Earnings Call: Q4 2020

Feb 24, 2021

Greetings and welcome to the Essential Properties Realty Trust, Inc. 4th Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Dan Dolan, Senior Vice President of Capital Markets. Thank you. You may begin. Thank you, operator, and good morning, everyone. We appreciate you joining us today for Essential Properties' Q4 2020 conference call. With me today to discuss our Q4 and full year results are Pete Mavoides, our President and CEO Greg Seibert, our COO and Mark Patten, our CFO. During this conference call, we will make certain statements that may be considered forward looking statements under federal securities laws. The company's actual future results may differ significantly from the matters discussed in these forward looking statements and we may not release revisions to these forward looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings release. With that, Pete, please go ahead. Thank you, Dan, and thank you to everyone who is joining us today for your interest in Essential Properties. We are excited to report our Q4 and full year results and more importantly, turn the calendar to a new year. While the COVID-nineteen pandemic is still very much with us, our tenants have adapted their businesses to profitably operate in the current environment and most importantly, pay rent reliably and timely. I want to take a moment to acknowledge all of our employees at Essential Properties and their incredible efforts over this unprecedented year. Our team members rose to the challenges presented by the pandemic by effectively managing tenant relationships, negotiating, structuring and documenting the appropriate tenant accommodations, working through necessary lease restructurings and asset repositionings and then seamlessly and aggressively shifting back to growth when the conditions warranted in the back half of twenty twenty. These actions have stabilized the portfolio with high occupancy and sustained rent collections and we are firmly on track to deliver attractive earnings growth in 2021 and beyond. Turning to the Q4. We saw a continued improvement in our rent collections and an increase to our In addition to these positive operating trends, our cost of capital has continued to improve and the capital markets remain conducive towards investing in external growth opportunities and maintaining a conservative balance sheet to support that growth. As such, with pent up demand from our existing relationships and renewed M and A activity from various growth oriented tenants, we invested $244,000,000 at a $7,100,000 initial cash yield in the 4th quarter, which was a record level of activity for us. Consistent with our investment strategy, 88% of our investments were direct sale leasebacks and 90% were transactions that involved an existing relationship, which speaks to the quality of our market relationships and the predictability of our investment platform from both a sourcing and underwriting perspective. All of these combined factors gave us the visibility in late January to provide 2021 AFFO guidance of $1.22 to $1.26 per share. Turning to the 4th quarter collections. We collected approximately 91% of our contractual cash ABR with another 3% attributable to recognized rent deferrals. In January, we collected 95% of our contractual cash ABR with another 2% attributable to recognized rent deferrals. The majority of these rent deferrals were granted due to the reintroduction of state and or local mandated shutdowns that disproportionately impacted certain tenants due to the geographic concentration of their operations. Over half of the recognized deferrals in January was provided to 1 tenant in the entertainment industry, whose entire business has been mandated to close since mid December. With that in mind, now that our rent collections are mostly on par with our net leased peers, many of whom derive the majority of the rents from investment grade tenants, we remain convinced that our disciplined investment strategy continues to provide for some of the best risk adjusted returns in the net lease sector. Turning to the portfolio. We ended the quarter with investments in 1181 properties that were 99.7 percent leased to 2 37 tenants operating in 17 industries. This is up from 16 industries last quarter as we broke out our 3.3% concentration in the equipment rental and sales industry. On a different note, I would like to highlight our progress towards reducing exposures to the more challenged industries of casual and family dining, health and fitness, home furnishings and movie theaters. Combined, these five industries now represent less than 17% of our ABR, which is nearly a 50% decline since the Q2 of 2018, our first reported quarter as a public company. This deliberate reduction in exposure was driven not only by our ability to dispose of assets in a timely manner, but also the smaller size of our asset base, which has allowed us to efficiently manage our diversity in order to adapt our portfolio to changing market and industry dynamics. That said, we continue to view both casual and family dining and health and fitness as core industries for Essential, but we will remain highly selective when exploring new opportunities. Due to the fungible nature of our real estate and our active releasing efforts, we had just 3 vacant properties at quarter end. As we have stated before, the value of our company does not reside in our leases, it resides in our properties and our ability to keep them consistently leased. Therefore, we see high and stable occupancy as a key indicator of that value. Our weighted average lease terms stood at 14.5 years at quarter end with 0.1% of our ABR expiring in 2021 and 4.8% expiring over the next 5 years. Our weighted average unit level coverage ratio was 2.9 times, which was a slight improvement over last quarter's 2.8 times coverage. This