Good day, welcome to the Getty Realty Corp. third quarter 2018 earnings call. Today's call is being recorded. At this time, I'd like to turn the conference over to Joshua Dicker, EVP, general counsel, and corporate secretary. Go ahead, sir.
Thank you, operator. I'd like to thank you all for joining us for Getty Realty's third quarter conference call. Yesterday afternoon, the company released its financial results for the quarter ended September 30, 2018. The Form 8-K and earnings release are available in the investor relations section of our website at gettyrealty.com. Certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to trends, events, and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Examples of forward-looking statements include our 2018 guidance and may also include statements made by management in their remarks and in response to questions, including regarding future company operations, future financial performance, and the company's acquisition or redevelopment plans and opportunities.
We caution you that such statements reflect our best judgment based on factors currently known to us, that actual events or results could differ materially. I refer you to the company's annual report on Form 10-K for the year ended December 31, 2017, as well as our periodic reports filed with the SEC for a more detailed discussion of the risks and other factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. You should not place undue reliance on forward-looking statements, which reflect our view only as of the date hereof. The company undertakes no duty to update any forward-looking statements that may be made in the course of this call.
Please refer to our earnings release for a discussion of our use of non-GAAP financial measures, including our definition of adjusted funds from operations, or AFFO, which was revised at the end of 2017, our reconciliation of non-GAAP financial measures to net earnings. With that, let me turn the call over to Christopher Constant, our Chief Executive Officer.
Thank you, Josh. Good morning, everyone, and welcome to our call for the third quarter of 2018. With Josh and me on the call today are Mark J. Olear, our Chief Operating Officer, and Danion Fielding, our Chief Financial Officer. Let me begin today's call by providing an overview of our third quarter 2018 performance, investment activities, and balance sheet initiatives. Then I will pass the call to Mark to discuss our portfolio in more detail. Finally, Daniel will discuss our financial results. Our third quarter results continued to benefit from the steady performance of our core net lease portfolio, as well as the ongoing execution of our acquisition and redevelopment strategies. As a result, our revenues, net earnings, funds from operations, and adjusted funds from operations all increased as compared to the prior year's quarter.
I'm also pleased that this consistent growth resulted in an increase in our recurring dividend, which was announced yesterday, further demonstrating our commitment to creating shareholder value. For the third quarter, our revenue from rental properties increased by almost 19% to $29.6 million, and our net income increased to $10.9 million. Our AFFO increased by 14% to $17.9 million, and more importantly, we reported AFFO per share of $0.44, which is a $0.04 increase or 10% over the prior year's quarter. As I alluded to earlier, we continued to execute on our acquisition strategy during the quarter by adding seven high-quality properties to our portfolio, all of which are leased to strong corporate tenants. For the year to date, we have added 39 properties and accretively invested $75 million in acquisitions.
In addition, we completed our third redevelopment project of the year, which is a state-of-the-art, new-to-industry convenience and gas location. The completion of this project marks our sixth completed redevelopment. We continue to grow our pipeline of projects as we believe this strategy allows us to unlock value in our existing portfolio and deliver superior returns by investing in well-located properties while bringing new corporate tenants into our portfolio. As we approach the end of 2018, we continue to underwrite additional transaction opportunities in the convenience gas and auto-related sectors. Overall, the volume of opportunities available for these types of assets remains strong, and we continue to see competition from both our REIT peers and other institutional real estate investors. With that said, we are staying true to our underwriting criteria.
As such, we continue to be focused on acquiring high-quality real estate and partnering with tenants who share our commitment to the growth and evolution of the convenience and gas sector. In addition, we are growing our pipeline of redevelopment projects and selectively disposing of properties where we have made a determination that the property is no longer competitive as a convenience and gas location and does not have redevelopment potential. Turning to our dividend, as we announced yesterday, our board approved a 9% increase in our recurring quarterly cash dividend from $0.32 per share to $0.35 per share. We believe this annual increase is appropriate given the company's significant growth over the last 18 months. In addition, on behalf of the Getty board of directors, I would like to welcome Mary Lou Malanoski to our board.
