Greetings, and welcome to the NETSTREIT Corp. second quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jana Galan, Investor Relations. Thank you, Jana. You may begin.
We thank you for joining us for NETSTREIT's second quarter 2022 earnings conference call. In addition to the press release distributed yesterday after market close, we posted a supplemental package and an updated investor presentation. Both can be found in the investor relations section of the company's website at www.netstreit.com. On today's call, management's remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. For more information about these risk factors, we encourage you to review our Form 10-K for the year ended December 31, 2021, and our other SEC filings.
All forward-looking statements are made as of the date hereof, and NETSTREIT assumes no obligation to update any forward-looking statements in the future. In addition, certain financial information presented on this call includes non-GAAP financial measures. Please refer to our earnings release and supplemental package for definitions, GAAP reconciliations, and an explanation of why we believe such non-GAAP financial measures are useful to investors. Today's conference call is hosted by NETSTREIT's Chief Executive Officer, Mark Manheimer, and Chief Financial Officer, Andrew Blocher. They will make some prepared remarks, and then we will open the call for your questions. Now I'll turn the call over to Mark. Mark?
Morning, everyone, and welcome to our second quarter 2022 earnings conference call. Before I discuss our investment activity for the quarter, I want to take a moment and say how pleased I am with the team's ability to consistently source attractive investment opportunities at strong yields and continue to be nimble and creative in a dynamic market. We have a unique and proven strategy, and our performance demonstrates our continued ability to execute and drive strong and steady results. With that, I am pleased to report that we completed $122.7 million of net investment activity for the quarter. In a market that is evolving rapidly with higher interest rates and macroeconomic uncertainty, we have remained disciplined and selective with the opportunities we pursue.
As we started to see changes in the acquisitions market, we pivoted to higher quality and better priced acquisitions, as shown by the higher yield for the quarter, which resulted in approximately $375,000 in dead deal costs in the quarter. We believe this was the right strategy as there was a clear economic benefit to being nimble in an evolving market. Since our IPO less than two years ago, we have more than doubled our portfolio size from 163 properties to 381 properties, our ABR from $34.5 million– $84.2 million, and enhanced our diversification metrics while maintaining the highest credit quality and stable portfolio in the net lease space, increasing investment-grade and investment-grade profile tenancy about 900 basis points to 81%.
Our portfolio is largely made up of tenants in the necessity, discount, and service industries, all of which are well-insulated from recessionary and/or inflationary pressures. Despite uncertainty in the current economic environment, we believe that the defensive nature of our portfolio will allow us to continue to outperform as we did during the COVID pandemic, where we were the only public net-lease retail REIT to collect 100% of our pre-COVID rents. In addition, we have a strong balance sheet with ample flexibility and liquidity to meet our investment goals for the year. Now turning to our investment activities for the second quarter. We acquired 22 properties for $117 million at a weighted average initial cash capitalization rate of 6.7% with a weighted average lease term of 10.9 years.
It is important to note that our second quarter acquisitions were on average at a higher going-in cap rate, better credit, and with longer lease term than prior quarters, which really demonstrates the strength of our team and ability to adapt and source high-quality opportunities in an evolving market. Rent commenced on three development projects that had total cost of $9.8 million at a weighted average investment yield of 6.5% and a lease term of 10.3 years. During the quarter, we entered into a $6 million convertible loan with a 12-month term and an interest rate of 6.5%. We expect this loan to be converted into fee-simple ownership of two properties by the end of 2022, with a cash cap rate in line with the current interest rate.
Additionally, we sold a Kohl's for $9.9 million at a 6% cap rate, and we terminated the lease with a small auto parts retail store and sold the property. We expect to collect the remaining lease payments in a lump sum, which should result in a small gain in a future period. Finally, we provided $4.6 million of funding to support ongoing development projects. At quarter end, we had six projects under development where we have invested $12.8 million to date. You'll notice our development activity is down from prior quarters due to recent completions, and we have taken a more cautious approach as we expect a more challenging environment for developers to perform within their previously negotiated construction budgets with tenants, given rising construction costs, rising labor costs, and economic uncertainty.