was a pleasant surprise for us as we had expected our coverage to migrate lower. However, due to the positive impact of 4th quarter investments, which had an average coverage ratio of 3.6 times and various tenants over 2 times coverage seeing their profitability accelerate year over year, our coverage managed to tick up. As we have mentioned previously, our traditional credit statistics, which focus on implied credit ratings and unit level coverage are somewhat skewed as these metrics have been negatively impacted by the pandemic related shutdowns, yet they do not pick up the benefits of forgivable loan programs and rent deferrals. Turning to the balance sheet. We finished the quarter with leverage of 4.8 times net debt to annualized adjusted EBITDARRE, which has us well positioned to finance our growth plans. While we are confident in our ability to grow alongside our operators and capture attractive investment opportunities, we recognize the pandemic could have a lingering impact on certain tenants and industries. As such, we remain diligent in our underwriting highly focused on tenants and locations that have shown resiliency and an ability to adapt throughout the pandemic. With that, I'd like to turn it over to Greg Seibert, our COO, who will take you through the portfolio and investment activity in greater detail. Thanks, Pete. During the Q4, we invested $244,000,000 into 108 properties through 33 separate transactions at a weighted average cash cap rate of 7.1%. These investments were made within 11 different industries with over 80% of our activity coming from 5 industries: quick service restaurants, equipment rental and sales, auto service, medical, dental and car washes. The weighted average lease term of our quarterly investments was 16.3 years. The weighted average annual rent escalation was 1.4%. The weighted average unit level coverage was 3.6x and our average investment per property was $2,200,000 Consistent with our investment strategy, 88% of our 4th quarter investments were originated through direct sale leasebacks, which are subject to our lease form with ongoing financial reporting requirements and 89% contained master lease provisions. From an industry perspective, car washes are now our largest industry at 15.5% of cash ABR, followed by quick service restaurants at 13.9%, early childhood education at 12.3% and medical dental at 10.6%. We view these 4 business segments as Tier 1 industries for essential properties and going forward, we see our industry concentration increases coming in the auto service, equipment rental and sales, pet care services, building materials and grocery. Conversely, we expect further reductions to the casual and family dining, health and fitness, home furnishings and movie theater industries. Due to our deliberate efforts to deemphasize casual and family dining and health and fitness, our combined concentration has declined 35% over the last 2.5 years to 13% of ABR today. In addition, our 2018 decision to redline the home furnishing and movie theater industries has resulted in our combined concentration declining 70% over the last 2.5 years to 3.6% of ABR today. From a tenant concentration perspective, no tenant represented more than 2.8% of our ABR at quarter end and our top 10 now accounts for just 21% of ABR, which compares to 39% 2.5 years ago. Increasing our tenant diversity is an important risk mitigation tool and a differentiator for essential properties as our top 10 tenant concentration is one of the lowest in the net lease sector. This is also a direct benefit of our middle market focus, which offers a significantly more expansive opportunity set than an investment strategy concentrated on publicly traded companies and investment grade credits. In terms of dispositions this quarter, we sold 23 properties, including 2 vacant properties for $39,000,000 in net proceeds. When excluding vacant properties and transaction costs, we achieved a 7.4% average cash cap rate on our dispositions in the quarter, which was slightly elevated this quarter as one of the tenants exercised their buyback option. As we have mentioned in the past, owning properties that are highly liquid is an important aspect of our investment discipline as it allows us to proactively manage industries, tenants and unit level risk within the portfolio. With that, I would like to turn the call over to Mark Patten, our CFO, who will take you through the balance sheet and financials for the Q4. Mark? Thanks, Greg. As we reported in our earnings release last night, we were pleased with our 4th quarter results, particularly the initial impact of our strong investment activity that kicked off in the latter part of the third quarter. Our operating results for the Q4 of 2020 compared to the same period in 2019 included total revenue of $41,100,000 for the 4th quarter, an increase of approximately $1,900,000 or nearly 5%, which was impacted by having to write off nearly $1,500,000 in revenues, including nearly $1,000,000 of straight line revenues previously recognized that mostly stem from the Chapter 11 bankruptcy filings of 2 tenants during the quarter. We also recognized an additional COVID related adjustment in the quarter as we picked up nearly $1,000,000 in property level expenses, specifically property taxes associated with the previously mentioned tenants that have filed for bankruptcy, as well as other vacancies that were resolved in the quarter. I'll mention here, we did move the aforementioned 2 tenants, which totaled 9 properties and represent less than 1% of our ABR at year end into non accrual status during the Q4 as a result of their bankruptcy filings. Total GAAP G and A was $4,700,000 in the quarter versus $5,300,000 in 20 19. We saw our recurring cash basis G and A for Q4 2020 decrease to approximately $3,300,000 which as a percentage of total revenue was just over 