Mary Lou has over 30 years of experience on Wall Street in various roles and is currently the Chief Financial Officer of Colony S2K. She brings a wealth of capital markets experience and will provide a unique and independent perspective to our company. We are excited by the enhanced strength and diversity that Mary Lou brings to our board, and we look forward to the benefits her experience and counsel will bring to our company. Finally, we are excited about our accomplishments year to date and about our outlook for the remainder of the year. We continue to benefit from the health and growth of the convenience store industry, stable cash flows received from our net lease portfolio, and our conservative balance sheet. We are focused on managing our net lease portfolio, expanding our portfolio through acquisitions, and selective redevelopment projects.
We remain confident that we'll be able to continue to successfully execute on our strategic objectives throughout the remainder of 2018 and beyond. With that, I will turn the call to Mark Ollier to discuss our portfolio and investment activities.
In addition, during the quarter, we acquired one property in Phoenix, Arizona for $2 million. Year to date, we have acquired 39 properties for approximately $75 million, and we expect to generate annualized revenue from these properties of approximately $5.4 million. Turning to our redevelopment program. During the quarter, rent commenced on one project. For the project, we funded a raise and rebuild of a convenience and gas station with Applegreen in Worcester, Mass. In this project, our total investment is approximately $1.4 million, and we achieved an incremental return on our investment of 13%. Year to date, this is our third completed redevelopment project. In aggregate, we have invested $4 million in six completed projects for aggregate incremental return on investment of 16%. Turning to our redevelopment pipeline.
In addition, during the quarter, we acquired one property in Phoenix, Arizona for $2 million. Year to date, we have acquired 39 properties for approximately $75 million, and we expect to generate annualized revenue from these properties of approximately $5.4 million. Turning to our redevelopment program. During the quarter, rent commenced on one project. For the project, we funded a raise and rebuild of a convenience and gas station with Applegreen in Worcester, Mass. In this project, our total investment is approximately $1.4 million, and we achieved an incremental return on our investment of 13%. Year to date, this is our third completed redevelopment project. In aggregate, we have invested $4 million in six completed projects for aggregate incremental return on investment of 16%. Turning to our redevelopment pipeline.
We ended the quarter with 13 signed leases and LOIs, which include nine active projects and four projects and properties which are currently included in our net lease portfolio, but which will be removed from active leasing when we receive various approvals required to commence construction. Our pipeline includes a wide range of retail uses, such as enhanced convenience stores and gas stations, specialty retail such as automotive parts and service, and quick service and fast casual restaurants. To date, we have invested approximately $3 million in these 13 projects, and we estimate that the total anticipated investment through completion will be $11 million. We expect that substantially all these projects will be completed over the next one to three years, with additional projects moving to rent commencement status before we close out 2018.
As a reminder, we expect our redevelopment projects to generate incremental returns to the company in excess of what we could expect if we invested these funds in the acquisition market today. For more detailed information on Getty's redevelopment projects, please refer to page 14 of our investor presentation, which can be found on our website. We remain committed to optimizing our portfolio and continue to anticipate redevelopment opportunities over the next five years, possibly involving 5%-10% of our current portfolio, with targeted unlevered redevelopment program yields of greater than 10%. During the quarter, our occupancy was 99%, compared to 99.5% at the end of the second quarter, as we added four properties to our vacancy list. The increase in vacant properties was an anticipated consequence of planned takebacks of underperforming gas sites based on negotiations with certain of our tenants as part of a broader arrangement.
We expect that we will either redevelop or dispose of these properties over time. As a result of our portfolio activities, we ended the quarter with 920 net lease properties, nine active redevelopment sites, and nine vacant properties, and our weighted average lease term is approximately 11 years. With that, I turn the call over to Daniel.
