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Good day and welcome to the Spirit Realty, Second Quarter 2018 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions]. Please note, today’s event is being recorded.
I would now like to turn the conference turn the call over to Cara Smith, Investor Relations. Please go ahead ma’am.
Thank you operator and thank you everyone for joining us today. Presenting on today’s call will be President and Chief Executive Officer, Mr. Jackson Hsieh; Chief Financial Officer, Mr. Michael Hughes; and Head of Asset Management, Mr. Ken Heimlich.
Before we get started I would like to remind everyone that this presentation contains forward-looking statements. Although the company believes these forward-looking statements are based upon reasonable assumptions, they are subject to known and unknown risks and uncertainties that can cause actual results to differ materially from those currently anticipated due to a number of factors.
I would refer you to the Safe Harbor statement in today’s earnings release and supplemental information, as well as most of our recent filings with the SEC for a detailed discussion of the risk factors relating to these forward-looking statements.
This presentation also contains certain non-GAAP measures and reconciliations of non-GAAP financial measures to most directly comparable GAAP measures, and they are included in today’s release and supplemental information furnished to the SEC under Form 8-K. Both today’s earnings release and supplemental information are available on the Investor Relations page of the company’s website.
For our prepared remarks, I’m now pleased to introduce Mr. Jackson Hsieh. Jackson.
Good morning and thanks everyone for joining our second quarter 2018 earnings call. This morning I will read out post-spin metrics and activity as well as our capital allocation plans. I will then turn the call to Mike Hughes who will discuss our financial results in more detail and provide our updated guidance for the year, reflecting the impact of the Spin-Off transaction. We will then take your questions.
The second quarter was another extremely busy period heard as Spirit. We completed the Spin-Off of SMTA in June, which was the combination of a significant amount of effort. We believe the Spin-Off was a watershed moment for Spirit and combined with other financial operational and managerial changes we have made over the last 14 months, has completely transformed our portfolio, operations and balance sheet into what we believe is now one of the premier investment opportunities in the triple-net REIT sector.
We believe our portfolio metrics speak for themselves. We own an extremely diversified triple-net portfolio with 1,512 properties leased to 250 tenants across 49 states and 32 industries. Our portfolio is 99.6% occupied with portfolio weighted average unit level rent coverage of 2.7 times. Our number one and top 10 tenets comprise just 3.8% and 25.5% respectively of our contractual rents, which is indicative of the diversity of our portfolio.
An additionally 43.1% of our tenants are investment grade and investment grade equivalent, and we have master leases that cover 38% of our contractual works, which provides additional predictability and stability of cash flows for our investors.
From an operational perspective, we’ve implemented a series of best practices and process improvements. We developed a proprietary property ranking system that allows us to apply strategic factors to our investment and property management decision making. We internalized our property management, which has virtually eliminated our vacancy through focused asset management oversight, and we have substantially improved visibility into our tenants’ current health and future growth plans.
Finally, our executive team is now fully in place to move us forward and our organizational improvements have enhanced a can-do attitude and culture at Spirit. I’m extraordinarily proud of our accomplishments over the last year, and I would like to acknowledge and thank the entire Spirit team for their dedication and effort.
With this strong foundation we now move forward with a clearly defined strategy. We’re approaching our growth decisions deliberately and strategically. We will seek to prudently enhance our portfolio, guided by our view on each industry’s growth prospects and our existing portfolio weightings.
And given our size after spinning off a third of our assets and half of our total debt, we have an advantage and that we do not need to acquire as much volume to move the needle in terms of earnings growth, positive impact on our portfolio metrics and tenet and industry type weightings.
Further, our low leverage investment grade balance sheet has never been stronger or more flexible. Approximately 80% of our real-estate investments are unencumbered from debt and we now have a portfolio that fully aligns with our capital strategy. With over $800 million of capital available to deploy toward growth opportunities, as well as multiple sources of asset recycling opportunities, we are well positioned to fund our future growth strategies.
Now turning toward our second quarter results. For the second quarter our contractual rent was $90.7 million and our cash rent received was $90.5 million. Our same store contractual rent rose 1.5% year-over-year. We saw especially strong performance from medical office, movie theaters and same-store tenant categories.
With regard to capital recycling, we’ve worked hard to improve our portfolio through better portfolio management and oversight, and we will continue to be deliberate as we move forward. In the second quarter we dispose of 11 properties, eight from SRC, but the remainder from SMTA for $24.4 million in gross proceeds. Five of these properties were income producing with a weighted average cap rate of 7.88%.
We sold three Shopko’s in the second quarter and the disposition of Shopko assets remains a key area of focus for the Spirit team in the coming quarters. We continue to utilize multiple avenues to source transactions and expect to have more sales to announce in the second half of the year.