8%, a favorable level compared to Q3 2020, which was nearly 11% of revenue and Q4 of 2019, which was 13.5%. Our Q4 2020 G and A benefited from lower or just over 11% of our total revenue. Net income was $5,700,000 in the quarter $42,500,000 for the full year. Our FFO totaled $26,200,000 for the quarter $104,400,000 for the full year of 2020, an increase of 3.4% and 26.3% respectively over the same periods in 2019. Our FFO per share on a fully diluted basis was $0.25 in the 4th quarter and $1.08 for the year, which represents a decrease over the same periods in 2019. Our core FFO was relatively flat to Q4 2019, totaling $26,200,000 which equated to $0.25 per share on a fully diluted basis. And core FFO for the full year 2020 totaled $106,700,000 up from $9,600,000 in 2019. On a per share fully diluted basis, core FFO for the year was $1.10 which is a decrease from 20.19. Our AFFO was up $4,400,000 an 18% increase totaling approximately $28,800,000 for the quarter. And for the full year AFFO was up $20,700,000 totaling $107,000,000 On a fully diluted per share basis, AFFO for the Q4 and full year was $0.27 $1.11 respectively. That's off $0.02 $0.03 per share respectively compared to the same periods in 2019. Consistent with our Q3, our per share metrics for FFO, core FFO and AFFO were obviously impacted adversely by the adjustments we made to revenues and receivables in connection with the pandemic. In addition, the full weight of our follow on offering in late September 2020 had an adverse impact on these per share metrics as the impact of deploying this into our record level of Q4 2020 investments was not yet fully reflected in our results. As it relates to the 2 tenants that I referenced earlier, these tenants and another tenant are current and paying rent today and in the aggregate, the ABR associated with these tenants is higher in Q1 2021 than what was owed to us in Q4 2020. So the good news is that the approximate $1,500,000 negative impact to our Q4 2020 cash NOI from these two tenants and formerly vacant properties is non recurring and therefore limited to the adjustments we made in Q4 2020. Separately, we collected substantially all of the $2,600,000 in deferred rent we were owed in the 4th quarter from those tenants that we accounted for on an accrual basis. Turning to our balance sheet, I'll highlight just a few points. With the addition of more than $244,000,000 of investments in the quarter that Greg mentioned, our total undepreciated gross assets was $2,600,000,000 at year end. Our unrestricted cash totaled nearly $27,000,000 with an additional $6,000,000 in restricted cash available for deployment in the new investments. Our long term debt on a gross basis ticked up by $18,000,000 which was really related to the draw on the credit facility that we made in late December in connection with our investment activity. From an equity perspective, we generated approximately $35,000,000 of gross proceeds from our ATM program, selling approximately 1,700,000 shares at a weighted average price of $20.50 a share. As Pete noted, our leverage at just 4.8 times as of year end continues to be well within our leverage targets and provides an ample runway for us to continue to pursue our strong pipeline of potential investments. Our external growth also remains supported by our significant liquidity position totaling approximately $415,000,000 as of year end, which of course excludes the $200,000,000 accordion feature on the credit facility and $70,000,000 available on one of the term loans. We continue to hold the view that our low levered balance sheet and significant liquidity is a strategic advantage for us and provides us not just a platform for growth, but a position of stability to weather a challenging macroeconomic environment such as we've seen during the height of the pandemic in these intervening months. With that, I'll turn the call back over to Pete. Thanks, Mark. We are excited that the operating environment and capital markets have allowed us to pivot away from managing through the pandemic with our tenants and properties and move forward with capitalizing on our robust pipeline of accretive investment opportunities in order to drive earnings growth. More importantly, we believe our disciplined and differentiated investment strategy has created an incredibly resilient net lease portfolio that should continue to generate attractive risk adjusted returns as we grow in the future. With that, operator, let's please open the call for questions. Thank you. Our first question comes from the line of Nate Crossett with Berenberg. Please proceed with your question. Hey, good morning guys. Obviously, acquisition volumes have been ramping. So I was just curious to know what kind of the run rate is baked into your guidance here. And then also just based on the current size of your team, is there kind of an upward bound limit that we should be thinking about? Sure. Thanks, Nate, and good morning. The 4th quarter was a really big quarter for us and we're happy with the results there. But as been our tradition, we don't provide acquisition guidance. We provide very specific detail on our trailing 8 quarters average and really guide people to that as an indicator of where we're likely to transact. And you can see that's been a wide range and it really depends upon the opportunities that come in, in any given quarter. But averaging out around 125, 150 with highs and lows, you can see in our disclosure. Our team, when we came public and has been staffed and remain staffed to transact at that level, And so as you look out in 2021, certainly our guidance has a range of assumptions built into it. But a good baseline is looking at the trailing average. Okay. That's fair. What about just your comments on pricing? It seems like for the year, it was pretty stable, just above 7%. Is that kind of your expectation for this year as well? Yes. The cap rates over the last eight quarters really range from 7.1% to 7. 