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Greetings and welcome to Third Quarter 2020 Spirit Realty Capital 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] Please note, this conference is being recorded.
I’ll now turn the conference over to your host, Pierre Revol, Vice President of Strategic Planning and Investor Relations. Thank you. You may begin.
Thank you, operator. And thank you, everyone, for joining us this afternoon. 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 risks 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, Q3 investor presentation, 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 and supplemental information furnished to the SEC under Form 8-K. Today’s earnings release, supplemental information and Q3 investor presentation 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?
Thanks, Pierre. And welcome, everyone, to our third quarter call. Before we get into the details of the quarter, I want to share an update I recently received from one of our tenants. A couple of weeks ago, we hosted a casual dining operator at our virtual all town employee meeting.
We own 13 of their units, representing a little over 20% of their operations. At the initial onset of the pandemic, they focused on addressing the immediate concerns, protecting their employees and guests, conserving capital and strengthening their liquidity position. But within a short time, they pivoted to offense and refocused on developing their omni-channel presence, increasing their online growth by 150% year-over-year, rationalizing their menu offerings and optimizing the use of their store footprint because they made good tactical and strategic decisions over the past few months, not only will they survive the pandemic but likely thrive and gain market share. And Spirit will participate in their growth.
I shared this story with you because it is emblematic of how many of our operators are adapting their business model to the changing landscape and how their focus in most cases has shifted from survival back to success. Like our tenant, we choose the opportunity and have shifted back to offense.
During the third quarter, we purchased $214.3 million of assets across 18 properties with an initial cash yield of 7% and an economic yield of 7.7%. The acquisitions this quarter included a mix of existing and new tenants, with a weighted average lease term of 14.8 years and annual escalators of 1.2%. Based on rent, approximately 38.1% of the acquisitions are publicly listed tenants and 19.8% are rated investment-grade. The asset types were weighted 58.4% retail and 41.6% industrial, which we think is a healthy mix for our intermediate term growth.
New tenants acquired during the quarter include off-lease only, a Florida used car dealership and Shutterfly, a market leader in personalized products. Off-lease only is the largest volume independent used car dealership in the U.S., selling thousands of cars in its four Florida locations and around the world through their website. We bought these high-performing locations under one master lease, and they are in the top quartile of our auto dealership portfolio across all our metrics, including our property rankings. The Shutterfly property is a built-to-suit, mission-critical, light manufacturing asset that serves as their only facility in the South Central region of the United States.
This building is brand new and sits in a very healthy and growing sub-market within the DFW Metroplex. We secure both of these opportunities after other institutional buyers pull back on their capital commitments during the second quarter, while our liquidity and balance sheet position allowed us to step in and buy these great assets with strong tenants at yields that are accretive to our shareholders.
The existing tenant acquisitions included At Home, Mac Paper, FedEx and Dollar General properties, all performed exceptionally well during 2020. And this moved FedEx into our top 20. Overall, we’re finding attractive opportunities that fit our underwriting and risk return framework. And as a result, we are raising our 2020 capital deployment guidance by $100 million.
Shifting to the portfolio, the health of our tenant base continues to improve. Our cash collections for the third quarter were 90% and October is at 93%. If you exclude movie theaters, which I’ll discuss in a few minutes, our cash collections were 94% for the third quarter and 98% in October.
It is worth noting, our properties are primarily located in the suburban and rural markets, not in CBDs, which have been more acutely impacted by COVID-19. And our operators are predominantly large and sophisticated. Approximately 85% of our tenants generate annual revenues in excess of $100 million and half for public companies. In addition, we made significant progress on both 2020 and 2021 expirations.
Since the beginning of the year, we have renewed 17 leases expiring in 2020 and excluding one movie theater property. We knew that remaining 16 leases at a recapture of 101% of prior rents. For our 2021 expirations, we renewed 25 leases with a 97% recapture of prior rents, reducing the rent expiring in 2021 from $27 million at the beginning of the year to $18.8 million. We anticipate the remaining 2021 maturities will follow the same trend we have seen thus far, and the percentage expiring will continue to drop each quarter.
There are four industries that I’m constantly asked about casual dining, gyms, entertainment, and movie theaters. So I’d like to take a few moments to update you on how these tenants are performing within our portfolio. Our casual dining concepts are fully open with indoor dining. Our 39 tenants are geographically spread across 32 states with no tenants in California or New York city. While there are many challenged casual dining operators out there, and no doubt many will close, our tenants are doing very well. In fact, we believe our tenants will ultimately be winners and pick up additional market share.
Our 17 gym operators are recovering quickly and seeing tenants and new memberships surpass their expectations. And similar to casual dining, rent collections have improved from 21.8% in the second quarter to 95.1% in October. The only major hurdle we have seen, which are gym operators has been local or state government regulations preventing them from opening in limited cases. When they are open, people are choosing to go to the gym.
Our entertainment assets are a mix of outdoor and indoor venues. A large majority are seeing healthy consumer demand and our financial performance is above target for the units that are fully open and operating. As you can see in the materials we released this afternoon, we experienced a 71.8% increase in cash rent collection in this segment for October. And we remained bullish about the near-term entertainment outlook.
Movie theaters is the only segment within our portfolio that is still being materially impacted by government closures. To continue to shut down of theaters in key markets like New York city and LA has resulted in studios holding back content, with most major releases now pushed back until the spring of 2021. This of course has made it challenging for theaters that are open to attract moviegoers and generate sufficient revenues. To be clear, we do not believe this is a demand issue. We believe people will go back to the movies when content is available, but the key markets need to open and the content needs to be released, which is outside the control of theater operators.
As such, we have structured most of our rent deferral arrangements – agreements with our movie theater tenants as percentage of sales arrangements, giving them time to conserve capital until content begins flowing. I would note that our 5.4% rent exposure in theaters is comprised of 2.7% regional and 2.7% national operators. And we have seen better financial performance from our regional operators this year, primarily driven by more nimble operations and better pre-COVID balance sheets.
On a positive note, we entered into a new lease this quarter with a strong regional operator for the four former Goodrich theaters. The new long-term master lease has a healthy stabilized yield after a period of percentage rent and the operator plans to invest significant capital to modernize these theaters. Similar to our casual dining tenants, the winners in the space will ultimately benefit from gaining market share, and we believe we have winning operators in real estate.
I’ll close up by saying that I’m very optimistic about the future of Spirit and our past back to earnings growth. Over the last six months, we’ve gotten incredibly close to our tenants, further invested in our technology platform. And we have developed a healthy pipeline of opportunities to pursue. These actions, along with raising $1.2 billion of capital, have put us in a great position to execute our plan and set us up for success in 2021. As we move forward, we will continue to execute our strategy of delivering operational excellence, steady and high quality acquisitions with a focus on organic rent growth while maintaining a conservative balance sheet. We believe this approach will result in predictable and steady earnings and dividend growth for years to come.
With that, I’ll pass it off to Mike for his remarks.
Thanks, Jackson. As we’ve done all the year, in addition to our regular reporting materials, we provided an investor presentation that contains incremental detail and disclosures about the health of our portfolio. This presentation is available in the Investor Relations section of our website, and we hope you will find the additional information helpful.
There were a lot of positive developments during the third quarter. We saw 98% of our tenants reopened and continue to ramp up with their operations. Our cash rent collections follow the same trend, currently standing at 93.3% in October with collections of 100% from our top 20 tenants, and 96.5% from public tenants. In addition to improving rent collections, we collected $3.2 million in deferred rent payments, representing 100% that was owned during the quarter. The combination of improving rent and deferral collections increased total cash collections by $21.4 million compared to the second quarter, providing operating cash after dividends of $9.1 million.
The repayment of deferred rent with the weighted average payback period of 13.3 months will provide additional cash flow for the next several quarters, helping to support our cash flow available for acquisitions and dividends. The third quarter also marked a return to grow with ABR increasing $13.7 million to $483.3 million, primarily driven by $15.1 million from acquisitions, slightly offset by accretive dispositions. Our unreimbursed property costs also improved the 2% of rental revenues, inclusive of $840,000 in prior quarter property tax recovery compared to 4.1% in the second quarter.
We also made strides in simplifying our income statement. Our two remaining mortgage loan receivables totaling $29 million were repaid in full. These loans were secured by casual dining and QSR portfolios. And the repayment for the original terms of the loans, speak to the strength and the underlying operators and the recovery of their businesses. We also completed the final separation of our management arrangement with SMTA in September. As a result of these two milestones, our future earnings will be completely driven by rental revenues.
As Jackson discussed, the one area of opportunity within our portfolio continues to be movie theaters. Now, last quarter, I talked to you in length about ASC Topic 842, and the relief provided by the FASBI through new accounting guidance. And one of the key considerations to recognizing deferred rent and revenues is that there is a minimum 75% probability that a tenant would repay the deferred rent as agreed. Given the elongated recovery we forecast for theater operators, we’re now recognizing approximately 70% of our theater revenues on a cash basis. For the 30% of theater revenues, which are being recognized in earnings, approximately 40% are being paid in cash.
Keep in mind that our analysis and decision to recognize theater rents on a cash basis only pertains to the probability of full deferred rent collection, not to the ultimate recovery of the tenant or the industry. We still believe that once theaters have content to provide, it will begin their recovery. And our theaters, which are well located in high quality locations, shall ultimately participate in our recovery, providing a substantial rebound to our earnings. Please note that for all tenants, third quarter rental income was reduced by $7.8 million of write-offs related to prior periods. Of which, $2.9 million were for cash rents and $4.9 million for straight-line rents.
In the meantime, the rest of our portfolio is recovering rapidly. Excluding theaters, our October rent collections, which were provided for on Page 3 of our investor deck are 98% and our reserves excluding theaters are 1%, which is in line with our original 2020 guidance provided in December. This performance really speaks to the quality of our tenants, credit underwriting and real estate.
We were also active in the capital market again this quarter. We issued $450 million in senior unsecured notes due February, 2031 with a coupon of 3.2% and repaid $222 million of our $400 million term loan and repurchased $155 million of the 3.75% convertible notes due May, 2021. We settled 2.8 million shares of open forward equity contracts during the quarter generating net proceeds of $100 million. In October, we settled 2.9 million shares of open forward equity contracts, generating additional $100 million net proceeds.
In addition, during the quarter, we entered into four contracts for 313,000 shares through our ATM program at a weighted average price of $37.06 per share. We currently have $1.1 billion of available liquidity, including cash, undrawn revolver capacity and unsettled forward equity. I mentioned earlier, how we made additional strides in simplifying our income statement, but I’m also pleased with the simplification of our balance sheet.
When we started the transformation of Spirit almost three years ago, we were a BBB- rated issuer with one series of senior unsecured notes outstanding, and only 31.4% of unsecured debt. Today, we were BBB rated, 91% of our debt is unsecured and 77% of our debt spread across five series of unsecured bonds. We believe the simplification both the balance sheet and the income statement is a culmination of several years of work that put Spirit in a great position to focus on growth and opportunity.
As Jackson mentioned, we are finding attractive acquisition opportunities. As a result, we are increasing our acquisition guidance for the year from $600 million to $650 million to $700 million to $750 million and providing disposition guidance of $90 million to $110 million. As we look forward into the fourth quarter in 2021, we believe our portfolio is in great shape with embedded growth opportunities and movie theaters recover, our acquisition pipeline is robust. The compelling opportunities across various industries and asset types then meet our rigorous underwriting criteria and our balance sheet and operating platform leave us well positioned to capitalize on those opportunities.
With that operator, let’s open up the line for questions.
Thank you. [Operator Instructions] Our first question is from Anthony Paolone with JPMorgan. Please proceed.
Okay. Thank you. I guess, my first question for Mike on the accounting side in the quarter. What for AFFO purposes did that $4.9 million in straight-line write-offs, that didn’t impact AFFO? Did it?
Yes. That’s correct. Only the $2.9 million of the cash rent that I’ve mentioned impacted AFFO.
Okay. And that $2.9 million, that takes the movie theaters, I guess, and other items that you mentioned down to sort of that 70% for instance level. Just trying to think about what the roll forward as a run rate?
Yes. I mean, movie theaters – our ABR at $26.2 million and we recognize about 30%, about $2.1 million a quarter in movie theaters of which 40% has been paid in cash for a run rate going forward.
Okay. So the bulk of that $2.9 million is the movie theater piece of it that you’re not recognizing.
Correct. I mean, there was some few other ins-and-outs in there. In total there was about $3.4 million of rent that was reserved from the third quarter. There were some that we reversed – went the other way that were reserved previously that were unreserved if you will. Also keep in mind, I mentioned the property tax. If you think about the impact of AFFO, there was $2.9 million of cash rents to AFFO. There’s also that $800-plus-thousand tax recovery too, that went the other way on AFFO as well.
Okay, got it. And then just more broadly on the deal for aside. It sounds like things are pretty strong. Can you talk about just how broad-based the activity levels are that you’re seeing? And whether this pickup in transactions for you all is some larger trades that seem to be hitting? Or is the market just really bad back to being that fluid.
Hey Tony, this is Jackson. There’s actually quite healthy deal flow out there right now. And it’s really come at a pretty high velocity in the last month and a half, two months. So, in our transaction bucket in the third quarter, we had a larger deal in there and I really want to talk about the shape of the fourth quarter, but obviously we increased our guidance that we’re confident about the transactions that we feel are under control at this point in the fourth quarter. But I would say, it’s quite robust activity.
Okay. Can you maybe break out a little bit of what you’re seeing out there in terms of cap rates among investment grade, non-investment grade or some of the broader categories attendance?
I would sort of say, generally, like if you had an asset that was working during COVID, you’re seeing really competitive interest from buyers and seeing quite significant cap rate compression. If you’ve got assets that were somehow impacted by COVID and they may be normalized or right-sized today, there’s a widening there that there’s a big divergence between those two general groups.
I’d also say that the industrial assets that we’ve been focused on and light manufacturing, that’s been extremely competitive in the last couple of months. And it relates to – so I’d say the range for non-investment grade industrial, we’re still finding high 6’s low 7 cap for the kinds of tenancy that we like with the right real estate. If the credits are even more attractive from an industrial grade standpoint for the same company, industrial assets, you’ll be seeing things that are low 6’s, high 5’s.
On the retail front investment grade cap rates have been pretty aggressive. We haven’t really done that much in that area, but I’d say that’d be in the mid 6’s, low 6’s, depending on the length and duration of the lease, where we’re focused on is once again, we do like some of that non-investment grade those little higher revenue types of businesses. And so there, we’re still seeing attractive yields. They call it a low 7’s, low 7 cap rate area.
Got it. Thanks. And just last one real for me. On the G&A side, it went down a brunch from 2Q to 3Q, I think 2Q was already down a bunch from 1Q. Just where should we think about that definitely out as run rate?
Mike, if you want to…
Yes. We’re probably about $1.3 million light in third quarter from a run rate. And we’d just seen some of that was just timing of certain expenses. Some it was some stuff from last year that didn’t repeat, at least didn’t repeat in this quarter. So again, from a timing standpoint, and there are some savings that we’ve been picking up all year from just less travel, less office expense and things like that. So I would expect that to come up by $1.3 million in the fourth quarter. And then just keeping my first quarter is our heaviest G&A quarter. And if you look at past years, just because, there’s just a lot of expenses, annual audit fees, more employer payroll tax, things like that, that do hit in the first quarter. So that’s always going to be our heaviest. If you think about modeling, you can kind of look back at the cadence from prior quarters’, prior years’ and see that. But yes, we definitely at $1.3 million light in the third quarter. Just a variety of stuff.
Our next question is from Haendel St. Juste with Mizuho Securities. Please proceed.
Good evening. So I wanted ask you guys about the right way to think about capital deployment here going forward? So should we be thinking of the new run rate here is $200 million, $250 million-ish per quarter? And then looking at your remaining availability from the forward looked like there is, I think another $250 million-ish of capital left to go, so $500 million, I think, including some leverage. So just kind of thinking about, what the right way to think about the runway propositions here as near term and then I guess, what role perhaps the equity leverage plays in the funding of next year’s acquisition opportunity? Thank you.
Mike, do you want to take that one?
Yes, I mean, we’re – obviously, in our guidance in acquisitions for this year, we haven’t have given for next year. We’ll see how that plays out. But just from a like a pass year acquisition standpoint, the midpoint of our guides plot for fourth quarter about $285 million. We fund half of that, say with equity $140 million-ish, we’ve drawn down $100 million so far in the fourth quarter, to do that, we draw another $40 million. That leaves us with $80 million, $90 million of equity left, plus we’re doing some dispose in the fourth quarter. And obviously, we have lots of liquidity. So I think we’re – from that standpoint, we’re pretty good through the first quarter. And we will – I think leverage will come down as runs come back. So that gives us some flexibility optionality on where we would need to get back to capital markets. But we’ll see how the acquisition pipeline stacks up. As we continue to see opportunities now really determine how much runway we have with our existing capital. But we always have the ability to flex leverage if we need to. And we’ve been pretty disciplined about when we raise capital, we’ll just continue to do that. And we’ll – from your just pace of acquisitions, we can, if we need to use a little more leverage, we can and we continue to be opportunistic and get disciplined on the capitalization side. I think we’ve got some runway.
Got it. Got it. Thank you for that. And then just looking at your collections here, it looks you have to bought 96%. So I’m just curious after seven months, is this is as good as it’s going to get? How much more upside potential you see there? And then how do we balance or how you think about the risk of the COVID, second wave is here, some of the industry that may be more at a disadvantage. So the opportunity for upside from here, how much better can you get? And you get the 98%, 99%, how much of a role, perhaps, maybe some acquisitions play in that. So as we hit perhaps the next quarter or next spring rate, at a point where we can be in that upper 90% category? Thank you.
Haendel, I’ll start. I mean, I think one way to think about it, and this is why we broke out the portfolio with movie theaters and without. So let’s talk about movie theaters. If you look at our portfolio, excluding movie theaters, in October, we’re collecting 98%. So assuming we close the gap on that last 200 basis points or 2% – sorry, and we get to a 100% there, right? So we’re pretty close. And that’s for a lot of tenancy right in the portfolio. And then let’s talk about the movie theaters, which is a smaller piece, it’s 5.4%. What we think we’ve done and we look at this analysis very carefully and we have nine operators that operate movie theaters for us. The ninth is that managers that’s taken over the Goodrich Theatres.
We believe we’ve reset the rents and the cash collection and the cash recognition at that appropriate level right now, given some of the extended timing of these major release windows. Look, if there’s any type of modest improvement in movie theaters and that’s going to be related to health, right. I think you’ll see a lot of that flow through into our P&L. And on movies, it’s been challenging, right? They’ve been pushing out these release dates for the major tent-pole films. But sure, you look at this, but if you look at what’s going on in China and in Japan where the infection rates for COVID are a lot lower than the Western countries. China during Golden Week, I mean, they have IMAX report a great numbers, not fully recovered, but very, very strong numbers. I think they hit $600 million in U.S. box office receipts over the eight-day period over Golden Week. And remember, that’s basically at 75% seat limitation.
In Japan, they shattered the record for the opening weekend of the Demon Slayer, which is a animated film. And for the first two days in October, October 16 to 18, that film opened at $44 million at the U.S. receipts. And in the 10 days, it’s grossed over $100 million. That’s the best 10 days for a film like that, for as a record, basically in Japan. So now these are all local films that are being distributed. In Finland and Sweden, they’ve also had good recovery for locally distributed films and releases. But then look at what’s happening in France, Germany, UK, they’re now in a four-week shutdown.
So like I guess what I take away from this, as if you’ve got good content, you got decent health. People are going into the centers in the movie theaters. And I believe that bodes well generally for theater venue operators. We just have to kind of see how these infection rates working. And so we felt like we put them down and that’s why we’re segmenting them differently. So people can understand that we’re not a movie theater rate. We have 5.5% of movie theater exposure, but if you looked at the performance, you think we owed a lot more. So hopefully that gives you some idea of how we’re seeing it.
Our next question is from Ki Bin Kim with SunTrust. Please proceed.
Thanks. The rent collection number of 90% and 93.3% for October, did that have any change of denominators from tenants that were already bankrupt? So as maybe as removed the denominator and did any asset acquisitions or dispositions change that number?
Mike, you want to go through that?
Yes. I mean, it’s really that there’ve been changes in ABR even throughout the year. We actually put a good page in our investor deck, probably ever has a chance to look at it. But if you look at Page 7 of the deck, we put out this afternoon, we did a walk maybe, our walk to address this specific question, because I know, it’s been a source of confusion, but a lot of companies. Maybe, every walk ABR from Q1, pre-COVID to current and we actually, I think show exactly what you’re asking. We show, okay, here’s our starting ABR. Here’s how it’s increased from acquisitions, lease escalators – here’s how it’s been reduced by bankruptcy, dispositions and restructurings as well as vacancies. And it was in that chart on Page 7, we also broke out in the bankruptcies. We show how much of its movie theaters, which is the largest lion’s share in the bankruptcy section, also in the restructuring. The lion’s share is moving as well. So, you can really see that.
And so yes, the denominators changed, our ABR was $476.4 million; before COVID, it’s currently $43.3 million, which is what all our rent collection is based on today. But as far as disclosure, right, I don’t think we’re hiding the ball. I think we’re definitely trying to make sure people are aware of how our ABR has changed and when we remove something from ABR means that leads to either, has been restructured and changed, where it’s gone in the case of bankruptcy that at least no longer exists. So, it comes out of our universe. But we do not reduce our ABR. We do not reduce it nominator for abatements or rent deferrals and things of that nature. Only if a tenant’s gone and lease has actually gone or has been permanently restructured or obviously sold. So, that’s what we show on Page 7. You’ll find that helpful.
Okay. This one, I clarify one thing. So on this Page 7, you show 1.8% loss due to bankruptcy and then 50 basis points loss due to reductions and/or modifications, how you call it. So call that 2.3%. Is that on top of the 5%, right off or nearby, you took this quarter and combining that 2.8% plus 2.2%?
No, no. When we talk about reserves, reserves are for leases that are in place. So, our reserves in the third quarter in total were 5.9% and those reserves are rent that we should have gotten in either in our ABR, but we didn’t get that. So, that’s how we think about reserves. Different from when it lease actually goes away, right. So, if you’re looking at our deck, if you’re looking at the pie – the pie charts, we’re looking at are actually for October, which is October reserve for 5%. We look at that again, those are all – those are our leases that are in place should be being paid on. And so we’re reserving that rent, that’s different than when a lease actually goes away, it comes out of our ABR universe.
Okay. So, I want to move that to make pre-COVID a perspective. So for October, it’s 5% reserve, right?
That’s right.
So, if I try to look at this performance, pre-COVID for today is the right way to think about it, 5% reserve plus the 1.8% bankruptcy and then 50 basis points for other modification. Is that the right way to look at it?
Yes. I mean, there’s definitely one way to look at it. We think about how much rent is currently not here. Obviously, the 5% reserve is hopefully something that we will get back over time. The stuff we’re showing on Page 7, where something went bankrupt and it’s gone well, obviously never come back. So, that would be the difference.
Okay. Thank you, guys.
Yes.
Our next question is from Nate Crossett from Berenberg. Please proceed.
Hi, good evening, guys. I appreciate the comments on the pipeline. I’m just curious in the higher velocity, because of the election and maybe, some potential fact changes or is it more an unthought of Q2? And I’m just curious for your perspective, if we go back into a lockdown, what the impact would potentially be on the pipeline?
Well, let me – I’ll start with, if we go into a lockdown, how that impacts pipeline. We were the beneficiary of the third quarter of picking up deals when we had not been the highest offer on those assets at that time, they had sort of find up with more aggressive pricing. And let’s just say, we picked them up at more attractive cap rates from our standpoint, 25 bps roughly, right? If we get another kind of air pocket, I don’t believe that’s going to change our strategy, because I think what we learned is we’re going to kind of – we’ll pause and weight, potentially be opportunistic, but we’re going to stick to moving forward with our pipeline.
There was some motivation for some issuers that were – that we were negotiating with to try to get things done before the election and we’re seeing some of that in our fourth quarter pipeline. But for the most part we – we’re a long-term investor. We want to – we believe we have a really high quality portfolio here. Hopefully, the numbers prove that out. We are dealing with movie theaters, which are 5.4%. But those will kind of sort themselves out some point hopefully sooner than later, but we have a – we had – if you recall our Investor Day back in 2019, we basically sold showed you guys, we had a – we have a high-quality real estate portfolio, high-quality tenancy, which is, 98% rent collections in October, right.
We laid out a very specific investment strategy. We are moving forward on that. If you just take out – took out the second quarter, look at the totality of what’s going to happen this year, probably say, wow, that’s pretty good and we’re really actually starting to work on the first quarter already for next year. So that’s kind of the plan. Obviously, if there’s a major pullback in the markets, we’ll obviously re-evaluate. but right now, we feel very comfortable with what we’re doing feels very manageable.
Okay. And that’s helpful. I’m just curious, what’s your guys’ appetite to add to casual dining exposure here. I appreciate the anecdote in your prepared remarks. So, I’m just curious that if we went back into a lockdown, is that tended in a much better position to pay if their stores were closed?
Well, it depends on what the – and this is like trying to forecast what a lockdown would look like, right. I think people have a – I think we have a better understanding of how the disease spreads that wasn’t maybe, the case back in April, and there was all kinds of pressure on PP&E, PPPs.
So today, just to pick casual dining, our operators are bigger, there’s either national or super-regionals. they have really made significant changes to their operating strategy. Now, they produce their menus. They are working on better efficient, online delivery and service look, the third-party delivery venues. They’re really good. They work, door dash and things like that, but they cost these guys quite a bit of profitability.
Municipalities are being much more flexible on pop-up drive-throughs. So, people are being very creative, those that have the ability to kind of manage through this. And what was interesting about that one operator we talked about, they are going to start moving on offense, not right away, but certainly, we will evaluate very carefully with them if they see opportunity. But I would say probably for us on casual dining, I wouldn’t expect us to do much this calendar year, but I could see maybe, potentially next year that could be an opportunity for us.
Okay. Thank you.
Our next question is from Linda Tsai with Jefferies. please proceed.
Hi. Thanks. I was just wondering, in what ways might your underwriting criteria have changed has pass since COVID.
so Linda, I mean, I would say first of all, our credit underwriting has not changed. Obviously, we were fundamental when doing – fundamental credit analysis is obviously quite significant, analyzing real estate, the rankings are significant. And the one thing that we have made changes to is our heat map. And if you go to that page, we have, we have added – if you look on the top portion on technological distribution, we’ve added the historical and forecast supply and demand impacts into the calculus on that horizontal axis and on the vertical access, we – on the Porter’s Five, we introduced this concept of essential services impact to the waiting. So that’s just more about kind of top line, how we think about the portfolio, but when it gets down to the nuts and bolts of credit analysis, do they have liquidity? If it’s a public company, private company, how resistance would they be?
Did they defer rent during COVID? Obviously, those are all questions that we answer. We ask ourselves. I mean, I would look at just – if you think about the two deals that we did, one of the bigger ones we mentioned, like the Shutterfly facility, I mean, a company is a very large company. It was taken private by Apollo. And if you looked at, off-lease, that’s also from a revenue standpoint, multibillion dollar revenue operation, big company, and it’s really great business model.
So, we’re looking for things that are large, sophisticated, obviously, that’s not – those are not experiential types of operations and they’re seeing their business improve. but I would say that, in the – in our heat map, we’ve made some changes and look, we’re continuing to evaluate what we’ve learned out of COVID, we have a robust credit and research function here, and we’ve been evaluating this and having this discussion internally for the past several months actually, COVID is going on. So, this is pretty much the net effect of all that you can see on page 12 of our deck.
Thanks. And then are you requiring any extra guarantees such as higher security deposits?
In some cases, we have actually asked for security deposits, I wouldn’t say for all businesses, but if there was a business that had a disruption, because of COVID, that’s something – and rent was deferred and we believe that the opportunity makes sense or we’re evaluating it. We’re structuring – we’ve structured some of those transactions with a REM reserve escrow.
Got it. Just one last one. Could you talk about your year-to-date disposition activity? What type of tenants were you selling out of this year? And then to what extent, would you expect dispositions to ramp in 2021?
I’ll let maybe, Ken give a little flavor on that. Maybe, Ken, if you want to take that on?
I’d say this year was a little different than what we’ve historically done. Earlier in the year, we specifically targeted a small number, a small bucket, some grocery stores and drug stores that we went to market with. And we – the reality is we executed quicker and at lower cap rates than we initially expected. The one thing I would say about our dispositions thus far, we’ve been able to take advantage of great cap rates in those two spaces; while at the same time, we chose assets that had a few risk characteristics that we thought it made a lot of sense to go ahead and exit now, given the low cap rates. As far as 2021 know, it’s the expectation would be it’s more back to a regular disposition program, more portfolio shaping.
just to follow-up on that, when you talk about a risk characteristic, is that in terms of just like a lease coming up for renewal or is it bankruptcy?
No, no. I would say it was more, more about if we felt like a particular property was over rented. Maybe, it’s a tenant that is not investment grade and that for long-term, we’d prefer given the window, we had to go ahead and exit a property, so that that’s some of the characteristics we looked at.
Our next question is from John Massocca with Ladenburg Thalman. Please proceed.
Good evening.
Hey, John.
Yes. So, you talked a little bit about casual dining and maybe, not doing too many more investments in that space, at least near-term. Does it look at some of the other categories that you mentioned that were kind of impacted, but ever covered? Are those all probably out of the question in terms of near-term acquisition activity, or is there maybe some opportunity there given it be a bit of a differentiated investment thesis?
Well, I mean like the easy ones are obviously the things that we’re doing car washes, distribution, the dollar stores, home decor at services, sporting goods, those are all things that are right in our wheelhouse right now. I mean, look entertainment, the performance within some of our operators within entertainment, pretty interesting, pretty positive. And so that might be an area that we’ll evaluate in the more near-term potentially, may not be that obvious to people, but there’s people are in those venues now.
Obviously, I think if we thought about those, they would have to have some form of a rent reserve in place for us, movie theaters, John, I don’t think we’re going to be doing movie theaters for awhile. We’ll see how this plays out with our existing investment. And then I mentioned casual dining. look on gyms, that’s another area. Gyms for us, our experience has been better than expected and there are some high-volume, low-price operators that are pretty interesting right now. We’re looking at some opportunities right now. But people are definitely going back into the gym. You have to be very selective with the operator in terms of value thesis and credit and things like that. But that’s another industry group that you could see us doing more potentially in the near-term.
Okay. And then I have a question on thesis a little bit. If you look at Page 6 of the presentation, of that kind of 13.6% of kind of deferred accounts receivable that is kind of net of reserves. How has the split of that maybe between the big three operators and some of the more regional operators? And then specifically essentially, I just want to say the studio movie grill, and rent there are any receivables there all fully net of a – reserved again, is that a fair statement, you’re going to assume?
Yes. We’re not going to get too far in the wheels on individual tenants. I mean, obviously, maybe if assumed it’s reserved. And what you’re looking at in the bottom chart net of reserves. So that’s what’s actually on our balance sheet, right, net of reserves. So we have $2.8 million of theater revenues of deferred rent receivables, our balance sheet at the end of Q3 that are end receivables, right, that are net of those reserves. So that is still we feel those are the tenants that we are not recognizing on a cash basis. So it’s the other piece that we reserved for.
So when we think about our AVR $26.2 million of theater revenues, 70% have been reserved for. So it’s a lot of tenants, and I’ll let you guys make assumptions onto what they are. But, we did obviously tenant-by-tenant analysis and the tenants that we did not reserve for, we feel have strong balance sheets nimble operations. They can weather the elongated recovery expect theaters to have to deal with. And again, 40% of the theater revenue that we are recognizing is actually being paid in cash, right? So the $2.1 million per quarter, and early on $1.4 million-ish that’s non-cash in there. So we feel good about that. But we don’t want to get into naming specific tenants on these reserve, but you could obviously assume studio movie grill is one of the ones we’ve reserved for.
Okay. And then one last detail question, property operating costs came down pretty deeply quarter-over-quarter. And I was just wondering why that was – sorry, I missed that in the prepared remarks, if that was already explained.
Yes. It came down from 4.1% the cost leakage, the 2%, it would be about 2.7% normalized. We did have a little over 800,000 of property tax recoveries, coming in from the prior quarter. And then we recognized in this quarter, so if you net that out, it’d be 2.7% still, obviously a big improvement, compared to last quarter. And that’s just a function of tenants doing better, less tenants kind of in the workout bucket. And so we don’t have – and they’re paying the taxes. So it’s tenants getting current on their taxes, tenants paying rent, it tends to I mean we’re arguing with fighting with whatever reaching deferral agreements and getting a good stand, that’s just simply the result of that.
Our next question is from Brent Dilts with UBS. Please proceed.
Hey guys. I have a couple of questions around the election, since we’ve already done some pretty deep digging elsewhere. The first is what key changes to your business do you expect under each administration? And the second, if we get a blue sweep, how do you think that might impact the 1031 market, given it’s an area that was included in the Biden camp’s high-level tax plan?
Beginning at forecast the elections, but 1031 is an easier one, it doesn’t really impact our strategy. And we’re selectively selling assets, many times we will sell assets into that particular market, but the thing about 1030 ones is it’s made a lot of things that we want to buy non-competitive. Maybe if you think about our business model, we’re really a long-term investor, we’re not a churner of assets in this business model.
So if there were changes to 1031 market, I could see that giving us more opportunity to increase our QSR portfolio be more competitive on C stores of where today it’s not – it doesn’t really work for – sort of for our kind of cost of capital and business strategy, at least on the QSR side, the stuff that the – at 1031 buyers are chasing after. And in terms of where our portfolio is positioned, like if you look at the distribution map of our assets, they tend to be in the lower Sunbelt areas of the country. Most of our assets are in very suburban kind of marketplaces. So when there is blue or red, I mean, the big takeaway is these operators have been able to get a deal with the first onslaught of sort of these challenges. If they have to go back again, they’ve made adjustments. The world didn’t fall – the sky didn’t fall for us on our head.
So I believe that they’ll manage through it. And like I said, we actually have talked about that internally about how that might impact us, but generally I think what we can say is, it’s really more local municipalities that have more stroke over where the things are open or closed versus at the State level. And so far we’ve been positively surprised with the recovery pace of our portfolio and just – it’s really the entrepreneurialism of our operators, I mean just very impressive. And so I think if there is another setback, we’ll get through with those operators, just like we did the first time.
Okay, great. That’s it for me. Thanks guys.
And we have one follow-up question from Ki Bin Kim. Please proceed.
Thanks. So we’ve at the result of COVID and how it’s created some winners and losers in retail. Have you thought about maybe taking advantage of the winners in COVID, which may not be winners forever, I’m thinking about tenants like assure retailers or home décor, weren’t particularly doing well pre-COVID, did well during COVID. I’m just curious if you think this is more of a opportunity to sell some of these assets.
I don’t know Ki Bin. I don’t think we would necessarily sell. I mean, we like – could use a good example, like on home decor at home, we liked it before COVID, we liked it at our Investor Day. What COVID has done is just enable to accelerate their success and market share, and they’ve been able to make more investment in their omni-channel and membership members part of their business to help them on the sales side. So, I mean, look, we’re not real flippers. I mean, I think we have a very deliberate strategy, if you go to our heat map, we’re going to stay on that middle to upper right quadrant of that field of industries, focus on good real estate, focus on good operators, focus on good rent. So rent to – rent per square foot kind of relationships and build duration and steadiness, like, portfolio, that’s really kind of like a game plan.
And look, there are opportunities to buy things in distress right now, but that’s not really our business model. We’re really trying to kind of create more steady cash flow growth and look, the movie theater part is, there is something that is going to take a little bit more time, just given their release schedules.
Got it. Thank you.
We have reached the end of our question-and-answer session. I would like to turn the conference back over to Jackson for closing remarks.
Well, first of all, I’d like to thank our associates here at Spirit, who’ve had to deal with all the number of different challenges that COVID has brought not just to our operations, but to our tenants operations, so a big shout out to them. I’d like to thank everyone for participating on our call this late afternoon. And just to let you all know that we’re in great position right now to execute our business strategy. The one that we laid out in our Investor Day presentation back in December of 2019, and I can tell you where myself and the board were extremely excited here at the company and we look forward to moving forward. Thanks.
This concludes today’s conference. You may disconnect your lines at this time and thank you for your participation.