Our capital deployment activity during the second quarter was modest as we continue to repurchase approximately $64 million of our common stock, bringing our year-to-date total to 21.2 million shares at a weighted average price of $7.90. Based upon yesterday’s close of SRC and SMTA that represents an over 20% return to our shareholders. We acquired four properties for a total of $15.2 million, all of which are now part of SMTA post-spin. We also invested $10.8 million in revenue producing capital expenditures related to an additional 25 properties, with approximately 86% of that spending being related to properties that are still part of the Spirit portfolio.
With the Spin-Off transaction now completed and our improvement in our cost of capital, we are focusing more intently on real-estate investments. During the past year we put significant effort into refining our capital allocation strategy, including an initiative to cultivate our existing tenant relationships which we believe will allow us to gain better access to deals outside of the traditional broker channel.
We’ve been very active building our acquisition pipeline and I’m pleased to share that we have executed purchase contracts totaling $185 million and have an additional $100 million of acquisitions and developments under our Letter of Intent, representing a healthy mix of developments, direct sale leasebacks and broker transactions.
We’re pleased with the diversity and quality of our investment pipeline which includes new and existing tenants with locations in nine states, including Lifetime Fitness, CircusTrix, Shooters World, Camping World, Andy’s Frozen Custard, Cole’s and Topgolf.
In aggregate this investment pipeline has a weighted average lease term of 17 years, which given our post-spin size meaningfully moves the needle for us by raising our portfolio average lease term from 9.6 years to 10 years. Approximately half of these deals were originated directly with the sellers which is a key initiative for Spirit, and include red bumps that are 30 basis points above our portfolio average.
All of these investments fit positively within our heat map and add more experiential and service type of tenancy to our existing portfolio. Further, the real-estate rankings for these assets are all accretive to our existing rankings within each particular property type. Finally, the initial cash yield on these $285 million in investments is 7.1% and the economic yield is 8.3%, which is an creative use for our capital.
The transaction market remains robust and we’re already building or investment pipeline of opportunities for 2019. Additionally, as the asset manager for SMTA we’ve built a separate investment pipeline that matches up with their specific cost of capital, portfolio allocation and industry heat map, utilizing the asset allocation policy that was put in place at the time of the Spin-Off.
In closing, we’re very pleased we were able to complete our Spin-Off transaction on time and as promised to our shareholders. But rest assured, we are not sitting still posted spin. Our vacancy is low, loss rent is deminimis, leverage is the lowest ever for SRC, we have momentum on Shopko store-sales and our management team and organization are forward looking. We are excited about the opportunities we have and we look forward to growing our company and creating even more long term value for shareholders.
Before I turn the call over to Mike, I want to remind everyone that SMTA reports tomorrow and we will be putting out recorded comments in order to help investors understand the strategy and provide good disclosure. This call will be available via a webcast link on SMTAs IR site and through a dial-in provided in the press release.
Go ahead Mike.
Thanks Jackson and good morning everyone. As Jackson mentioned, it was a very busy quarter at Spirit. We are happy to have the Spin-Off of SMTA completed. Though the Spin-Off has caused some noise in our financial statements this quarter, which I know can be challenging for investors, starting the third quarter and moving forward, we expect that our financials will be simplified and easier to understand.
Before I get into second quarter numbers, I want to give some color around the presentation of our financial statements to help walk everyone through the incremental information we are providing.
Under the accounting literature for discontinued operations, the Spin-Off of SMTA qualified as a strategic shift for Spirit. Meaning the Spin-Off had a material impact on Spirit’s operations and financial results. Accordingly, Spirit had to apply discontinued operations accounting starting on the May 31, 2018 Spin-Off date, which of course impacts all of our financial statements and disclosures. So let me give you a quick rundown of the impact.
Starting with the income statement, the results of both SRC and SMTA are included in net income for two of the three months ended June 30 and five of the six months ended June 30, 2018. However, all of revenues less expenses related to SMTA then collapse into a single line item called income or loss from discontinued operations.
The same net activity for SMTA related to the prior year comparison periods, has also been collapsed into the same line item. The income statement for the three and six month periods ended June 30, 2018 and 2017 for SMTA discontinued operations is disclosed in Note 8 of our 10-Q which we expect to file later today.
Since the Spin-Off occurred in May 31, there’s no impact of discontinued operations on the June 30, 2018 balance sheet, which represents SRC as a standalone entity at that point in time. However there are a few line items appearing as of June 30 that I’d like to point out.
First, is the inclusion as an asset of the $150 million in SMTA preferred equity owned by Spirit post-spin. Second, we are now including a $33.6 million investment in the MTA notes issued last year, which we are required to hold as the issuer of those notes. Part of the split, that investment was eliminated in consolidation and we’re now recognizing a $29.4 million mortgage net liability for loans made in 2014 from MTA to Spirit for certain assets owned by Spirit.
