Please note that this conference is being recorded. At this time, I'll turn the conference over to Amy Ahn with Investor Relations. Amy, you may now begin.
We thank you for joining us for NETSTREIT's second 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. 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, reconciliation 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. We 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 thank you for joining our call today. As detailed in our quarterly disclosure, we reported another solid quarter of investment activity with continued improvement in many of our key portfolio metrics. In addition, we recently completed a number of capital markets transactions that enhanced our balance sheet and strengthened our liquidity position, which Dan will cover in his section. All in all, our portfolio continues to perform at a high level, and our opportunities for external growth continue to increase in both size and quality, which has us highly optimistic about our ability to compound earnings and achieve attractive total returns for shareholders.
Starting with the portfolio, as of quarter end, we had 531 investments that were leased to 87 tenants that operate within 25 retail industries across 45 states, with 82% of our portfolio, as measured by ABR, being leased to tenants with investment-grade ratings and investment-grade profiles, and 87% coming from necessity-based discount or service-oriented retailers. We have not deviated from our focus on high-quality tenants and defensive retail categories. Our occupancy remained stable at 100%, and our weighted average remaining lease term of 9.4 years was unchanged quarter-over-quarter. In terms of near-term lease expiration risk, based on our strong tenant relationships and the visibility we have into the performance of our properties, we are highly confident in the renewal prospects for the 2.5% of ABR that expires between now and the end of 2025.
Coupled with the strong balance sheet and ample financial resources of our high-quality tenant base, we continue to believe our in-place cash flow stream should prove highly durable in any economic environment. Turning to capital deployment, we closed on $115 million of net investment activity this quarter, which was primarily funded with the attractively priced equity capital that we raised in August 2022. Tenant quality remained high, as 81.3% of our second quarter investments were leased to investment-grade rated and investment-grade profile tenants. Our second quarter investments had an initial cash yield of 6.8% and a weighted average lease term of 11.6 years.
Of note, over half of our second quarter investment activity involved tri-party negotiations, whereby the tenant agreed to extend out a large portion of their existing leases with NETSTREIT to 15 years, as well as add rent escalation clauses to the new and existing leases that were previously flat. These IRR accretive transactions, which modestly pressured cap rates in the quarter, not only enhanced our portfolio's internal rent growth profile, but also provided us with increased visibility into the desirability of our properties. We believe these collaborative industry re-relationships will drive additional opportunities for NETSTREIT as we look to become a greater part of the embedded solution for retailers and developers alike.
From a pricing perspective, while we believe cap rates have largely leveled off for assets that we pursue, we do expect third quarter investments to have slightly higher cap rates than this quarter, despite there being no change in tenant quality. Turning to dispositions, we sold two properties with 4.6 years of remaining lease term in the second quarter for $4.1 million at a 6.7% blended cash yield. In the back half of the year, we expect to see our disposition activity increase relative to the first half as we look to manage certain tenant concentrations. Of note, most of the planned disposition activity is being done to free up investment capacity with the same tenant, albeit at higher yields with better lease terms.
Looking at our investment pipeline, we are seeing increased opportunities for traditional fee simple acquisitions due to the impact of higher interest rates, a significantly less active 1031 marketplace, Limited competition from highly levered buyers. As we touched on earlier, we are seeing both retailers and developers consider our capital as an alternative financing option, given the unattractive nature of the debt markets and/or the limited availability of financing from both small community and regional banks. While all of these market dynamics are resulting in more attractive cap rates, we're also seeing an increased willingness by retailers, especially those committed to growing their store count, to sign leases with longer lease terms and embedded rent escalations.
While loan origination opportunities remain plentiful, we have become even more selective in the types of loans that we may originate and how we allocate capital to these investments. We are only focusing on those opportunities that can lead to sustainable long-term value from a relationship perspective and/or ultimately fee simple ownership. We will continue to take advantage of our size and mine our unique sourcing channels for attractively priced opportunities to drive outsized risk-adjusted returns for shareholders. With $227.7 million of net investment activity closed in the first half of 2023, we remain ahead of pace, which gives us the confidence to increase our 2023 net investment activity guidance to at least $450 million from our prior guidance of $400 million.
