as to why it's moved up is it just timing of deals hitting or is it just more activity in that industry? Just any color there would be helpful.

Mary Fedewa -- Chief Executive Officer

Hey, John, it's Mary, I'll just touch on that briefly. So, as Tyler mentioned, it's really the result of coming out of COVID and these industries this one, in particular, that is now looking to grow and do some M&A activities. And it can be things like adventure parks, or laser tag places, or worldly ball, or other things along that line with family go families go and have a lot of activity. That's really the type of asset class it is, in particular.

John Massocca -- Ladenburg Thalmann and Company Inc. -- Analyst

OK. Just one quick one, sorry, to tack on, but is that a competitive cap rate environment right now? Or is it potential maybe get some outside yield in that particular 10-year industry?

Mary Fedewa -- Chief Executive Officer

It's in line with what's happening with cap rates today. So I would say it's not anything outside of the normal range that we're seeing.

John Massocca -- Ladenburg Thalmann and Company Inc. -- Analyst

OK. That's it for me. Thank you all very much.

Mary Fedewa -- Chief Executive Officer

Thank you.

Operator

The next question will come from Linda Tsai with Jefferies. Please go ahead.

Linda Tsai -- Jefferies -- Analyst

Hi. Congratulations to you, Cathy, and then also to you, Sherry. In terms of the $8 million receivables collected as of September 30th. You mentioned you have $34 million remaining and the vast majority will be collected by the end of 2022.

How should we think about the remaining amount coming online? Is it pretty evenly until the end of next year?

Cathy Long -- Chief Financial Officer

Yes, I think so because most of the tenants are on a payment schedule that we try to spread the amount that they owe fairly evenly over a time period. So, yes, I think if you kind of bake that in that's probably fair.

Linda Tsai -- Jefferies -- Analyst

Thanks. And then, you've had success in writing in rent escalators 1.8% this quarter 1.9% last quarter. How easy or difficult is it to get this from your tenants right now when they're also experiencing an inflationary environment and wage increases?

Mary Fedewa -- Chief Executive Officer

This is Mary. We've actually been able to get you to know the rent increases. We haven't seen any difference or any change in that. So we'll continue to get what the market will bear and its escalations with our direct approach and asking for those rent escalations.

And as it relates to the labor and inflationary prices I could have Craig comment out a bit on that for you, which I think you might find interesting as we talked to our tenants.

Craig Barnett -- Executive Vice President of Underwriting and Project Management

Sure. Yes. So the overwhelming sentiment based on our conversations with our tenancies, they're managing and adapting and demand actually remains very strong. And it's driving businesses across all of our industries.

From a labor pressure perspective, I think everyone is doing more with less automation is a key capital investment today in the restaurant space. There's a movement obviously for ordering online and to go pick up. I'm sure able to do more or less with there and that's very profitable for our restaurants. Reduced menu sizes.

So there they're managing and adapting from a labor perspective from specialized labor. Our customers are telling us they're tapping employment pipelines early. They're establishing relationships with secondary or trade schools and everyone's looking to create incentive programs to obviously retain labor. From a supply chain perspective where they're procuring alternate sources of possible adapting to more efficient manufacturing processes to -- for their current capacity and for example from furniture retailers, we're hearing that their procurement practices or they're switching to procurement practices.

What is shown in the showroom is immediately available. Instead of taking special orders. So they're winning businesses by having less lead time. And then just from an inflationary, to your question, a lot of our customers are able to pass on these inflationary increases to their customers and actually, some of them are realizing they have more pricing power than they actually realized and ending up very much more profitable in that case.

So hopefully that kind of gives you some color on that.

Operator

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

Haendel St. Juste -- Mizuho Securities -- Analyst

Good morning. Cathy, it's been a pleasure. Best of luck to you in the next adventures and Shery welcome. 

Cathy Long -- Chief Financial Officer

Thank you.

Haendel St. Juste -- Mizuho Securities -- Analyst

So my question is I guess on recovery rates on the fourth quarter dispositions Can you talk about what they were and how they compare historically.

Craig Barnett -- Executive Vice President of Underwriting and Project Management

So for most -- from the strategic and property manager perspective, we almost broke even at cost. And that actually includes some vacant. And so now we can actually go and reinvest those funds and that is well above our historical recovery. And then as you saw we meet 15% over cost on our one opportunistic sale.

Haendel St. Juste -- Mizuho Securities -- Analyst

Got it. OK. Thank you for that. On the impairments in the quarter.

Lots of talk about cap rate compression. I guess I'm curious, why impairments now and maybe, which tenants or property types they're tied to. Thanks.

Cathy Long -- Chief Financial Officer

It's Cathy. So the impairments were generally in the restaurant sector and those are properties we're likely to sell. So normally they're not impaired if you want to spend the time to relet properties, but you have to do the analysis to say, are we better off holding on to the property and bearing some cost on property taxes and things like that. Or are we better to sell the property at a slight loss and then reinvest it in a new property and get revenue right away? And so when you make that analysis on occasion there are some restaurant properties you just want to sell.

And so we took the impairment on those. Does that help?

