Good morning, ladies and gentlemen, and welcome to the Essential Properties Realty Trust Second Quarter 2022 Earnings Conference Call. At this time, all parties are on a listen-only mode. A question-and-answer session will follow the formal presentation. If you would like to register a question, please press star one on your telephone keypad. If you require operator assistance during the event, please press star zero on your telephone keypad. This conference call is being recorded, and a replay of the call will be available two hours after the completion of the call for the next two weeks. The dial-in details for the replay can be found in yesterday's press release. Additionally, there will be an audio webcast available on Essential Properties website at www.essentialproperties.com, an archive of which will be available for 90 days.
It is now my pleasure to turn the call over to Daniel Donlan, Senior Vice President and Head of Capital Markets at Essential Properties. Thank you. Please go ahead.
Thank you, operator, and good morning, everyone. We appreciate you joining us today for Essential Properties Second Quarter 2022 Conference Call. Here with me today to discuss our operating results are Peter Mavoides, our President and Chief Executive Officer, and Mark Patten, our Chief Financial Officer. During this conference call, we'll make certain statements that may be considered forward-looking statements under federal securities law. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to those forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings press release. With that, Peter, please go ahead.
Thank you Dan. Thank you to everyone who is joining us today for your interest in Essential Properties. As our second quarter results indicate, our portfolio continues to perform at a high level with just two vacancies, same-store rent growth of 1.9%, and unit-level rent coverage now at the highest level in our history. Additionally, with the recent data indicating a slowdown in demand for consumer discretionary goods but continued strength in the demand for services, our portfolio remains well-positioned in the current economic environment as over 93% of our ABR is derived from service-oriented and experience-based businesses. On the investment front, we remained active in support of our long-standing tenant relationships, but we did deliberately slow our investment pace to allow seller expectations to better reset to the rapid changes that occurred in the capital markets this quarter.
Looking out to the back half of the year, we see our investment pace trending towards our eight trailing eight quarter average at modestly higher cap rates, which along with the recent closing of our $400 million unsecured term loan, supports our decision to increase our 2022 AFFO per share guidance to a range of $1.52-$1.54 from a previous range of $1.50-$1.53. Turning to the portfolio. We ended the quarter with investments in 1,561 properties that were 99.9% leased to 322 tenants operating in 16 industries. Our weighted average lease term stood at 13.8 years, with only 4.3% of ABR expiring through 2026.
Our weighted average unit level coverage ratio improved to 4.0 x from 3.8 x last quarter. While our traditional credit statistics, which focuses on implied credit ratings and unit level coverage, experienced strong sequential improvement this quarter, these statistics are negatively skewed by, one, our trailing 12-month reporting convention, which lags our own reporting by one to two quarters, and two, the fact that various municipalities were still placing capacity restrictions on certain industries well into 2021. We continue to expect these statistics to improve sequentially, particularly at the low end of the coverage spectrum, as demand for the services and experiences that our tenants provide largely improved throughout 2021 and into the first half of this year. During the second quarter, we invested $176 million through 23 separate transactions at a weighted average cash yield of 7%.
These investments were made in 11 different industries, with 70% of our activity coming from the quick service restaurant, car wash, and family entertainment industries. The weighted average lease term of our investments this quarter was 17.2 years. The weighted average annual escalation was 1.5%. The weighted average unit level coverage was 2.7 x, and the average investment per property was $3.9 million. Consistent with our investment strategy, 100% of our quarterly investments were originated through direct sale-leasebacks, which are subject to our lease form with ongoing financial reporting requirements, and 86% contained master lease provisions.