5%. I would say that there's really 2 factors going into that, 1 being the industry mix and 2 being the overall competitive environment. And really, our industry mix, as we've said on the call has been gravitating towards the more secure industries we invest in and away from some of the more risky industries and that's impacted our cap rate down. And then I would add, it's awful competitive out there right now. A lot of people have a lot of capital to put to work in the space. I think coming through this pandemic, there is a greater appreciation of the durability of the assets in the space, specifically the middle market tenants. And so we're seeing a lot of competition. And we fight to get every basis point we can on our transactions. And generally, my guidance there has been low to mid-7s. I would say low-7s. Greg and I have been investing in this space for 20 years and really, it's rare that we had been investing below 7% and it's becoming more and more common. And so there is a lot of competitive pressures on that. It's hard for me to see a scenario where an entire quarter is sub-seven, but I wouldn't put it out of the realm of possibility. But certainly, we're trying to get the best risk adjusted returns. And fortunately, our cost of capital is supportive and to make those accretive even if we do dip down, but low 7s would still be the guidance. Okay. Just quickly on the cost of capital side, do you guys think that you're getting closer to a potential investment grade rating at some point just given that you're growing pretty quickly? Well, sure. I would remind you we have an investment grade rating from Fitch. We certainly have maintained an investment grade quality balance sheet since coming public. We hadn't really pursued a 2nd investment grade rating, really because we hadn't needed to support our debt activity. I think that may be on the calendar here for 2021. And so certainly something we're thinking about and looking at, but I do think if we needed it, we could get. Okay. Thank you. Thank you, Nick. Appreciate the questions. Our next question comes from the line of Haendel St. Juste with Mizuho. Please proceed with your question. Hey, good morning. Hope everyone's well. So first question, I was hoping you guys could talk about the 2 bankruptcies in the 4th quarter, Love's and Ruby Tuesday. It sounds like from your comments that you've made some real progress there. So maybe can you share some color? Have you released all of the former boxes? What are the recoveries look like? What do you think they'll look like? And maybe also clarify what's embedded in your guidance for those resolutions? Thanks. Yes, I would start by saying those the guidance has the resolution of those situations in our guidance. I would say, the recoveries are not static and certainly complicated, particularly as you think about our Ruby Tuesdays where we sold assets at material gains over the investments and repositioned assets and taken assets back vacant to be repositioned and the recovery is really just a face rate of rent and really could release an asset to a local tenant that would trade at an 8% cap or release an asset to Chick Fil A on a ground lease that would trade at a 4% cap. So the static recovery number is not something are going to disclose on either of those investments. What I would say is, generally we provide some very detailed numbers on our recoveries in our supplemental, generally in a 90% range. And certainly both of those my expectation on both of those scenarios would be ultimately when everything shakes out, we would be relatively consistent with that. Okay. Maybe differently, it sounds like you're further along with the Ruby than the Luvs. And I guess curious on the demand for the Luvs furniture boxes, what type of market is there? And maybe some color on what the rent levels broadly in the market are for that type of space? Yes. It really I would start and say that we only had 4 Loves 4 former advance sites. And so we don't have a broad sample set. Recoveries can be as low as $6 a square foot or as high as $18 a square foot really depending on the specific sites. As we sit today, we have one remaining Loews furniture and we have worked to reposition 2 of them to another furniture operator and the one of the the third one we repositioned is not in the furniture use, but generally the recoveries and the assets are decent and fungible. Appreciate that. And one on the question stats on Page 15 and stuff, I was hoping you could shed some light on some of the figures and the drivers of sequential changes in January versus the 4th quarter. Collections overall, you noted, were up to 97% in January versus 96% in 4th quarter, but your cash collections were up from 91% last quarter to 95%, while the deferral declined from 5% in 4Q to 2% in January. So can you talk a bit about some of those sequential changes, maybe a bit of color on the leases you mentioned restructuring and also what's left in that 2% deferral bucket and when do you expect to convert that to cash there Haendel. Generally, we had I would say the biggest change in collections of cash rent was certainly the expirations of deferrals. As we said on the call, we had some new deferrals that crept in late in Q4. But generally, when we approach the deferrals in the Q2 of last year, we really weren't looking out beyond the end of the year, really recognizing that the situation would change, it would be materially different. So the biggest change in collection of cash rents, I would say, is just the expiration of deferrals. We also had a bunch of repositionings, assets that went offline and came back online throughout the 4th into the first, which is going to contribute to that. Sitting here at 95% collections and 2 percent recognized