The loans have a remaining term of nine years and bear interest at 1% per annum. This liability was also previously eliminated in consolidation.
The December 31, 2017 balance sheet, total assets and total liabilities of SMTA have been condensed and bifurcated separately. The December 31, 2017 balance sheet detailing the assets and liabilities of SMTA are disclosed in Note 8 of the 10-Q.
As it relates to the consolidated statement of changes in stockholders equity for the six months ended June 30, 2018, the distribution of the net assets to SMTA in conjunction with the Spin-Off is shown as a single line item SMTA, Dividend Distribution, which represents the net assets of SMTA on a historical cost basis.
There are no significant changes to the consolidated statement of cash flows, which does not bifurcate the cash flows from SMTA. Rather the net cash flows from operating and investment activities related to the discontinued operations are disclosed separately in Note 8 to the financial statements in the 10-Q for all periods presented.
Certain non-GAAP measures comprising Spirit’s consolidated AFFO and adjusted EBITDA are included in the earnings supplement on pages six and 28 respectively. The AFFO for the three and six month periods ending June 3, 2017 and 2018 and adjusted EBITDA for the second quarter of 2018 do not bifurcated the discontinued operations of SMTA. Accordingly, we have also provided AFFO for the month ended June 30, 2018 separately in order to give investors insight into Spirit’s run rate AFFO as a stand-alone entity.
Now turning to second quarter results, rental revenues declined $7.3 million compared to the same period last year, driven by a $7.2 million decline in contractual rents as we were a net seller of $171 million in real-estate for the last 12 months.
Interest income declined by $460,000, primarily due to the early pre-payment of a $7.1 million loan receivable in April, which resulted in the reduction of interest income of $600,000 related to the acceleration of non-cash amortization. Also other income increased by $1 million due to the prepayment penalty related to the same mortgage note receivable.
Unreimbursed property costs or leakage declined by $1.4 million, primarily due to fewer vacant properties and distressed tenants and represent only 2.3% of second quarter rental revenues compared to 3.5% for the same period last year. Reserves for loss rent declined by $1.4 million representing only 0.3% of contractual rents.
General and administrative expense was $13.5 million and included $1.4 million in accelerated stock grant amortization expense related to the SMTA stock dividend distributed to restricted shareholders. We regard this one-time distribution and the resulting charge as a transaction related expense and an add back for the calculation of adjusted EBITDA and AFFO.
Related party fee income, which is a new line item this quarter was $2.2 million and included one month of SMTA asset management fees and MTA property management fees. Separately we recognized preferred dividend income of $1.25 million for our investment in SMTAs preferred equity. The detailed breakdown of this income can be found in Note 11 of the 10-Q. Despite the Spin-Off of SMTA on May 31 and the net sale of real-estate over the last 12 months, AFFO per share was $0.20 compared to $0.21 for the same period last year.
Now turning to the balance sheet, our adjusted debt to annualized adjusted EBITDA which included two months of operations for SMTA was 3.6x. Performa for the Spin-Off of SMTA, that metric equates to approximately 4.8x.
During the second quarter we retired the full $123 million of Series 2013-1, Master Trust 2013 secured notes. There is no prepayment penalty associated with that repayment. Also during the quarter we repurchased 8.1 million shares of common stock reducing our outstanding share count to 426.6 million shares.
As Jackson mentioned, we dispose of eight Spirit assets during the quarter. Of those dispositions two properties were transferred to CMBS special services and satisfaction of $22.4 million in secured debt schedule to mature in 2018. The net book value associated with those properties was $14.4 million and resulted in a gain on extinguishment of debt of $6.7 million.
We have one remaining CMBS loan in default that we anticipate resolving by year end and mortgages collateralized by one vacant asset with a loan balance of $9.6 million, including $2.9 million of capitated default interest accruals. Subsequent to quarter end we borrowed $420 million on our delayed drop of term loan facility. The proceeds were used to repay our live credit, which currently has a zero balance.
Our liquidity remains exceptionally strong, giving us the runway to close our acquisition pipeline without needing to tap the capital markets. As of August 6 we maintained $833 million in available liquidity, consisting of approximately $25.6 million in available cash and $800 million of availability under our revolving credit facility. In addition we have approximately $7.4 million in the Master Trust 2013 release account.
As of June 30, 74.6% of our debt is unsecured and 80% of our assets are unencumbered. We are also pleased to report that in recognition of our work to strengthen our balance sheet, Fitch upgraded their credit outlook from neutral to positive and Moody’s upgraded their outlook from negative to neutral.
Now turn our guidance, we’re introducing full year 2018 AFFO per share guides for Spirit of $0.75 to $0.76 excluding severance, which includes five months of operations for SMTA.