Thank you, Mark. Turning to our financial results. For the third quarter 2018, our total revenues and revenues from rental property, which excludes tenant expense reimbursement and interest income, grew 18% to $34.7 million and 19% to $29.6 million, respectively. The primary drivers of the increase over the prior year's quarter were the impact of rent received from our investment activity in the second half of 2017 and 2018 year to date. During the third quarter of 2018, our property costs, environmental expense, and general and administrative expenses were all comparable to the results of the third quarter ended 2017. For more information on specific expense movements, please refer to yesterday's earnings release. Our FFO for the quarter was $17.9 million, or $0.44 per share, as compared to $16.2 million or $0.42 per share for the prior year's quarter.
Our AFFO for the quarter was $17.9 million or $0.44 per share as compared to $15.7 million or $0.40 per share for the prior year's quarter. Turning to the balance sheet. We ended the quarter with $425 million of borrowings, which includes $100 million under our credit agreement and $325 million of long-term fixed rate debt. Our weighted average borrowing cost is 5.1%, and the weighted average maturity of our debt is 5.4 years, with 76% of our debt being fixed rate
Our earliest debt maturity is not until 2021. Our debt to total capitalization currently stands at 28%, our total debt to total asset value is 36%, and our net debt to EBITDA is 4.5 times. In addition, we used our ATM program during the quarter and issued $7 million of capital at an average price of $28.69 per share. Our environmental liability ended the quarter at $60.9 million, down $2.7 million so far this year. For the quarter, the company's net environmental remediation spending was approximately $2.3 million. Finally, we are turning our 2018 AFFO per share guidance to $1.70-$1.74 per share from a range of $1.68-$1.74 per share. Our guidance range includes the impact of our year-to-date acquisition activities and our capital market transactions.
As a reminder, our guidance does not assume any future acquisitions or capital market activities, although it does reflect our expectation that we will continue to execute on our redevelopment, leasing, and disposition activities. Specific factors which impact our guidance this year include, one, the full year impact of our earnings from the second half of 2017 and 2018 year-to-date acquisitions. Two, our expectation that we will forego rent when we recapture properties from our net lease portfolio for redevelopment. Three, our expectation that our weighted average cost of borrowing will increase in 2018. Four, the full year impact of the dilution associated with the company's 2017 and 2018 capital raising activities. With that, I will turn the call back to Chris.
Thank you. That concludes our prepared remarks. Let me ask the operator to open the call for questions.
If you would like to ask a question, please signal by pressing star one. We'll take our first question from Craig Mailman with KeyBank.
Hey, good morning, guys. Chris, you mentioned the opportunity set is still pretty strong here. Just curious, with the volatility we've seen in rates, have you guys seen any movement in cap rates or maybe even on the margin, a little bit less appetite from competing buyers?
Well, two questions there. I don't think there's been any reduced appetite from competing sources of capital. I do think what you're starting to see is the expectation of a premium cap rate is sort of diminishing. People are kind of starting to adjust to maybe a new norm within the rising rate environment. All transactions take time to go from start to finish. I think it's going to take time for that to filter its way into completed deals.
Helpful. How much would rates need to move for you guys to kind of reevaluate return thresholds need on either acquisitions or even incremental redevelopments?
Well, our redevelopment pipeline is several hundred basis points over the acquisition market. I think you'd have to see significant movement there. I think we feel pretty comfortable that we'll be able to accretively invest in the acquisition market, even with a rising rate environment.
Okay. Just lastly, you guys have at the ATM a bit, you are at four and a half times debt to EBITDA. How do you look at the different sources of capital today, given where the stock is trading and has performed this year versus maybe using incremental debt?
Well, we've said before that we prefer to operate sort of in a four and a half to five and a half times net debt to EBITDA range. We're certainly at the low end of that. The company has always been a conservative company throughout its history and into today. With that said, when we look at acquisitions, we can take advantage of the fact that we are a low-levered balance sheet at the current moment and use our debt capacity to fund deals. We don't expect to live as a highly levered entity post-acquisition.
