NetSTREIT Corp. (NTST) Q2 2022 Earnings Call Transcript

NetSTREIT Corp. (NTST -0.06%)
Q2 2022 Earnings Call
Jul 29, 2022, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the NETSTREIT Corp. second quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

[Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Cathy Corbullek, investor relations. Thank you, Cathy. You may begin.

Unknown speaker

We thank you for joining us for NETSTREIT's second quarter 2022 earnings conference call. In addition to the press release distributed yesterday, after market close, we posted a supplemental package and an updated investor presentation. Both can be found in the Investor Relations section of the company's website at www.netstreit.com. On today's call, management's remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. For more information about these risk factors, we encourage you to review our Form 10-K for the year ended December 31, 2021, and our other SEC filings. All forward-looking statements are made as of the date hereof, and NETSTREIT assumes no obligation to update any forward-looking statements in the future. In addition, certain financial information presenting on this call includes non-GAAP financial measures.

Please refer to our earnings release and supplemental package for definitions, GAAP reconciliations, and an explanation of why we believe such non-GAAP financial measures are useful to investors. Today's conference call is hosted by NETSTREIT's chief executive officer, Mark Manheimer; and chief financial officer, Andy Blocher. They will make some prepared remarks, and then we will open the call for your questions. Now I'll turn the call over to Mark.

Mark?

Mark Manheimer -- Chief Executive Officer

Good morning, everyone, and welcome to our second quarter 2022 earnings conference call. Before I discuss our investment activity for the quarter, I want to take a moment and say how pleased I am with the team's ability to consistently source attractive investment opportunities at strong yields and continue to be nimble and creative in a dynamic market. We have a unique and proven strategy and our performance demonstrates our continued ability to execute and drive strong and steady results. With that, I am pleased to report that we completed $122.7 million of net investment activity for the quarter.

In a market that is evolving rapidly with higher interest rates and macroeconomic uncertainty, we have remained disciplined and selective with opportunities with the opportunities we pursue. As we started to see changes in the acquisitions market, we pivoted to higher quality and better-priced acquisitions, as shown by the higher yield for the quarter, which resulted in approximately $375,000 in dead deal cost in the quarter. We believe this was the right strategy as there was a clear economic benefit to being nimble in an evolving market. Since our IPO less than two years ago, we have more than doubled our portfolio size from 163 properties to 381 properties, our ABR from $34.5 million to $84.2 million, and enhanced our diversification metrics, while maintaining the highest credit quality and stable portfolio in the net lease space increasing investment grade and investment-grade profile tenancy about 900 basis points to 81%.

Our portfolio is largely made up of tenants in the necessity, discount, and service industries, all of which are well insulated from recessionary and/or inflationary pressures. Despite uncertainty in the current economic environment, we believe that the defensive nature of our portfolio will allow us to continue to outperform as we did during the COVID pandemic, where we were the only public net lease retail REIT to collect 100% of our pre-COVID rents. In addition, we have a strong balance sheet with ample flexibility and liquidity to meet our investment goals for the year. Now turning to our investment activities for the second quarter.

We acquired 22 properties for $117 million at a weighted average initial cash capitalization rate of 6.7% with a weighted average lease term of 10.9 years. It is important to note that our second quarter acquisitions were on average at a higher going-in cap rate, better credit and with longer lease terms than prior quarters, which really demonstrates the strength of our team and ability to adapt and source high-quality opportunities in an evolving market. Rent commenced on three development projects that had total cost of $9.8 million at a weighted average investment yield of 6.5% and a lease term of 10.3 years. During the quarter, we entered into a $6 million convertible loan with a 12-month term at an interest rate of 6.5%.

We expect this loan to be converted into fee simple ownership of two properties by the end of 2022. And with a cash cap rate in line with the current interest rate. Additionally, we sold a Kohl's for $9.9 million at a 6% cap rate, and we terminated a lease with a small auto parts retail store and sold the property. We expect to collect the remaining lease payments in a lump sum, which should result in a small gain in a future period.