deferrals. We really end up talking about the 3% and a good chunk of that remains our 5 theaters leased to AMC. And they continue to struggle, that industry continues to struggle and I'm sure you've gotten some much more insightful commentary on the movie industry from other net lease peers who have much larger exposures, but that remains a good chunk of the 3% that we're not collecting. And if I could follow-up on, you said you mentioned that there was some deferral that crept in late in the quarter. I'm curious, it sounds like there might have been COVID restriction related. So maybe some color on the tenant industry and what makes you think that that's money good deferrals? Thanks. It was COVID related and the reinstitution of shutdowns, largely the sectors that remain challenged are the entertainment and fitness centers as you would imagine. What gives me comfort in recognizing those deferrals is that those tenants have remained current and those tenants remain creditworthy and are supported by good capital structures. Our next question comes from the line of Katie McConnell with Citi. Please proceed with your question. Great. Thanks. Good morning. Can you maybe just touch on the timing of 4Q acquisitions and whether an acceleration of closings before year end might be the reason for the lighter volumes year to date? Yes. I mean listen, generally in this business, Katie, And this Q4 was no different. We fight like heck every quarter to front end them and for whatever reason they tend to slip. And that trend is particularly acute in the Q4 where you have some I would argue sitting here at 50, I wouldn't say that, that's I would argue sitting here at 50, I wouldn't say that that's a slow start to the year. We feel good about that. We feel good about our pipeline and are excited for a big March. All right. Thanks. And then can you provide some more background on what drove the tax adjustment burden to fall on you in the Q4? And could that be a risk for any other bank or key tenants that you have exposure to? Yes. I mean that when we kick out a tenant and terminate a lease, we become liable for those taxes and paying those taxes bankrupt tenant isn't paying it. And that's what happened. And so that's as a landlord and owning over 1100 properties, we certainly bear the risk of taxes and we pass those risk through to our tenants. But to the extent that tenant becomes uncreditworthy, we become liable. Now oftentimes, we'll receive a bankruptcy claim that will make us whole for those taxes and it becomes more of a timing issue. But that's certainly a risk for all net lease investing. But in general, I think it was outsized in the Q4 and shouldn't be repeated in the Q1 here. Okay, great. Thank you. Thank you, Katy. Our next question comes from the line of Sheila McGrath with Evercore. Please proceed with your question. Yes, good morning. Pete, I was wondering with the benefit of hindsight, if either tenants or essential properties as a landlord are requiring any new lease language surrounding a shutdown, like providing more clarity on what a short term deferral might look like? That really, Sheila, that hasn't crept into our lease negotiations. Quite frankly, I wouldn't be surprised if tenants start looking to share that risk of state mandated shutdowns. Currently, the tenants bear those risks and are required to pay rent regardless of mandated shutdowns, which is why we were forced to structure deferral agreements as opposed to tenants being able to say force majeure and not pay rents as of rights. And ultimately, the leases are allocation of risks. So that hasn't crept in and quite frankly given the nature of the pandemic and hopefully it's a once in a lifetime event for us. Topical. Okay, great. And one last question. You did have more dispositions in Q4 than typical. Just wondered what the drivers there are? And do you expect larger disposition volume in 2021 as you reduce casual dining and exposure to gyms? No, I think those industries are right sized where they are. We had one large tenant buyback that happened in the Q4 and quite frankly that tenant wasn't performing as we would have expected. So we were happy to transact and move those assets back and be able to redeploy that capital into better performing operators. I would say our historical average is a good guide on the dispositions much like on the acquisition. So it's certainly heightened in the 4th quarter, but that $15,000,000 ish a quarter feels about right for 2021. Okay. Thank you. Thank you, Sheila. Our next question comes from the line of Ki Bin Kim with Truist. Please proceed with your question. Thanks. Good morning. So there were a couple of moving pieces to the revenue run rate this quarter, and you guys did a good job outlining some of them. But just given how some of these kind of troubled tenants have been released like Town Sports or Ruby Tuesdays or Love Furniture, I'm just curious how much ADR is on the come and not in the 4th quarter run rate? I don't know what you mean by on the come, Ki Bin, but Dan, why don't you tackle that? Yes. I mean, so Ki Bin, I think the main aspect would be Town Sports. They paid us the new Town Sports paid its rent in December. So I think that's a big piece of it. And then you just have the non accrual tenants that are paying us and paying us on a cash basis. So as those folks potentially pay us more going throughout 2021, that's potential upside to the run rate as well. Yes, I would say it's certainly the Q4 is certainly depressed from a run rate perspective, and we have good momentum in the Q1, which is reflected in our guidance. So I guess one piece of that is the $1,500,000 right of ABR and expenses that was a drag in the Q4, that will reverse. My question was with some like Town Sports, you have 1 month of rent. I'm not sure if there's other aspects to other tenants that you only