I guess what I was getting at too is you guys have said kind of four and a half to five and a half is the range, but how far below that four and a half would you bring it down if your cost of equity is attractive to lock it in versus levering up a bit?
I don't have a specific number to give you, Craig. We take all factors into account when we look at our growth plans and our balance sheet.
Great. Thanks, guys.
We'll take our next question from Mitch Germain with JMP Securities.
Chris, you talked about the pricing dynamic in the investment sales market. Do you think that there is a reluctance for some of your competitors to put capital to work knowing that there could be some upward pressure at cap rates, or are you still seeing a ton of money flowing into the space?
I really don't see a reluctance. What you do see is there's a lot of significant M&A transactions going on, there doesn't seem to be any lack of appetite from strategics or financial buyers. Obviously, we can play with either one of those parties in an M&A context. The short answer, Mitch, is no, I don't think there's any diminished appetite in the market right now.
Great. That's helpful. You did a 30-property acquisition earlier this year. You just did a six-property sale-leaseback. When you think of your pipeline today, looking at it, does it have a bit of both, or is it maybe skewed to one versus the other?
We tend to favor portfolio acquisitions, right? A portfolio can be defined as a six-property deal, or it can be defined as 30 or 50, like we did last year. With that said, we certainly look at one-off situations where we really like the tenants or the real estate, and the economics work. We have a program that Mark runs that we are able to look at all types of assets, big and small, in our sector.
Got you. Last from me, with the dividend bump, how much do you kind of bake into your analysis the potential environmental liability that could be realized? I mean, is that considered when you're looking at the different factors as to where the cash flow of the company is headed?
Absolutely. The board takes into account all of our sources and uses of capital, environmental being a use, and factors that into their dividend decision in terms of the raise that was done yesterday.
Great. Congrats.
Thank you.
We'll take our next question from Joshua Dennerlein with Bank of America Merrill Lynch.
Hey, good morning, guys.
Morning.
Maybe just that Applegreen portfolio that you did the sale-leaseback on. Maybe you could walk us through how that came about, and I don't know if you can provide any color on the initial cap rate, and maybe some kind of added rent bump that you're getting.
Yeah. The Applegreen relationship started sort of at the beginning of 2017 or maybe even late 2016, when they were looking to come into the U.S. market in a more meaningful way. Obviously, the deal that we closed in October of 2017, they were here in a smaller way, but was their major entrance into the U.S. market, and we were a big part of that transaction. I think from their side and from our side, it made a lot of sense to work together on this add-on acquisition in Columbia. The six properties that were acquired by Applegreen, which we helped fund, were very much in line and near the remainder of their portfolio down in that market. That's kind of how the transaction came about.
We funded $17.25 million, and we expect our initial first-year cash rent to be about a million and a quarter. That can kind of give you our range as to what we think the going-in return is. The lease has effective annual bumps in it in line with what we published in our presentation.
Great. Thank you, Chris. Maybe turning to the development pipeline, it looks like you have four projects that are going to wrap up by the end of the year. Is there any color on any timing, like is it early fourth quarter, or towards the end of the year, and is that when rent will commence?
Sitting here today, right, it's from today through the end of 12/31. They're staggered.
Staggered, okay. What kind of yields are you getting on the projects in the active construction?
Yeah. We've completed six projects. Our incremental yield on our additional investments thus far has averaged or totaled 16% in aggregate. What we've said all along is that we target a program-wide 10%+ return for an entire program. I think those numbers probably help get out there.
Awesome. Thank you, Chris. I guess when we think big picture, what's kind of the latest thoughts on how many of the properties in your overall portfolio could go through the redevelopment pipeline?
We continue to believe that approximately 5%-10% of the portfolio over the next five-plus years are projects that we can access the property, work with an identified tenant to come up with either a new convenience and gas use or an alternative retail use. I think that we feel pretty confident in that range of properties.
Great. Thank you. I'll yield the floor.
We'll take our next question from John Massocca with Lennon Berg Salman.