At quarter end, our portfolio was comprised of 381 properties with 75 tenants, contributing approximately $84.2 million of annualized base rent. The portfolio had a weighted average lease term remaining of 9.5 years, with 81% of ABR represented by tenants with investment grade ratings or investment grade profiles, and the portfolio remains 100% occupied. We added 4 new tenants in the quarter, which includes a Sprouts grocery store with solar panels on its roof, augmenting our ESG efforts, an Ulta store, a Moe's restaurant, and an NTB automotive service store. Subsequent to quarter end, we acquired seven properties for $45.4 million, including closing costs.
With the recent acquisitions, we have completed $304 million in net investment activity year to date, which is over 60% of our full year $500 million targeted net investment activity. This level of activity is a testament to the experienced team we have in place and our focus to grow the portfolio with high quality tenants. We believe we are well-positioned to maintain our momentum for the remainder of the year and beyond. With that, I'll turn the call over Andrew Blocher to go over our second quarter financial results and 2022 guidance.
Thank you, Mark, and once again, thank you all for joining us on today's call. In our earnings release published yesterday after market close, we reported net income of $0.04, Core FFO of $0.26, and AFFO of $0.28 per diluted share for the second quarter. The portfolio's annualized base rent grew to over $84 million in the second quarter, up 52% from June 30, 2021, driven by 114 acquisitions, seven developments, and two mortgage loan receivables since the end of the prior year's second quarter. Interest expense increased $600,000– $1.5 million from $900,000 in second quarter 2021, due principally to our higher average balance outstanding on the revolver and increased base rates compared to second quarter 2021.
G&A increased to $4.9 million in the second quarter compared to $4 million from second quarter 2021, primarily due to an increase in the number of employees from 24 to 30 to support our growing portfolio. In addition, as Mark referenced, we had approximately $375,000 of dead deal costs in the quarter, but we do not expect this increased level of dead deal costs in the future quarters. Turning to our balance sheet, at quarter end, we had over $39 million in escrow to facilitate acquisitions that closed on July 1 and total debt of $412 million outstanding, of which $175 million is from our fully hedged term loan with the remaining balance from our revolving line of credit.
We launched a recast of our credit facility on July 11 to expand our revolver from $250 million– $400 million and to add a $200 million long five-year term loan to our debt structure. The new term loan is expected to be freely prepayable at any time, providing optionality to access the private placement market or to seek other capital markets alternatives for refinancing if we see attractive longer-term opportunities. The $600 million recast is already fully committed and is expected to close in mid-August, at which time our liquidity will increase by $350 million. We intend to leave our existing $175 million term loan outstanding, which has a fixed all-in rate of 1.36% and matures in December 2024.
On June 23, we settled 2.4 million shares, receiving net proceeds of $50 million under our forward sales agreement associated with our January offering. We have until January 10, 2023 to settle the remaining 4.5 million shares associated with our forward sales agreement. During the quarter, we did not make any sales under our ATM program. At June 30, 2022, our net debt to annualized adjusted EBITDA ratio was 3.7x after giving consideration to the remaining shares outstanding under the forward sales agreement from our January offering, well below our target range of 4.5x–5.5x . With regard to our dividend, earlier this week, the board declared a $0.20 regular quarterly cash dividend to be payable on September 15 to shareholders of record as of September 1.
Our payout ratio for the quarter was 71%. For our 2022 AFFO per share guidance, we're maintaining our previous guidance range at $1.14–$1.17, but due to market volatility, have widened some of the expectations in our underlying assumptions. Our guidance includes the following assumptions. Investment activity in the year, including developments where rent has commenced and mortgage loan receivables net of dispositions to remain at least $500 million. Cash G&A is expected to remain in the range of $14.5 million–$15 million, which is inclusive of transaction costs. Non-cash compensation expense is expected to remain in the range of $5–$5.5 million.
