Essential Properties Realty Trust Inc

NYSE:EPRT

Earnings Call Analysis

Essential Properties Posts Strong 2023 Finish

Essential Properties Realty Trust wrapped up 2023 with $315 million in Q4 investments, totaling over $1 billion for the year, yielding an impressive 8% growth in AFFO per share. The company's portfolio showcased resilience amidst a volatile capital market, reflected in stellar occupancy at 99.8% and solid same-store rent growth of 1.5%. Essential's investment discipline paid off, favoring durable service-oriented operators, leading to robust unit level rent coverage of 3.8x. Their strategy in addressing all net lease investment risks, including corporate credit, unit performance, and real estate basis, fortified their property portfolio's durability. Essential maintained a proactive role as a capital provider for its tenants, leveraging their position amid strained bank funding and credit market dislocations. They concluded the year with a pro forma leverage of 4.0x and nearly $800 million in liquidity, ensuring continued capital for investment opportunities and affirming a guidance of 5% growth in AFFO per share for 2024, ranging from $1.71 to $1.75.

Robust Financial Health Heading into 2024

The company has forecast a promising 2024, with AFFO (Adjusted Funds from Operations) per share guidance ranging from $1.71 to $1.75, setting an ambitious yet attainable growth rate of 5% at the midpoint. This outlook is grounded in the strong financial performance observed at the closure of 2023, which, coupled with a prudently managed balance sheet and ample liquidity, leaves the company well-equipped to execute its growth strategies in the foreseeable future without reliance on additional external equity capital.

Conservative Leverage and Liquidity Strategy

In terms of financial leverage, the company has consistently favored a conservative approach. It has suggested that a reasonable leverage ratio would be in the range of 4.5x to 5.5x, implying that the current position of 4x offers comfortable headspace for strategic financial maneuvers if needed. This low leverage ratio is a deliberate choice that indicates not only a sound financial structure but also showcases the company's ability to handle potential upticks in leverage responsibly.

Funding Mix and Financial Flexibility

Reflecting on its funding mixture, the company has traditionally leaned on a 60/40 equity-to-debt ratio. However, with the generation of almost $100 million in free cash flow, the new funding configuration has subtly shifted to a blend of approximately 60% equity, 30% debt, and 10% free cash flow. This new mix underscores the company's operational efficiency and liquidity foresight, allowing for a flexible approach towards growth investments.

Healthy Portfolio Despite Slight Downtick in Rent Coverage

A minor 20 basis-point decrease in unit level rent coverage has been linked to the acquisitions made in the fourth and third quarters of the prior year. Despite this small decline, both deals were struck at a solid 3.3x, indicating judicious investment choices and a balanced, healthy portfolio that doesn't raise significant concerns.

Sustained Rent Growth Fueled by Established Contracts

The company's same-store rent growth is steadily driven by rent escalations, built into existing leasing agreements. Escalation rates range from 1.25% to 2%, averaging out at 1.7%, which allows for a reliable growth in income reflective of contractual commitments and provides some insulation against market inconsistencies.

Advantageous Position in the Competitive Capital Marketplace

The company stands in a favorable competitive position with a distinct advantage over alternative sources of capital such as bank loans and high-yield markets, due in part to the leverage loans and private credit dynamics. This enables it to act on growth opportunities with agility and secure funding at potentially better rates than the current market offers.

Bond Market Presence and Potential Pricing Benefits

In the context of the bond market, the company's existing bonds are actively trading in the mid-6s range. The management harbors optimism that any new debt issuance might be priced even more favorably, possibly in the low to mid-6 range, which would enhance the company's ability to leverage the debt markets efficiently for future growth.

Earnings Call Transcript 2023-Q4

[Operator]

Good morning ladies and gentlemen, and welcome to Essential Properties Realty Trust Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions] This conference call is being recorded, and a replay of the call will be available 2 hours after the completion of the call for the next 2 weeks. The dial-in details for the replay can be found in yesterday's press release. Additionally, there will be an audio webcast available on Essential Properties' website at www.essentialproperties.com, an archive of which will be available for 90 days. On the call this morning are Pete Mavoides, EPRT's President and Chief Executive Officer, Mark Patten, EPRT's Chief Financial Officer, and Rob Salisbury, EPRT's Senior Vice President and Head of Capital Markets. It is now my pleasure to turn the call over to Rob Salisbury.

[Robert Salisbury, executive]

Thank you, operator. Good morning, everyone, and thank you for joining us today for Essential Properties' Fourth Quarter 2023 Earnings Conference Call. During this conference call, we will make certain statements that may be considered forward-looking statements under federal securities law. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to those forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings press release. With that, I'll turn the call over to Pete.

