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Earnings Call Analysis
Q2-2024 Analysis
Broadstone Net Lease Inc
Broadstone Net Lease reported a robust second quarter for 2024, indicating strong execution on its strategic objectives. The company is nearing the completion of its healthcare portfolio simplification strategy, having successfully redeployed proceeds from the sale of 38 assets for $262 million into new investments worth $217.3 million early in the quarter. This transition has proven effective, as the stock is now trading at an 18-month high, suggesting investor appreciation for the company’s operational strategy.
For the quarter, Broadstone Net Lease generated Adjusted Funds From Operations (AFFO) of $70 million, translating to $0.36 per share—an increase of 2.9% year-over-year. This increase is primarily attributed to lower interest expenses despite moderate lease revenue declines due to the ongoing healthcare simplification efforts. Furthermore, the company reiterated its AFFO guidance for 2024, maintaining a range of $1.41 to $1.43 per share.
Broadstone continues to exhibit a solid investment pipeline, with a total of $408.6 million under control, including $307 million earmarked for new build-to-suit investments. These investments focus on essential sectors, particularly in food distribution and manufacturing, which are projected to yield impressive cash returns in the mid-7% to low-8% range, ultimately translating into straight-line yields above 9%. The management anticipates the phased commencement of rents during 2025 and 2026 as these projects come online.
The company remains vigilant regarding potential credit risks, particularly in consumer-centric industries, as high interest rates impact tenant performance. Nevertheless, Broadstone maintains an impressive rent collection rate of 99.8% for the quarter, reflecting the overall strength of its diversified portfolio. The management has a consistent watch list to monitor high-risk tenants, reinforcing their proactive approach to tenant management.
Broadstone is committed to further reducing its healthcare exposure, with expectations to drop to approximately 11% of its total Annualized Base Rent (ABR) by the end of 2024. The remaining dispositions will follow standard asset management practices, which the company anticipates may extend into 2025, ensuring optimal value extraction from its holdings.
The Board of Directors has sustained a dividend of $0.29 per common share, payable to holders by mid-October 2024. Given the company’s successful redeployment efforts, this dividend is well-covered, offering an attractive yield compared to current market conditions. This consistency represents Broadstone's commitment to delivering shareholder value while navigating through strategic changes.
Looking ahead, Broadstone's management expresses cautious optimism regarding the commercial real estate landscape, highlighting an anticipated increase in acquisition volume as interest rates stabilize. The company’s leverage remains reasonable at 4.9x, affording it the flexibility to capitalize on future opportunities while efficiently balancing its capital allocation strategies. The next quarters will be critical as Broadstone strives for continued sustainable growth and enhanced shareholder returns.
Hello, and welcome to Broadstone Net Lease Second Quarter 2024 Earnings Conference Call. My name is Kiki, and I will be your operator today. Please note that today's call is being recorded.
I will now turn the call over to Brent Maedl, Director of Corporate Finance and Investor Relations at Broadstone. Please go ahead.
Thank you, everyone, for joining us today for Broadstone Net Lease's second quarter 2024 earnings call. On today's call, you will hear prepared remarks from Chief Executive Officer, John Moragne; President and Chief Operating Officer, Ryan Albano; and Chief Financial Officer, Kevin Fennell. All 3 will be available for the Q&A portion of this call.
As a reminder, the following discussion and answers to your questions contain forward-looking statements, which are subject to risks and uncertainties that can cause actual results to differ materially due to a variety of factors. We caution you not to place undue reliance on these forward-looking statements and refer you to our SEC filings, including our Form 10-K for the year ended December 31, 2023, for a more detailed discussion of the risk factors that may cause such differences. Any forward-looking statements provided during this conference call are only made as of the date of this call.
With that, I'll turn the call over to John.
