NetSTREIT Corp. Q3 FY2024 earnings call

• Investment Activity: Completed $152 million of gross investments in the third quarter, highest on record with a blended cash yield of 7.5% (8% straight - line). More sale - leasebacks, longer weighted - average lease term of 12.5 years. - Portfolio: Ended the quarter with 671 properties 100% leased to 93 tenants in 26 industries across 45 states. Over 75% of ABR leased to investment - grade or investment - grade profile tenants. Weighted - average lease term remaining 9.5 years, less than 3% of ABR expiring through 2026. - Disposition Activity: Completed 8 dispositions in the quarter for total proceeds of $24 million at a weighted cash yield of 7.3%, reducing select tenant concentrations and recycling proceeds. - Industry Concentration: Comfortable with long - term productivity of assets in pharmacy and dollar store industries. Walgreens' store closures likely to have minimal impact on occupancy, concentration reduced from 5.9% to 4.8%. Big Lots: One location marketed for lease, remaining six locations assumed by Big Lots with extended lease term to average 7.5 years, some rent relief during bankruptcy. - Development Projects: Four development projects totaling over $18 million commenced rent in the quarter. Development pipeline has eight projects with total estimated cost of $22 million, including estimated remaining funding of $7 million.

In the third quarter of 2024, NETSTREIT completed $152 million of gross investments, the highest quarter on record with a blended cash yield of 7.5% (8% on a straight - line basis). A greater portion of investments were sale - leasebacks with a longer weighted - average lease term of 12.5 years. The portfolio ended the quarter with 671 properties 100% leased to 93 tenants in 26 industries across 45 states. Over 75% of total ABR is leased to investment - grade or investment - grade profile tenants. Weighted - average lease term remaining on the portfolio is 9.5 years with less than 3% of ABR expiring through 2026. Third quarter disposition activity saw 8 dispositions for total proceeds of $24 million at a weighted cash yield of 7.3%.

• Maintained 2024 AFFO per share guidance midpoint and updated the range to $1.26 to $1.27 from prior range of $1.25 to $1.28. - On October 18, the Board declared a quarterly cash dividend of $0.21 per share, payable on December 13 to shareholders of record as of December 2. The AFFO payout ratio for the third quarter was 66%.

• Market - related risks: 1031 market dried up over the past year but starting to come back a bit. Seller expectations for the past year + continue to be an issue. - Tenant - related risks: Lower - income and middle - income consumers under pressure, job growth slowed. Potential noise around publicly traded companies' performance impacting the portfolio. - Cost - of - capital risks: Impact on ability to acquire at an accretive pace as cost - of - capital is a factor.

Q: As you look into the fourth quarter and maybe the first quarter of next year as you're shedding some of your non - core assets, do you still expect to maintain an accretive acquisition spread versus your dispositions?

A: Yes, we do. I think just looking forward to the fourth quarter and maybe early in the first quarter, where we have some visibility, we expect cap rates to stay pretty close to where they are right now, maybe slightly below where we've been for the first three quarters, but the dispositions that we're looking at currently are at lower cap rates than what we achieved in the third quarter.

Q: How do you see your Dollar General exposure progressing over the next year or so? And then can you comment on the quality of your locations? You gave a nice little analysis about your Walgreens being Blend & Extends and high foot traffic, but can you maybe unpack the Dollar General exposure?

A: Yes. Sure. So, yes, the Dollar General portfolio that we have, I think is a little bit unique. In that, we were able to partner with the tenant and get most of our leases extended, and then really the ones that weren't extended, we've gone out and sold the vast majority of those. So we're left with just under 15 years of weighted - average lease term with an average of 1% annual increases in the leases. So a little bit unique when you compare our dollar store portfolio to others. But yes, I mean, there are a number of loans in there. So I think those will get paid off here in the next year or so. So that really kind of brings the concentration down below 10% just with that. And then, we are looking at a handful of dispositions just to try to get that concentration down a little bit, which I think will certainly be well below 10% here in the next couple of quarters.

Q: The drugstore and pharmacy exposure decreased 160 bps sequentially. Can you offer some comments on the disposition market and maybe also the element of seller financing when addressing the Walgreens dispositions? Is this something we should be expecting going forward?