[Peter Mavoides, executive]

Thank you, Rob. And thank you to everyone joining us today for your interest in Essential Properties. We finished 2023 with a strong $315 million of investments in the fourth quarter and just over $1 billion invested for the full year. This translated to AFFO per share growth of 8% in 2023, which we are proud of given the industry backdrop of heightened volatility in the capital markets and wider bid-ask spreads in the transaction markets, serving as a testament to the resilience of our differentiated investment strategy and variable portfolio. As the fourth quarter results indicate, our portfolio continues to perform at a high level with unit level rent coverage of 3.8x, occupancy of 99.8%, and same-store rent growth of 1.5%. The overall health of our portfolio is a result of our disciplined underwriting process which focuses on growing operators in durable service and experience-based industries and owning granular and fungible properties that generate strong cash flow for these operators. By underwriting and focusing on all 3 risk factors associated with net lease real estate investing, corporate credit, unit-level performance and lease risk and real estate basis, we're able to construct and own an exceptionally durable portfolio of properties. Regarding our strong and consistent year of investments, we remained active in support of our long-standing tenant relationships as they increasingly turn to us as a valued and reliably consistent capital provider to grow their businesses given the limited funding availability in the bank market and the continued dislocation in the credit markets and the diminished level of competition from other net lease investors. With quarter end pro forma leverage of 4.0x and liquidity of nearly $800 million, our balance sheet continues to be well capitalized for continued investment activity as we look to aggressively capitalize on these trends that are creating the opportunity to generate historically wide risk-adjusted returns. We are affirming our 2024 AFFO per share guidance of $1.71 to $1.75, which implies year-over-year growth of 5% at the midpoint. Turning to the portfolio. We ended the quarter with investments in 1,873 properties that were 99.8% leased to 374 tenants operating in 16 industries. Our weighted average lease term stood at 14 years at year-end, which is consistent year-over-year, with only 4.7% of our ABR expiring through 2028. From a tenant health perspective, our weighted average unit level rent coverage ratio was 3.8x this quarter, down slightly from last quarter, driven in large part by investment activity. Our same-store rent growth in the fourth quarter was 1.5%, an improvement from 1.2% in the third quarter, driven primarily by positive leasing results and asset management activities, including at a gym operator that we discussed in our last earnings call. During the fourth quarter, we invested $315 million through 43 separate transactions at a weighted average cash yield of 7.9%, representing a continued increase in pricing power for sale leasebacks as we noted on the last earnings call. Our investment activity in the quarter was broad-based across most of our industries, with no notable departures from our well-defined investment strategies. The weighted average lease term of our investments this quarter was 17.6 years, and the weighted average annual escalation was 1.9%, generating an average GAAP yield of 9.1%. Our investments this quarter had a weighted average unit level rent coverage of 3.3x and the average investment per property was $3.0 million. Consistent with a key tenet of our investment strategy, 97% of our quarterly investments were originated through direct sale-leaseback transactions, which are subject to our lease form with ongoing financial reporting requirements. 72% contained master lease provisions and 96% were generated from existing relationships. Looking ahead to the first quarter of 2024, we have closed $40.9 million of investments to date at a cash yield of slightly above 8, and our pipeline remains robust as an increasing number of middle market companies are seeking sale leaseback capital as a financing alternative as other sources of capital have become unavailable or uneconomic. While we have capitalized on the dislocation in private credit markets, generating heightened pricing power with favorable lease terms, we are cognizant of the potential for easing in the monetary policy over the course of 2024, which could alleviate financial conditions, bringing with it a lower cap rate environment. Should our pricing power diminish later this year, we would hope to benefit from a commensurate reduction in our cost of debt capital such that our net investment spread is maintained. As a value-added capital provider, we are able to dynamically price our sale-leaseback transactions, which over time has afforded us the ability to generate investment returns in excess of market pricing. That being said, our current pipeline today suggests that our investment cap rates should be stable in the near term. From a tenant concentration perspective, our largest tenant represents 3.8% of ABR at quarter end, and our top 10 tenants now account for only 18.1% of ABR. Tenant diversity is an important risk mitigation tool and a differentiator for us, and it is a direct benefit of our focus on unrated tenants and middle market operators, which offers an expansive opportunity set. In terms of dispositions, we sold 9 properties this quarter for $30.6 million in net proceeds at a 6.6% weighted average cash yield with a weighted average unit level coverage ratio of 3.5x. As we have mentioned in the past, owning fungible and liquid properties is an important aspect of our investment discipline as it allows us to proactively manage industry, tenant and unit-level risks within the portfolio. Going forward, we expect our disposition activity over the near term to remain relatively in line with our trailing 8-quarter average driven by opportunistic asset sales and ongoing portfolio management activity. With that, I'd like to turn the call over to Mark Patten, our CFO. Mark?

[Mark Patten, executive]

Thanks, Pete, and good morning, everyone. As Pete noted, we had a great fourth quarter, which was punctuated by a strong level of $315 million of investments at a 7.9% cash cap rate. Among the headlines from the quarter was our AFFO per share, which reached $0.42. That's an increase of 8% versus Q4 of 2022. On a nominal basis, our AFFO totaled $67 million for the quarter. That's up $11.1 million over the same period in 2022, an increase of nearly 20%. This AFFO performance was in line with our expectations when we updated our guidance last quarter. For the full year ended December 31, 2023, our AFFO per share totaled $1.65 per share, which is an increase of 8% over 2022. On a nominal basis, our full year 2023 AFFO increased by 21% over 2022, totaling $253.4 million. Total G&A was $7.3 million in Q4 of 2023 versus $6.5 million for the same period in 2022, with the majority of the increase relating to an increase in compensation expense. Our recurring cash G&A as a percentage of total revenue was 5.2% for the quarter and 5.9% for the full year of 2023, which compares favorably to the 5.8% and 7%, respectively, for the quarter and full year of 2022. We continue to expect that on an annual basis, our cash G&A as a percentage of total revenue will decline in 2024 as our platform generates operating leverage over a scaling asset base. Turning to our balance sheet, I'll highlight the following. With our $315 million of investments in Q4 of 2023, our income-producing gross assets reached $4.9 billion at year-end. From a capital markets perspective in the fourth quarter, we completed the sale of approximately $47.9 million of stock, all on a forward basis on our ATM program. Additionally, during the quarter, we settled $190.6 million of the forward equity we raised in September. At year-end, our balance of unsettled forward equity totaled $130.6 million. Our pro forma net debt to annualized adjusted EBITDAre adjusted for unsettled forward equity was 4.0x at year-end. We are committed to maintaining a conservative balance sheet with best-in-class leverage and liquidity. At year-end, our total liquidity stood at nearly $800 million. Our conservative leverage, robust balance sheet and significant liquidity positions the company well to fund our growth plans for 2024 based on the pipeline we see today. Finally, the strong performance to end the year in 2023, our conservatively capitalized balance sheet, and the investment pipeline we're seeing all support our previously issued 2024 AFFO per share guidance range of $1.71 to $1.75, which implies a 5% growth rate at the midpoint. It's also important to note that with the ATM equity issuance achieved this quarter, we do not require additional external equity capital to achieve our 2024 guidance. With that, I'll turn the call back over to Pete.

[Peter Mavoides, executive]

Thanks, Mark. In summary, we are quite pleased with our fourth quarter and full year results and remain excited about the prospects for the business. Operator, please open the call for questions.

[Operator]

[Operator Instructions] It comes from Connor Siversky with Wells Fargo.

[Connor Siversky, analyst]

A quick question on the liquidity profile. Understanding that a chunk of that $800 million in liquidity is really predicated on the revolver, I'm curious with the robust pipeline you mentioned, how comfortable would you be -- how comfortable would you be letting leverage run toward the end of this year? And then what is the desired funding mix for each incremental acquisition between free cash flow, capacity on the forward, and the revolver?

[Peter Mavoides, executive]

Mark, why don't you tackle that one?

[Mark Patten, executive]

You got it. All right, a couple of things. In terms of just kind of funding mix, generally speaking we had been largely probably 60/40 in terms of equity and debt. But now with almost $100 million of free cash flow, that's probably more like 60 equity, 30 debt and 10 is kind of your free cash flow. That's kind of how we think about looking at liquidity. In terms of running leverage up, I guess what I would say is we've said pretty consistently that if we were to choose a range that we thought was reasonable in terms of leverage, it would be 4.5x to 5.5x. If you think about that and we're sitting at 4x now, we've got a fair amount of runway to go before we ever even kind of step into that range. [audio dropped]

[Peter Mavoides, executive]

Next question, operator?

[Operator]

Our next question is from --

[Peter Mavoides, executive]

Hold on, Operator. Connor, were you good?

[Connor Siversky, analyst]

Yes. No, I'm good. I think the line cut out for a second, but I'll leave it there for now. Thank you.

[Operator]

Your line did just cut out at the very end there.

[Peter Mavoides, executive]

Next question please, Operator?

[Operator]

Our next question comes from Josh Dennerlein with Bank of America.

[Farrell Granath, analyst]

This is Farrell Granath on behalf of Josh. My first question I wanted to ask, if you could go into a little bit more detail on the unit level rent coverage and the slight downtick or how that was attributed to recent acquisitions?

[Peter Mavoides, executive]

Yes, listen, we provide pretty granular detail in our supplemental on the unit level rent coverage. Clearly, the headline number decreasing from down 20 basis points, some of that is attributable to the acquisitions in the fourth quarter as well as the acquisitions in the third quarter, both of which were at 3.3x. There's always some ebbs and flows with different operators and different reporting periods and the like. But overall, the portfolio is in a great spot, and we're not seeing any concerns that give us pause.

[Farrell Granath, analyst]

Great. And I guess on the flip side of that, the increase in your same-store rent growth, is this being driven off of either different lease terms, higher escalators? Or what's the type of driver that's going into that?

[Peter Mavoides, executive]

Yes. I mean that's just going to be the rent escalations built into our contracts. Generally, they range from anywhere between 1.25% on up to 2%. On average, it's 1.7% I believe. There's different compounding periods. And clearly, at 1.5%, that represents a pretty solid flow-through of those escalations for us. And that's going to kind of ebb and flow as we've disclosed.

[Operator]

Our next question comes from Smedes Rose with Citi.

[Smedes Rose, analyst]

I just wanted to ask you a little bit, you talked about some of the more traditional sources of capital either not available or just becoming too expensive. But are you seeing other kind of competitors come to the market? Or do you have sort of a relative advantage at this point as you look for new acquisition opportunities in this environment?

[Peter Mavoides, executive]

Yes. Thanks, Smedes. And I think that's a great question. I appreciate you asking it. We have a relative advantage to alternative sources of capital currently like the bank market and the high-yield market and leverage loans and private credit. A lot of those traditional sources of capital have been priced inside of sale-leaseback capital. In the current environment, we're able to compete pretty competitively with those sources. And then secondarily, the traditional sale-leaseback market participants are somewhat limited, particularly from the private buyers who are more reliant on debt financing and accessing the ABS market. A lot of those guys are a little more conservative in the current environment. Both from an alternative capital perspective and from a competitor perspective, we're finding a nice opportunity to put capital to work.

[Smedes Rose, analyst]

Okay. And then just you mentioned you have a lot of room to draw on the -- you have the revolver. But if you were going to just issue kind of 10-year unsecured debt today, can you just give us a sense of where you think it would price?

[Peter Mavoides, executive]

Yes. I think the best mark would be our current bonds, which are out there trading, and they're kind of in the mid-6s. I would think that hopefully a new issuance out of the yield curve could price inside of that, so call it low to mid 6.

[Operator]

Our next question comes from Eric Borden with BMO Capital Markets.

[Eric Borden, analyst]

I just understand that the majority of the acquisitions completed in the fourth quarter was heavily driven by existing relationships. But looking ahead and given the limited access to the bank markets for some of your potential tenants, are you seeing an uptick in new potential partners in the pipeline?

[Peter Mavoides, executive]

That's a great question. I generally tell people we like to see 80/20 or 75/25 percent mix, where we're 75% existing relationships, 25% new relationships. Because it's important for us to continually source new relationships because eventually, some relationships outgrow us. Clearly, in the fourth quarter at 96%, it's more skewed towards existing relationships. In the current environment, we try to maintain our most profitable relationships and service the relationships that generate the best risk-adjusted returns and take care of the good clients and reliable clients, and that's kind of what we're doing. I think in a more normalized environment, we would head back down to that 75/25 or 80/20. But clearly, partnering with long-term relationships is bringing value to us and we're bringing value to them. And it's a dynamic market that we're happy to have those relationships.

[Eric Borden, analyst]

Okay. That's helpful. And then maybe on the disposition front, just given the potential for lower yields in the back half of the year, is there potential for that quantum of total dispositions to rise above your 4-quarter trailing average just given the benefits there?

[Peter Mavoides, executive]

Yes. I think the expectation should be it's going to be more towards our 8-quarter average. Clearly, the current market for dispositions is a bit challenged. We have a very granular and fungible portfolio, but the lack of financing out there is making it a little more difficult to sell assets than in a normalized environment. And we'll focus on kind of managing individual tenant and industry exposures and getting out of any risky assets that we see. But I would expect it to be closer to the 8-quarter average. And really, we don't see the need to lean into dispositions to generate accretive capital given where we are from a balance sheet perspective.

[Operator]

Next question comes from Nate Crossett with BNP Paribas Asset Management.