Thank you, Brent, and good morning, everyone. I am pleased to report another strong quarter of results. We are on the cusp of substantially completing our healthcare portfolio simplification strategy, having fully redeployed those proceeds into closed and committed investments, and are continuing to build a strong pipeline focused on our core building blocks of growth, seeing incremental revenue generating capital expenditures with our existing tenants and build-to-suit funding opportunities with our development partners that supplement our traditional net lease acquisition pipeline. I am exceptionally proud that we were able to successfully navigate that process. At the same time, we redeployed the proceeds into attractive investment opportunities.
We are incredibly proud of the progress we've made on our strategic objectives for 2024. While we recognize that the current outlook for interest rates has provided a tailwind for the broader net lease space, we believe investors are beginning to reward our consistent and successful execution on our strategic initiatives. Our shares are now trading at or around an 18-month high, and we believe there is still plenty of room for continued multiple expansion as we fulfill our growth objectives.
As we've previously reported and discussed on last quarter's call, the majority of the $217.3 million of cash flowing investments we made in Q2 were closed early in the quarter and sourced through direct relationships. Throughout the quarter, we continued to creatively source investment opportunities that fit within our buy box, notably including build-to-suit and forward commitments through existing relationships. We believe these opportunities are an important part of our core building blocks and a key differentiator in our mission to drive long-term sustainable growth.
As we move into the back half of the year, we are maintaining our AFFO guidance range of $1.41 to $1.43 per share and slightly adjusting our investment disposition and cash G&A ranges. Starting this year with a view that a neutral AFFO per share result might be our best-case scenario as a result of our decision to strategically exit clinical healthcare, I am pleased that our execution this year will result in modest growth for 2024, and more importantly, will set us up well for 2025 and 2026.
Before I walk you through details on our growing investment pipeline, which now encompasses nearly $408.6 million of new investments under control and commitments to fund developments, I would like to further highlight the significant progress we've achieved this year on our clinical healthcare simplification strategy.
Our team executed decisively early in the first quarter and through the first half of the year, completing the sale of 38 assets for $262 million. This momentum continued early in the third quarter, with a third-party buyer completing due diligence on 15 additional assets, closing on 5 of them in early July with the remaining 10 assets scheduled to close in October. These successful transactions will bring our total clinical healthcare dispositions to $342.5 million year-to-date at a weighted average cash cap rate of 7.9%.
Combined with our redeployment efforts and incremental investment activity, we anticipate this will reduce our healthcare exposure to approximately 11% of our total ABR at the end of 2024. While we continue to engage in negotiations and marketing for our remaining clinically oriented healthcare assets, we anticipate these sales will follow a more typical asset management approach and take time to achieve optimal disposition outcomes.
With a substantial majority of our clinical healthcare simplification strategy successfully behind us, I'm excited to look ahead and walk you through our evolving investment pipeline that we announced last night, including a number of highly compelling build-to-suit transactions we have been pursuing as part of our overall mission to drive long-term sustainable growth.
Of the $408.6 million in investments under control and commitments to fund developments, approximately $307 million are brand new specialized industrial and QSR build-to-suit assets, including food distribution, cold storage, and manufacturing properties delivering in 2025 and 2026. These investments represent unique opportunities for us to capture higher going in cash cap rates and straight-line yields compared to much of the regular way product that we are seeing in the traditional acquisition market.
We are achieving these attractive yields not because we are running up the risk spectrum, but because we are creatively sourcing and structuring investment opportunities with our developer partners. Once construction is completed and these assets are stabilized, we believe they would trade up to 150 basis points to 200 basis points tighter than where we executed. We are not only generating attractive yields on high-quality build-to-suits, we are also creating long-term value and NAV accretion. Ryan will go into more detail on some of the specifics around our current pipeline and opportunity set.
We view these development opportunities as an increasingly important part of our core building blocks to sustainable long-term growth, which include best-in-class fixed rent escalations, revenue-generating CapEx investments in our existing tenants and assets, development funding opportunities, and traditional external acquisitions.