collected partial rent. But so starting in Q1, is that $1,500,000 plus what other dollars are that should we be modeling going forward? Well, part of it is the $1,500,000 is a catch up over several quarters. So not going to be 1 quarter shot for the 1 as part of that's a straight line catch up. Okay, got it. And how much rent are you currently collecting from AMC and if there's been any dialogue that you've had with your tenant? Yes, I'd just stop short of deferral through the end of the year, that really was kind of dependent on the level of revenue they achieve at our sites. And certainly, we've been in active dialogue with them and as have all their landlords and it remains a fluid situation. Got it. And just last question for me. What kind of G and A run rate should we expect in 2021? Well, I think where we settled out in Q4, I mean, I think that was a pretty good run rate other than I think it's going to tick up a little bit simply because one of the things we from a compensation level in terms of incentives, just obviously this year being tougher than most, but on some of the professional fees, we're hopeful that that's kind of a recurring better news. So I think probably where we finished off, let me just grab it real quick. I think probably if you look at just total G and A for getting cash G and A unless that's kind of where you're going, but I think full G and A, it's probably it will probably tick up a little bit from that 24.4% that we had for the full year. So probably a little bit more than that, call it 1,000,000. Okay. Thank you. Our next question comes from the line of Greg McGinnis with Scotiabank. Please proceed with your question. Hey, good morning, everyone. So PRT has had a fairly concentrated approach to target industries in which you're looking for acquisitions, but we noticed that you added other services to the industry exposure disclosure this quarter. Just curious what that category encompasses and whether or not you're starting to look into other industries for transactions? Yes. Thanks, Greg. I would say, we've always had another services bucket. And generally when an industry reaches a sufficient concentration to warrant being separated out, we will do that much like we did with equipment rental and sales. The underpinnings to our investment thesis is owning service and experienced based real estate and coupled with granular fungible pieces of property, right, which is manifest in our $2,100,000 investment per asset. And then the services are pretty self explanatory. So we are certainly open to other industries to the extent that they are service based industries and they have real estate fundamentals that meet our fungibility and granularity criteria. And so we're open, we're constantly looking to expand our investment universe and that remains a challenge for the investment team here. As we sit today, what sits in that 2.3% of other services, I don't know that off the top of my head, Dan, what do we got? Dan's giving me a blank stare because he doesn't know either. What was that? Our 2.3% other services, what's in that bucket as we see today? It's mostly funeral homes. Okay. And we have some other assets which maybe have a we have one particular that has a small retail and a service component. And some of those are just not real easy to identify them into one of our existing buckets. Great. Thanks, Greg. Okay. That's fair. And just another one. You've mentioned lowering exposure to some categories where you're not as bullish on future prospects. I'm just curious if there's any specific tenants right now in the portfolio that may be rent paying, but you have some near term concerns. Kind of trying to get at whether or not that 97% rent recognition in January is a fair run rate until AMC is dealt with and maybe a little bit, assume the other minority of tenants, where you're also not recognizing rent? Yes. I mean, listen, we have 237 tenants and certainly some of them are on our watch list and we're working to right size those investments as you see in our disposition activity. Certainly, the 3% that's in the non recognized, 2 thirds of that is AMC and the other is a bunch of little guys that I would say is not terribly material. We're hopeful that 1% comes back online, but it's certainly not a driver of our story. All right. Thanks for the time. Thank you. Our next question comes from the line of Caitlin Burrows with Goldman Sachs. Please proceed with your question. Hi, good morning. I was wondering if you could just talk about on guidance, what additional credit events, if any, are assumed in the guidance range, whether that's bankruptcy impacts, bad debt levels and how that compares to 2020 or 2019 actual results? Sure. And welcome back, Caitlin, and thank you for initiating on us. Listen, this whole COVID pandemic in our view really accelerated the restructuring of weak tenants within the portfolio. And so I think the high level of restructurings we experienced in 2020 largely from our perspective is in the rearview mirror. And as we look out to 2021, we expect a much more normalized level of credit events. As we've disclosed in the past, a good proxy is roughly 50 basis points of ABR. And we certainly bake in a generic credit loss assumption as well as specific situations that we know of. And I think guidance incorporates all those scenarios. Okay. And then maybe similarly in terms of increasing from the recognized rent levels, I think in the Q4, it was about 94%. Does guidance assume an increase as the year goes on or not? Yes. I mean, we expect the deferrals to burn off. We expect guys who aren't paying to either start paying or we have the ability to kick them out and put people in who will pay. And we make a very tenant by tenant, asset by asset assumption as we look at the portfolio and we build up our guidance. And I think we don't envision a scenario where