Good morning. Can you maybe provide a little more color on the takebacks, the increased vacancy? Were those all with one tenant, or were they with a collection of kind of underperforming assets across a couple of different tenants?
Yeah, no. Certain of our leases, particular leases that came out of the Getty Petroleum Marketing bankruptcy, had some rights in the leases where our tenants can give a select number of properties back to us. Also, in many of those leases, we have the right to pull properties out, which is where a lot of our redevelopment projects are coming from. This was our tenants exercising those rights, giving us advance notice so that we can sort of come up with a plan for each one of those properties. Mark mentioned, we expect to either sell or redevelop those properties. Obviously, if we can redevelop, there's probably upside in that rental figure. If we dispose of the property, we expect to be able to reinvest the proceeds in either development funding or the acquisition market.
In the near term, maybe how much NOI, if any, was lost from these give backs?
De minimis.
Okay. One last question on that. What % of the portfolio has these kind of give back rights to it right now?
Well, it's a tough question to answer. The leases that came out of the Getty Petroleum Marketing, the unitary leases, most of those leases have these give back rights in them. We are approaching the end of the window for our tenants to give additional properties back to us. I think you will see maybe a handful of these over the next 12-24 months, but it's not a significant number of properties.
Okay. Maybe switching gears to the acquisition side. It seems like a lot of some of the recent operator M&A activity has been, maybe for not necessarily rural, but assets in smaller markets. I know your focus has been on the urban and suburban product. How small of an MSA would you be willing to go into as part of a transaction?
Yeah, it's a great question. We've certainly looked at a lot of transactions, and some of which are in more rural markets. I think when we get a package that is a portfolio that's maybe out of our core urban/suburban strategy, we do our best to come up with a subset of properties that would fit with our model. Sometimes we're able to do that, and sometimes not. We generally would like to stick to markets that have a core retail center, and some sort of, whether it's university or state capital or a city or a growing hub that's driving population growth, that's keeping income stable, that's creating miles driven, which is customer visits for our tenants.
It's really hard to say how small we would go, but the markets that are outside of our core strategies have to have some components of that in order for them to be interesting to us.
Makes sense. That's it for me. Thank you very much.
Again, that is star one to ask a question. We'll take our next question from Anthony Paolone with JPMorgan.
Thanks and good morning. Not much left here. Just want to go back just real quick on Mitch, his question earlier about free cash flow. Do you have a dollar amount? Just everybody's definition here differs a bit on where you think you're running on a free cash flow basis after environmental and dividends and stuff right now.
Not off the top of my head, Tony. I'd have to look at the numbers and be able to kind of help tie that together for you. We could certainly think about publishing some sort of figure going forward.
Okay. Then just on the deal flow, it sounds like you have a lot of activity, you have access to capital, the yields have been hovering around that low seven. Just what is the inhibiting factor from just having a little bit more perhaps robust quarter-to-quarter amount of activity? Is it that it's hard to keep it at the seven two or it kind of goes to where the properties are? What is happening?
Well, I think what we're trying to do is acquire strong real estate, that strong real estate, obviously we want it to be an attractive convenience and gas use or other auto use, obviously have a strong partner on the counter side. Really I think what the limiting factor is today is not necessarily return, it's not necessarily opportunity set, it's kind of geographic location and quality of the underlying real estate.
Okay. Got it. Then last one, you may have mentioned this or alluded to it, just the general split of activity between just traditional gas stations, C stores, any other automotive-related categories, what does that look like right now?
Yeah. I think the portfolio today is probably 95%+ C store gas station. We're certainly looking at the other auto sectors. We've done a little bit in terms of the tire and battery, the lube guys, we've looked at car washes, service-
Auto body.
Auto body. Thank you, Mark. Right now to say that that's a meaningful piece to our existing NOI It's just not there yet.
Okay. Got it. Thanks.
There are no further questions at this time.
Well, thank you everyone for attending the call this morning. We look forward to getting back together with everyone when we report our year-end earnings in 2019.