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Greetings and welcome to Spirit Realty Capital Q2 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference call is being recorded.
I would now like to turn the call over to your host, Pierre Revol, Senior Vice President, Strategy Planning and IR. Thank you. You may begin.
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; and Chief Financial Officer, Mr. Michael Hughes; Ken Heimlich, Head of Asset Management, will be available for Q&A.
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 risk and uncertainties that can cause actual results to differ materially from those currently anticipated due to a number of factors.
I'd refer you to the safe harbor statement in today's earnings release, supplemental information and July update deck as well as our most 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. Reconciliation of non-GAAP financial measures to most directly comparable GAAP measures are included in today's release, supplemental information and July update deck furnished to the SEC under Form 8-K. Both today's earnings release, supplemental information and July update deck are available on the Investor Relations page of the company's website.
For prepared remarks, I'm now pleased to introduce Mr. Jackson Hsieh. Jackson?
Thanks Pierre, and welcome everyone to our second quarter call. As most of you know, we decided to move up this call from its originally scheduled date. Since COVID-19 hit, Spirit has made a concerted effort to provide our stakeholders with more robust and granular information, more often about our portfolio health, rent collection and tenants.
We believe this approach is not only warranted given the circumstances but also aligns with our culture and the way we approach our business every day. One of the models, all of us work by is that there isn't good news, there isn't bad news, there is just news. We believe moving up our call to provide more timely information is just the right thing to do in the Spirit of that model.
Our people, processes and technology have really made it possible to provide enhanced timely disclosures, all while running the day-to-day operations remotely. Today, my update will focus on number one, cash collections and deferrals; two, tenant performance; three, active portfolio management; and four, our external growth pipeline.
Mike will then discuss our financials, the revenue recognition treatment of our deferrals and provide you with an update on our capital markets activities. First, cash collections and deferrals. Monthly cash rent collections have continued to improve, reaching approximately 78% in April, 71% in May and 77% in June, an increase of 18%, 6%, and 1% respectively, since each month was initially reported, aggregating to 75% for the second quarter.
For July, rent collections were 85% and all of our top 10 tenants paid rent. The improvement in rent collection has been primarily driven by more tenants reopening and returning to business and completing the term of rent deferral contractual arrangements. As of the end of July, 92.4% of our real estate assets are fully or partially open versus 85.8%, as of our NAREIT meetings at the beginning of June.
Going forward, we expect our rent collections to improve throughout the remainder of the year. Generally, following the path laid out by our deferral agreements with May being the trough where rent deferrals were most heavily concentrated. Furthermore, the initial contracts we negotiated have changed very little. And thus far, we have only executed one short-term extension to a deferral agreement for a movie theater tenant.
As of June 30, $1.4 million of contractual rent remains abated and $9.7 million of contractual rent remains deferred. Of which $4.6 million is subject to percentage rent based upon sales, giving us an opportunity to capture some or all of the deferred rent this year depending on tenant performance.
Second, tenant performance. COVID has certainly changed the way we live, at least for now. And there have been several clear winners within our portfolio and some were challenged industries. It's probably not surprising that our tenants who provide essential staples, supplies and services are doing extremely well, such as supermarkets, dollar stores, drug stores, and home improvement.
In many cases, these tenants have seen their sales increase since COVID hit. As traffic patterns recovered in May and June, our auto-related tenants saw their businesses begin to thrive again, such as C-stores, auto service, auto parts and car washes. Sporting goods has become another bright spot as leisure and recreation has shifted predominantly to outdoor activities, like biking, camping, and like.
Not surprisingly, quick-serve restaurants have proved a mainstay in a post-COVID world. And despite a few early hiccups as operators figured out how to adjust their labor model for drive-through and pickup only, I believe this segment will emerge as a real winner with a more profitable business model.
The real dark horse winners have been home decor and home furnishings. At Home, one of our top tenants is a perfect example. They gave a business update earlier this week on their fiscal second quarter results and crushed it. Despite being shut down in many states for some period, At Home has performed remarkably well, partly fueled by pent-up consumer demand and investment in their omnichannel initiatives.
But they have seen continued growth and captured new customers on a steady pace since reopening, indicating that consumers are willing to return to bricks-and-mortar retailers, who provide selection and value as well as large square footage conducive to social distancing. Prior to COVID, we had conviction around the home decor and furnishings industry, and we are even more confident about their prospects going forward.
There are still some industries that remain challenged. Our casual dining tenants are still operating under limited capacity guidelines in many states and municipalities as are our health and fitness tenants. In addition, entertainment is still struggling to find its footing with state and regional regulations. As our movie theaters, which are being impacted from creeping delays in new studio content release dates.
Even with these challenges, we are seeing some green shoots. For casual dining, health and fitness and entertainment tenants that have been able to reopen and operate with limited capacity. We have seen strong demand for their business and profitability at lower levels of occupancy. The consumer demand we have seen for our entertainment assets bodes well for movie theaters when they are finally able to reopen and gain access to major film releases.
In addition, since studios have not released any blockbuster films this year, there should be a prodigious amount of content that will drive moviegoer demand once reopenings occur. While I can't predict the length and breadth of COVID-19 in every state or regional governmental response, I am confident that our tenants businesses are relevant and in demand. The vast majority of our operatives are meeting the challenges put upon them and that when consumers can go to them, they will.
I also take comfort in the fact that within each of our more challenged segments, we are diversified regionally and amongst operators. And our tenants tend to be large operators or public companies that are sophisticated, have access to capital and most importantly, the staying power to either ride out COVID or adapt to it.
Additionally, our four Goodrich Quality Theaters purchased as part of the SVC transaction late last year received multiple offers during their bankruptcy proceedings. We're in the final negotiations with a strong creditworthy regional operator with 20 year absolute net master lease on all four theaters. Terms discussed include a provision funding tenant improvements with the return in a low 8% range and percentage rent commencement to occur in the fourth quarter.