With that, I'll hand the call over to Dan to go over our second quarter financial results.
Thank you, Mark, and good morning, everyone. Turning to our second quarter earnings, we reported a net loss of $792,000, or $0.01 per diluted share. Core FFO totaled $17.6 million for the quarter, or $0.29 per diluted share, a 12% increase from the prior year period. AFFO totaled $18.7 million for the quarter or $0.30 per diluted share, a 7% increase from the prior period. Turning to G&A, total G&A expense, excluding one-time items, increased 4% year-over-year to $5.1 million, which was primarily due to a higher employee count. However, with total G&A representing 16% of total revenues in the second quarter versus 21.5% the year prior, we saw a considerable improvement in this ratio.
Similarly, on a quarter-over-quarter basis, our cash G&A declined 1.6%. As we look out to the balance of the year and beyond, our G&A should continue to rationalize relative to our asset base and total revenues, as the company has reached the proper scale to effectively operate our business on a go-forward basis. Turning to the balance sheet, we had total debt outstanding of $489.4 million at quarter end, with a weighted average contractual interest rate, including the impact of fixed rate swaps, of 3.49%. During the quarter, we amended and restated our $175 million senior unsecured term loan to extend the maturity to January 2027 from December 2024. All details are in our supplemental.
Please note that we fully hedged this term loan using a combination of forward-starting swaps that result in an all-in fixed rate of 1.37% through November 2023, which then adjusts to 3.12% through December 2024, with a final adjustment thereafter to 3.65% through the fully extended maturity of January 2027. Additionally, in subsequent to quarter end, we closed on a new $250 million senior unsecured term loan with delayed draw option, which has a fully extended maturity date of January 2029. The term loan includes accordion feature that allows the company to increase the total loan amount to $400 million. At closing on July 3rd, we drew down $150 million and plan to draw the remaining $100 million in the first quarter of 2024.
We fully hedged the $250 million term loan at an all-in fixed interest rate of 4.99% through January 2029. As a result of these debt transactions, we no longer have any debt maturing until 2027, and our only exposure to a variable rate debt is via our revolving line of credit, which has nothing outstanding as of today. We'd like to thank our banking partners for executing these transactions during what remains a tight lending environment. We also note that demand for both term loans far exceeded the principal balances raised, which we believe speaks to our ready access to efficiently priced capital. At quarter end, our liquidity was $307 million, which includes $13 million of cash on hand and $294 million available on a revolving credit facility.
When including the closing of our $250 million term loan in July, our pro forma liquidity increases to $557 million, which provides us with ample dry powder to meet our increased net investment target for 2023. From a leverage perspective, our net debt to annualized Adjusted EBITDAre was 4.6x at quarter end, which remains well within our targeted leverage range of 4.5x-5.5x. Turning to the dividend, on July 24th, the board declared a quarterly cash dividend of $0.205 per share, which represented a 2.5% increase versus the prior period, and is our first increase in the company's dividend since our IPO. The dividend will be payable on September 15th to shareholders of record as of September 1st.
Based on this new dividend amount, our AFFO payout ratio for the second quarter was 68%, which we believe bodes well for future dividend increases. Lastly, echoing Mark's sentiment, we have all the components in place to execute on our external growth plans and to provide the best risk-adjusted returns to our shareholders. We are updating our 2023 AFFO per share guidance to $1.20-$1.23 and increasing the midpoint by $0.015. We will now open the line for questions. Operator?
Thank you. We'll now be conducting a question-and-answer session. If you'd like to ask a question today, please press star one from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press Star two if you'd like to remove your question from the queue. For participants that are 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. Thank you. Our first question today comes from the line of Wes Golladay with Baird. Please proceed with your questions.
Good morning, everyone. You mentioned you're building in higher escalators on some of the new deals. Is this something you've tried for in the past, or is this something new that the tenants are more open to?
Yeah, no, this is something that tenants are more open to, I think, you know, out of necessity. you know, just with a 1031 market that's not nearly as active as it was, you know, call it 18 months ago, we've been able to negotiate those in. Anytime that we're at the table negotiating directly, you know, with a tenant, we're trying to push for better escalators. you know, always a challenge with more of an investment grade than investment grade profile type focus where the leases tend to be flatter.