A: Yes. Thanks, Ravi. Yes, I mean, I'd say the dispositions market has gotten a little bit better. I think a lot of you are aware, the 1031 market really did kind of dry up over the past year, but is starting to come back a bit. So we're seeing more interest in our assets. And as you mentioned, the success that we've had in pretty quickly reducing our exposure on the -- in the pharmacy sector. We did use seller financing on a couple of the transactions in the third quarter. And kind of really the thinking there was we were able to get an interest rate slightly higher than the cap rate that we sold the assets at so kind of maintains a healthy yield. But those were assets that we felt like the rent was a little bit above market, so reduced our exposure by more than the air that we felt like was in the rent. We do not think that we're going to be using seller financing much more in the future, but it is a tool that we reserve the right to use in the event that it gets us to a better outcome. So specifically around those Walgreens, we sold -- in the third quarter, the average cap rate was about a 7.2% when the interest rate was slightly higher than that. So I think 7.2% change. So certainly, felt like that was a pretty good outcome. But in the fourth quarter, we've been able to sell some assets without using seller financing, and think that's likely going to be the path that we go on a forward basis.

Q: What would you say is a steady acquisition run rate for the next five, six quarters on a longer - term basis, particularly given the fact that outstanding equity has decreased and the current [WACC] is a bit elevated?

A: Yes. Look, I mean I think if given where our cost - of - capital is today, we're not able to achieve sufficiently accretive spreads to acquire at the pace that we're acquiring at today. So I think it just remains to be seen what our run rate would look like. I think the team is certainly built to do anywhere from net investment activity of $100 million to certainly $150 million, right now, though, we do have plenty of capacity to continue to invest. And I think as we see our cost of capital season over the next couple of quarters, we'll think about how that impacts our ability to grow on a go - forward basis.

Q: Just on the Big Lots, understand the additional term there, but from a cash rent perspective, what's the rent difference going forward versus what was in the previous leases?

A: Yes. So we've got the one location that is being marketed for sale. We do think that there is -- it's likely -- for lease. Yes, yes, yes, for lease, sorry. Yes, not likely not selling that. So yes, up for lease, we're talking to a number of different retailers and grocers. We do think that the rent is likely to be at or even a little bit higher. So when it's all said and done, we think the rent is going to be equivalent to where we are today or where we were going into the bankruptcy.

Q: And for the existing leases that will continue with Big Lots?

A: Yes. There is a small amount of rent decrease there including we're not collecting rent here during the bankruptcy period. But I think the increase in the rent that we're likely to get the Bowie site will likely offset that.

Q: The proportion of IG came down in the quarter, you mentioned, on the sale - leaseback. What are the expectations for that percentage going forward as and would you expect to see more IG acquisitions kind of in the future quarters? And if so, how are you thinking about cap rates there that would make them more attractive versus what you saw this previous quarter?

A: Yes, Nick, and that's exactly what was really kind of driving our decisions around what we were acquiring in the second and third quarter. We just saw much more attractive risk - adjusted returns on the larger operators that might not have an investment - grade rating, certainly, not going out and doing a lot of the small deals with four - or five - unit operators, but still larger operators that we're comfortable with where we're getting really strong unit - level economics and replaceable rents. And so that has been an area where we've been pretty successful with. I would expect the fourth quarter to see that investment grade kick up a little bit higher than it's been in the second and third quarter.

Q: Just going back to the Walgreens and Family Dollar topic, can you just maybe provide a high - level view on what you think the remaining asset sales, what those cap rates could be? And is your ultimate goal -- I guess, what is your ultimate goal, like how much to lower the percentage ABR from those type of tenants?

A: Yes. So as it relates to Family Dollar, as you're aware, we've been selling down that exposure over the past couple of years, really starting with the assets that we felt like were not -- either not profitable or not very profitable. And so we're really left -- really currently left with a portfolio of Family Dollar that generate positive cash flow. We think they're good stores. That being said, we're likely to continue to sell that exposure down over the next year or so. And so, that has down to a little bit more than 1% of ABR. And then as it relates to Walgreens, as I mentioned in the prepared remarks, we've gone from 5.9 to 4.8 in a pretty quick -- pretty quickly. I would expect to see us continue to sell that down, maybe not quite as quickly as we did in the third quarter, but I think kind of a target of getting that below 3% is achievable here in the next six or seven quarters.

Q: Acquisitions obviously accelerated in the quarter. I was wondering if you could speak a little bit on how you're characterizing the current transaction environment, especially compared to the first half of 2024, both as far as maybe increasing opportunities, but then on the flip side, maybe increased competition for deals?

A: Yes. Sure. So we've certainly seen the opportunities that pick up quite a bit from earlier in the year. But competition, we are expecting that to kick up, but really haven't been running into much competition when we're out looking for locations. Really -- the competition for us has really been seller expectations for the past year - plus and that continues to be the case. But we're seeing great opportunities on the investment - grade side, sale - leaseback side, Blend & Extend side, the development side. So we're pretty excited about what we're seeing out there. It's just going to be a matter of where our cost of capital is.

Q: You mentioned in the prepared remarks about sort of getting ahead of Big Lots prior to 2024. I'm wondering if you can speak to any current consumer trends or other components of proactive portfolio management that you're monitoring right now.