We are raising the low end of our previous AFFO per share guidance for Spirit as a standalone entity, performa for the expected distribution of Spirit MTA REIT as if SMTA have been distributed as of January 1, 2018 by $0.01 per share, moving our guidance range to $0.67 to $0.68 excluding severance.
Due to our robust acquisition pipeline, we are increasing the range of capital deployment guidance and raising the low-end of our range for leverage guidance. Capital deployment comprising stock repurchases, revenue producing capital expenditures and acquisitions increases from $400 million to $500 million to $450 million to $550 million. Through the second quarter we have repurchased $168 million of common stock and spent or committed $90 million in acquisitions developments and to forward take our commitments. Our range for leverage defined as adjusted debt to adjusted EBITDA is now 5.2x to 5.4x.
Finally, we’re reaffirming our disposition guidance of $50 million to $100 million. With respect to Spirit’s common dividend, the board of directors declared a quarterly cash dividend of $0.18 per share for the second quarter.
As we noted on our last call beginning in the third quarter, we are targeting a dividend payout ratio as percent of AFFO of approximately 75%. We believe that this dividend policy will enable us to maintain our conservative, low leverage balance sheet and offer the accretive reinvestment of retained earnings which will provide steady and achieve dividend growth in the future. As always, the actual amount of quarterly dividend distributions is subject to approval of our board directors.
With that, I will now turn the call back over to Jackson.
Thanks Mike. Just as a friendly reminder before we get into Q&A. We want of focus everyone on Spirit. If you have questions related to SMTA, as I mentioned they will report tomorrow and you can reach out to Ricardo with questions.
Operator, we are ready to open up the line.
[Operator Instructions] Today’s first question comes from Vikram Malhotra of Morgan Stanley. Please go ahead.
Thanks for taking the question. Could you maybe just walk us through you know on appropriates of run rate for some of the key items, interest expense, G&A, just given all the volatility in the quarter. I’m just trying to get a sense of what the back half could look like for some of the big picture items.
Yes sure Vikram. I mean on G&A in particular, I mean that’s been a noisy number I think for a while. If you look at last quarter and this quarter, last quarter we had some severance. If you take that out, we’re about $12 million of G&A, kind of run rate at this quarter. If you take out the decelerated stock for amortization and you’re at 12, which would imply a $48 million run rate. So I’d say $48 million to $50 million is probably a good run right for the G&A.
Okay, and interest expense?
Yeah, interest expense, you know it’s been pretty consistent when you look at like the performer Q for the last quarter and you look at where we are today. I mean assuming there could be some changes with our capital structure as we refinance debt and of course if we do acquisitions down the road and what not, but where we stand today, I think it’s a good run rate until things start moving around from a capital structure standpoint.
Got it. Jackson, I guess one of the goals eventually is to sort of get you know re-rating for Spirit as it is today, given sort of the leverage, the profile, the property profile, etcetera. Can you maybe just walk us through kind of how you’re thinking about the next maybe six to nine months from the actions you can take to kind of close the gap from a multiple perspective?
Sure Vikram, thanks for that. So I think you know for the next six months we’re actually ahead of my own internal schedule as per what to do over the next six months I think the first priority is to demonstrate you know our acquisition win and statistics. So on that front, you know I think we made a reference to this $285 million.
You know it’s unusual for us to talk about forward acquisitions, but you know this company spun off as you know SMG in June. So we only have sort of a month to talk about our standalone Spirit profile, so we didn’t expect to close any acquisitions in the second quarter.
But as it relates to the third quarter, you know about half of that pipeline, a little bit over the half of the $185 million pipeline will close in the third quarter. You know some additional information about that pipeline, you know 94% of the tenants in that pool of opportunities will provide unit with level reporting, so that’ll increase our current 42% unit level corporate reporting statistics up to 50%, just from that one acquisition of $285 million.
So when I made that point about moving the needle, I mean as we continue to demonstrate new acquisitions or call it selective asset recycling, which we will continue to do, you know we are going to have a material change in that sort of portfolio of metric or this portfolio and I just think it’s good portfolio already, it’s just going to get better. And I think in time when people see it and they look at some of these other portfolio statistics, which was you know – you know we have six vacant properties right now. We have a loss amount of $200,000, leverage is really low you know and we’ve got a lot of momentum on Shopko sales, you know I think that’s going to be the green light when it clicks on.
Okay, that makes sense. And then the last one, just you mentioned specific SMTA questions for tomorrow or we can follow on, but could you just talk about the market in general for Shopko assets?
You know I’d rather reserve it for tomorrow, because you know it’s a material part of SMTA strategy and you know I don’t want a gun jump what they’re going to talk about. What I can tell you is it’s a very important priority for this senior management team. The four executive leaders of this company have bonus metrics tied to specific dollar volume Shopko sale targets.