Haendel St. Juste -- Mizuho Securities -- Analyst

I appreciate the comments there. Last one is on the cap rate compression story we've heard all around us and in the quarter here from your -- you and your peers. I guess I was on the impression I was a bit more Q4 larger deal and better credit I guess. So I guess I'm curious if you think anyone enters your sandbox? I thought there was a bit more of an insulation from competition given what you guys are doing versus some of your peers?

Mary Fedewa -- Chief Executive Officer

Yeah, this is Mary. You're correct. I think on larger deals we're probably seeing a little bit more compression and we're seeing quite a bit of compression in the manufacturing space. So we're still able to originate -- it's that year seven and a half and we're pleased with that.

Haendel St. Juste -- Mizuho Securities -- Analyst

And new competition I guess that's both on the largest side, but also how about on the direct side where you normally your bread and butter going directed to the tenant?

Mary Fedewa -- Chief Executive Officer

Haendel, there's been across space. There's been a lot of new entrants into the space. I would say, and that obviously, it's driven by a low-interest rate environment. And it's just a good place to fight to have yield.

But we do have the niche. We have the average deal size of nine to $10 million and we find ourselves in it, in a nice place there to continue to grow fully, and we don't see as much competition there. That's correct.

Operator

The next question will come from Nate Crossett with Berenberg. Please go ahead.

Nate Crossett -- Berenberg Bank -- Analyst

Hey. Good morning. Question on funding sources for '22 maybe you can just remind us the mix that you target for Master funding versus unsecured. And then I was just wondering if you've ever priced out preferred equity and what that might look like? I think one of your peers did their first preferred offering this quarter and I was just curious if that was something you've ever considered.

Cathy Long -- Chief Financial Officer

Yes, it's Cathy. So we haven't done any preferred equity-to-date, but we do always evaluate any opportunity and strive to get the most flexible and efficient capital stack that we can. So it's not as though we would rule that out. When we're looking at master funding versus doing a senior unsecured deal.

We're committed to both markets so chances are we would do one of each during a year, in particular, because master funding has the ability to have prepayments without penalty when you have some more tranches coming up that are going to be at higher interest rates. We will take advantage of that and likely just refinance that with new master funding get at a lower price and then fill in the rest of the debt stack with the senior unsecured market, which has been a very robust market with attractive rates. If that helps?

Nate Crossett -- Berenberg Bank -- Analyst

Yeah. That's helpful. Thank you. And then I just had one on, maybe you can just remind us of your tolerance of tenant concentrations.

I think you have a new top tenant this quarter. Maybe just how do you balance those concentrations versus opportunities with those tenants like LVMH, or Spring, or Cadence?

Mary Fedewa -- Chief Executive Officer

Yeah. Hey, Nate, it's Mary.  So you're right we have a new top tenant US LVMH and they actually acquired one of our customers that we had already here at the STORE, which pops them up to the top there. So we're going to stay disciplined at around 3% of ABR and we'll end -- battle -- will -- we can manage that by -- we might be buying, maybe selling some stuff, or maybe as we grow the portfolio will grow into a little bit. And so on.

So that tends to work itself out right around 3%.

Operator

The next question will come from Sheila McGrath with Evercore ISI. Please go ahead.

Sheila McGrath -- Evercore ISI -- Analyst

I guess one last one for me. Cathy, I apologize if you already said this but on the deferred COVID like paybacks of $34 million. Can you remind us how that all flows through FFO or AFFO next year?

Cathy Long -- Chief Financial Officer

Yes, It does not flow through AFFO. So what we did was we were reporting revenue and eat whether it was receivable or in cash. We were reporting the revenue. We didn't think it was collectible.

We didn't report the revenue at all. So if we were reporting the revenue it was in an AFFO. So that is just not a boost to AFFO. 

Sheila McGrath -- Evercore ISI -- Analyst

OK. Thank you.

Cathy Long -- Chief Financial Officer

Yeah.

Operator

This concludes our question and answers session. I would like to turn the conference back over to Ms. Mary Fedewa for any closing remarks. Please go ahead 

Mary Fedewa -- Chief Executive Officer

Thank you, and thank you all for participating in our call today and for your continued support and interest in STORE. We look forward to seeing some of you at NAREIT next week. Please feel free to reach out to us if you have any additional questions and have a great day.

Operator

[Operator signoff]

Duration: 60 minutes

Call participants:

Megan McGrath -- Investor Relations

Mary Fedewa -- Chief Executive Officer

Craig Barnett -- Executive Vice President of Underwriting and Project Management

Cathy Long -- Chief Financial Officer

Sheila McGrath -- Evercore ISI -- Analyst

Tyler Maertz

Caitlin Burrows -- Goldman Sachs -- Analyst

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Ki Bin Kim -- Truist Securities -- Analyst

Ronald Kamdem -- Morgan Stanley -- Analyst

John Massocca -- Ladenburg Thalmann and Company Inc. -- Analyst

Linda Tsai -- Jefferies -- Analyst

Haendel St. Juste -- Mizuho Securities -- Analyst

Nate Crossett -- Berenberg Bank -- Analyst

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