Finally, we provided $4.6 million of funding to support ongoing development projects. At quarter end, we had six projects under development where we had invested $12.8 million to date. You'll notice that our development activity is down from prior quarters due to recent completions, and we have taken a more cautious approach as we expect a more challenging environment for developers to perform within their previously negotiated construction budgets with tenants, given rising construction costs, rising labor costs and economic uncertainty. At quarter end, our portfolio was comprised of 31 properties with 75 tenants contributing approximately $84.2 million of annualized base rent.

The portfolio had a weighted average lease term remaining of nine and a half years with 81% of ABR represented by tenants with investment-grade ratings or investment-grade profiles and the portfolio remains 100% occupied. We added four new tenants in the quarter, which include a sprouts grocery store with solar panels on its roof, augmenting our ESG efforts, an Ulta store, a MOS restaurant, and an NTB automotive service store. Subsequent to quarter end, we acquired seven properties for $45.4 million, including closing costs. With the recent acquisitions, we have completed $304 million in net investment activity year to date which is over 60% of our full year $500 million targeted net investment activity.

This level of activity is a testament to the experienced team we have in place and our focus to grow the portfolio with high-quality tenants. We believe we are well positioned to maintain our momentum for the remainder of the year and beyond. With that, I'll turn the call over to Andy to go over our second quarter financial results and 2022 guidance.

Andy Blocher -- Chief Financial Officer

Thank you, Mark, and once again, thank you all for joining us on today's call. In our earnings release published yesterday after market close, we reported net income of $0.04, core FFO of $0.26, and AFFO of $0.28 per diluted share for the second quarter. The portfolio's annualized base rent grew to over $84 million in the second quarter, up 52% from June 30, 2021, driven by 114 acquisitions, seven developments, and two mortgage loan receivables since the end of the prior-year second quarter. Interest expense increased $600,000 to $1.5 million from $900,000 in second quarter 2021, due principally to our higher average balance outstanding on the revolver and increased base rates compared to second quarter 2021.

G&A increased to $4.9 million in the second quarter compared to $4 million from second quarter 2021, primarily due to an increase in the number of employees from 24 to 30 to support our growing portfolio. In addition, as Mark referenced, we had approximately $375,000 of dead deal costs in the quarter, but we do not expect this increased level of dead deal costs in the future quarters. Turning to our balance sheet. At quarter end, we had over $39 million in escrow to facilitate acquisitions that closed on July 1, and total debt of $412 million outstanding, of which $175 million is from our fully hedged term loan with the remaining balance from our revolving line of credit.

We launched a recast of our credit facility on July 11 to expand our revolver from $250 million to $400 million and to add a $200 million long five-year term loan to our debt structure. The new term loan is expected to be freely prepayable at any time, providing optionality to access the private placement market or to seek other capital markets alternatives for refinancing if we see attractive longer-term opportunities. The $600 million recast is already fully committed and is expected to close in mid-August, at which time our liquidity will increase by $350 million. We intend to leave our existing $175 million term loan outstanding, which has a fixed all-in rate of 1.36% and matures in December of 2024.

On June 23, we settled 2.4 million shares, receiving net proceeds of $50 million under our forward sales agreement associated with our January offering. We have until January 10, 2023, to settle the remaining 4.5 million shares associated with our forward sales agreement. During the quarter, we did not make any sales under our ATM program. At June 30, 2022, our net debt to annualized adjusted EBITDA ratio was 3.7 times after giving consideration to the remaining shares outstanding under the forward sales agreement from our January offering, well below our target range of four and a half times to five and a half times.

With regard to our dividend earlier this week, the Board declared a $0.20 regular quarterly cash dividend to be payable on September 15, to shareholders of record as of September 1. Our payout ratio for the quarter was 71%. For 2022 AFFO per share guidance, we are maintaining our previous guidance range at $1.14 to $1.17, but due to market volatility have widened some of the expectations in our underlying assumptions. Our guidance includes the following assumptions: Investment activity in the year, including developments where rent has commenced and mortgage loan receivables net of dispositions to remain at least $500 million.