So I’m looking around the room at these guys and we’re planning on trying to get it. So yes, we are really pretty focused on it and so is the board, in a sense it’s an important part of the SMTA story, so we’ll give more dollar on that mark.
Is it for a specific time, that target you mentioned?
This is a year, it’s a calendar year. These are calendar year – yeah, sure.
Okay.
And our next question today comes from Ki Bin Kim of SunTrust. Please go ahead.
Thanks, good morning guys. Can you tell about what you are looking to buy, you know what are the quality metrics and some other kind of leave parameters and how that compares to you know how previously you guys used to buy assets.
Well, you know we haven’t bought assets for a while, so as you know. Look it all starts with these process changes and strategy that we put in place when I joined the company. So you know we had to heat up, you know we had a ranking system and so it’s really quite clear if you look at some of that data we put out in the June presentations that we were under or overweight, but I’ll give you a couple of things to think about.
You know the portfolio that we have, that we mentioned some of the names, you know we want long term leases. You know we want meaningful, annual run escalators or bumps or in the case if we can get CPI escalators as well.
We’re looking for primarily what I’ll call you know internet resistant industries, because that kind of – you know our challenge with that reality, so service is important, entertainment is important, quality of operators is important, and really what’s also important is just doing direct business with a concept that we think can perform. So we’re probably not going to do the one or two unit operator. I mean we want to deal with operators that have more skill or with the operators that we believe can get skill with our partnership.
But if you specifically look on page 16 of our supplemental, you know the weightings of our contractual rent percentage changed in relation to the spin-off of SMTA. So you know convenience stores moved up from 6.5% of contractual work to 10.8%. Drug stores and pharmacies increased from 4.8% pre-spend to now a 7.4%. You know grocery also nudged up a bit.
So I wouldn’t be surprised if you see us selectively look to recycle some of that percentage down and then increase in the areas of health and fitness, entertainment, professional services, you know warehouse clubs, building materials and distribution in terms of those areas, so you know those are kind of like – basically that’s where you’ll see us I think start to increase percentage.
Okay, and can you help us maybe get a better sense of your new asset management philosophy and kind of day-in, day-out how you are based on monitoring your tenants in a better way.
I’ll let Ken answer that. He’s in the room and you know he’s done a great job of really helping us get a stronger hand on the business as we move forward.
Well yeah, easing up there’s several metrics that we use in the asset management function; Jackson’s mentioned some of them. We do the property ranking as an integral part of that. We are monitoring property rankings, we are monitoring coverages, we are monitoring lease explorations, getting on you know out in front of those; we’re constantly looking to extend the duration of the portfolio. So we’ve got multiple avenues that we monitor.
But how about for the tenant that don’t report you know all the financial. How do you monitor them from me the perspective of how their businesses are actually doing?
Well, the good thing is a lot of those, you know I don’t have a percentage in my head, but a lot of those are going to be investment grade. But we have other ways that we monitor it. It can range from director conversations with the tenants where they may not share financials, but we do have conversations with them on a regular rhythm to monitor performance. We’re monitoring rent, obviously real estate taxes, insurance; those are all indications of tenant health that we monitor on a daily basis.
Okay, and in terms of your leverage profile, I know this quarter that the EBITDA metrics had a couple of months of SMTA in it, so it’s not very useful. By the end of the year, after you’ve deployed your capital in terms of acquisitions and share buybacks, where should we be at the year-end on a pro forma basis?
Yeah Ki Bin, this is Mike. So you know one thing in my prepared remarks that I didn’t mention that in Q2 we were kind of pro forma 4.8, because I know that the two months of SMTAs had a meaningful number. So if you take out SMTA in Q2 we should be around 4.8.
At the end of the year, I mean it’s going to be in our guidance. You know, I think that if we were to hit the top end of our capital deployment range and we’ll be at the top end of our leverage range. If you know some deals fall out and we fall somewhere below that, then you’ll be between a 5.2x and 5.4x.
Okay and just the last question. There are some reports that Shopko hired a ground restructuring advisor. Could you just provide any kind of initially thoughts you have on that and how that matters to your own compensation plans and the plans for SMTA and I guess linked to you guys in selling your Shopko assets.
Look I’m not going to comment on – look first of all, there’s always all kinds of people saying the wrong things about Shopko, so I’ll just leave it at that and I’m not going to address that question. But we are very comfortable with the pace and progress of Shopko sales. It’s a key part of SMTA strategy. So we’re going to be able to talk more robustly about that in the second half of the year.
Okay, thank you.
[Operator Instructions]. Today’s next question comes from Haendel St. Juste of Mizuho. Please go ahead.
Hey there. I just wanted to follow-up on the leverage question for a sec. It looks like after buying the assets and the contract under LOI your leverage will be somewhere in the mid to upper five on debt-to-EBITDA. So maybe you could talk about the levers you are looking at pulling here to get you back down to your telegraphed threshold with equity for instance, be part of that conversation?