Third, active portfolio management. At our Investor Day last year, we talked about the importance of portfolio shaping and building a fortress portfolio. And one of the key tools in that process is targeted dispositions. Given my previous remarks about the industries that are winning right now, we have seen pricing for certain assets compressed considerably, making now an opportune time to exit targeted exposures in grocery and drug stores. As of today, we're under contract or LOI to sell four grocery stores and four drug stores amounting to $90 million and a 5.75% weighted average cash yield. These dispositions further evidence to liquidity within our portfolio and the robust demand for high quality freestanding retail properties.
Finally, external growth and pipeline. As you may recall in our last quarterly remarks, I stated we shifted many of our acquisition team members to their prior roles as asset managers. Having completed the majority of rent deferral agreements and with better visibility on our rent collections, we began moving team members back to transactions that we put on hold and sourcing new opportunities.
During the second quarter, we closed on only one transaction, a Texas-based sausage processing, packaging and distribution company, whose products can be found at H-E-B, Costco and Walmart to name a few. As Mike will discuss more in his remarks, we have total available liquidity of $1.2 billion, allowing us to be offensive. And we're seeing attractive opportunities that meet our investment criteria with less competition as compared to pre-COVID. We do expect to see a more normalized acquisition run rate levels in the third and fourth quarter. Pricing for the same assets that we pursued in Q1 2020 has become more attractive in many cases. And with the experience of COVID-19, we have seen our strategy of investing in public non-investment grade companies validated.
Before I hand it over to Mike, I wanted to remind you of a point I made at our Investor Day. There were several misconceived notions around a triple-net REIT. It takes a great deal of active management of fortress balance sheet, strong operating systems, outstanding people, a defined and disciplined investment strategy and a high quality portfolio. We have these at Spirit and believe they will drive our success for years to come. Mike?
Thanks, Jackson and good morning. I'm glad we can finally report on the second quarter after months of incremental updates. As you probably seen this morning, we have given you a lot of information, as we did last quarter, in addition to the earnings release, earnings supplemental and 10-Q, we've posted at our investor deck, this full detail about how COVID-19 is impacting our tenants industries, our rent collections, and our property costs. We hope you find the information helpful.
Given, there are a lot of questions around the revenue recognition accounting for deferred and abated rent, I'll just start there. Part of COVID-19 subsequent changes to lease payments that were not provided for in the original lease were generally accounted for, as a lease modification under ASC Topic 842. As applied to current circumstances, unless the lease contract already contained explicit or implicit enforceable rights and obligations, that required the less or to defer a rent for the lessee in the event of a pandemic or similar hardship, any deferral provided by the lessor would be considered a least modification.
In that event, the deferred rent would not be recognized during the deferral period. But instead, only when actually paid for the new rent schedule under a modified lease. In response to the large volume of rent deferrals caused by COVID-19 and the impracticability of analyzing every impact at least per ASC Topic 842, the FASB provided some relief through new accounting guidance for less sores and less seas.
In short, the guidance provides that, if a lease concession related to the effects of the COVID-19 pandemic does not result in a substantial increase in the rights of the lessor or the obligations of the lessee, and the lessor and the lessee can treat the modification as though it were already enforceable. Set another way, the lease modification accounting would not apply.
We apply the guidance to our deferrals recognizing revenues for the second quarter in the following manner. First, the deferred rent must be repaid within the original lease term. Second, the original lease term or other significant lease terms cannot be materially modified. And finally, there is a minimum 75% probability that the tenant will repay the deferred rent as agreed, taking into consideration tenant’s credit worthiness, liquidity, and the impact of COVID-19 on its business. The probability of collection for deferred rent amounts will be reevaluated each quarter and the revenue treatment for each tenant is subject to change based on the facts and circumstances at the time of evaluation.
We recorded $110.2 million of base cash rent during the second quarter, of which $22.3 million was deferred. We deferred approximately 300,000 of rents that did not meet the revenue recognition criteria, specifically, their probability of collection hurdle. The deferred rent that was recognized in our revenue is also included in our non-GAAP metrics. As that deferred rent is repaid, the cash will be booked, they can say rent receivable on our balance sheet. Therefore, those repayments will not flow through our GAAP income or non-GAAP metrics in the future.
Deferrals not recognized or booked on a cash basis and will only be recognized in our income statement and our non-GAAP metrics once that rent is paid. Since abated rent is generally forgiven and never repaid, there is no revenue recognition for abatements. We've added $2.4 million of rents during the second quarter. Finally, we evaluate our rental income for collectability by assessing our tenant’s risk of payment based upon their industry, historical experience, payment history, and financial condition.
In accordance with GAAP, we record a provision for losses against rental income for those amounts that are not probable of collection, we commonly refer to this provision as lost rent. Our lost rent for the second quarter was $4.2 million or 3.6% of second quarter base rent, approximately 500,000 resulted from bankruptcies, 1 million from lease restructures, the rent was permanently reduced and 2.7 million from tenants who remained the fault at quarter end. A breakdown of these numbers for Q2, as well as July can be found on Page 4 in our investor presentation, which we posted on our website this morning. Just to be clear, the sum of lost rent, deferrals unrecognized and abatements is the total amount of base rent not recognized in revenue or our non-GAAP metrics.
Now turning to our P&L. As you know, we're no longer providing earnings guidance for the year, but reported second quarter AFFO per share of $0.71. Annualized base rent, which annualizes the rent in place at quarter end was $469.6 million, down $6.8 million compared to last quarter. The bulk of the reduction was due the restructuring of the four Goodrich Theaters with the DIP Lender while in bankruptcy, temporarily reducing the rent on those theaters by 90% during the quarter, offset by only limited Q2 acquisitions.
As Jackson mentioned, we are working on finalizing the lease within U.S.C for our Goodrich Theaters and hope that they will return to more normalized rent levels later this year. Property cost leakage or unreimbursed property cost is high for us this quarter, at 4.1% primarily driven by the accrual of property tax reserves for the current and prior periods for tenants that have either defaulted or for which in our belief, there is sufficient doubt regarding the tenant's ability to meet their obligations.