Cash G&A is expected to remain in the range of $14.5 million to $15 million, which is inclusive of transaction costs. Noncash compensation expense is expected to remain in the range of $5 million to $5.5 million. Due to a combination of increased borrowings and a significant increase in the forward curve since we most recently provided guidance, our cash interest expense expectations have been increased and widened from our previously stated $5.5 million to $6.5 million, to $7 million to $9 million. Noncash deferred financing fee amortization, which is not included in our cash interest expense, is increased from $600,000 to the range of $800,000 to $900,000 to reflect the pending credit facility recast.

And lastly, a decrease to full year 2022 diluted weighted average shares outstanding, which includes the impact of OP units, from our previously stated 52 million to 54 million shares to now be in the range of 50 million to 52 million shares as a result of higher projected debt balances for the remainder of 2022. These changes will not impact our targeted leverage as we continue to expect our net debt-to-EBITDA to be between four and a half to five and a half times. To wrap up, we're confident in the ability of our portfolio to offer stable and predictable cash flow during a time of economic uncertainty, and we appreciate the support of our bank group as we finalized our largest round of debt financing. During our tenure as a public company, we have demonstrated our ability to execute and build our best-in-class portfolio.

Our team remains focused and diligent as we look forward to meeting our investment goals for the remainder of the year. With that, we will now open the line for questions. Operator?

Questions & Answers:

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator instructions] One moment, please, while we poll for questions. Thank you.

Our first question is from Todd Thomas with KeyBanc Capital Markets. Please proceed with your question.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Hi. Good morning. First question, in terms of funding investments throughout the balance of the year, you have the remaining shares to settle from the forward equity in January. And Andy, you just discussed a little bit of the -- in the revised guidance, the -- your expectation for the weighted average shares.

But I was just wondering if you could just talk about plans to permanently finance the line balance from here and also discuss thoughts on raising equity capital in the back half of the year as you look toward the $500 million net investment guidance that you maintained?

Andy Blocher -- Chief Financial Officer

Yeah. Thanks, Todd. Yeah. So, from our perspective, look, we're taking a big step by funding line balance with the recast that we just talked about.

It's a $600 million recast where we stand right now, we've got about $900 million of current in-place commitments. We're waiting on another $170 million more. We'd anticipate that that would close in the next couple of weeks but it is fully committed. That's like I said, it's a long five years, a new long five-year term loan that goes along with the existing term loans that comes to maturity at the end of 2024.

So we feel like from a debt perspective, we're pretty locked up and we're adding -- as I said in my remarks, we're adding another $350 million worth of debt liquidity to the balance sheet. On the equity side, yes, we've got $95 million roughly of equity that remains undrawn under the forward from a -- on the leverage and lowering the share count expectation, the real key there is we just wanted to get greater certainty on the debt financing before we decided to be more efficient on the funding mix, right? So, if you recall, we started off the year, we were talking about a private placement, the private placement market closed very, very quickly. That's when we move to the debt market, and we're really thankful for the support that we have. We still have access to -- I think it's roughly $160 million worth of equity through the ATM and just feel very confident with where we stand as we look out at the opportunity set that Mark and his team is looking at on the asset side.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

OK. Does the current budget have any additional equity capital being raised throughout the balance of the year? It looks like you'd be in sort of the high five times range on a net debt-to-EBITDA basis, pro forma the remaining $250 million of acquisitions or so. You mentioned the four and a half to five and a half times target leverage level. I realized you've been below that by a wide margin for many quarters and it may bounce around a little bit above that in the near term.

But where would you expect to be at year-end?

Andy Blocher -- Chief Financial Officer

Yeah. I mean I would think that we'd probably be a more efficient leverage probably around five. And like I said, we're never going to talk about specifically a -- the specific methods that we have available to us. But we have not been active on the ATM and we do have that as a tool at our disposal to take advantage on a go-forward basis.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

OK. And then in terms of asset pricing and acquisition cap rates, I was just curious if you could talk about pricing trends whether you are seeing cap rates widen a bit as buyers and sellers begin to adjust the higher interest rate environment and sort of what you're seeing in the pipeline today?