Okay. Then, maybe you'll comment on dispositions. I want to make sure I understood it correctly. It sounded like you said you're going to do some, I guess, maybe asset management, maybe get rid of the cycle, some of the bad or I guess, more riskier tenants. You also said you're going to sell some of the same tenant and go buy them. How should we look at the mix of what you're doing on the disposition front?
Yes, I think overall, similar to what we've done in the past, and that's, you know, we'll look at, you know, potential credit risks. We'll look at, you know, concentrations that can get a little bit higher with a smaller portfolio. As it relates to the second part of your question, that was kind of more directly related to, you know, tenants where we see a lot of opportunity with getting, you know, very attractive new leases, and then cycling out of some of the shorter-term leases where we can sell those assets at or below the cap rates that we're acquiring the assets at.
Got it. And maybe just one final one. Can you maybe talk about your tenant watch list? I know you have a pretty high exposure to the IG or IG-like assets, but just maybe the balance of the portfolio.
Yeah, sure. I mean, we, you know, credit score every single asset in the portfolio, and that's held up, you know, to be, you know, very strong. You know, there are a couple of, you know, assets with one particular tenant that, you know, we may look to sell out of during the quarter. I think you may see some exposure, you know, reduce where, you know, there might be a little bit of risk. You know, feeling really good about the portfolio.
Great. Thanks for the time.
Thank you. Our next question is from the line of Eric Wolfe with Citi. Please proceed with your questions.
Thanks. It's actually, Nick Joseph here with Eric. Maybe just on cap rates, it sounds like 3Q may be trending a bit higher than what you saw on 2Q at 6.8%. I was hoping you could quantify that.
Yeah, sure. I mean, I wouldn't expect to see a really big move. I mean, when you look at the fee simple acquisitions that we've done really since the fourth quarter of last year, it's been pretty flat, kind of your 6.8%, 6.9%, up to maybe a 7%, you know, cap rate. I think we're likely to be at the high end of that in the third quarter.
Thanks. When you're at 6, 9 or 7, does that give sufficient kind of spread versus history in terms of investment spreads?
Yeah. Hey, Nick, it's Dan Donlan. It does at these levels. We can definitely sufficiently raise accretive equity. I think the magnitude at which we raise that capital is just ultimately depending on the sizing and pricing of the investment opportunities we see ahead of us.
Thanks. Maybe just on that, when you talk about accretive equity, you know, how are you thinking about that, either relative to investment spread, or is it, you know, it seems like in the second quarter, it's a bit below, where street NAV is. How do you triangulate between that when making the decision?
Yeah, I mean, look, we look at next 12-month AFFO yield, we look at run rate AFFO yield, and we look at implied cap rate when we think about raising equity. As Mark alluded to in the quarter, we did have $90 million of well-priced capital from the August 2022 raise. We definitely achieved a nice spread, call it, you know, 30, 40 basis points relative to our all-in equity that we pulled down this quarter. Going forward, our spot cost equity continues to be favorable. That's, you know, I think if you think about where we just raised the debt at 5%, you know, if we're looking at investment spreads, you know, kind of around 130, 120 basis points.
Thank you very much.
Our next question is from the line of Todd Thomas with KeyBanc Capital Markets. Please proceed with your questions.
Yeah. Hi, thanks. I just wanted to follow up a little bit on that discussion, you know, just around, you know, the investments that were completed in the quarter being funded with attractively priced equity that was, you know, sort of agreed to or, you know, issued on a forward basis almost one year ago. Your cost of capital is higher than it was last year. I'm just curious how that might impact how you think about investments heading into 2024, as you work through, you know, sort of your dry powder during the balance of the year.
Yeah, look, I'll just kind of echo what I just said to Nick. First off, we're at 4.6 times leverage relative to our targeted range of 4.5-5.5 times. Thankfully, you know, we have dry powder to deploy. As we think about our cost of equity, it's a spot cost to equity today. It is accretive, and, you know, we'll be judicious with how we raise capital. I think that you should expect from us going forward.