From an industry perspective, early childhood education remains our largest industry at 13.7% of ABR, followed by quick service restaurants at 12.9%, car washes at 11.7%, and medical and dental at 11.3%. Of note, unit level coverage for our early childhood education portfolio is now above pre-pandemic levels as our operators have experienced strong pricing power due to a favorable supply-demand imbalance. From a tenant concentration perspective, our largest tenant represents only 3.2% of our ABR at quarter end, and our top 10 tenants account for just 19% of ABR, which was down 20 basis points versus last quarter. Increased tenant diversity is an important risk mitigation tool and differentiator for us, and it is a direct benefit of our focus on unrated tenants and middle market operators, which offers an expansive opportunity set.
In terms of dispositions, we sold eight properties this quarter for $26.1 million in net proceeds at a 6.2% weighted average cash yield with a weighted average unit level coverage ratio of 1.1 x. As we have mentioned in the past, owning liquid properties is an important aspect of our investment discipline as it allows us to proactively manage industries, tenants, and unit-level risks within the portfolio. We expect our level of dispositions to remain elevated in the back half of the year as cap rates for individual granular properties remain near historic lows. With that, I'd like to turn the call over to Mark Patten, our Chief Financial Officer, who will take you through the financials and balance sheet for the second quarter. Mark?
Thanks Peter, and good morning, everyone. The second quarter was another strong quarter for us, which was certainly an output of the performance of our portfolio. The notable elements of our reported operating results for the second quarter of 2022 are as follows. Total revenue was up $14.4 million or 25.2% versus the same period in 2021, totaling $71.4 million for Q2 2022, which reflects the impact of our net investment activity and the performance of our tenant base. I'll mention that in contrast to last quarter, our investment activity this quarter was heavily weighted toward the back end of the quarter, while our asset dispositions occurred more toward the beginning of the quarter.
Total G&A was just over $7 million in Q2 2022 versus $6.5 million for the same period in 2021, which primarily was reflective of higher non-cash stock compensation expense. Our cash G&A moved lower sequentially from Q1 2022 by approximately $400,000, which included the impact of lower payroll-related costs, which as I mentioned in our Q1 2022 conference call, were elevated in Q1 2022, and the adjustment to our incentive compensation accrual in Q2 2022. Our cash basis G&A continues to scale favorably as a percentage of total revenue coming in at just 6.8% for Q2 2022 versus 8.1% for Q2 2021. Net income was $35.8 million in the quarter.
Our FFO totaled $54 million for the quarter or $0.41 per fully diluted share, a 28% increase over the same period in 2021. Our nominal AFFO totaled $50.6 million for the quarter, up $10.7 million over the same period in 2021, which on a fully diluted per share basis was $0.38, an increase of 12% versus Q2 2021. Turning to our balance sheet, I'll highlight the following. With another solid quarter of investments, our income producing gross assets reached $3.7 billion at quarter end. From an equity perspective, we generated approximately $32 million of net proceeds during the second quarter on our ATM program.
Our ATM activity was lighter than recent quarters, in part due to the challenging dynamics in the equity markets, but also as we generated liquidity through recycling capital from asset sales and loan repayments. Subsequent to quarter end, we closed a $400 million five and a half year term loan. We completed the term loan through an amendment of our $800 million credit facility. The rate on the term loan is floating at one-month term SOFR plus 95 basis points. At closing, $250 million of the term loan was funded, with the remaining $150 million available on a delayed draw basis. We greatly appreciate the support of our lender group in partnering with the company to get this fully pre-payable term loan executed at attractive rates.
Our net debt to annualized adjusted EBITDARE was 4.7 x at quarter end, and our total liquidity, including the remaining $150 million available to us on the term loan, is approximately $808 million. We utilized the $250 million funding from the term loan to effectively pay off the outstanding balance on our revolver. Our conservative leverage position, strong balance sheet, and significant liquidity position continues to be supportive of our investment pipeline and future growth plans. Lastly, I'll reiterate that our current investment pipeline outlook for the core portfolio and strong performance this quarter provided us with a basis to increase our 2022 AFFO per share guidance range to $1.52-$1.54 that Peter mentioned, which implies a 14% year-over-year growth rate at the midpoint.
With that, I'll turn the call back over to Peter.