Mark Manheimer -- Chief Executive Officer

Yeah, absolutely. So yeah, I mean, you saw a pretty big pivot from us early on in the quarter, which resulted in a little bit of dead deal costs, which we always like to try to avoid, but the increase in pricing with just the -- a lot of the typical buyers falling out of the market. I think a lot of the 1031 buyers that use leverage, the ones that were locked in an exchange needed to close on those transactions. But once those kind of really flowed through the market, we've really seen less activity with 1031 buyers.

They're still there, but any of them that use a decent amount of leverage are not going to be -- we don't anticipate being as active. And then certainly, the larger private equity firms that are using a lot of leverage are more or less completely out of the market. And so we pivoted during the quarter, and I think it shouldn't be lost on everybody that not only did we get a 6.7% cash cap rate on acquisitions. But then when you look at the quality of what we acquired during the quarter from a credit standpoint, weighted average lease term, et cetera, we are really excited about the opportunities that we saw during the quarter, which is why we pivoted.

And so certainly, in my view, our highest quality portfolio acquisitions during the quarter. So, we hope that continues to be the case. But I think certainly, we've seen in the neighborhood of 25 basis points on average increase in the areas that we're looking for.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

OK. Great. And one last one. Andy, if I could just go back to the recast and the term loan.

Is the term loan fixed or variable? And do you plan to put hedges in place?

Andy Blocher -- Chief Financial Officer

Yeah. I mean, so that's -- when we talk about the interest expense guidance expectations, the SOFR -- the forward SOFR curve has just been like literally all over the place, right? We had shown our rate to our Board recently and the current market is well inside of that. So, we're going to evaluate. I think our thought at this point is while it has a delayed draw feature, we would likely fully draw it down at closing.

And then the question is going to be what does the forward curve look like at that point? And how do we think about fixing that in either in full or in part based on market conditions at that point in time? But like with the Fed increase in rates by 75 basis points, with the GDP read yesterday, as they said you've seen a little bit better forward curve recently than we have seen not but like a week or two ago, right? So that's an evaluation that we'll make, and we'll certainly make you aware of that at that point in time.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

OK. Great. All right. Thank you.

Operator

Thank you. Our next question is from Nicholas Joseph with Citi. Please proceed with your question.

Chris McCurry -- Citi -- Analyst

It's Chris McCurry on with Nick Joseph. Are you seeing any -- I just want to follow back up on the transaction market, are you seeing any buyers pull out of certain markets more so than other markets? And has there been differences in buyer appetite across different qualities -- across the quality spectrum for different assets?

Mark Manheimer -- Chief Executive Officer

Yeah. No, it's a good question. I think really where we started to see more buyers pull out, it really had to do with more of the leverage buyers at lower cap rates. So the higher quality transactions that were, in many cases, well below the cap rates that we're acquiring assets at.

A lot of those deals started -- we started to get a lot more calls on those types of transactions as kind of the lower 4 cap rate range transactions, people relying on debt, you start getting to niggle leverage a lot more quickly on those types of transactions. So as you start moving up the cap rate scale, that started to creep in more and more as interest rates continued to rise. So I think it's really been much more the buyer that's relying on leverage. You saw it really in industrial, which we're not really active there at all, which had lower cap rates.

You've seen like Amazon distribution centers kind of that were trading in the 3s kind of trading at kind of the higher 4s, up to a 5 cap. So really pretty big displacement in that market. And then as you start creeping up into retail and some of the lower cap rate deals, just the debt doesn't pencil for the higher leverage buyers. So that's really where we've seen the biggest impact.

And so we've certainly just seen a massive increase in our opportunity set, which allowed us to be significantly more selective on the quality, as well as on pricing this particular quarter. And we're seeing that into the third quarter. So we're pretty excited about what we're seeing in the third quarter as well.

Chris McCurry -- Citi -- Analyst

Got it. And then with a tougher macro backdrop today, how are you guys thinking about the watch list? Are there any tenants on the watch list that maybe you're keeping a closer eye on? Or how has the watch list evolved?

Mark Manheimer -- Chief Executive Officer

Yeah, sure. Yeah, and it's pretty similar to what we were starting to see last quarter as it relates to the consumer, especially on the lower end. They're really starting to get under more and more pressure. Savings for the consumer are back to pre-pandemic levels.