we have assets that we're not collecting rent that we don't collect rent in the future. Okay. And then maybe on the unit level rent coverage, it looks like that was the same in 4Q 2020 and 4Q 2019 at 2.9 times, but the distribution of tenants has shifted to the amount with coverage above 2 times has declined and the portion with coverage under 1x is up. I was wondering if you could just go through some of the details on how that distribution and pie chart that you show has shifted, but the overall remains unchanged? Yes, I think certainly my commentary on the call was we really have been steering people away from that disclosure as we didn't feel it was particularly relevant, given the nature of the pandemic and the fact that the majority of our tenants were offline for an entire quarter and partially on line for the balance of the year. And that's one of the reasons why we've transitioned to provide monthly collections data is because that is much more real time and indicative of the risk in the portfolio. So I don't spend a lot time looking at that distribution just because it doesn't take into account the pandemic nor does it pretty noisy kind of through the Q2 until we start getting the full effects of this pandemic behind our tenants. Okay, got it. So I think you maybe kind of answered it, but then would you say that it's fair to think that those that have shifted in there that that's a temporary shift and that over the kind of medium to longer term you would expect those metrics to look more similar to pre pandemic? Yes, certainly. And I would say, if we were to go through the exercise of affecting all of those sites for the deferrals that were granted, I would imagine it looks pretty similar to pre pandemic levels, if not better. Okay. Thank you. We done, operator? We got any more questions, guys? We're the operator. Operator, are you there? Ladies and gentlemen, I apologize for the delay. We're going to go ahead and resume our conference. Our next question is going to come from the line of Sam Choe with Credit Suisse. Please proceed with your question. That was quite a long delay. Thank you for taking my questions. I think most of them have been answered. But I'm seeing that Mavis Discount Tires entered your top 10 tenants. Am I correct to assume that this was an example of a you guys expanding on it's creating a distinct relationship? Yes, Yes, Sam. And we apologize for the gap there. We lost our operator somehow, but we're happy to plow through the rest of the questions here. Yes, we did some investments with them earlier in the year and we're able to do some add on investments with them. They're a great tenant, a great company. We have really good sites in the Northeast that we were happy to add to our portfolio. Got it. So I think in your prepared remarks, you said that most of the growth around 80%, 90% has been pre existing relationships. So could building on pre existing relationships increase top 10 tenant exposure or given that growth will be throughout your entire portfolio that should be relatively flattish? Yes. We have relationships with the vast majority of our tenants and we look to continue to grow with them. When tenants start populating our top 10, we kind of get capacitized with our exposures and kind of stop investing at some point. And certainly managing our top 10 concentration, managing our individual concentrations are important portfolio construction considerations that we weigh. And so I would expect the vast majority of our investments to be outside of our top ten. Got it. One more for me. So your strategy of reducing exposure to the more challenged segments makes sense, obviously. But I'm seeing that you guys added some health and fitness assets during the quarter. What was I mean, what did you like about those assets? Because I think you mentioned that you still consider casual dining in health and fitness core operations? Yes. I would think the what you're seeing and adding that was the re tenanting and repositioning of our Town Sports that was in bankruptcy in the Q3 and emerged during the 4th and started paying rent during the 4th. We like gyms that are well positioned from a membership perspective and a revenue perspective and a competition perspective. They have high coverage. There are newer facilities that are well positioned against, older facilities within those local markets and have a rent basis that gives us comfort that if it doesn't work out as a gym, we'd be able to put another user in there at a similar rent level. And so we're open to investing in gyms and we continue to evaluate opportunities in the health and fitness space. And I think it's not going to be a material part of our investments, but certainly we'll continue to look there. Got it. Thank you. And hopefully the operator is still on. Yes, of course. Thank you. Everyone, we'll move on to our next question, which is coming from the line of RJ Milligan with Raymond James. You may proceed with your question. Hey, good morning, guys. Most of my questions have been asked and answered. I'm just curious, with the recent spike in the 10 year, has that had any impact on your business? And then at what point or what level does the 10 year need to get to before it does to have an impact on your business? Yes. Certainly, I would say the recent spike has not had any material impact on our business. We're making 15 to 20 year investments at spreads to our cost of capital that is historically wide and really has crept in. And certainly, you overlay that with a 60 to 90 day transaction movement isn't going to really impact those transactions. We think a move in the rate would ultimately help us as it would disadvantage more leverage dependent private buyers and also create make alternative capital sources for our tenants more expensive. I would stop short of saying what that move would have to