Great. Thanks, Mark. Operator, please open the call for questions.
Thank you. The floor is now open for questions. If you would like to ask a question, please press star one on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. Once again, that's star one to register a question at this time. The first question is coming from Greg McGinniss of Scotiabank. Please go ahead. Mr. McGinniss, please make sure your phone is not on mute.
Definitely on mute. Thank you very much, operator. Good morning. Peter, you mentioned in the opening remarks that cap rates remain near historic lows. Just curious, you know, what do you think may change that, right? Could we potentially see expanding cap rates in the back half of the year? I mean, debt costs have obviously gone up. Just curious what you think holding the cap rates and whether that might change.
Yeah Greg thanks for that. I made that comment really in the context of our dispositions and the market for our individual assets. You know, kind of granular properties being sold into the retail investor and 10 31 market. That market remains very tight and I think that market is driven by a different dynamic that's not necessarily entirely correlated to interest rates. You know, it's really a hunt for yield and tax deferrals and other things. I also made a commentary around you know, our forward pipeline. Obviously we closed our pipeline at a 7% cap rate and our expectation for the back half of the year is to see some modest increase and expansion in cap rates there. And so it's an interesting market.
One of the reasons we deliberately slowed our pipeline in the quarter was to allow the pricing of assets where we buy to catch up to the movements in rate, and we would expect to see that flow through in the back half.
Okay, thanks. Then in thinking about the current environment and whether or not we're in a recession right now are you starting to see any impact to your tenants? I mean the tenant credit metrics all look pretty strong and continue to improve on that trailing 12 month basis. But are you having to look at some of your tenants in terms of potential credit loss this year or those that might be going on your watch list?
No, we really haven't seen any of the weakness flow through. In fact, you know, the coverages are at all-time high levels and, you know the portfolio is really, and we said this a number of times in the prepared remarks portfolio is in great shape and performing well. I think one of the things that's underappreciated is you know the stress test that these tenants went through with COVID and the right sizing of their operations and rebounding from that. We're not seeing any cracks nor do we anticipate. You know our tenants are really doing a great job.
Okay. Just a comment not a question, but the Chicken N Pickle concept looks amazing, and I want one in New York.
Yeah well those guys are a great operator. They got a great concept that's really resonating, you know, I don't know that we would want the basis that it would cost to put it in New York, if you're talking about the city. They are definitely expanding and that concept has some good legs to it.
Thank you.
Thanks, Greg. Appreciate it.
Thank you. The next question is coming from Nicholas Joseph of Citi. Please go ahead.
Hey, it's
You know, I had a tough time with that question. You really broke up. Did you catch it, Dan? No? Repeat the question.
It felt like cap rates and.
Yeah, I can repeat it. I was just curious if there was any impact market by market on rising rates to buyers?
Yeah no I mean you know, it's much of the retail investor and 1031 market that we sell in is a national market and you know, we really haven't seen much of that flow through and you know, there's pretty wide dispersion in rates based upon the asset class as well as the purchase price of the assets. I haven't seen material changes in that market, certainly not by geography.
Got it. Are there any changes to you know lease escalations in some of your newly signed deals? You know the impact of inflation or maybe a tougher macro backdrop has that impacted you know, conversations around lease escalators?
It really hasn't. If you think about how we operate our business where, you know, 80%+ of what we're doing in any quarter is repeat business with guys where we already have a negotiated lease, you know it's really not creeping into the narrative. We're doing 20-years leases and you know, this recent spate of inflation, you know for the first time in 30 years really hasn't changed that negotiating dynamic.
Got it. Thank you.
Thank you.
Thank you. The next question is coming from Haendel St. Juste of Mizuho. Please go ahead.
Hey guys Good morning. Peter , you had I think $330 million under contract or LOI. What portion of this, I guess, is still in the pipeline for the third quarter? Trying to understand, you know, what's in the pipeline, the type of deals. The volume for the second quarter is obviously a little bit below the historical trend. I'm curious if any of these deals are now part of the pipeline for the second half as you're looking at it, and maybe give us some color on what's in that pipeline, any new categories? Thanks.