Due to a combination of increased borrowings and a significant increase in the forward curve since we most recently provided guidance, our cash interest expense expectation has been increased and widened from our previously stated $5.5–$6.5 million to $7–$9 million. Non-cash deferred financing fee amortization, which is not included in our cash interest expense, is increased from $600,000 to the range of $800,000–$900,000 to reflect the pending credit facility recast. Lastly, a decrease to full-year 2022 diluted weighted average shares outstanding, which includes the impact of OP units from our previously stated 52 million–54 million shares to now be in the range of 50 million–52 million shares as a result of higher projected debt balances for the remainder of 2022.
These changes will not impact our target leverage as we continue to expect our net debt to EBITDA to be between 4.5x–5.5x . To wrap up, we're confident in the ability of our portfolio to offer stable and predictable cash flow during a time of economic uncertainty. We appreciate the support of our bank group as we finalized our largest round of debt financing. During our tenure as a public company, we have demonstrated our ability to execute and build our best-in-class portfolio. Our team remains focused and diligent as we look forward to meeting our investment goals for the remainder of the year. With that, we will now open the line for questions. Operator?
Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that 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 your handset before pressing the star keys. One moment please while we poll for questions. Thank you. Our first question is from Todd Thomas with KeyBanc Capital Markets. Please proceed with your question.
Hi, good morning. First question. In terms of funding investments throughout the balance of the year, you know, you have the remaining shares to settle from the forward equity in January. Andrew Blocher, you just discussed you know, a little bit about the revised guidance, you know, your expectation for the weighted average shares. I was just wondering if you could just talk about plans to permanently finance the line balance from here and also discuss thoughts on raising equity capital in the back half of the year as you look towards the $500 million net investment guidance that you maintained.
Yeah. Thanks, Todd. Yeah, so from our perspective, you know, look, we're taking a big step by, you know, funding the line balance with the recast that we just talked about. You know, that's, it's a $600 million recast where we stand right now. We've got about $900 million of current in-place commitments. We're waiting on another $170 million more. We'd anticipate that would close in the next couple weeks, but it is fully committed. You know, that's like I said, it's a new long five-year term loan that goes along with the existing term loan that comes to maturity, you know, with the at the end of 2024.
We feel like from a debt perspective, you know, we're pretty locked up and, you know, we're adding, as I said in my remarks, another $350 million worth of debt liquidity to the balance sheet. On the equity side, yeah, you know, we've got $95 million roughly of equity that remains undrawn under the forward. On the leverage end, lowering the share-count expectation, the real key there is we just wanted to get greater certainty on the debt financing before we decided to be more efficient, you know, on the funding mix, right? If you recall, we started off the year, we were talking about a private placement. Private placement market closed very, very quickly.
That's when we moved to the debt market. You know, we're really thankful for the support that we have. You know, we still have access to, you know, I think it's roughly $160 million worth of equity, you know, through the ATM, and just feel very confident with where we stand as we look out at the opportunity set that Mark and his team is looking at on the asset side.
Okay. Does the current budget have any additional equity capital being raised throughout the balance of the year? It looks like you'd be in sort of the high 5 times range on a net debt to EBITDA basis, you know, pro forma the remaining $250 million of acquisitions or so. You know, you mentioned the 4.5x–5.5x target leverage level. I realize you've been below that by a wide margin for many quarters and you know, it may bounce around a little bit above that in the near term. Where would you expect to be at year-end?
Yeah, I mean, I would think that we'd probably be at more efficient leverage, you know, probably around five. You know, like I said, you know, we're never going to talk about, you know, specifically, you know, the specific methods that we have available to us. But, you know, we have not been active on the ATM, and we do have that as a tool at our disposal, you know, to take advantage on a go-forward basis.