We provide you with additional detail on our property cost leakage on Page 7 of our investor presentation. A couple of final things to note on our income statement, G&A was lower this quarter, primarily due to a reduction in bonus accruals and travel expenses. And you also noticed a new line item add back to AFFO and EBITDA are recalled costs related to COVID-19. These charges are primarily related to legal costs associated with negotiating and executing deferral and abatement agreements for tenants impacted by the pandemic.
Finally, I'll end with the balance sheet. When COVID-19 hit the U.S., we moved quickly enhanced our liquidity by partnering with our relationship lenders to secure a new $400 million, two year term loan with a borrowing rate of one month LIBOR, plus 150 basis points. Following NAREIT in early June, we raised $330 million equity proceeds bringing our quarter in leverage down to 4.9 times, inclusive of our unsold forward contracts.
Keep in mind that we raised this $730 million of capital after COVID-19 hit and we’re able to raise the debt and equity at weighted average costs of 4.4%. I think the ability to raise well-priced capital, even in a time of great uncertainty speaks to the strength of our company and the triple-net lease sector. We currently have approximately $1.2 billion of liquidity consisting of the forward equity, $29 million in cash and $800 million in undrawn revolver capacity. So the balance sheet is in exceptionally great shape. Despite what can only be characterized as a challenging environment, I believe Spirit is a well positioned company in a steady and durable industry and with our replenished balance sheet capacity, I look forward to pivoting to offense in building an accretive acquisition pipeline again.
With that, I will open up the call for questions.
Thank you. At this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Shivani Sood with Deutsche Bank. Please proceed with your question.
Hey, good morning. You guys highlighted the good liquidity position and more attractive asset pricing that you're seeing in the market. Can you give us a sense of what you might be looking for in the pipeline? And then just given the uncertainty that we're still facing? I'd be curious to hear, if your team is looking for additional credit enhancements or anything in terms of the underwriting.
Hey, good morning Shivani, it’s Jackson. I'll sort of start with that. I mean, I’d just anecdotally give you kind of example like the transaction we closed in the second quarter, that deal got pushed one quarter, the pricing of that asset was about 45-ish basis points wider than we originally had anticipated doing in the first quarter, when COVID first sort of came upon us. I'd say that for assets similar to that, so they would be either non-investment grade, public or private industrial\manufacturing, in this case, it was food manufacturing, distribution, manufacturing.
We're seeing those assets about 40 basis points to 50 basis points wider and what we experienced in the pre-COVID environment. So that's where we're putting a lot of our time and attention right now. Obviously, on the investment grade side, especially given the 1031 market is still functioning, we're seeing cap rates compress in that area. In terms of our growth posture, we obviously get a lot of work in the front end, trying to get the balance sheet ready to restart our acquisition pipelines.
So with that put in place and our ability to get more visibility on rent collections and sort of help the portfolio, which by the way has continued to increase since we started giving these updates in April. Just kind of giving us the conviction that we’re going to move forward, and like I said, I talked about this normalized acquisition runway, which in my mind, if you look at what we did last year and stripped out the SVC transaction, that about $800 million for the year. And so we kind of think of that as sort of a normal $200 million type quarter as a sort of normalized run rate for a company.
So we feel good about that for the balance of the year, for third and fourth quarter. A big part of what we didn't talk about too much, I’d just put it out there, as COVID sort of engulf the organization, we moved a lot of our asset manager or acquisition team into asset management, there was obviously a lot of experience in that group. But we had also made commitments to bring on board two very experienced acquisition numbers in a one that has a very focused industrial orientation to his resume and experience, and the other years of experience in C-stores. They came on board as we were sort of going through this whole rent deferral process.
And obviously, we didn't move them into that deferral team, but they continue to advance the pipelines. And so, I feel really good about what we're seeing, given the kind of liquidity that's out there for those types of businesses that fit in that category of small publics, not investment grade and those industries that we like. As it relates to security deposits and things like that, areas that have – what I'll say challenged performance, where they may have asked for a deferral. I think you can expect that if people are looking at acquisitions for those types of industries, that there is going to be some type of security deposit put in place i.e. three months, six months, maybe even a year of rent that's potentially held in escrow to extent a tenant has to close down again.
We're sort of seeing that anecdotally and we expect that to continue for certain types of industries and tenants. So for instance, like an entertainment area, if you were looking at a gym today, if you were looking at anything that was nonessential, that was closed during COVID, my guess is assets like that, if they're going to – there'll be transactions like that this year, you’ll see them have some form of a security deposit from rent to accept there is a closure.
Thanks for that excellent color. And then just one clarifying one for us. You mentioned in your opening remarks, and I think these were the numbers $9.7 million of rent remains deferred $4.6 million of that is subject to percentage rent. So can you clarify, are those tenants only paying percentage rents until the deferred amounts are recurred or recovered or is the deferred amount will be payable through percentage rents?
So the way I think about it is, we kind of went through pretty methodically each deferral request. And important thing to note is, I think we have like 36 tenets that asked for deferrals that retracted them, just because of the business got better. So that's an important concept not to mention. But as it relates to the way we entered in the percentage rent, it sort of was an evolving discussion. In April, May when these rent collection – when these deferral conversations started strike up, our kind of go-to idea was one to three months of rent deferral, depending on the circumstances and facts around the tenant, and you've got to pay back within on a 12 month schedule starting either in October of this year or beginning of next year, depending on sort of liquidity, whether they were open or not, those kinds of factors.
I'll give you a good example, like in the movie segment. We had one tenant that we agreed to a deferral just like that. And with the studios pushing these release dates out and States pushing reopenings, they came back and said, look, we think it may make more sense to put us on some form of percentage of sales rent between now and say year-end, and then we'll kick back to a more normalized rent. So there's not a kind of one size fits all, as it relates to percentage rent. But we approached percentage rent as trying to sort of match up what the challenges were for that particular industry or tenant or business.
For instance, like showing in our movie segment, only about half of our movie tenant is on a percentage rent structures right now. So, now that may continue to evolve and increase, but as time goes on, because a lot of its depending on sort of what State regulations and municipalities are doing with theaters and studio release dates. But, hopefully that will give you some color as to what that – how we enter there.
And so those – sorry, just one last one. In the rent collection by industry at Page 6 on the investor presentation, are those amounts, the percentage of rents included in those collection amounts by months?