Yeah, one is it’s not going to be high fives, it will be kind of the mid fives or so. It would be 5.2 to 5.4. But we’re certainly comfortable putting it a little bit above that range and I think that we have some incremental leverage capacity before we hit kind of our ceiling, especially from a timing standpoint. You know if we go above – under 5.5 is where I want to kind of peak out. You know from a timing standpoint we go a little above that because we have a big acquisition pipeline. If that’s fine we can float back down at the appropriate time.
And the other thing just to notice, we are going to do some more capital recycling next year. We saw some assets we’re about to sell this year that we’re recycling and we’ll do more of that next year. So from a pipeline standpoint we’ll be doing a lot more capital recycling.
And then we also will have a lot more free cash flow. You know with the lower rent expense we have, the more conservative dividend policy, we are going to be doing quite a bit more free cash flow that we can use as equity, you know leverage it appropriately and do more acquisitions. So we don’t have an immediate need and you’ll obviously see how the pipeline shapes up to identify what kind of capital raises we would need to do.
Okay, thanks for that. And then on the $285 million under LOI, curious how much of that was sourced internally not via brokers or intermediaries, and then how should we think about the potential impact of your platform and costs, maybe G&A personnel as you move towards – as you move more toward direct, non-brokered, non-marketed deals?
Just from a G&A standpoint it’s not going to make any difference, because it’s really the same team. A lot of this is being executed in partnership with the asset management teams. You know Ken mentioned, the way you get ahead of your tenants is talking about current health and future health and future development opportunities, so that’s like easy pipeline right. But it’s connecting the dots between the acquisition teams, our strategy effort, researching and credit, you know where I kind of see where the portfolio needs to go and it’s kind of bringing all those groups together on the pipeline that we have to-date.
So $185 million is actually – we have hard money, expect to close soon and those opportunities are what, 285. I’d say half of that; over half was sourced just directly with the seller, with just non-broker kind of a situation.
I’m not sure that’s going to be the percentage all the time. Sometimes it will go up, sometimes it will go down, but we’re going to change the nature of how we are interacting with our current tenants. I can say, personally my time – that I spent more time post-spin on the road meeting our largest tenants, sources of capital, working probably most directly at this point with our acquisition team. I feel like I can have the most impact there. So it’s all part and part of the puzzle for us.
Okay, thank you for that. And one last one, wouldn’t be complete without – the call wouldn’t be complete without the mentioned of Amazon. So curious, looking at your exposure to the drug store pharma industry, you’re looking at 7.5% of revenue. Curious what you are thinking about that long term? What the right exposure to drug stores, pharmacies given Amazon’s acquisition of PillPack and any thoughts you have on that.
Yeah, okay look I’m not going to try to [inaudible] as some of my other peers have already talked about sort of – in general sort of impact there, but high level, you know you guys know these numbers. You know PillPack is estimated to have $100 million of annual revenue across this $400 billion addressable market.
What’s interesting to me of all these different things is if you sort of just focus on the mail order portion of the pharmacy business, you know over the long period, the market share for prescriptions over the mail decreased from 14.7% in 2010 to 7.8% in 2017. So i.e., it’s not that easy to get people to convert, to flip over to mail prescriptions and during that same period, you know the pharmacy chain-stores increase their market share step from that same period from 50.2% to the 57.9%.
So I think it’s – first of all, it’s going to be a lot longer than people think in terms of the impact. I think the bear’s [ph] entry as it relates to regulatory, the relationship between a consumer and a pharmacist is – it’s not that easy to break and it’s also a very complex and interwoven supply chain. So I don’t think that we are thinking that this is going to disappear overnight.
The other thing is, if you look at our drugstore portfolio in particular, you know the average five mile population is about 125,000, you know it was in our drugstore portfolio. But what’s interesting is the median age of population within five miles of our stores are 40.5 years, so it’s three years older than the average U.S. population as a whole.
So I mean I think that sort of bodes well for what CVS, Rite Aid and [inaudible]. I think the bigger issue for us is, the drugstore portfolio that we have are generally flat leases and as I told you in the past, you know we’re looking for more escalations, we’re looking for more service. So on the one hand, drug stores are great they’re really liquid. If we want to sell them, we can sell them very easily. They are very comfortable in their ability to pay rent. But as a result of the Spin-Off, our pharmacy exposure went from 4.8% of contractual rents up to 7.4%. So I would not have sort of drilled that percentage up like that.
So I think in time you will see us you know selectively continue to reduce exposure, not because we’re afraid of Amazon, but just it’s a relationship of flat leases, it’s a larger percentage than we are focused on. We are trying to build more organic growth in this portfolio, so…
I appreciate it. Thank you, Jackson. Take care.
And our next question today comes from Ryan Hawthorne of RBC; please go ahead.
Hi, are there any new relationships that you guys could kind of talk about that could be a source of new transactions or new acquisitions?
Yeah I mean look, we have a lot. If you look at the pipeline, for instance we had referenced Topgolf and we are not getting too specifically with them. That’s a new relationship.
Well, lifetime Fitness will be a new one and there’s a handful of others. So we’ve got, we’ve got a very robust pipeline, not just the ones that we mentioned here, but we were actually – we are already building on 2019 pipeline already1 and let’s not forget the tenants that we currently have in our portfolio.
You know we have 400 plus tenants and we’re like the majority of them. So you know it’s just trying to find opportunities that kind of match up from a strategy standpoint for us on where we are trying to drive the portfolio and some of the numerical statistics that we are looking at relative to lease type and duration. Because you are just matching it up and obviously you we’re in the business of trying to price credit appropriately; it’s a big part of what we do with the real-estate backstop.
So it’s all of those kind that go into the mix. It’s not like we are trying to increase all new tenants, that’s not really the focus. We have very specific strategies, industries that we like and you know we are very intellectual as to how we look at our current portfolio and where we want that portfolio to be in five years.
Okay, thank you.
Thank you.
And today’s next question comes from John Massocca of Ladenburg Thalmann. Please go ahead.
Good morning everyone.
Good morning.
I know you guys are kind of resistant to answer questions about SMTA, but I just want to ask this one, because it’s about management. Has there been any progress with regards to hiring a permit SMTA, CEO?
Like I said, we said we don’t want to talk about SMTA, because they haven’t really announced yet, but that’s going to be obviously a board decision over there. I can tell you – what I will tell you is that the board of SMTA, the new board of independent trustees you know have spent quite a bit of time actually, just time-time getting to understand our process, the portfolio, the decisions they have to make as it relates to capital allocation and the things that were set up as part of the Spin-Off structure. So I’ll just leave it at that, that Ricardo is interim-CEO and CFO and Treasure and you know we’ll continue to spend time working with the new board, but that will ultimately be their decision.
Understood. And maybe be just kind of as a reminder, how far along in that for 450 to 550 of capital deployment between what closed and when to SRC in 2Q and stock buyback and then also maybe including the 285 you have under contract. And then how much additional kind of acquisition capacity did that give you beyond that to 285?
Yeah so, if you look at what we’ve done so far, of that 450 to 550, we’ve kind of got spoken for 168 million of stock we repurchase. We did a little bit of acquisition in the first quarter, about $3 million. We had a $759 million of redevelopment and $12 million of forward commitment. So $168 million of stock buyback is done, $90 million of the 450 to 550 is spoken for and so that really leaves what’s under contract in LOI.
Anyway after that, like we have some capacity. We have over $800 million liquidity. So we have a lot of – even net of all this we are going to have quite a bit of a liquidity on hand and we saw a little room on the leverage side and we’ll have, you got any additional free cash flow that we can put to use, as well as lot of capital recycling going in the year. So definitely have some ability to continue to work at acquisition pipeline before we need to raise any capital.
Yeah you know the disposition cap rate that we you know announced in the second quarter, that’s not going to be really indicative of what’s coming in the third and fourth quarters. There are some things that will be sold at very low. From a spread wise relative to where we’re buying things, and we are doing that not because just they are low, but because from a waiting standpoint just overall strategy where this portfolio was, we are going to do that.
So this accretive recycling is a key portion of what we’re going to do, because I said to you earlier, like our cost of capital is improving, it’s not there yet. You know I got a new buy-back program in place. We are always going to look at that, we are always looking kind of at our cost of capital that’s improving, our pipeline is improving. So we think we’ve got a number of different levers to pull in order to drive earnings and drive accretive acquisitions relative to not only cost of capital, but just accretive to the portfolio itself.
You anticipated my second question there. How long do you think that kind of runaway is in terms of capital recycling, if you kind of get to the end of this 450 to 550 and you are not trading at a range that you want to be. I mean could you potentially just capital recycle for a year or would you kind of run out of assets at a certain point within 2019.
No, I mean like I wouldn’t want to put a time on it, but you know we have – this portfolio is really good, it’s very liquid. The properties are – I can tell you its really good, because the things that we look at that we have to – it’s very competitive in the acquisition market today and if you talk to some of our other CEO peers. I’ll tell you that the spreads from quality, properties have really not changer much at all and so there’s a lot of demand for them.
So there are tremendous amount of opportunities where we can redeploy what I’ll call either flat to low growth leases or maybe non-reporting kinds of leases and opportunism and kind of par laid them into 8% plus economic yield or into acquisition that will increase AFFO and do all the right things. So, I would rather not put a volume number on it, but I don’t think that we run out of bandwidth for a while so if we had to.
Understood and then there’s one quick kind of detailed question. The 2.7 fixed charge coverage ratio coverage that you had for the portfolio, was that a weighted average or median number and then if you kind of had to guess just broad strokes, what would be the four wall coverage there?
Well, the fix charge coverage, that has a couple months of SMTA, so it’s not really a clean number and I’ll have to get back to you on with the clean number. But the actual number is higher. As far as the four wall coverage, that’s in our step and I think that’s 2.7x.
Apologies. Our next question today comes from Chris Lucas from Capital One Securities. Please go ahead.
Hey, good morning everybody. Jackson just kind of a bigger picture question. You mentioned I think distribution as one of the target areas for you. As you think about the portfolio down the road in terms of exposures to retail industrial and office assets, is there a sort of ranges that you think about in terms what that portfolio looks like down the road, a few years?
It’s not going to change, it’s going to have a more service orientation obviously as it relates to what’s traditionally called retail. We define it as service retail, traditional retail, but it’s going to just have more of a service orientation.
I would say like the – like distribution of – it’s very competitive and so it’s really hard for is to find sort of the right opportunity, where it makes sense for our cost to capital. So I think that – I would say if you look at our current weightings, you know I think our service industries, I think I’d like to see them up. They are currently 58% of contractual rent, you know that probably will move up to hopefully 65%.
And you know I could see industrial, increasing slightly. I don’t think data centers are going to increase dramatically in our portfolio. And then I think just in terms of – you know I think that’s basically – Once again, just increase our surface industry portfolio, but we don’t have a target number that we are shooting for at this point. It’s really more quality of tenancy, very specify to particular industries. We have a much higher fulcrum as it relates to actual significant industries versus the high level retail industrial mix.
Okay and then as it relates to this sort of what you think about in terms of how you come up with your disposition pipeline if you will. Is that coming sort of off the bottom of the heat map, is that coming off of a sort of dislocation of value, is it lease characteristics. How do you think about that pool that goes into this disposition pool?
I think it’s a combination of all those factors. There are no shortage of properties in this 1,500 plus portfolio that if I ask Ken, I want to sell this or that, that he can sort of get that done. So what we are really doing is we have a ranking system that’s really critical of what we do.
There are certain times when certain assets are right for sale. I’ll give you a good example. We were exploring right now a distribution center that we have in the pet industry. Not that we don’t like the pet industry, but we took the pricing on that particular asset relative to the credit profile of that particular pet tenant, is going to price extremely through that where that credit would trade on a standalone basis. So that’s just one example of something we’ll look and explore.
The other is we are just about to go through our property by prosperity ranking system in another couple of weeks here, the last couple of weeks of August. And so that’s going to involve a pretty significant time-effort on the part of Ken’s team, credit team, asset management team and I think that we’ll drive – that gives us a chance to really look at this portfolio and great detail as we think about what makes sense to sort of settled, when it’s the right time to sell and so that’s a focus, that I’ll leave you with.
Great. Thank you. I appreciate you taking my questions this morning.
And our next question is a follow up from Ki Bin Kim of SunTrust. Please go ahead.
Hey guys. Do you guys official set any dividend for SRC?
I’m sorry, we were setting a new divided for SRC was the question?
Do you guys set an official divided rate?
No, no, the last thing we declared was Q2. So we’ll declare the Q3 divided in normal course. Anyway, as we said a couple of times, it’s going to be based on targeting around a 35% of AFFO per share.
Okay, and any new tenants creeping up in your watch list.
It is Ken. The answer is, no. The credit watch list is very, very stable. I mean we are always monitoring certain folks, but as far as trend wise, it’s very stable. I’d suggest the positive trends in both our occupancy and our loss rent performance that we exhibited over the past year is indicative of credit watch list, very stable.
Okay, thanks.
And our next question is a follow-up from John Massocca of Ladenburg Thalmann. Please go ahead.
Just a quick one, is the SMTA comp set up in a manner that – what happens to managements SMTA related incentive compensation with SRC as acquired. Is this kind of set up in a manner that it doesn’t work against incentivizing you guys to entertain appropriate offers for SRC?
That question to be honest, doesn’t make any sense. I mean we are – we work for our shareholders, both companies, and if there are things that are more compelling, we’ll look at them and its nothing to do with comp or any of that stuff.
Okay, but just so, it wouldn’t change divesting in any type of your compensations, okay. That’s it from me. Thank you.
And ladies and gentleman, this concludes our question-and-answer session. I’d like to turn the conference back over to the management team for any final remarks.
Okay look, I thank you all for joining this morning and we look forward to tomorrow’s call with SMTA and we’ve got – it’s nice to be back in what I call more regular state of the triple-net business right now. Thank you.
Thank you, sir. Today’s conference has now concluded and we thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.