You're starting to see consumers rely more on credit cards. And Walmart and Target results, I think, illustrate necessity products they're selling, and discretionary is not so we took a pretty deep dive into our portfolio. I feel really good about the defensive nature about what's in our portfolio. I think if we have one tenant in particular that I think has seen pretty poor results most recently, that would be Best Buy.

They've had a bit of a rough year, it is really just the health and the preferences of the consumer have shifted, but their sales are above pre-pandemic levels, and we're very confident in the tenant's resilience and the assets that we own. So we don't feel like there's any risk to the rent or anything like that. But I think we need to be pretty cautious on that particular tenant. But we do -- I think we do a pretty good job of underwriting not only in the tenant health, but the cyclicality and predictability of tenant health in various different economic environments.

And we certainly have a pretty volatile market out there. And then I think we also do a pretty good job of applying an appropriate asset management plan after we acquire the assets. If you recall, last year, we sold an RV asset, which was -- that was kind of at the peak of its cyclicality doing extraordinarily well last year. You're starting to see Keystone and Winnebago in the news with not so positive news.

So we're really happy that we moved out of that asset last year. So I think that speaks to how we're thinking about when we can opportunistically move out of certain assets and really trying to focus on assets that we feel like are going to do very well in any economic environment.

Chris McCurry -- Citi -- Analyst

Good color there. Thank you.

Operator

Thank you. [Operator instructions] Our next question comes from Connor Siversky with Berenberg. Please proceed with your question.

Connor Siversky -- Berenberg -- Analyst

Hey, there. Thanks for having me on the call. Just quickly on the development pipeline. I noticed the spend this quarter was around $5 million.

And again, in the context of kind of these heightened risk factors and maybe seeing some of your developers pulling back from activities. Can you provide any expectation for what that run rate spend might look like through the end of the year and possibly into 2023?

Mark Manheimer -- Chief Executive Officer

Yeah, sure. I mean it's going to be pretty dependent on what's going on with construction costs, labor costs, etc. So a typical development deal for us is where we're partnering with a developer. They cut a deal with -- they've got their construction budget and they've got whatever they paid for the land or whatever they've signed up to or get the land under contract for and then they negotiate what the rent is going to be with a tenant and that kind of locks in what their yield should be and what they can flip the asset at.

And so we've been very active in having conversations with the developers that we work with and they're really just getting squeezed. So the construction cost being higher, labor costs being higher, as well as more difficulty even really getting labor. So seeing the pressure that they're under and knowing that the tenants are typically not willing to renegotiate the rents that they've agreed to, we don't want to be put in a situation where the developer is coming back to us and asking us to take the pain. So we are like, we just see a lot of opportunity in other areas right now where we think it's prudent for us to kind of take a step back and really see where that -- how that plays out and take a cautious approach and especially in an environment where we have ample acquisitions opportunities.

Connor Siversky -- Berenberg -- Analyst

Got it. Understood. And then maybe just a bit of a modeling question on the 26 investments included -- completed during the quarter. Can you give us any sense of time waiting as to when those 26 were completed?

Andy Blocher -- Chief Financial Officer

Yeah, Connor. I think that our -- from bringing them on to the portfolio, I think we had an average of about 20 days.

Connor Siversky -- Berenberg -- Analyst

Sorry, say that one more time.

Mark Manheimer -- Chief Executive Officer

And that -- 20 days, and that was somewhat influenced by early in the quarter where we started to see cap rates start to move and seeing better opportunities where we pushed back on some other transactions, anything that we saw in diligence, we pushed back pretty aggressively on some of the sellers. And so we ended up with more of a back-end weighted quarter, which I think will likely reverse itself in the third quarter.

Andy Blocher -- Chief Financial Officer

Yeah, and Connor, just recall, I mean, we obviously -- we closed roughly $40 million on the first day of the quarter, right, in the third quarter. So we're well ahead of that pace.

Connor Siversky -- Berenberg -- Analyst

OK. So for the second quarter, we're looking at just for clarification, 20 days after March 30 or 20 days before June 30.