So yes, they are. So like, if you're looking at July – yes. And one thing to kind of note, which I think is like one final point on that page. When we were at our NAREIT presentations, if you’ve looked in our retail industry category, there were 12 sub-industries within retail that had some form of deferral or whatever you want to call it, sort of some deferral structure in place. Well, that's now reduced to eight and it's continued to drop down as we go forward every month. So it’s not just the percentage is going down, it's the actual kind of industries that are – that fit within each of these buckets that is reducing as well.
Okay, great. Thanks for that color.
Thanks.
Our next question comes from Ki Bin Kim with SunTrust. Please proceed with your question.
Thanks, and sorry if I’ve missed this. But, can you just talk about the rent write-off activity? I noticed in your 10-Q, you wrote-off about $5.6 million of rent and kind of reimbursements, which accounts for about 4.6% of your rental income run rate. So I'm just curious, how did you come up with that $5.6 million write-off? And when I compared that to – I'm sorry, July’s lost rent of 2.2%, if I compare that to 2Q's lost rent of 3.6%, and if I deduct it from that 4.6% that you wrote-off, and it doesn't leave you much of a reserves. So I'm not sure if that math is perfectly correct, but can you just talk a little bit more about that?
Mike, do you want to try to hit some of his comments, some of this. But, maybe you could do it again?
Yes. I mean, given the way that we approach our reserves, I kind of covered this with my prepared remarks and we evaluate the tenants every quarter. And based on the situation of some of our tenants, whether they're – some of them bankrupt or some of them were behind our rent or we had gone check three months and down paid rent, we haven't struck an agreement, we started reserving rent, which I think we spell out I think pretty clearly on Page 4 of our deck. And that's, what really drove a large increase in our rent reserves this quarter, I'm not sure if that answers your question, but that, I mean, there are new tenants this quarter that are driving that, and then you see the detail on Page 4 down below, we kind of break out, that's what we call lost rent and we break out in that bucket.
What makes that up with this restructure or driven by bankruptcy or the other bucket, which the other buckets, the biggest bucket and that includes tenants that – either we’re reserving because we don’t think they’re going to be able to continue paying rent or they haven't paid rent and we just had not struck an agreement yet.
Okay. And 85% rent collected in July. Is there any change in the denominator or is the denominator any smaller due to second quarter’s rent that was lost through bankruptcies or restructurings?
Yes. So If you actually look in the footnotes, we give the ABR down there. And actually, if you look at from Q2 to July, the ABR actually went up due to some rent bumps, we have $117 million in Q2 and that went up to $39.3 in July, which if we analyze that, it’s a fairly large increase. But now, the nominator we're including, we show a lost rent, we show abatements and all that, we're actually including all of that in the denominator. So we're not manipulating the denominator by taking out abatements or taking out lost rent, we’re trying to give you a clear picture of look, if you start with what – everything that we should have gotten contractually before we started to say reserve or abate and whatnot, this is the clearest picture that we can give you based on where the starting point should have been.
Okay. Thank you.
You’re welcome.
Our next question comes from Haendel St. Juste with Mizuho. Please proceed with your question.
Mizuho. Thank you and good morning, everyone. So Jackson things have changed a bit since we last talked at NAREIT, your tone seems a bit more measured, or maybe it's just earlier in the day. But in all seriousness, your stocks, your peer stock prices are down since then, COVID cases are up and you have about 30% of your revenues from the COVID hotspot States, Florida, California, Arizona, Texas. So I'm curious how that impacts your near-term view? Or I guess how your near-term view on the business has evolved since then, since last month, are you guys optimistic?
And then how does all of this play into your pace of capital deployment versus preserving balance sheet liquidity? You talked about deploying, I think $200 million per quarter here from the next couple of quarters and look at the forward $350 million or so, I thought that would have been deployed a bit more sooner. So I'm just curious on sort of the views – your views, the evolution, since NAREIT in near-term capital deployment. Thanks.
Yes. I mean, I would say overall a very – I'm still very positive. We just really – given the conversations that we're having in the portfolio with the operators, it’s just was very positive. Yes, I would say that, if you think about just the temperature of what we seen, I mean, April was kind of a disaster, right, just not maybe clear COVID, what the government was going to do. Closures in June was sort of the opposite in some ways, States are aggressively reopening, there is real pent up demand, people open, people are showing up.
And then sort of they got tempered in late June and caught early July with these case numbers going up. What I feel good about today is that the operators that we have and the real estate that we own, the lease structures that we have, that nature of the liquidity of our – the large majority of our tenant base. They have come to figure out how to perform in COVID. They figured out how to protect their employees, they figured out how to do their purchasing, they figured out how to – if they have to re-mange their balance sheet, not just rent deferrals, but it related to debt exchanges, are we doing term loans or sale leasebacks, if you sort of work through a lot of that.
So it gives us a lot of comfort that we've got a pretty sophisticated kind of base and diversified industry base. And we've got real people – real demand from consumers. So I would say overall, when I look at sort of the totality of what we've seen since NAREIT, every month that we've kind of given an update since April, it's gotten better, just notionally the top 10, top 20, percentage of rent collected by publics, industry, deferrals were going down and yet case numbers are going up, but it's sort of not fundamentally stopping people, generally that who’re participating in a lot of the businesses for our tenants.
And so, yes, of course, we're not going to go – we're going to be very prudent about deploying capital, but we also see a great opportunity to get what I'll call very, very attractive risk adjusted returns and things that we liked before COVID, like what we did, what we did in the first quarter, a lot of these industrial and especially in the food area. And we see opportunities continue to deploy which we want to deal. And the pace of our acquisitions really are going to be dependent on making sure, we get the right assets that we want with the right operators, the right restructures at the right price.
And so, the nice thing about not having guidance out there is, we think this is what it's going to be, but if the market is not there, we won't chase it, right. So, and if there is more, we'll do more. But I think we feel very confident at this point about the systems and strategy that we put in place for the upside has really protected us on the downside with COVID, that's what we really believe. And you know where we are today, organizationally, we're sort of pivoting back into the growth mode.