Okay. Are you able to share where, you know, you expect leverage to be at year-end, just given the increase in net investment activity that you're anticipating? Is there any additional equity capital raising activity or any capital raising activity embedded in the updated guidance?
Yeah, look, I think you should expect us to, you know, manage our leverage within the 4.5x-5.5x range, which is consistent with what we've provided in our guidance range.
Okay. Then, you know, just as we, as we think about, you know, moving forward here, you know, clearly you have a, you know, a sense around, you know, the pace of investments and, and the pipeline that you're working on. You know, just curious, just in, in the current environment, you know, if you would expect the pace of investment activity to, you know, remain relatively steady from 2023 levels as we, you know, begin to think a little bit about 2024?
Yeah. I think a little premature for us to start thinking about, you know, what we're gonna do in 2024. It's been a pretty, you know, volatile, you know, market, and need to understand kind of where our cost of capital is, and what the market looks like and what our opportunity set is. You know, looking at our opportunity set right now, it's as robust as we've seen. We really only have visibility going out, you know, call it 75, 90 days out. So a little bit difficult to say what the opportunity set looks like in 2024 and kind of what the macro backdrop looks like. Yeah, I mean, I think the general idea, you know, for the company is to continue to grow.
All right, thank you.
The next question coming from the line of Ki Bin Kim with Truist Securities. Please proceed with your question.
Thanks, Don. Good morning. You know, Dan, given the timing of the equity settlement towards the end of the quarter, how should we think about the cadence of earnings going into 3 Q? Should there be a little bit of a dip before it comes back?
Look, I, I think the impact to earnings would really come from the term loan that we refinanced. You know, that's gonna be moving from 1.37% at the end of November of this year to 3.12%. I think that's really, you know, obviously, that's gonna be dilutive as you think about kind of, you know, where we are. I think there's plenty of offsets to that, and I think the idea around, you know, swapping the term loan and extending it out was to smooth out earnings growth between 2024 and 2023 and then 2025 versus 2024.
Could you just provide any kind of high-level color on Big Lots? You know, you know, I guess, what your plans are for that tenant, if you're looking to sell and, you know, potentially, what kind of recovery ratio, what that looks like?
Yeah, sure. I mean, I think, you know, they did just do a sale-leaseback, which is providing them a lot of liquidity for a period of time. I think they're, they should be just about done with their promotional activity. I think we might have one more quarter of seeing margins, you know, kind of in the low thirties, which is lower than they've been historically. Hopefully they can kind of start to turn the corner after that. Kind of turning to the assets that, you know, that we own, predominantly very low rents, you know, kind of around $7 a foot on average, in, in kind of almost $10 markets.
I feel like the real estate, we're pretty well covered with that. You know, there are buyers out there that are not your typical net lease buyers, that are more focused on, kind of a value add type situation. You know, I think that can be very attractive for those types of buyers. I wouldn't be too surprised to see, you know, us selectively, decrease our exposure there.
Okay. Thank you.
Thanks, Ki Bin Kim.
Our next question is from the line of Joshua Dennerlein with Bank of America. Please proceed with your questions.
Hi, this is Farrell Granath on behalf of Josh Dennerlein. I was hoping you could give a little bit more color on your new term loan, specifically on maybe your rationale on the tenure and the extendibility to, the 5.5 years.
Yeah, Hey, look, the, the term loan market is an extremely attractive market right now relative kind of the private placement in the unsecured bond market. You know, certainly at our size, you know, call it $1.7 billion-$1.8 billion in gross assets. It, it's a, it's a tool that we can utilize going forward. As we think about, you know, debt raises, you know, in a year or beyond, the private placement market, you know, or the public unsecured bond market would then become more attractive as we'll get to the proper scale, which is basically $2 billion, before you can start to access that market efficiently. That's why we chose to go with what we did.
Great. Thank you.
Our next question is from the line of Greg McGinniss with Scotiabank. Please proceed with your question.
Hey, good morning.
Good morning, Greg.
Maybe just touch on that term loan again real quick. What was the thought process on issuing a new term loan versus maybe using the accordion feature on the, the other term loan that's already in place?
Yeah, look, I think we wanted to raise new capital five and a half years, and go out as long as we possibly could. That's really the rationale around doing the five and a half year.
Is the accordion still something that you'd think about tapping or no?
For the 5.5? I mean, look, it's, I think it all just depends on where the market is, Greg. You know, thankfully for us, we, you know, have basically locked in our long-term debt needs through 2025. You know, to the degree that the opportunity set in front of us increases, and, you know, the long-term rates remain pretty unfavorable, it could be something we'd look at, but I think longer term, we'll wanna match fund our, you know, our long duration leases, which with longer duration debt.
Okay. Switching gears a bit, could you provide some color on maybe the discussions that you're having with merchant developers and any interesting deal structures or cap rates that you're negotiating there?
Yeah, sure. I mean, I, I think that is certainly an area that's been under pressure. you know, community banks and smaller regional banks have much more limited ability to lend them attractive capital like they had in the past, you know, really for the past, call it, you know, 10, 15 years. With a, you know, much shallower 1031 market, they need to rely on institutional capital. Those conversations are ongoing, and it certainly has been a part of what we've done over the past couple of years, you know, and a larger chunk of what we've done over the past couple of quarters, and I think that's likely going to continue as long as retailers continue to want to grow and developers have that need for our capital.
Okay, thanks. sorry, so is there any sort of, you know, changing cap rate trends there that you can comment on?
I mean, you know, I think overall you've seen over the past, you know, since the Fed started increasing rates, you know, 525 basis points, you know, 16 months ago, you know, you've seen, you know, cap rates move up, and I think it's, you know, maybe moved it up slightly more as it relates to the developers that were at one point in time, able to get very aggressive cap rates from a 1031 market that's now essentially gone. It's, you know, nothing more than maybe up, you know, 150 basis points from, you know, from the peak.
All right. Thanks, Mark.
Thank you. As a reminder, to ask a question today, you may press star one from your telephone keypad. Our next question is from the line of Nate Crossett with BNP. Please proceed with your questions.
Good morning. The lease escalation you talked about, I think it might be helpful if you just quantify what it is. Is it zero to now one? You know, what percent of the tenants are gonna be kind of migrated over to that lease escalation?
Yeah, I think, you know, those the retailers that we've worked with that are, you know, really trying to grow and feeling a little bit of the pressure to bring in some institutional capital are likely to kind of need to adjust what their lease terms are, whether that be, you know, the, the tenor or the or the lease bumps. What we've been able to get, you know, up to now has been, in some cases, 1% annually, and in some cases, 5% every 5, you know, versus, you know, completely flat in the past.
Okay, that's helpful. I don't know if you guys are willing to just disclose what you've closed so far in 3Q. Maybe just like, what does the pipeline look like in terms of loans versus acquisitions? If you can just maybe talk to, like, the difference in current pricing between doing a loan and straight acquisition.
Yeah, sure. Yeah, I mean, the, you know, we, we don't usually get into what we've closed so far in the quarter, but that being said, you know, the pipeline is, you know, very strong with a lot of opportunity out there. You know, we're not as focused on, you know, adding as, you know, loans to the portfolio. As I said in the prepared remarks, you know, we, you know, could consider, you know, adding some loans if that, you know, creates a path to some fee ownership of some assets that we really like at attractive pricing.
Maybe just like a strategy question here, like, investment grade % is incredibly high now. Like, do you feel like that gives you more leeway to, I guess, do non-investment grade stuff if the yield, and get a little extra yield there, or what's the thinking on that?
No, I mean Yeah, we're probably a little bit less dogmatic about whether something is investment grade or investment grade profile or if it's just a credit that we really like. We have always added properties to the portfolio that we, you know, feel really good about the operator, and feel like there's not a lot of risk. Not just looking at whether it's investment grade or not investment grade, but I would expect our investment grade percentages to likely, you know, continue similar to what we've done in the past if we're just looking at the forward pipeline.
Okay. Okay, I'll leave it there. Thank you.
Thanks.
Thank you. We've reached the end of the question-and-answer session, and I'll turn the call over to Mark Manheimer for closing remarks.
Thanks, everyone, for joining the call today. We appreciate everybody's time.
This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.