Mark Manheimer -- Chief Executive Officer

Yeah, 20 days before.

Andy Blocher -- Chief Financial Officer

Yeah, 20 days average outstanding is the way that I would go about it.

Connor Siversky -- Berenberg -- Analyst

OK. Thank you. That's all from me.

Operator

Thank you. Our next question is from Josh Dennerlein with Bank of America. Please proceed with your question.

Unknown speaker

Hello. This is Dan [Inaudible] on behalf of Josh Dennerlein. I was hoping to see if you can elaborate more on where you see the best opportunities for capital recycling within the portfolio.

Mark Manheimer -- Chief Executive Officer

Yeah, sure. I mean we're always kind of taking a look at the portfolio where we see potential risk. Fortunately, we took such a deep knife to the portfolio before going public that there really isn't much of anything that has -- there's any concern. Now that being said, we do keep relationships with various other counterparties in the marketplace, whether they be DSD operators or 1031 buyers or even brokers that have some relationships where somebody may find themselves in a trade and need to close on something quickly.

So we'll take advantage of those types of opportunities and sell assets here and there. I think like our 7-Elevens and some other assets within the portfolio, oftentimes, we get pretty aggressive offers on those, sub-five range. And so in the event that we can sell some of those assets in -- at pretty aggressive cap rates, and we feel like we can redeploy the capital efficiently and accretively. We're always willing to do that, but we also don't want to be out of the market selling $50 million, $60 million, and not be able to replace it in the quarter because that puts some pressure on earnings.

Unknown speaker

Great. Thank you. And then also, could you -- sorry, could you also remind us on what the mix between the fixed rent bumps and the inflation-linked bumps within the portfolio as well?

Mark Manheimer -- Chief Executive Officer

Yeah, sure. I mean we have a few assets in the portfolio that have CPI bumps, but I think oftentimes people think of that as inflation protection. But the reality is, almost all of the CPI rent bumps in the net lease retail space are three times CPI -- the lesser of three times CPI or 2% or 1% or whatever the transaction is, depending on how that lease is structured. We would rather just have 1% or 2% fixed rate bumps for the periods of time where there isn't inflation to make sure that we're getting the maximum rent growth.

So having a few leases in the portfolio of CPI with caps we kind of view those as inferior to the fixed rate bumps, but maybe two-thirds of the portfolio has some level of rental increases.

Unknown speaker

Thank you.

Operator

Thank you. Our next question is from Connor Siversky with Berenberg. Please proceed with your question.

Connor Siversky -- Berenberg -- Analyst

Just one more from me here. I'm just looking at the provision for impairment recognized in Q2, was that any -- was that related at all to any assets that were maybe slated for sale and then moved back on to your operating portfolio once mark-to-market?

Mark Manheimer -- Chief Executive Officer

Yeah. We kind of had a kind of odd situation related to the advanced auto parts store that we sold in the quarter where we terminated the lease and then sold the property during the quarter. So -- and then we're expecting to get a lump sum of the remaining lease payments in the third quarter. So just that timing led to what would be an impairment and then likely a gain after that or some revenue that is a little bit unusual.

But all in all, if you put all those pieces together, it actually would result in a slight gain. So it's just a little bit of a funky accounting scenario.

Connor Siversky -- Berenberg -- Analyst

Got it. Can you quantify what that gain would be at all?

Mark Manheimer -- Chief Executive Officer

I mean, we're talking about $100,000 or something like that, so pretty minimal.

Connor Siversky -- Berenberg -- Analyst

OK. Understood. Thank you.

Operator

There are no further questions at this time. I would like to turn the floor back over to Mark Manheimer for any closing comments.

Mark Manheimer -- Chief Executive Officer

Well, thanks, everybody, for joining us today, and we certainly look forward to continuing the dialogue in the future. Take care.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Unknown speaker

Mark Manheimer -- Chief Executive Officer

Andy Blocher -- Chief Financial Officer

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Chris McCurry -- Citi -- Analyst

Connor Siversky -- Berenberg -- Analyst

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