Got it. Thank you for that. And maybe just some color on the near-term outlook for dispositions. I'm assuming you close on, I think the $90 million you mentioned before assets. Are you done for the year? And just curious on the demand for those assets overall in the marketplace, did you see more demand than you thought, and then were those flat leases? I think you mentioned that drug stores and grocery, just curious on the core growth profiles as assets.
Yes. Maybe Ken, I’ll pass it to you. But it was very robust demand, but I'll say maybe you want to give a comment on how we – the brand extends the most drug stores and the nature of those supermarkets.
Yes. The short answer is, yes. What we've seen so far has exceeded our expectations in both pricing and timing of how quick the interest was and the depth of the interest. On the drug stores, yes, they are flat leased, they – some of them are actually and I think all four may be double-net. So these are, again, asset types in lease structures that we've previously identified that, we're okay, letting go them, especially with the kind of cap rates we're seeing for those types of industries today.
Okay. And would that be for the year then? Or are you planning perhaps – maybe the opportunistic gets demand or pricing comes in a bit more? Just curious on the level of dispositions we should expect near-term?
I would suggest that's the bulk of it. When – if somebody makes you an offer that is compelling, obviously in the assets that we have targeted, we're going to respond to that, but I suggest that’s the bulk of the dispositions.
Got it. Thank you, guys.
And then one thing, hang on, I was going to say, like, in terms of our tone, it's interesting, like the team's done a phenomenal job, Ken and the credit team, legal team, just working through that very, very judiciously that the number of deferral requests. And I think anecdotally, when you see a large number, like 36 retract deferrals, or we also say, no, you're not getting a deferral and then they pay rent, but that's sort of a good fact better. And then you see things like tenants, I won't name names, but you agree on a deferral, we're ready to go and papered up. And then they come back and say, guess what, you know what, businesses exceeding our expectations, we're just going to settle up all the rent right now.
And larger tenants, I would say fit in that category. It just sort of gives us a lot of comfort that country is dealing with the COVID challenge as best they can, people in this country, sure, they’re locked down, but I think they've kind of figured out, put the mask on, be careful, wash your hands, whatever, but they're not going to stay home and hide, they're going to go out to the supermarket, they're going to go to the home decor store and we fit out that room. They're going to pick some of them going to go to those entertainment assets. Some of them are definitely going to movie theaters today. We have movie theaters that are open right now, so – in the States that they're allowed to.
So I think that, we're all – everyone is sort of moving forward and disaster there is, and hopefully we'll have a new fiscal stimulus package at some point, that comes down to help people on the economic front, which are the trends – well for our tenants.
I think you mentioned movies again, I was curious if you had any thoughts you wanted to share on perhaps the AMC Universal deal?
I think, I don’t – it’s – from what I can see from afar, just to understand a little bit about it. I mean, I don't know if I would read a wholesale change into the way movie theaters are – I don't think this is quite a quick game changer as most said. I mean, this Universal agreement with AMC is a very isolated agreement with them. Now, obviously Universal is going to try to go to other operators, big ones and small ones to try to do a similar thing. And what they effectively did was just open up a new window for – on a film-by-film basis that they choose at that premium $20 service directly to the consumer.
The DVD, hard drive copy theatrical structure hasn't been changed. And I'm not sure if Universal is going to get full adoption by all of the movie operators, you’re not just the one and done thing. And not sure how significant it's going to be anyway. But, if you think about $20, I mean, if a person can go to a movie theater and buy two tickets, they might want to just go and do that versus just stay home, and everybody is sick of staying home anyway, and just watch the movie. So my personal belief is I do believe that movie theaters are still relevant. I think that when the content comes up, people will go.
I actually think that the movie theaters are going to be smart as to how they bring people in, people wear masks, they'll speak in a certain way. But if you think about our movie theater, everybody's facing forward, you're not yelling and screaming, they're not drinking and trying to talk over people, there is good ventilation. So I think that when people actually finally get into a movie theater and they do it in a safe way, you'll see this go back to some form a little bit normality, that's what I believe,
Appreciate the thoughts. Thanks, Jackson.
Yes.
[Operator Instructions] Our next question comes from Nate Crossett with Berenberg. Please proceed with your question.
Hey, good morning guys. Just now on the theaters, what's the percentage of your theaters that are open right now? And we've seen some of these guys get funding from PE. So I'm just wondering, have you noticed a change in the conversations after that funding has occurred?
I mean, Ken, do you – we have one, I mean, we have – and you can see what's – it actually says 100%, I’m just looking at the charter, but I know we have one in Georgia, that's open.
Okay. Go ahead.
Yes, the majority of the conversations we're having with the theaters is how they're playing for the reopen. And obviously they're having to be head on a swivel and adapt the continued push in the release dates. But at one time, a couple of things that we do like is, it's allowed them to put plans in place, whether that’d be how they're going to clean the theaters and whatnot and how they're going to staff. It's built up a very large backlog of tent-pole films that will now get released later in the year, 2021 and into 2022.
So what – we're – when we talked to our tenants, they're really focused on the next 18 months, but here is what I would suggest too is, the – you look at the Goodrich, that was – went into bankruptcy before COVID, Midwest regional operator, we have a four unit master lease, we had at least four, five different regional operators, make offers for our four theaters. We were very, very pleasantly surprised at the interest, we have operators that were talking to that are willing to put millions of dollars into these buildings. And this is – what you would think is, the lowest point in the theater industry. So it kind of reinforces our belief that the theater industry is going to be there, it's going to go through some changes and whatnot, but fundamentally it's still there.
Okay. That's helpful. And then just one on the acquisition deal that you said the pricing was, I think about 50 basis points wider post-COVID. Was that just because of less competition? And do you think – do you get the sense that the increase in pricing is going to be a temporary phenomenon? Or, I'm just wondering because the tenure keeps going lower.
Yes. I mean, I think to me at the present phenomenon, for tenants that are, I call it like manufacturing tenant that's smaller, like middle market, small tenant or even a public tenant. When we think about closing it, right, COVID comes in April, May, things starts up, reopen again, which company has got the liquidity, the most liquid, the most investment grade, and then it moved to non-investment grade, but the liquid big companies started to see spreads come in, capital see their cost of funding normalized.