While the commercial real estate and lending environment has certainly played a role in generating these opportunities, we believe there's a long-term role for Broadstone Net Lease as the funding partner of choice for our development partners, even when interest rates eventually decline. The regular way transaction market is beginning to show increased activity as we get into the back half of the year, though absolute levels remain compressed and much of what we are seeing continues to price at levels we believe misrepresent the underlying risks.
We remain highly selective and are excited about the $69.3 million of investments we have under control and expect to close in the third quarter. The combination of our building blocks will naturally vary based on market conditions, as is the case today with more muted volumes for traditional sale-leaseback and assumption deals. Our ability to rely on more than one investment channel and allocate capital to the areas where we see the best risk-adjusted return opportunities provides a compelling path to near and medium-term value creation and earnings growth.
Turning to our portfolio through dispositions and ongoing investment opportunities, our portfolio composition is becoming gradually more weighted towards our industrial and defensive retail and restaurant sectors. These assets continued to perform well during the quarter as evidenced by 99.8% rent collections excluding Green Valley and 99.3% occupancy as of June 30, 2024.
While our overall operating results remain strong, we are seeing incremental pockets of credit risk as the broader impact from the duration of higher interest rates appears to be having an effect on consumer-centric industries and entities with less flexible capital structures. We remain vigilant in our tenant monitoring efforts and maintain great confidence in our portfolio due to its diversified construction, which limits the impact of any potential individual credit event and our proven ability to manage through any such situation that may arise.
With that, I'll turn the call over to Ryan, who will provide additional details on our transaction efforts, our building blocks for growth, and portfolio updates.
Thanks, John, and thank you all for joining us today. Before turning to routine portfolio updates, we wanted to expand on our growing pipeline of built-to-suit opportunities. As John mentioned, we have currently committed to fund 7 opportunities for a total estimated cost to build of approximately $307 million. While still subject to final structuring and relevant permitting approvals, we anticipate funding of these developments will have varying construction start dates through the end of 2024, anticipate rent commencement dates that will be phased in over the period of Q1 2025 and Q2 of 2026.
Outside of these 7 opportunities, there are more than $400 million of additional build-to-suit investments that we are actively evaluating as we balance this robust pipeline alongside other traditional acquisition activity. These opportunities typically represent initial cash yields in the mid-7s to low-8s and taken together with long lease terms and rent escalations between 2% and 4%, translate into straight-line yields north of 9%. We believe these built-to-suit investment opportunities are highly compelling, with newly constructed buildings, typically well-located assets, and strong tenant credit with yields that are superior to most of the regular way transactions that we have evaluated since the interest rate hiking cycle began.
Now turning our attention back to routine updates. As John mentioned, during the first half of the year, we were able to execute on key pieces of our healthcare portfolio simplification strategy through the completion of a portfolio sale during the first quarter comprised of 37 assets for $251.7 million at a 7.9% cap rate. Further, shortly after the quarter, we sold the first tranche of a 2-phase 15 properties healthcare portfolio for just inside an 8% cap rate. And the next tranche is scheduled to close in early October.
As we step through this disposition effort and begin focusing on the remaining properties identified, we anticipate various transaction timelines that comfortably extend into 2025, given the need to address some combination of shorter lease duration, space utilization rates, and elevated credit risk. As we have communicated in the past, we are intently focused on the tactical execution of our healthcare property sales and maximizing value for our shareholders. In addition to executing the portfolio sale during the second quarter, we sold 3 other properties on an individual basis, including 1 healthcare property, 1 industrial property and 1 small vacant office property for $24.4 million, representing a 7.3% cap rate on tenanted properties.
Alongside our disposition efforts, we executed on a strong set of investment opportunities, closing $247.8 million of investments. This investment activity included $165.1 million of acquisitions with a corresponding cap rate of 7.3%, an additional $30.5 million of funding associated with our UNFI build-to-suit investment, and $52.2 million related to the previously discussed transitional capital.
As part of our investment activity during the quarter, we are excited to add Jelly Belly Candy Company, a newly acquired subsidiary of Ferrara Candy Company, to our top 20 tenant roster. As a quick update on our UNFI build-to-suit investment, we have funded approximately $161.3 million through June 30th, and the project remains on track for delivery and rent commencement no later than October of this year.
As we look towards the earlier stages of our investment pipeline, we continue to source opportunities across all of our core building blocks and generally favor investments where we can provide a holistic capital solution where price is not the sole variable of importance to the seller, as evidenced by our transitional capital investment and our growing pipeline of built-to-suit investments.
Now, I'll briefly shift our focus towards the strength of our in-place portfolio. As we progress through the second quarter, trends remain largely unchanged. Our high degree of rent collections for the quarter continue to provide confidence in the overall strength of our portfolio. While we remain confident that our portfolio will continue to deliver strong performance and generate durable and predictable cash flows, we remain cautious of the macroeconomic backdrop, which includes continued caution on industries that are sensitive to discretionary consumer spending. Our watch list has remained fairly consistent so far this year and consumer-centric tenants, as well as some of our remaining clinically-oriented healthcare properties remain in focus.
As we've highlighted in previous quarters, Red Lobster, which represents 1.6% of ABR remains on our watch list. As reported in recent headlines, the company appears to be heading towards a resolution of its Chapter 11 proceedings in the second half of the year. Our 18 master lease properties remain open and we continue to work towards a resolution alongside the proceedings and will provide updates as available.
With recurring negative headlines related to the home furnishing space, we continue to monitor the sector, specifically including our tenant at home, which represents approximately 1% of ABR. We own a distribution center in Plano, Texas and a strong retail site in Raleigh, North Carolina, both of which we expect would be assumed through any potential reorganization event. Further, both sites are well located in strong markets and we believe they would garner significant interest from alternative users if we were ever to get them back.
Lastly, we only had 3 vacant properties as of June 30th, including 2 for which we were actively negotiating leases with new tenants. We anticipate these leases to commence and begin paying rent late this year or early next year, resulting in minimal downtime at the properties.
In summary, while the broader market environment for regular way net lease acquisitions that align with our targeted investment criteria remains challenging, we continue to demonstrate our differentiated approach to capital allocation, focusing on the pursuit and execution of investments that enhance the value of our highly diversified portfolio, while simultaneously employing an active portfolio management strategy to drive strong operating performance.
With that, I'll turn the call over to Kevin for him to provide an update on our financial results for the quarter.
Thank you, Ryan. During the quarter, we generated AFFO of $70 million or $0.36 per share, an increase of 2.9% in per share results year-over-year. Results were largely driven by lower interest expense and partially offset by lower lease revenues, both as a result of our healthcare simplification strategy.
As John and Ryan mentioned, our portfolio continues to show resiliency, realizing 33 basis points of bad debt year-to-date, excluding Green Valley. Cash G&A continues to be well controlled, incurring $7.8 million during the quarter, or a 1.4% decrease year-over-year. As a result, we are lowering our G&A guidance from $32 million to $34 million to $31.5 million to $33.5 million.
Once again, we ended the quarter in a strong and flexible financial position with leverage of 5.1x net debt, up slightly from 4.8x at the end of the first quarter. Our net debt on a pro forma basis for our UNFI build-to-suit was 4.9x, which, combined with approximately $920 million of revolver availability gives us ample capacity as we evaluate incremental investment opportunities.
To reduce rate uncertainty through 2025 and mitigate some of our near-term rolling swap maturities, we executed $460 million in forward-starting SOFR swaps during the quarter. These new swaps are scheduled and are supplemental and begin in March of next year with maturity spread across 2030, locking in a weighted average SOFR rate of 3.7%.
At our quarterly meeting, our Board of Directors maintained our $0.29 dividend per common share in OP unit, payable to holders of record as of September 30, 2024, on or before October 15, 2024. Given our successful redeployment efforts, our dividend remains well covered and still represents an attractive relative yield in this market environment.
Lastly, we are reaffirming our AFFO guidance range of $1.41 to $1.43 per share. In addition to the cash G&A reduction I previously mentioned, we are raising the low end of investment guidance from $350 million to $400 million, and tightening our dispositions range to $350 million to $450 million. Please reference last night's earnings release for additional details.
And with that, we will now open the call for questions.
[Operator Instructions] The first question is from Eric Borden from BMO Capital Markets.
John, you've certainly made some solid progress sourcing a number of investments through multiple investment verticals. Just curious, not asking for guidance here, but how does the next 12 months play out for you in terms of the mix of development opportunities, pure-play acquisitions, and any other things that may be developing in the pipeline?
Yes. Thanks, Eric. So it's a balance here. With the $307 million in the 7 development deals that we have in the active pipeline, plus another $400 million or so in that active prospect bucket. We've got a lot of really great opportunities in the development build-to-suit that we're very excited about. As one of the core building blocks that we have for providing sustainable growth, we're very excited that we're laddering into this development process and the way that we had planned and have talked about with investors starting earlier this year.
So the strategy is playing out well, but there's still a balance. We've got $69.3 million of regular-way acquisitions in the pipeline today. We still continue to be a little disappointed in the volumes that are out there, as well as what we're seeing in terms of the quality of the product and where pricing is landing. But if you've got a view towards having a little bit of relief on the interest rate side, depending on how the Fed meeting goes today and over the course of the next 3 months to 12 months or so, I think you start to see a little bit more regular way acquisition volume.
The great thing with where we sit today from a balance sheet standpoint is that we're at 4.9% on a pro forma basis. We have evaluated where we would land over the course of that development pipeline, and we stay comfortably below 6% throughout it. And we've got ample liquidity, as well as ample room to be able to do regular way acquisitions. So our goal is to be able to balance those things together and give the type of attractive growth that we know our shareholders are expecting.
I appreciate that. And then on the capital allocation side, just with shares up 23% over the last 3 months, has your thoughts on capital outlay changed? Are you willing to issue equity here today? Or will the majority of future investments be funded via the capital recycling program and potentially on a leverage neutral basis?
Yes. So the equity is certainly more constructive today than it was 3 months ago. That being said, we don't need any right now. We've got ample liquidity. Our leverage is well south of where we are looking to operate on a sustained basis. We've got pretty great availability on our revolver today. We've also been very successful in the last 18 months, 24 months on capital recycling, between the $200 million we did last year at a 6 cap in the clinical healthcare assets that we've been selling this year, as well as a handful of things that we've identified that we'd be able to sell if we needed to.
We're very comfortable continuing to fund our growth through recycling and through dispositions if the cost of capital that we're looking at in the equity and debt markets isn't attractive to us. So opportunity set, of course, plays a role in this as well. And we'll balance all those things together, but certainly more constructive, but not where we want it to be. And it's something that we don't need right now either.
I appreciate that. And last one for me, just on the new development opportunities. Ryan, sorry if I missed this, but did you say the cash yields you're targeting are in the mid-7s, up into the low-8s?
Yes. So if you're looking at the development opportunities, right now we've got upfront cash yields in the mid-7s. And then when you straight line it over the term of the lease that we're looking at, you're in that mid-8, sometimes low-9s. So very attractive relative to what we're seeing in the regular way space, which is still sort of settling in that low-7s on an upfront cash yield basis getting into the 8s on a straight line.
The next question is from Upal Rana from KeyBanc Capital Markets.
You mentioned the development funding commitments of $339 million. Any additional color you can provide on those commitments?
Yes. So we've got -- UNFI is part of that. We got about maybe another $32 million on UNFI. We're very excited about the progress there. Looking for that to come online, late Q3, rent commencement no later than mid-October. We've got about $32 million or so left, but the project, we're expecting to come in slightly under budget and slightly ahead of schedule. So that feels really good.
Of the $307 million in the build-to-suits for new ones, there's 7 different opportunities that range from things as small as $2 million in the QSR space to as large as $170 million in distribution and manufacturing spaces. These are all from new and existing development relationships. So we're expanding the roster of folks that we're working with and we feel really good about the active prospects that we have, as Ryan mentioned, with another $400 million or so that we're actively evaluating.
That was helpful. And then in terms of the healthcare simplification strategy, so it looks like you complete about 65%. On the remaining 35%, are those the one-offs that you had mentioned in prior calls that will take some time to kind of get off your portfolio?
Yes. Those are all the onesie-twosies that we'll work through in a traditional asset management approach. There are some in there that have great value that we're just making sure that we're getting the right value out of, and there's a handful that will require maybe a lease extension, some tenant improvement, some work on our end to make sure that we can get the right value out of those. So the timeline on those will comfortably extend into 2025.
Okay, got it. And then lastly, on maybe cap rates here, it seems like maybe, what do you think 3Q kind of trends from here and any early indication on where maybe 4Q might be headed?
Yes. I mean, we've seen cap rates sort of plateau this year on -- if you look at like sort of mid-market industrial, that's been really hot this year, as hot as we saw it in 2022. You're getting 20 [ bids ] on any particular acquisition that's out there. You're starting to see those creep down past the low-7s into the high-6s. We're still solidly in the 7s as we think about capital allocation. So we're looking for the right opportunity.
As you heard Ryan say in his remarks, we're continuing to be very disciplined and focused on where we're looking to allocate the capital. And if we're not seeing it in regular way deals, we're very fortunate to have multiple channels that we can allocate capital to with the build-to-suits where we're getting those mid-7 upfront cash rates and those cash cap rates, and then the straight line yields in the mid-8s to low-9s.
So our expectation is back half of the year, you're going to start to see some more product come online as there's a little bit more certainty around the interest rates. And hopefully, we'll see a more constructive environment in terms of pricing on a risk-adjusted basis.
[Operator Instructions] The next question is from Caitlin Burrows from Goldman Sachs.
Maybe just on the acquisition pipeline, I think you said it was about $70 million. Could you go through if to what extent that's a mix of like a lot of QSR-type small deals versus just a couple larger industrial, or what that mix might be as we try to get a sense for what could ultimately close?
Yes. So a portion of it is a retail acquisition, large single site supported goods, and then the other is a fairly large industrial acquisition. So there's 2 deals in that pipeline.
Got it. Okay. And then back to the build-to-suit topic. I think I've kind of asked this in the past, but we've heard build-to-suit can be difficult because it's tough to get the land. So can you just talk through again how you would do that, if there's been any change in thinking? And I think you mentioned in the past that you'd be working or buying from somebody who already has the land, so you wouldn't need to, like, go, I guess, get approvals and source it yourself. But, yes, is that still the case? And how do you kind of get past that hurdle of getting the land that's attractive for this user that they want?
Yes. So that's a great question. The build-to-suit strategy is very different than your regular way. Net lease, sale-leaseback and assumption process where the land is already in hand with someone else. The way that we've been thinking about our commitments to fund developments is to have the certainty around that to be able to report it out to you all, the land needs to be in hand. It's not necessarily in our hand yet, but we'll have an opportunity to acquire it over the course of the process. But the land is under control by the developer or by the tenant, depending on the situation.
We're in a place where we feel very comfortable that the business deals have been agreed to between the developer and their client, and the relationship between us as the funding partner here. You're still in the process of negotiating final documentation, but our ability to have surety around that development pipeline starts with is the land under control, because that's going to be critical to whether or not the client decides to move forward with the project. And for the 7 that we have and the $307 million in that pipeline, that is the case.
Thank you. As we currently have no further questions, I like to hand over to John Moragne for closing remarks.
Thank you, Kiki, and thank you, everyone, for joining us today. We are incredibly excited and proud of all that we've accomplished so far this year. But we're just getting started, so we'll have more to come with our Q3 earnings call come October-November. Thank you all for joining us and enjoy the rest of your day.
This concludes today's conference call. You may now disconnect your lines. Thank you.