Yeah Haendel , as you know as we say the pipeline's very dynamic and usually represents a 90-days forward look and can, you know some deals can even extend well beyond that given the M&A nature of some of our investments where we're supporting a transaction that has uncertain timing. It's impossible to say you know exactly what the percentage. The commentary in the call was that we expect our investment levels to return to the eight-quarter average in the back half of the year. That would suggest a 200-ish sort of number. The pipeline certainly supports that commentary. In terms of composition of the pipeline, there's really nothing new.
Again, I would reiterate, when you're doing 80% repeat business and relationship business it's you know the deals are coming from your portfolio and the deals that you've done in the past, and those relationships. By design, the pipeline's gonna look a lot like what we own, and there's really nothing noteworthy but for you know some expansion in the cap rates at the margin.
Great. Maybe one on dispositions. Wanted to understand the cap rate there, a bit lower than we expected. The volume's a bit more, I understand. It's, you know, an incremental source of capital these days. Maybe you could talk about the level of cap rates. Is that a level we should expect? Maybe the decision to sell assets so late in the quarter did that influence you know, what you sold or the cap rates at all? Thanks.
Yeah. You know listen, I think the timing of dispositions you know, is reflective of our decision to, you know kind of lean into capital recycling as a result of the movements in rates that we saw in, you know kind of during the quarter. You know, that sales cycle is just by design but you know puts it towards the end of the quarter. We anticipate staying on our front foot, you know, in terms of dispositions in the back half of the year. The cap rates on dispositions are gonna vary wildly and, you know, it's not a material part of the financial picture so I wouldn't you know, guide much lower than you saw printed.
I would expect that you know, we would generally transact, you know, kind of around that six range or below. You know, I did make the commentary you know, that Citi asked about at the beginning that the market remains pretty robust, and it's somewhat disconnected from the movements in rates. There's a real you know, disconnect for us to sell into that and realize those rates despite the movements in cap rates and interest rates as well as selling off you know, kind of the assets that we don't wanna hold on a long-term basis.
The liquidity we've built into the portfolio is an important risk mitigator for us and this important source of capital, and you should expect us to tap that as we look at the back half of the year.
Thank you.
Thank you, Haendel.
Thank you. The next question is coming from Sheila McGrath of Evercore. Please go ahead.
Yes, good morning. Peter, borrowing costs are up, you know, depending on the company, 50, 100 basis points or more. I just wonder, based on your experience in the net lease sector, if you think that cap rates could move in lockstep with borrowing costs rise, or do you expect a lag here?
Well, I think there's certainly always a lag right? As you kind of clear through your pipeline which you know, I made the commentary, is usually about a 90-day pipeline. I think that's one of the reasons why, you know, you look at our second quarter print at 176 is a seven cap. You know, those were largely deals that we were committed to prior to the movements in rates and, you know why we're guiding to low sevens and above that here in the back half. There's certainly a lag in the movement of cap rates, and generally, there's not a lockstep movement in cap rates to interest rates. But you know they do move, you know, in the same direction. Just it takes a little while, and it's a little muted.
Okay. The cap rate for acquisitions tweaked back to 8%. It hasn't been at that level you know, for a couple years. Just wondering, were you able to originate current product with higher annual escalation?
Yeah, that's what that would indicate. It also goes lines up with you know our WALT being so long, you know, at 17.2 years, you know we were originating deals that were a little longer as well.
Okay. Thank you.
All right. Thank you, Sheila.
Thank you. The next question is coming from Joshua Dennerlein of Bank of America. Please go ahead.
Hi. Good morning. This is Elizabeth Boykin on for Josh. Back to the question on tenant credit quality. I was wondering if you could explain why the rent coverage ticked down to 2.7 x, from, you know, about 3.3 last quarter. If you could explain, you know, the trend in that.