I mean, I use even anecdotally our spreads, we're BBB ready company. Our spreads were kind of honestly like a joke in April and May, it continued to compress today to more normalize levels. Right now, I would say that for smaller companies, smaller revenue based companies, that liquidity is still challenging for them. And so that makes like a sale leaseback opportunity to be pretty attractive. Remember, we’re not doing three year financings, I mean, these are 15, 20 year long-term financings on – we're going to hopefully mission critical assets.
So we can't readjust our pricing, just like a short-term lender can. But I do think that we offer a very compelling form of long-term capital, that's just really not there right now, personally for a lot of companies. That said, and what I just described like the example we talked about with Texas-based company. My guess is as lenders get back to business that liquidity is going to continue to fall down, it's a non-investment grade, smaller revenue kind of companies, spreads to start to tighten, and then all of a sudden it'll get more competitive. But right now, I think it's – we're not the only one competing, but it's a lot less than what it was earlier in the year, I can say that.
Yes. If the 1031 exchange program goes away, is that good for you guys because less competition or…
Yes. The 1031 market is like, I would say, most of the buyers of our supermarkets and drug stores are selling or exchange buyers. To me, like, what that would sort of imply is, maybe pricing starts to look a little bit more attractive where we can become a little competitive there potentially, if 10 31 were to go away.
Okay. Thanks, guys.
Sure.
Our next question comes from Linda Tsai with Jefferies. Please proceed with your question.
Yes, hi. With the security deposits, were any of those applied for 2Q or July payments?
None.
None, no.
I can tell you that when we talk about these security deposits, some of the things that we're looking at in the third quarter that we'll close, that we expect to close, will have some rent structures like that in place, whether it's like a deposit that covers for a certain period of time. To the extent, there's some form of a non-performance. And then after a certain period of time that security deposit will release to the operator. So just to give us a bridge between now and normality.
Thanks. And then on Page 5 of the investor presentation, it looks like there was higher variation in a monthly collection from private equity versus public tenants than the retail category. Why have the PE collections lag that of the public tenants?
It's interesting. Like if you – look not all PE firms are the same, as you know sort of generalities, the nice thing about public companies is they're generally in the camp of, I want to lower my permanent cost of capital. And they're basically permanent companies, right. So high leverage is not necessarily good so they generally systematic, they're trying to reduce leverage and improve profitability. PE is different as you know, right. So they're more transitory, its either they're going to hold it, sell it, merge it, recap it, something's going to happen, there'll be an event-driven issue.
We probably had more challenge in the private equity negotiations in the beginning as it related to collection. So but I would say, it’s generally, it's sort of a case by case basis on the sponsor and the situation versus an overall trend. But what I will tell you is like the public strategy of investing in public tenants, tenants that are public or investment grade has helped us quite a bit from a performance standpoint.
The rent deferral agreements with the PE firms, are they any different from the public ones?
I would say that probably yes. I mean, that's a good way to describe it. I mean, some were – it really depends on the industry and the leverage situation that the PE portfolio company is sort of sitting in. I mean, I'll go back to my old example I use it all the time. When I came on board here in 2016, Shopko had been an asset that had been owned by this company for a long time. This PE sponsor had given a recap the company several times over, taking all its capital out and then some. So when I kind of came down to fix it, they were like, wow, you got to do whatever you want to do, we're – if there's something would be done, that's interesting first of all, we'll do something.
So a lot of the private equity, the things that we look at, when we're doing a private equity deal, what's the nature of the sponsor. How long have they been in the investment? They still have capital, do they still have skin in the game. Because at some point when they start to not have that, I think it tends to be more challenging when you're talking about a rent deferral, like if you don't do this, see you later kind of conversation.
Thanks. Just one last one, what are cap rate targets for industrial and C-stores? We heard about cap rate compression in industrial. What are you seeing and how do you source these assets?
C-stores, for really highly sought-after C-stores, I mean, they're right now, obviously competitive, really low five cap, high four cap for prime-prime C-store assets in the right market place with the right rent to sales. Industrial for us, we – the industrial we're focused on is not multitenant industrial and multitenant industrial, the shorter term leases in these major industrial nodes. Those are not the things we're buying. Obviously those are fairly competitive and are driving to be re-tenanted and things like that.
The industrial that we categorize are mission critical assets for those particular tenants, they may be in a major node or major market generally. But it's something unique to that business. And so it's a combination of a real estate as well as credit underwriting. If we're looking at buildings for industry that are really way out locations, that's a totally different kind of risk profile will be evaluated.
So I would say, just generally the industrial we're looking at is demanding a higher cap rate because it's not designed to be kind of main and main Class A core industrial asset. That's certainly set up for returning, maybe it's an A-, could be a B+, or it could be a B+ building, really a location but overriding is a great tenant, great industry.
I mean, I go back like, our deal we did with Party City, it's a major distribution center. If there are other distribution centers in Chester, which is in upper West Chester County, but the critical facility for that company even during COVID, which stayed open as they were distributing the goods out. So when we look at this industrial sector, we look at it through a couple of different lenses versus saying what bread and butter industrial we would focus on.
Our next question comes from Joshua Dennerlein with Bank of America. Please proceed with your question.
Yes, hey guys. I guess, you mentioned you hired two folks on the acquisition team. One, who's going to focus on C-stores, one on industrial, I'm curious to learn more about their backgrounds. And then are there any other areas of focus that you're going to hire in for the acquisition team?
When we talked about, Josh at Investor Day, I think we had highlighted, we were looking at adding on more depth into that team. And so we are obviously when we made that statement, we had been involved in that process. These are individuals which later in the year, we'll get a chance – we'll get more back on that. But they're very experienced, very tenured in their respective industry expertise that they fit in.
And obviously in industrial, it's a major area of focus for us. And so that was obviously very logical and that person has done a great job. And a very – we'll see a lot of opportunity to sort of arrive off of the efforts. And individuals that had C-store experience, someone that's worked for operators done development. And as you know, C-stores is a big portion of our portfolio.