Okay. In terms of asset pricing and acquisition cap rates, I was just curious if you could talk about pricing trends, whether you're seeing cap rates widen a bit as you know, buyers and sellers begin to adjust to the higher interest rate environment and sort of you know, what you're seeing in the pipeline today.
Yeah. Absolutely. Yeah, I mean, you saw a pretty big pivot from us early on in the quarter, which resulted in a little bit of, you know, dead deal costs, which, you know, we always like to try to avoid. You know, the increase in pricing was just the, you know, a lot of the typical buyers falling out of the market. You know, I think a lot of the 1031 buyers that use leverage, the ones that were locked in an exchange needed to close on those transactions. Once those kind of really flowed through the market, we've really seen less activity with 1031 buyers. They're still there, but any of them that use a decent amount of leverage are not going to be, we don't anticipate being as active.
Certainly the larger private equity firms that are using, you know, a lot of leverage are, you know, more or less completely out of the market. We pivoted during the quarter, and I think, you know, it shouldn't be lost on everybody that not only did we get a, you know, 6.7% cash cap rate on acquisitions, but then when you look at the quality of what we acquired during the quarter, you know, from a credit standpoint, you know, weighted average lease term, et cetera, we were really excited about the opportunities that we saw during the quarter, which is why we pivoted. Certainly in my view, our highest quality portfolio acquisitions during the quarter.
We hope that, you know, continues to be the case. You know, I think, you know, certainly we've seen in the neighborhood of 25 basis points on average, increase in the areas that we're looking for.
Okay. Great. One last one. Andy, if I could just go back to the recast and the term loan. Is the term loan fixed or variable, and do you plan to put hedges in place?
Yeah, I mean, you know, that's, you know, when we talk about, you know, the interest expense guidance expectations, you know, the SOFR, you know, the forward SOFR curve has just been, like, literally all over the place, right? You know, we had shown, you know, a rate, you know, to our board recently and, you know, the current market is, you know, well inside of that. So we're going to evaluate. I think our thought at this point is while it has a delayed draw feature, we would likely fully draw it down at closing.
Then the question's going to be: what does the forward curve look like at that point, and how do we think about, you know, fixing that, you know, in either, you know, in full or in part, based on market conditions at that point in time. You know, like, you know, with the Fed, you know, increasing rates by 75 basis points with the GDP read, you know, yesterday, I think that you've seen a little bit better forward curve, you know, recently than we had seen, you know, not but, like, a week or two ago, right? That's an evaluation that we'll make, and we will certainly make you aware of that at that point in time.
Okay, great. All right, thank you.
Thank you. Our next question is from Nicholas Joseph with Citi. Please proceed with your question.
Hey, it's Christian Curry on with Nick Joseph. I just want to follow back up on the transaction market. Are you seeing any buyers pull out of certain markets more so than other markets? Has there been differences in buyer appetite across different qualities, across the quality spectrum for different assets?
Yeah, no, it's a good question. You know, I think really where we started to see more buyers pull out, it really had to do with more of the leverage buyers at lower cap rates. You know, the higher quality transactions that were, you know, in many cases well below the cap rates that we're acquiring assets at, you know, a lot of those deals started, you know, we started to get a lot more calls on those types of transactions as, you know, kind of your lower four cap rate range, you know, transactions. You know, people relying on debt, you know, you start getting to negative leverage a lot more quickly on those types of transactions.
As you start moving up the cap rate scale, you know, that started to creep in more and more as interest rates continued to rise. I think it's really been much more the buyer that's relying on leverage. You saw it, you know, really in industrial, which we're not, you know, really active there at all, which, you know, had lower cap rates. You've seen, like, Amazon distribution centers kind of, you know, that were trading in the threes kind of trading at the end kind of the higher fours up to a 5% cap. Really pretty big, you know, displacement in that market. As you start creeping up into retail and some of the lower-cap-rate deals, just the debt doesn't pencil for the higher-leverage buyer.