Yeah you know I would say you know, a more important trend to focus on is the trend of the overall portfolio, not our overall in quarterly investments. That number is for the investments that we made during the quarter, and those investments are heavily influenced by the mix of industries and property types that vary widely from quarter to quarter. The bigger trend is, you know, our portfolio's overall coverage expanding to 4 x, which is the highest it's been. You know, that 2.7 is very small percentage of the overall portfolio and really heavily influenced by the specific deals that we do.
Okay. Thank you. For my second question, I'm just wondering if you all have changed, you know, your thinking around underwriting new acquisitions. It seems to be on track, and you haven't, you know, changed your outlook for that for the eight-quarter trailing average. Given the conditions, has there been any change in how you're thinking about underwriting?
I guess there's really two questions inherent in that, one is underwriting risk, and two is managing the business and the growth within the business. You know, our evaluation and underwriting risk in our tenants is you know evolved over you know decades of investing in this asset class and you know that has not changed nor is it likely to change. In terms of our pace of acquisitions, you know, while our cost of capital isn't where it has been, it's still attractive and there's a lot of opportunities with less competition, quite frankly as this market volatility has shaken out a lot of the competition that we were seeing from earlier in the year.
We have great relationships that continue to bring us opportunities to invest and build a portfolio and grow earnings. We feel good about what we're seeing here in the back half of the year, and we're gonna continue to deploy capital towards that.
Great. Thank you.
Thank you.
Once again, ladies and gentlemen, that is star one if you would like to register a question at this time. The next question is coming from Ki Bin Kim of Truist Securities. Please go ahead.
Thanks. Good morning. Can you talk about the debt raise you guys just did? I believe it's still floating, if you have any plans to swap it and what that cost could look like.
Yeah. Thanks for that question. You know, I'll start with saying what we've consistently said before, that our philosophy is really to match fund our leverage to our long-dated leases, which we certainly plan to do. It just strikes us that, you know, now is not an opportune time to lock in that long-term funding, you know, given the dislocation that we see in the public unsecured debt market. Not swapping the long five-term loan really sort of preserves our optionality around the prepayment capability, and that's really why we were there.
If you could just kind of help me satisfy my curiosity, though. What would the swap rate be if you did it in this type of market?
Go ahead, Dan. What do you got on that?
Yeah. It's around 2.3% right now, Ki Bin, on a five-year basis.
Okay. If cap rates do tick up higher, I'm guessing it's not gonna be for all types of assets and all categories together, right? What do you think shakes loose first, and would those types of assets be things that you'd be interested in? I guess I'm asking, you know, for the things that you're typically looking to buy, would those cap rates move, you know, upwards as well?
Yeah Listen it's you know. Remember, the way we invest is providing sale-leaseback capital to growing operators within our targeted 16 industries, largely relying on relationships that we know and have done deals with in the past. Our competition, the price of those deals really are based on two factors. One is the level of competition, and two is our competition with competing capital sources. You know, we largely compete against other forms of capital, whether it be unsecured financing or mortgage financing or what have you. To the extent that that capital becomes more expensive or less available, our sellers, our counterparties, our tenants are less price sensitive.
We're seeing ability to move cap rates across the entire spectrum of opportunities that we invest in all our industries. We continue to avoid, you know highly auctioned you know, competitive situations where there's a competitive dynamic that you know, forces the cap rate down, like in the investment-grade existing lease deals. We're seeing the ability to move cap rates across all our opportunity sets, albeit, you know at a modest rate.
Okay. Thank you.
All right. Thank you, Ki Bin.
Thanks, Ki Bin.
Thank you. The next question is coming from John Massocca of Ladenburg Thalmann. Please go ahead.
Good morning.
Good morning, John.
Just on the disposition front, it seems like a lot of the capital recycling was kind of based around loan receivable prepayments. Just curious what the outlook for more of these kinda tenant prepayments is in the near to medium term, given kind of we've had kind of big lumpy slugs of that in the last two of the last three quarters.