And we think that there's a lot of ability to actually improve the quality and direction of our existing C-store portfolio. So that individuals working on that right now. So you might see some distributions, some more dispositions in that segment over time, as well as more acquisition as well, once again, overall improvement in the quality of it. So and I think in terms of new people after that, I think for now the team, as we balance the team there – I think we're in pretty good shape right now in terms of numbers of people in that effort right now for what we're trying to do.
Got it. Thanks, Jackson. That's it for me.
Our next question comes from Vikram Malhotra with Morgan Stanley. Please proceed with your question.
Hi guys. Thanks for taking the questions. Just maybe first I wanted to clarify, I heard a comment earlier about percentage rent sort of being included in the 85% metric. It's probably a very small amount, but if you were to just include rental income, what would that percentage be?
Vikram, you might – just repeat that question totally again, I just didn’t catch half of it.
You said the 85% included tenants that also were just on a percentage rent basis. And I know it's a small amount, but just what's the – because percentage rent is a new thing you've now entered into versus what you had seen May or in June, I guess. What is the percentage of just pure rent collection?
So the 85% is just contractual, Mike, if I’m not mistaken, just fixed rent came in. So the percentage that we're talking about is sitting in that. If you look on that Page 4, Vikram, this base rent uncollected, it basically sitting in there.
Got it.
I made this reference to total of $9.7 million of deferred rent, the $4.6 million less than $9.7 million. That's the – those are restructured, those are structured deferrals that have this percentage rent component. For a period of time, they're limited. They're not percentage rent forever, they kind of – if you think about why we did percentage rent. Generally, it's probably because the tenants shut down, closed.
And so when they reopened, they think there's a lot of ramp time, or like a movie theater. There might be challenges with distribution of movies. So we're trying to find a bridge to get them, to get them from fixed payment. And by the way, things could do better. I made a comment about this, we can get paid back hopefully sooner.
Got it. No, I guess I was confused because I think you had mentioned on the page where you give the industry rent collection. I think in that page, you have the percentages include those tenants that are on percentage rent if I'm not wrong.
Yes. On Page 6 in the deck, the July rent collection that you're talking about, the 85% that does not have any percentage of collection – we didn't collect any percentage rent in July.
Okay, fine. So just on the collection, I guess, obviously your bull case would be in the third quarter of both year-end you go back to kind of normal, regular collections, pre-COVID. But given sort of now, you've seen a pickup in cases in some of the key states, Florida, Texas, you're now at 85, I'm assuming kind of your base case for the next few months or the next two quarters would be some percent lower. Is that the case? Are you planning for a certain amount of deferrals to just continue into year-end?
Look, we don't want to give predictions as to what it's going to happen, but I would tell you that I guess made a comment earlier since we started these little interim updates and these quarterly reports since April of this year. We've seen our collections increased. I expect August to be higher than July and expect September to be higher than August. And that's partly because of just contractual deferrals of operating.
But also a lot of our tenants have sort of figured out sort of how to deal with some of the challenges that are put on them. It's not perfect like if you think about gyms today, 10% of our gyms are in California, guess what, they shut the gyms down again. I'm not sure when they're going to reopen but – so those particular gyms that are set in California are experiencing some pain. But the other gyms that have reopened are actually performing well.
So we're not – we're internally as a team. We're not expecting rent to go down from this point in July. We're actually – we expect collections to continue to increase. Albeit, we're not going to be happy until we get 100% of our rent collected, to be honest with you.
Okay, fair enough. And then maybe just last one, just cyclical impacts of the recession, you see obviously, you started to see some bankruptcy, just some loss rent, et cetera. What are you – can you give us a rough sense sort of range, sort of what are you baking in for occupancy at year-end?
Well, just – I mean, on the recession, great examples like, look at companies like At Home. I mean, they are – COVID in some ways has really accelerated what we thought it would be doing maybe a couple of years from now. But in terms of their rollout in omnichannel, but a lot of our tenants actually are going to perform well, if the economy turns down. People are going to travel less, they're going to fly less. They're going to need some form of entertainment or staple goods or services.
So we don't have a lot of luxury things in our real estate and we don't have a lot of urban exposure, a lot of its suburban. And so if you think about that COVID recession case, we think that the suburbs will probably do a little bit better. We think that tenants that are providing essential services and experience will be better, urban may be more challenged, right.
So we think that we're positioned as well as you could be from just a portfolio standpoint, if there's a down leg, further down leg. And then the things that we're buying in the third and fourth quarter, you should expect them to have some ability to withstand an economic downturn, right. So we're buying things that are essential food type businesses, essential technology, essential services type businesses right now, those are the things that we're really focused on.
Our next question comes from John Massocca with Ladenburg Thalmann. Please proceed with your question.
Mike, did you want to follow up with one other comment?
Yes. I want to follow up on one thing on just lost rent. Because Vikram mentioned I think it's worth clarifying. Just lost rent is high this quarter, I think pre-COVID, our lost rent was very, very low in sub 1%. And typically when we have lost rent, we don't expect the tenant to pay. They're typically on their way out. We did provide additional detail on our lost rent on Page 4 of this quarter because lost rent is just, it’s a little different in the COVID world. So just to kind of come back to the lost rent at 3.6%, and 9% were subject to restructuring. So again, that is rent that has been restructured. So that is kind of fixed.
We do have some tenants in bankruptcy, but that bankruptcy bucket there will be tenants that come out of there with some kind of lease restructure. So even though we reserved for that today, there is some opportunity to recapture some of that. And the other bucket, which is kind of a new bucket, which is the largest driver of lost rent this quarter.
A lot of that are tenants that haven't paid rent through the quarter and we just haven't reached an agreement with yet. So there will be some recapture there as well. So when you think about the forecasting of the future, I know you mentioned lost rent. The lost rent has a different characteristic this time, a different field because there is going to be some recapture in our lost rent, it's not just gone forever, as it would be traditionally when lost rent was more normalized. Just want to point that out. Thanks.