That's really where we've seen the biggest impact. We've certainly just seen a massive increase in our opportunity set, which allowed us to be significantly more selective on the quality as well as on pricing this particular quarter. We're seeing that into the third quarter. We're pretty excited about what we're seeing in the third quarter as well.
Got it. With the tougher macro backdrop today, how are you guys thinking about the watch list? Are there any tenants on the watch list that maybe you're keeping a closer eye on? How has the watch list evolved?
Yeah, sure. Yeah, it's, you know, pretty similar to what we were starting to see last quarter, as it relates to the consumer, especially on the lower end. They're really starting to get under more and more pressure. You know, savings for the consumer are back to pre-pandemic levels. You're starting to see consumers rely more on credit cards. You know, Walmart and Target results I think illustrate, you know, necessity products are selling and discretionary is not. We took a pretty deep dive into our portfolio. Feel really good about the defensive nature about what's in our portfolio. I think if we have, you know, one tenant in particular that, you know, I think has seen, you know, pretty poor results most recently, that'd be Best Buy.
You know, they've had a bit of a rough year. It's really just the health and the preferences of the consumer have shifted, but their sales are above pre-pandemic levels. You know, we're very confident in the tenant's resilience and the assets that we own, so we don't feel like there's any risk to the rent or anything like that. You know, I think we need to be you know, pretty cautious on that particular tenant. You know, we do you know, I think we do a pretty good job of underwriting not only the tenant health, but the cyclicality and predictability of tenant health in various different economic environments. You know, we certainly have a pretty volatile market out there.
I think we also do a pretty good job of applying, you know, an appropriate asset management plan after we acquire the assets. You know, if you recall last year, you know, we sold an RV asset, which was, you know, kind of at the peak of its cyclicality, doing extraordinarily well last year. You know, you're starting to see Keystone and Winnebago in the news with, you know, not so positive news. We're really, you know, happy that we moved out of that asset last year. I think that speaks to how we're thinking about when we can opportunistically move out of certain assets, and you know, really trying to focus on assets that we feel like are going to do very well in any economic environment.
Good call, yeah. Thank you.
Thank you. As a reminder, if you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. Our next question comes from Connor Siversky with Berenberg. Please proceed with your question.
Hi out there. Thanks for having me on the call. Just quickly on the development pipeline. Noticed the spend this quarter was around $5 million. Again, in the context of kind of these heightened risk factors and maybe seeing some developers pulling back from activities, can you provide any expectation for what that run rate spend might look like through the end of the year and possibly into 2023?
Yeah, sure. I mean, it's going to be pretty dependent on what's going on with construction costs, labor costs, et cetera. A typical development deal for us is where we're partnering with a developer. They cut a deal with. You know, they've got their construction budget, and they've got, you know, whatever they paid for the land or whatever they've signed up to, you know, got the land under contract for, and then they negotiate what the rent's going to be with the tenant, and that kind of locks in what their yield should be and what they can flip the asset at. We've been very active in having conversations with the developers that we work with, and they're really just getting squeezed.
You know, the construction costs being higher, labor costs being higher, as well as more difficulty even really getting labor. Seeing the pressure that they're under and knowing that the tenants are typically not willing to renegotiate the rents that they've agreed to, we don't want to be put in a situation where the developer's coming back to us and asking us to take the pain. We just see a lot of opportunity in other areas right now where we think it's prudent for us to kind of take a step back and really see where that you know how that plays out and take a cautious approach and especially in an environment where we have you know ample acquisitions opportunities.
Got it. Understood. Maybe just a bit of a modeling question on the 26 investments included, completed during the quarter. Can you give us any sense of timing as to when those 26 were completed?
Yeah, Connor, I think that our, you know, from a bringing them onto the portfolio, I think we had an average of about 20 days.
Sorry, say that one more time.
Yeah. Twenty days, and that was somewhat influenced by early in the quarter where we started to see cap rates start to move, and seeing better opportunities, where we, you know, pushed back on some other transactions. Anything that we saw in diligence, we pushed back pretty aggressively on some of the sellers. We ended up with more of a back-end weighted, you know, quarter, which I think will likely reverse itself in the third quarter.
Yeah, Connor, just to recall, I mean, we, you know, we obviously we closed, you know, roughly $40 million on the first day of the quarter, right? In the third quarter. We're well ahead of that basically.
Okay. For the second quarter, we're looking at, just for clarification, 20 days after March 30 or 20 days before June 30?
Yeah. 20 days before.
Yeah. 20 days-
Okay.
Average outstanding is the way that I think about it.
Got it. Okay. Thank you. That's all for me.
Thank you. Our next question is from Josh Dennerlein with Bank of America. Please proceed with your question.
Hello, this is Dan Gao on behalf of Josh Dennerlein. I was hoping to see if you could elaborate more on where you see the best opportunities for capital recycling within the portfolio.
Yeah, sure. I mean, we're always kind of taking a look at the portfolio where we see potential risk. You know, fortunately, we took such a deep knife to the portfolio before going public that there you know really isn't much of anything that there's any concern. Now that being said, you know, we do keep relationships with various other counterparties in the marketplace, whether they be DST operators or you know 1031 exchange buyers or even brokers that have some relationships where somebody may you know find themselves in a trade and need to close on something quickly. You know, we'll take advantage of those types of opportunities and sell assets here and there.
I think, you know, like our 7-Eleven and some other assets within the portfolio, oftentimes, you know, we get pretty aggressive offers on those, you know, sub-5% cap range. You know, in the event that we can sell some of those assets and, you know, at pretty aggressive cap rates and we feel like we can redeploy the capital, efficiently and accretively, you know, we're always willing to do that. You know, we also don't want to, you know, be off the market, you know, selling $50–$60 million and not be able to replace it in the quarter because that, you know, that puts some pressure on earnings.
Great. Thank you. Could you also remind us on what the mix between the fixed rent bumps and inflation-linked bumps within your portfolio as well?
Yeah, sure. I mean, you know, we have a few assets in the portfolio that have CPI bumps, but, you know, I think oftentimes people think of that as inflation protection. The reality is, almost all of the CPI rent bumps in the net-lease retail space are, you know, 3x CPI, you know, the lesser of 3x CPI or 2% or 1% or whatever the, you know, transaction is, you know, depending on how that lease is structured. We would rather just have 1% or 2% fixed-rate bumps in you know, for the periods of time where there isn't inflation, to make sure that we're getting the maximum rent growth.
you know, having a few leases in the portfolio with CPI, you know, with caps, you know, we kind of view those as inferior to the fixed-rate bumpss. you know, maybe two-thirds of the portfolio has some level of rental increases.
Thank you.
Thank you. Our next question is from Connor Siversky with Berenberg. Please proceed with your question.
Just, one more from me here. I'm just looking at the provision for impairment recognized in Q2. Was that related at all to any assets that were maybe slated for sale and then moved back onto your operating portfolio once mark-to-market?
Yeah, we kind of had a you know a kind of odd situation related to the Advance Auto Parts store that we sold in the quarter where we you know terminated the lease and then sold the property during the quarter. And then we're expecting to get a lump sum of the remaining lease payments in the third quarter. Just that timing led to what would be an impairment and then likely a gain after that or you know some revenue that is a little bit unusual. But all in all, if you put all of those pieces together, it actually would result in a slight gain. It's just a little bit of a funky accounting scenario.
Got it. Can you quantify what that gain would be at all?
I mean, we're talking about, you know, $100,000, something like that, so pretty minimal.
Okay. Understood. Thank you.
Thank you. There are no further questions at this time. I would like to turn the floor back over to Mark Manheimer for any closing comments.
Well, thanks everybody for joining us today, and we certainly look forward to continuing the dialogue in the future. Take care.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.