be. And I certainly think as you think about the forward yield curve, that level of dramatic move isn't what the market is anticipating. Okay. That's helpful. And then just in terms of typically going after non rated or below investment grade tenants as we've moved through the pandemic. Any change in thoughts? Does that given the performance of those assets in your portfolio, does that make that strategy more attractive, less attractive, any interest in increasing investment grade exposure or perhaps going even further down the credit curve in terms of new investments? Yes. Listen, I think our middle market strategy is really governed by our desire to be a sale leaseback provider of choice to our tenants. And because in the context of the sale leaseback, we're competing on the quality of our execution and the reliability of us as a counterparty and we're able to structure long term investments on our lease form with our terms. And sitting here in January with 97% money good rent and comparing that to my investment grade peers, we feel pretty good about the quality of the portfolio that we've assembled and the nature of our tenancy, particularly when you couple that with the fact that this portfolio has been roughly constructed at a 7.5% cash cap rate with almost 100 basis points pickup to GAAP cap rate. As I said in the prepared remarks, we think we're getting some of the best risk adjusted returns in the net lease space. And I think if anything, we feel our investment thesis has been validated through this pandemic and we'll continue to be disciplined and invest in relationships and sale leasebacks with people that we know and trust and assets that have good marketability. Okay. And my final question is, as you're thinking about new sale leasebacks and structuring those leases, any changes or contemplated changes in the shape or form of the escalators going forward? Listen, I would say the lease escalations are always intensely negotiated provision with the counterparties wanting to pay as little as possible and us wanting to get as high as possible. The market range tends to be flat to 2%. On occasion, you'll see higher than 2%. I would say, you see flat with investment grade tenants. On average, we were 1 4 in the quarter. Historically, we've been closer to 1.6, 1.7, and that's really just illustrative of the sample of deals we did, not a change in the market. And so that negotiation remains dynamic and we'll continue to push to get as good as escalations we can. And tenants will continue to try to lower their cost of funds as much as they can. I would say, we like being kind of below 2%, because when you have higher escalations, you have a scenario where instead of seasoning favorably, your rents may be growing faster than the tenants profitability. And as you get further from your underwriting, it's better for the tenant to grow faster than your rent, so your rents get more better coverage and more stable. Thanks very much. You got it. Thank you. Thank you. Our next question is coming from the line of John Massocca with Ladenburg Thalmann. Please proceed with your question. Good morning. Good morning, John. Good morning, John. Most of my questions have also been answered, but just a quick one. You mentioned cap rate compression that you were seeing out in the marketplace today. I mean, I guess as you think about middle market, non investment grade tenants, what are some of the alternative financing sources out there that have been driving some of this cap rate compression? Is it competing REITs? Is there more access to bank capital now than there was maybe even prior to the pandemic? Just what are the factors there? Because I think one of the benefits of kind of middle market net leases supposed to be kind of the stickiness of those cap rates? Yes. Listen, I would argue that stickiness certainly remains. And over the past year, we've really transacted in a 20 basis point window despite all the noise and the volatile movements in interest rates. So, John, I don't think that stickiness is gone. Most of the competition is coming from other net lease capital investors, whether it's public REITs who are dipping down into the middle markets to fill their investment appetites or private guys who've discovered the technology of the ABS financing are now able to compete on levered basis with a more aggressive cost of capital. I would certainly say bank financing is no more easy to get today than it was 6, 8, 9, 12 months ago. And I guess as someone who's really utilized the ABS in the past, how sustainable do you think some of that private market, high leverage, ABS backed investment in the space is? Is this kind of a passing phase you think in your opinion? Or could that be a real kind of cap rate compressor if you will going forward? Listen, that's a very efficient market. It's a very efficient way to access debt capital. And it's been around for a long time. Greg on the call here did one of the first ABS bonds a long time ago. And I think its use is more prevalent today and I would anticipate it being here as a competitive factor going forward. Okay. That's it for me. Thank you all very much. Thank you. Thank you. Thank you. I'm not seeing any additional questions coming in at this time. So I'd like to pass the floor back over to management for any additional closing comments. Great. Thank you, operator. And again, we apologize for the drop to host and leaving you guys waiting for a bit there. But thanks for your time today. Clearly, we're excited about the Q4, but more importantly, we're excited about 2021, where the portfolio has come and our ability to continue to invest and grow. So we look forward to meeting with a lot of you investors at the Citigroup Conference upcoming and stay well and thank you. Thanks again. Bye now. Ladies and gentlemen, we thank you for your participation on today's