Okay. Our next person in queue, our next participant is John Massocca with Ladenburg Thalmann. Please proceed with your question.
Good morning, everyone.
Hey, John.
Just thinking on the acquisition side of things, has last couple of months changed maybe what your kind of return threshold is going forward. I guess to that same kind of vein, are there opportunities maybe for kind of contrarian investments out there, I mean I don’t think its really contrarian any more, but you kind of mentioned how home decor had rebounded significantly. Are there other places that maybe haven't rebounded yet where maybe you see an opportunity to get kind of above market cap rates or relatively higher cap rates, maybe you could give long-term in place?
I mean, I think John, like what we're seeing today is the stuff that we liked before COVID, that's working well in COVID. We're getting better returns to straight out. So we're diligently working through that kind of opportunity. And that to me is like the safest because it's sort of proven. We understand what they do in our portfolio. It's more predictable and we're getting a better yield so that to me, like you want to do that.
I was looking at different segments, as you know we have our research effort. I spent a lot of time with Dave and Travis, our credit – Head of Credit, constantly sort of really looking at what works, what doesn't work, how do things affect, how we look at our heat map, our rankings, how does recession impact?
So we are looking at those – through those lenses. But I would say today, we're not making kind of wholesale changes in what we do. I think we said in the first quarter, we're trying to add more industrial focused assets into our portfolio that hasn't changed. If we pursue things that have potential closure risk and we're comfortable with those industries and tenants, you'll likely see security deposits in place. I don't think, we're not wholesale changing anything that we're doing right now. But we will continue to evaluate new opportunities in each segment.
Understood. And then maybe with kind of the in place portfolio, I apologize if I missed this in the kind of prepared remarks. Can you provide some color on the makeup of the tenants to receive the abatements and I guess when you kind of think about kind of the traditional abatement conversation that's going on, where it's usually kind of term for given rent? I mean, what gives you confidence that those tenants are going to kind of continue to operate to payout rent through that additional term?
I'm going to let Ken hit that because we have very few abatements and like I said, they’re case by case.
Yes. So there were some very, what I would call tactical strategic times. We felt an abatement made sense because the vast majority of the small abatements that we did do, we got a much stronger lease structure that could be term, it could be master lease. It could be a lot of different things. But we felt like, hey, if you want to trade one month of abatement that is in the past.
And we come out of this with a better longer term lease where there were times when we said we're going to make that trade and we did. And it just makes a lot of sense. This is not about, hey, how's this going to affect us this quarter? This is about how do we improve the portfolio long-term.
Were there any particular industries that were overweight in those abatements? So that's my final one.
I'd suggest that it was not any particular industry that – it was weighted. There was several different industries, it was more – not about the industry, more about the tenant's position in the long-term outlook of the portfolio.
Okay. That's it for me. Thank you all very much.
Thanks.
Our next question comes from Greg McGinniss with Scotiabank. Please proceed with your question.
Hey, good morning, everyone. Jackson, first on transactions, you mentioned that you expect to see a more normalized acquisition levels in Q3 and Q4. And I know you mentioned that you're happy to not be providing guidance but does the $300 million quarterly average that we saw ahead of the pandemic seemed reasonable based on what you see in the market today. Just trying to get a sense for how deep the transaction environment is compared to last year?
That’s still more comfortable like 200 per quarter, at least from here on out, I consider that more than normalized because 300 a quarter included that one large portfolio we did late last year. So I took that out, it's kind of more like 800, so around 200 a quarter. And obviously, to say that, that means we've been working on things well in advance of this.
Okay, thank you. And then for a second, just my second question here. So based on the some deferrals, based on the disclosures on Page 4, regarding the expected second half deferrals, is the right way to interpret the $4.6 million number versus the $39.3 million in July rent. That basically there's no deferrals in place for August and September?
No. I think the way I would think – what I would look at on Page 4 is, we've got $4.6 million in the second half at an average period of six months. So the next six months we're going to have kind of variable rent collection on that $4.6 million through the second half. And then I would look at that $5.1 million on that page. That's just a straight vanilla, fixed deferral, that has a pretty short duration right now, less than two months.
So if you think about July that's August, September, we have be done with that $5.1 million and then it's going to be sort of TBD on the $4.6 million. Then you've got the abated $1.3 million there. So in the second half so that's kind of like – that's how we get to 100%. When you really think about this, it's going to be the pace of that $4.6 million that we sort of highlighted there, which is the percentage rent. And that percentage rent, by the way, I mean, we don’t give a lot of guidance on this, but that actually reverts back to a fixed rent at some point.
100%, yes.
It's not a permanent, it’s not a long-term percentage rent. It's a very short window that gives us an opportunity to win this tenant opportunity if its not so good. But those deferrals go back to a normalized, some of them will flip right back to a normalized. You have to start paying rent periods at a date certain and then sort of catch up for rent that we’re accruing still.
So that'll be fixed plus additional deferral on top? Those percent rent payments?
I mean, the way I think about the percentage rent is, let's say, we could have structured a tenant to say, we’ll defer the next three months rent, that's fixed, right. All the percentage rent does in some cases is it just helps us get current rent to the extent there is, but we still got a meter going on the three months, you've got to catch up.
And then there's others where it's a straight percentage with a fixed deferral at a date certain. Maybe a simple way to describe it, I don't know, I'll try to not get too…
No. Just I would say that the highlights are all of these percent rent features are time limited. The vast majority expire by the end of this year. And any – whatever rent they paid based on that percent rent, just to be clear, any shortfall between that and contractual rent is deferred. So that will come back at some point typically that paybacks going to start in 2021.
Okay. Thank you. I appreciate the clarity there.
We have reached the end of the question-and-answer session. At this time, I'd like to turn it back to Jackson Hsieh for closing comments.
Okay. Well, look, we all want to thank you for rearranging your schedules to participate in our call. And look, the headline here, take away here is that we feel very good about the current status of our portfolio and obviously our balance sheet. And the entire organization is very excited to be re-pivoting back to what I'll call a normalized acquisition growth posture going forward. So thank you, guys. Thank you all for participating. Take care.
This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation.