Good day, welcome to the NETSTREIT Corp first quarter 2023 earnings conference call. Today, all participants will be in a listen-only mode. Should you need assistance during today's call, please signal for a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. If you would like to ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note that today's event is being recorded. At this time, I would like to turn the conference over to Amy An, Director of Investor Relations. Please go ahead.
We thank you for joining us for NETSTREIT's first quarter 2023 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 31st, 2022, 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 of our non-GAAP measures, reconciliations to the most comparable GAAP measure, 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, Dan Donlan. 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?
Good morning, everyone, and welcome to our first quarter 2023 earnings conference call. Before we begin, I am pleased to welcome our new CFO and Treasurer, Dan Donlan, to the NETSTREIT team. Dan brings strong corporate finance, capital markets, and operational REIT experience to our platform, and he is committed to helping the company generate sustainable long-term value for shareholders. Welcome aboard, Dan. Turning to our first quarter results, we had an active start to the year despite the volatile capital markets environment and an uncertain macroeconomic backdrop. Our best-in-class portfolio continues to perform exceptionally well in the face of persistent inflation, recession concerns, interest rate increases, and higher volatility. We have maintained 100% occupancy, 100% rent collections, and any disruption to our tenants' sales and profitability has been minimal.
Having spent a good portion of 2022 locking in significant portions of our capital structure by prudently accessing the capital when conditions were supportive, we started 2023 with ample dry powder to make investments that meet our quality and return thresholds.
During the quarter, we completed net investments of $112.7 million, including the acquisition of 20 properties for $67.7 million at a weighted average cash yield of 6.9%, two senior loan investments, which are secured by 49 properties for $46.1 million at a weighted average cash yield of 9.3%, two completed development projects for $14.8 million and $4.5 million of additional funding to support ongoing development projects, and eight dispositions for $15.8 million at a weighted average cash yield of 6.8%. Notably, based on total ABR, 95% of these first quarter investments were with Investment Grade and Investment Grade Profile tenants.
Overall, while the net lease industry transaction market remains less active today than this time last year, we are seeing a healthy pace of opportunities at attractive prices with better terms as financing contingent and levered buyers remain sidelined. While our first quarter net investment activity has us slightly ahead of pace versus our 2023 target, we have taken and will continue to take a judicious approach to the investments we pursue. We are extremely mindful when it comes to capital deployment. We are staying disciplined in our credit underwriting standards and the pricing of assets. As we have demonstrated over the past three years through a variety of macroeconomic environments, we can be nimble and capitalize on opportunities as they arise.
Currently, stress in the regional banking sector has created dislocations in the net lease transaction market, which has provided us with opportunities to maintain our growth strategy momentum. We remain in constant communication with existing talent, existing tenants, developers, and other landlords to provide financing solutions where we see the best risk-adjusted returns. This solutions-based approach with a growing number of counterparties has helped expand our industry relationships while increasing the number of opportunities for NETSTREIT. With that in mind, we have seen an increase in alternative investment structures, including mortgage loans. In the first quarter, we funded $46 million of loans for our borrower's purchase of 49 convenience stores leased to Speedway, a subsidiary of 7-Eleven. The loan-to-value of the underlying collateral is approximately 60%, and we're in first lien position with no capital ahead of us.
The loans have a three-year term and a weighted average interest rate of 9.3%. While this is a larger loan exposure for us, it provides outsized risk-adjusted value to NETSTREIT, in addition to demonstrating our creativity in deploying capital. At March 31st, our 100% occupied portfolio was comprised of 488 investments with 83 tenants, contributing $108.9 million of annualized base rent. Tenants with Investment Grade ratings or Investment Grade Profiles represented 82% of ABR. A key part of our execution is recycling capital where the risk value or return is no longer meets our criteria. In the first quarter, we accretively sold eight properties for $15.8 million.
Excluding investments associated with mortgage and loans receivable, the portfolio has a weighted average lease term of 9.4 years, with no lease expirations in 2023, and only 0.3% of total ABR expiring through 2024. As we look to the balance of 2023, we will continue to focus on scaling our portfolio of high quality tenants while prudently managing our balance sheet and liquidity position. Despite ongoing economic uncertainty, we continue to believe our durable cash flow stream and attractive growth profile offer compelling total return potential for investors. With that, I'll turn the call over to Dan Donlan to go over our first quarter financial results and 2023 guidance.
Thank you, Mark, and thank you to everyone joining us today. I'm incredibly excited about the opportunities that lie ahead for NETSTREIT, and look forward to spending more time with the broader investment community over the coming weeks and months. Turning to our first quarter earnings, we report a net income of $0.03, core FFO of $0.28, and AFFO of $0.30 per diluted share. As it pertains to our G&A expense, with a fully built out executive and senior management team, our G&A should continue to rationalize relative to our asset base as we grow the portfolio. At March 31st, our balance sheet had total debt of approximately $480 million, with a weighted average contractual interest rate, including the impact of fixed rate swaps of 3.4%.
After giving consideration to the settlement of all outstanding forward shares, our net debt to annualized Adjusted EBITDAre was 4.1x, which remains well below our targeted leverage range of 4.5x-5.5x. Moving on to capital markets activities in the quarter. We used our ATM to issue 147,000 shares at a weighted average net price of $19.96, which generate $2.9 million of net proceeds. Pursuant to our forward equity offering in August 2022, we settled 2.6 million shares in the quarter, which generated approximately $50 million of net proceeds. As of March 31, 2023, 4.8 million shares, or approximately $91 million, remained unsettled under the August 2022 forward sale agreement.
Regarding our dividend, on April 25th, the board declared a $0.20 regular quarterly cash dividend pay to be payable on June 15th to shareholders of record as of June 1st. Based on this dividend amount, our AFFO payout ratio for the first quarter was 67%. Turning to 2023 guidance, we are maintaining our AFFO per share range of $1.17-$1.23. This range assumes investment activity, including acquisitions, completed developments, and mortgage loans receivable from net of dispositions of at least $400 million in 2023. We'll now open the line for questions. Operator?
We will now begin the question-and-answer session. As a reminder, to ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Eric Wolfe with Citi. Please proceed.
Thanks. Good morning. It's actually Nick Joseph here with Eric. Wondering if you could walk through kind of your appetite or preference between the loans versus on balance sheet acquisitions and how you think about underwriting those differently as you look to do deals?
Yeah. Look, yeah, I mean, I think the Speedway loan was maybe a little bit of a one-off, as it relates to, you know, not only the risk return there, where we really saw what we felt like was an outsized return for the risk that we're taking, kind of stepping in at a 60% LTV, you know, position ahead of all the equity, and getting a 9.3%, you know, interest rate. I think that's probably not likely to appear again in the future. I think I would think about it as being maybe a smaller piece of what we're going to be doing in the future. Certainly a little bit outsized in the first quarter.
I think we'll probably be doing, you know, somewhere in the neighborhood of 5%-10% of volume on a go-forward basis. Of course, that can kind of move up and down, you know, quarter by quarter. I would expect those yields to be a little bit closer to where, you know, to where we're buying properties. You know, right now the transaction market is, you know, certainly in flux from sellers that, you know, this time last year were eager to sell their properties to, now there, you know, typically needs to be a reason for them to have to sell their properties or to, be okay with the pricing, you know, that we're seeing today.
This was kind of an avenue of us building relationships with a lot of those, you know, future sellers, as well as sprinkling in a little bit of, you know, really strong risk-adjusted returns. I think, you know, we're a little bit hesitant to make that a huge part of what we do, just as we start to think about eventually those loans are gonna get paid off, and wanna minimize any replacement risk down the road.
Thanks. That's helpful. How are you thinking about current, I guess, equity cost of capital, but even if you, if you want to do it on a weighted average basis there, versus acquisition cap rates? Are you comfortable with the current investment spread, or would you need cap rates to expand, to really do more accretive deals?
Yeah. Hey, Nick, it's Dan Donlan. Look, first and foremost, I think you should expect us to continue to prudently manage our balance sheet and maintain leverage within our targeted range of 4.5x - 5.5 x. Given where our leverage is today at 4.1x using the impact of the forward, you know, we can be judicious with how we deploy equity capital as we are highly mindful of investment spreads today relative to our weighted average cost of capital.
That said, when you look at our current cost of equity, you think about the impact of our free cash flow and where we believe we can source debt in excess of five years, we're getting to anywhere from 100-130 basis points of investment spread, relative to where we can deploy capital today.
Thanks. You're comfortable with that 100-130 basis points. How does that compare to history?
I think historically that's been a little bit higher, when we were certainly when we were in a much lower interest rate environment. Of course, we want that to be, you know, closer to, you know, to the norm, but I, you know, we're comfortable deploying capital with that type of spread.
Thank you.
The next question comes from Todd Thomas with KeyBanc Capital Markets. Please proceed.
Hi. Thanks. Good morning. Just wanted to circle back to the loan investment. You have other loans on the book as well. You know, to the extent that additional opportunities arise, is there a threshold? I think you said 5%-10% maybe of volume going forward, might be, you know, sort of the right way to think about it. Is there a threshold for loan investments relative to, you know, the balance sheet or portfolio that would govern how large that book might be overall as in the future?
Yeah. I think right now we're in a position, in a situation where, there's heightened opportunities, on the loan side, which I don't think is going to necessarily be the case, long into the future. You know, in the short term, I think that's probably a good barometer. We don't want to let we don't want to let our loan book get, north of, you know, 10%, although they're not all created equally.
You know, looking back at the loans that we've done in the past, I think those are either going to end up where those will convert into us having fee ownership of those assets, so there wouldn't be any disruption, you know, to the, to the income, or we get paid off at rates that are, you know, I think pretty easy for us to take that capital and redeploy accretively. Those are kind of a little bit less of a risk in my mind as we kind of think about, you know, the reinvestment risk. I think the typical type of, you know, loan in the future is likely gonna be kind of you've got a group that, you know, historically had relied on regional banks.
You know, it's harder to get LTVs higher or harder to get, you know, debt at all for a lot of, a lot of these types of developers and, and other types of counterparties. Right now there's an opportunity for us to kind of step in, provide 100% of capital and own the property, provide 100% of or 90% of the capital or 85% of the capital, and collect all of the cash flow for a period of time, where we get ROFRs on each of those transactions. So there's, you know, there's some nuance to each of these, and we're really trying to balance.
you know, we don't wanna take on and have, you know, 25% of, you know, of our book be loans that are gonna get paid off, and then we can't redeploy the capital accretively. That's really kind of the way that we're thinking about it. If you're looking for, just a threshold for, you know, for modeling purposes, I don't think we're gonna let it get north of 10%.
Okay. Got it. Then, you know, in terms of the reinvestment risk there, and I guess just for modeling purposes in general, do you plan to provide some additional disclosure around the loan portfolio, you know, as that grows in order to, you know, sort of, you know, detail some of the maturity dates, loan rates, and some other terms that might be important for underwriting purposes?
Yeah, I mean, we'll kind of have to evaluate, you know, as we start adding loans into the portfolio, if we feel like that is helpful to investors to understand the story. Certainly, you know, something that we would consider. I think, you know, we've added that into some of our disclosure already in this quarter, which I think should give a clearer picture as it relates to credit risk. You know, as it relates to loan maturities, you know, we've kind of taken maybe a different tact than others as we think about, you know, having two-year loans, three-year loans versus, you know, 10, 15-year loans, which we've seen, you know, some peers kind of take more of the latter approach.
We kind of like to be able to, you know, be back at the negotiating table a little bit sooner and reassess whether we'd like to be paid off or if we want to extend the loan, maybe get some, you know, extension fees and things like that, you know, if that's prudent at the time. You know, we'll evaluate, but certainly I think you can rely on us to provide disclosure to make sure that investors understand, how we're deploying capital and what exactly the risks are within the portfolio.
Okay. Then in terms of the guidance, I'm just curious, you know, was that loan or those two loans, you know, almost $50 million at, you know, call it a 200-250 basis point premium yield to your acquisition yields? Was that contemplated in the guidance? Just as it pertains to the guidance, you know, then that you know, which you maintained, is there anything, you know, sort of offsetting, you know, some of that premium investment yield, you know, that is impacting the guide, you know, on the other side?
Hey, it's Dan Donlan. Look, yes, this, the loan was contemplated in guidance. Look, given that we only set guidance two months ago, and there's a lot of volatility out there in the world right now, we just thought it prudent to wait a few months before revisiting our guidance range.
Okay, great. All right. Thank you.
Our next question comes from Greg McGinniss with Scotiabank. Please proceed.
Hey, good morning.
Hi.
In thinking about the opportunity set for normal course acquisitions, where we had the Speedway loan that helped offset lower acquisition volumes in Q1, what are you seeing in the transaction market that's giving you confidence to maintain net investment volume guidance and, you know, when thinking about that 5%-10% range on the secured mortgage loan investment going forward?
Sure. I mean, I think we've seen a continued migration from late last year of sellers that did not want to sell, were having trouble believing that cap rates had moved as much as they had, even though obviously interest rates, you know, have moved. Now they've seen enough comps out there where they've got some debt coming due or various other reasons why, you know, they're coming to the table. You know, we're seeing that bucket that we talked about on the last call of people, you know, really trying to hold the line as much as they can.
The second bucket of, you know, either sellers that need to sell or the ones that say, "Okay, I need to transact, and I don't foresee cap rates dropping like a rock anytime soon." That second bucket continues to grow. We've seen the opportunities, you know, increase, and we've just had to be extraordinarily selective, certainly as it relates to the loans, because I think that opportunity is certainly there for us. We're seeing a lot more opportunities on the fee simple side than we had earlier in the year.
Great. Thanks. Looking at the development pipeline, looks like you haven't had added any projects there, I think, in two quarters. Can you give us some sense of how you're viewing developments today or partnering with merchant builders, what that opportunity might look like as compared to other uses of capital?
We saw certainly some stress coming to merchant developers for quite some time. We've acquired some properties, you know, from them when they were willing to, you know, kinda come to cap rates that we thought made sense. When you think about, you know, the ones that are going out, developing a lot of stores for some of the tenants that we're trying to grow with and had historically relied on regional banks and, you know, selling the properties into the 1031 market, which historically has been much more aggressive on a cap rate basis than the institutions are willing to go. That pressure has continued to build, and we made the decision that there are other ways to partner with the developers than just funding development.
We've been working on a number of transactions, either, you know, providing equity takeouts at the end or buying some of their properties. You know, a couple of those will likely be some of the loans that we do. I think in the next quarter, we'll likely be providing a little bit more disclosure on some of those transactions after they come to fruition. I think they should be viewed pretty favorably by the market as I think we got, you know, pretty creative, like we have in the past, and it should yield pretty positive results.
Thanks, Mark. Just to clarify on that, we should probably expect to see the development pipeline come down as other investments offset that capital use.
Not necessarily. You know, a lot of, you know, our counterparties right now are developers, and it's just gonna be how we end up structuring those investments, whether they are, you know, typical, you know, equity takeouts, funding the development, you know, some loans that could potentially convert into fee ownership, just regular loans or just, equity takeouts at the end of construction. There's a number of, you know, types of transactions that we're working on right now, some of which have closed already, some of which are still in the pipeline of being negotiated.
All right. Thank you very much. Appreciate the time.
Thanks.
Thank you. The next question comes from Josh Dennerlein with Bank of America. Please proceed.
Hi, this is Farrell Granath for Josh Dennerlein. I just wanted to ask about, as you've been increasing your Investment Grade tenant base, what is the competition for these assets been looking like?
Yeah, sure. I mean, I'd say overall, the competition is very much muted versus what we've been seeing in the past. I mean, the leverage buyer, whether that be private equity firms or even some larger family offices, that have relied on using debt capital as a big, you know, part of their capital stack, they're largely out of the market. It's become very difficult for 1031 buyers to achieve the yields that they need, you know, when they go out and try to source some of these transactions and then go to their community bank and try to get some debt.
We've really, you know, not only seen the opportunity set, you know, pick up and I think transaction volume pick up industry-wide in the second quarter, versus the fourth quarter and first quarter, but we're, you know, operating in an environment with significantly less competition.
Great. Thank you.
Our next question comes from Alex Fagan with Baird. Please proceed.
Hey, guys, and welcome to the team, Dan. I have a question, if you can provide some more color on the external growth opportunities and maybe any more detail about what's in the pipeline and stuff that you're seeing.
Yeah, I mean, I think what you'll see us acquire in a lot of the tenants will be similar. I think there will be a couple of new names that we've tried to get on our portfolio for a long period of time that may come in some smaller portfolios. We're, you know, certainly excited about the credit quality of what you'll see us buy a little bit in the grocery sector, some in the, you know, discounters and dollar store area and quick service restaurants that is another area that we've seen a little bit more opportunity than we had in the past at cap rates that make sense for us. Typically, that's, you know, the ones that we really have tried to do business with.
The cap rates historically have been a little bit too aggressive for us, we've seen some movement there. I think you'll see it likely won't deviate much, you know, from where we've been in the past other than, other than a few new names.
Our next question comes from Linda Tsai with Jefferies. Please proceed.
Hi, good morning. From a valuation perspective, what kind of multiple would you assign to the loans versus the rest of your portfolio?
Yeah, you know, it's a, you know, certainly a smaller portion of the, of the portfolio. You know, a lot of it, you know, certainly what I think we'll be doing in the future, will be at, you know, pretty similar cap rates. I don't think there necessarily needs to be, you know, too much of a differentiation there.
Thank you.
As a reminder, if you do have a question, please press star then one on your telephone keypad. The next question comes from Ki Bin Kim with Truist. Please proceed.
Thanks. Good morning. Just want to go back to the loans that you made this quarter. What does the interest coverage look like from Speedway?
We're essentially, you know, taking all of the rent, in that, you know, 9.3%. The cap rate on the transaction, from the buyer's perspective was about a 5.6-5.7 cap rate. We collect all of the cash flow. I think what's interesting for the borrower and the reason why this was an interesting opportunity for them, is that they have uncapped CPI bumps, which should be, you know, hitting in about two and a half years. When those increases hit, you know, that could be a good opportunity for them to either refinance this out or, you know, we could extend, you know, terms depending on, you know, what we wanna do at that point in time.
There's certainly there will be a lot of value creation associated with those properties when those CPI, you know, CPI bumps hit. The borrower is a, you know, large 7-Eleven developer, so they've got a really strong relationship directly with the tenant, which is how they were introduced to this opportunity and have really good insight as to the performance of the location. A really strong portfolio. We would certainly like to own them, but just not at the cap rate that the borrower was paying.
Just to clarify, I was asking about the four-wall coverage for the entire interest payment. What does that look like?
Yeah. they it's north of 3x.
Okay. Can you remind us, like, what types of tenants make up the Sub-investment grade profile, group within your portfolio? If any of those tenants are seeing any kind of incremental pressure from the banking changes that we're seeing.
Yeah. I mean, a lot of that's gonna be, you know, quick service restaurants. You know, that was a big part of what we did to the portfolio before we went out and tried to raise capital, both privately and publicly, going back to, you know, 2019, is getting all of the, all of the tenants and locations out of the portfolio that we did not want to own, we did not want to own long term. What we're left with is, in general, a lot of quick service restaurants and a lot of, locations that generate extraordinarily high, rent coverages.
You know, I think higher than what you'd see from, you know, maybe some of the Sub-investment grade peers with what we're left with in those, you know, in that portfolio. You know, locations that we feel like the best risk-adjusted return, you know, for us was to hang on to those properties.
Thank you, and congrats, Dan.
Thank you.
Thank you, Ki Bin.
At this time, there are no further questioners in the queue. This does conclude our question-and-answer session. I would now like to turn the conference back over to Mark Manheimer for any closing remarks.
Thank you all for joining us today. We look forward to speaking with you all again very soon.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.