A: Yes. Sure. So I mean, certainly, the lower - income consumers have been under pressure. That's kind of really creeped up into the middle - income consumer, even job growth has slowed. So we're being pretty cautious around the consumer and making sure that not only are we investing in businesses that we think have a mode of protection around what's going on with the consumer, but then also making sure that we have -- the companies have balance sheets that can withstand some disruption and unit - level economics, where we've got a pretty solid cushion there. But yes, I mean, I think it continues to just be maybe slightly worse than it was a quarter ago with really kind of the same issues.

Q: Mark, you talked about the relative strength on your remaining Walgreens. How does that differentiate from the two assets you did sell in the quarter?

A: Yes. Sure. I mean the assets that we sold, we think are good assets, maybe a little bit shorter in lease term. And so, we know that not only will there likely be a focus on the total ABR that we have with Walgreens, but then also what is the lease expiration schedule look like. And so really kind of pushing out, as we mentioned. We don't have any leases expiring until 2030 other than one that generates phenomenal sales on the front end and has phenomenal foot traffic, where we think it's extraordinarily unlikely that they would close that store. So really continue to strengthen that portfolio, push out -- have longer weighted average lease term. We went from nine years to 10 years during the quarter as well. So I think upgrading the quality is important. Walgreens continues to face pressures on reimbursement rates on the drugs that they provide. And so, yes, we're keeping an eye on that. There is -- we want to be prepared for the event that things get worse. We don't know if they're going to get worse or better, but we feel like we're pretty well positioned in the event that things get a little bit worse.

Q: Great. Thanks for taking my question. Mark, you talked about the relative strength on your remaining Walgreens. How does that differentiate from the two assets you did sell in the quarter?

A: Yes. Sure. I mean the assets that we sold, we think are good assets, maybe a little bit shorter in lease term. And so, we know that not only will there likely be a focus on the total ABR that we have with Walgreens, but then also what is the lease expiration schedule look like. And so really kind of pushing out, as we mentioned. We don't have any leases expiring until 2030 other than one that generates phenomenal sales on the front end and has phenomenal foot traffic, where we think it's extraordinarily unlikely that they would close that store. So really continue to strengthen that portfolio, push out -- have longer weighted average lease term. We went from nine years to 10 years during the quarter as well. So I think upgrading the quality is important. Walgreens continues to face pressures on reimbursement rates on the drugs that they provide. And so, yes, we're keeping an eye on that. There is -- we want to be prepared for the event that things get worse. We don't know if they're going to get worse or better, but we feel like we're pretty well positioned in the event that things get a little bit worse.

Q: Just a quick follow - up on Walgreens. How do you gauge the health or performance of those Walgreens compared -- I mean, I guess you can't really compare it to the entire chain because its different locations, but how would you describe the quality of the Walgreens or Family Dollar stores that you have remaining?

A: Yes. I think that we've got locations that are going to stay open and continue paying rent and that are profitable locations for each of the tenants. And so, we get some information from the tenant that's required on lease and then we've got a very strong relationship with both of those tenants. So we have pretty open conversations about what they're thinking about doing within the -- with the stores that we own. And so, that's allowed us to get out ahead of some potential closures and some potential risk, which is, I think, really imperative is not only when you acquire the asset having those conversations, but an ongoing basis with our asset management department with the tenants. And so, that's really what gives us so much confidence that we've got locations that are going to continue to perform well.

Q: In terms of bad debt, kind of considering your previous levels that you've been assuming, would you ever consider maybe even next year increasing assumptions of bad debt just given headlines and current risk associated with pharmacies and retail, in general?

A: Hi, Farrell, it's Dan. The answer is no. And I would note that we didn't necessarily have credit losses this quarter or this year. We simply had a temporary rent relief. So as you think about kind of our expectations coming out of 2024 for the core portfolio, the prior model would have assume that these credit -- that credit losses would have stayed in perpetuity when in fact, they're only temporary in nature. So as we think about the core portfolio coming out of 2024, it's actually in a better position than what we envisioned when we set guidance in January.

Q: Also given the current headlines, I know you went through a lot of the underwriting parameters that you set, but I was curious, is there anything that you're being more scrutinous about or either requiring more P&L reports among tenants kind of just going forward in your underwriting?

A: Yes, thanks, Farrell. So yes, I mean, I think we've had a pretty good understanding as to how the tenants are doing within the four walls of the boxes that we own. And I think we are very careful about what we put into the portfolio. I think if there is maybe a lesson learned, it would be just having some higher concentrations with publicly traded companies where there's just a lot of news and noise -- potential noise around their performance on a quarterly basis can then turn around and impact us. And so, yes, we certainly feel very strongly that the assets that we put in the portfolio were going to continue to pay rent and are going to be good performers for the company.