I would start, you know our loan book is pretty modest at, you know, $200-ish million. It's, you know, there's not a ton. You know, I would expect that we continue to get some loan payoffs in the back half of the year. You know probably, you know, and not as big as we saw in this quarter, but, you know, so at some level.
Okay.
And those are hard to-
Go ahead.
We don't control those, and it really depends on the borrower when they source alternative capital or decide to repay. You know, it comes at us when it comes at us.
Okay. Maybe bigger picture, you know, kind of with recession and an economic pullback, at least in people's minds or kind of, you know outlooks going forward. You know, as you kind of look back in your experience in kind of the sale-leaseback market with the middle market credits, in prior cycles, maybe, and maybe as you look forward, if there is an economic slowdown, you know, how correlated do you feel deal flow is to economic activity? You know, essentially, if your tenants either aren't confident or in a position to expand or consolidate, I mean how do you think that flows through to your transactions? Do you think it's kind of immune to that because you're you know, a reliable source of capital maybe?
Yeah. I would say we are somewhat immune to that because, you know, our opportunity set is so large and our investment volumes are so modest relative to that opportunity set. We go to market with great cost of capital relative to a lot of alternatives. I would also point out that, you know, our 16 industries and our service and experience base, you know, service industry focus is one of the bright spots of the economy and really fighting the trend. You know, services and experiences are doing pretty well. Our tenants within those industries continue to do well.
You know, that's one of the reasons why we're, you know, maintaining our kind of guidance and raising our guidance despite, you know, what is not a completely sunny outlook.
Okay. That's it for me. Thank you very much.
Thanks, John.
Thank you. The next question is coming from Christopher Lucas of Capital One. Please go ahead.
Hey, good morning, everybody. Peter, just kind of going back to the disposition pool that you guys are thinking about and just kind of reviewing the last, you know, trailing eight quarters is sort of a mix of what appears to be sort of risk mitigation in terms of low coverage type assets being sold, as well as maybe some more median credit issues. I'm just curious as to when you guys think about the disposition pool that you're looking at to sort of fund acquisitions, is it risk mitigation or is it relative value that drives what goes into that pool?
I would say it's more, you know, and not to be cute, but it's more relative value around risk mitigation. And selling assets that, you know, just don't meet our long-term investment horizon and, you know, just moving them out. Remember, there's an interesting dynamic that goes on when we're selling assets out of a master lease that, you know, we're establishing a rent on a specific asset and, you know, really, and that affects the hold position on the overall position. But by and large, it's risk mitigation.
On occasion, we'll get an inbound offer or unsolicited offer for assets where, you know, the price is just, you know, way off the charts relative to our thinking on value, and we'll hit that bid. For the most part, it's a risk mitigation.
Okay, thanks for that. As it relates to, I guess I'm just trying to understand. We talk about interest rates and its impact on, you know, cap rates. I guess I just wanna make sure that, you know, is there a specific, you know, rate benchmark that you're looking at? Obviously, with the increased concerns about a recession, you've seen a sort of a flight to the 10-year come down quite a bit just in the last couple of weeks. Just kinda curious, when you think about what drives that potential move in cap rates, you know, what rate are we really talking about?
I think the 10-years really becomes the best proxy given the long-dated nature of this asset class, and just the liquid nature of the 10-years. You know, most investors in this space are looking to match fund and term debt, you know, similar to the underlying lease term. You know, I think the 10-years becomes the best proxy.
Okay. That's great. Thank you. That's all I had this morning.
All right. Thank you very much, Chris. We appreciate it.
Thank you. At this time, I'd like to turn the floor back over to Peter Mavoides for closing comments.
Great. Well, thank you all for your participation today and your questions. We appreciate your interest in our company. Everyone have a great summer. Thank you.
Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time and enjoy the rest of your day.