[Nathan Daniel Crossett, analyst]

[audio difficulty]

[Peter Mavoides, executive]

Nate, I got to tell you, I don't -- you came through broken up. I didn't catch that question. I don't know if you're on a handset or not. He might come back in. Why don't we just -- Operator?

[Operator]

The next question comes from Greg McGinniss from Scotiabank.

[Elmer Chang, analyst]

This is Elmer Chang on with Greg. Just on tenants, is there more conservatism on bad debt expense or credit losses baked into 2024 guidance versus the say 25 to 40 basis points you've experienced historically given uncertainty with the consumer? And then how much of that is tied to experiential operators feeling demand pressures from consumers either returning to work or still feeling the effects of inflation?

[Peter Mavoides, executive]

Listen, we have conservative rent loss assumption and credit loss assumptions built into our guidance as we always do. We take a very close look at our portfolio and look at individual exposures to include the credits, unit level coverage and our rent basis to try to anticipate where we might take any rent loss. And there's a wide range of assumptions baked into guidance around that. As we've said in the past, generally when you see us raising guidance throughout the year, it tends to be partially driven by the fact that those credit losses aren't really coming to play. The 40 to 50 basis points, we don't give specific guidance on the numbers in there. But it's certainly -- the range of guidance as a range around that I think is fair to say. We really don't have specific concerns about the consumer and specifically as it relates to the service and experience-based industries that we're in. Our experiential tenants are doing great and continue to -- we continue to see good sales trends there and coverage improvements and our credit loss assumptions are going to be much more specific to individual situations and investments. But that's baked into guidance, and we feel good about the guidance that we've reiterated today.

[Elmer Chang, analyst]

Okay, thank you. And then you mentioned -- you mentioned those experiential consumers, not being concerned about them. But within the portfolio of early childhood and casual dining operators, how would you characterize their ability to pass through higher cost to consumers now that it seems inflation is easing a bit and given you've talked about these types of businesses not being able to raise rates in the past several quarters?

[Peter Mavoides, executive]

Yes. Listen, I think early childhood is going to be much different than casual dining. Our early childhood education providers have done a good job of passing through increases. It tends to be lumpy around semesters and new students, but we've seen increasing trends there. I think the casual dining sector is -- the price is a little more A), competitive, B), less discretionary. And certainly, those guys are going to have less ability to drive through inflationary pressures and we are seeing some margin compression there. But ultimately, on both -- in all those industries, those end up being equity owner risks and not landlord risks. And we don't see any outsized losses flowing through the portfolio in general and then in specific in either one of those industries.

[Operator]

Our next question comes from Haendel St. Juste with Mizuho Securities.

[Haendel St. Juste, analyst]

First question is on -- I guess there's a new tenant in your top tenant list here, Tidal Wave Auto Spa. Maybe can you spend a moment talking about them, the opportunity to do more with them and your overall exposure to kind of the carwash/car care vertical which I think is about 15% here?

[Peter Mavoides, executive]

Yes. Tidal Wave is a tenant that we've been doing business with for a number of years and a number of deals over the years, and they've kind of eventually moved into our top 10. It's about a 200-plus unit chain. It's currently led by its founder and the company was founded back in 1999, so a well-run company. It's been in business for a long time, and we're happy to have them in our top 10. Generally, we are, as we've said in the past, very comfortable with carwashes given the trends in the industry and the stability of the cash flows and the high margins and the solid rent coverage. And that's why you see it as one of our top industries. The exposure kind of came back a little bit in the last quarter, but we continue to see good opportunities to invest in that space and we like it, so we'll continue to do so.

[Haendel St. Juste, analyst]

Appreciate that. And then maybe I think you made a comment on your pipeline saying that the cap rates in there suggest that cap rates should be stable near term. Can you spend a moment or 2 on talking about the pipeline? What's in there? Any new categories? And broadly, your expectations for cap rates given the choppiness in the capital markets.

[Peter Mavoides, executive]

Yes. As we said on the prepared remarks, the pipeline is full. And when you're running a business that's nearly 100% sale-leaseback and nearly 100% follow-on business, your new -- your forward pipeline is going to look a whole lot like your portfolio. And that's what it looks like, so really nothing new. We're investing across all our industries and largely with existing relationships. In terms of cap rates, as the commentary around the competitive landscape would suggest they're remaining stable. And clearly, I think around an 8. As I said on the prepared remarks, we would expect once the market normalizes and competition comes back in a more normalized fashion, we would expect some downward pressure on cap rates. Clearly, if there's -- if interest rates trend down, we would expect some downward pressure on cap rates. But we're just not seeing that as we sit here in the first quarter.

[Haendel St. Juste, analyst]

Appreciate that. And maybe on the terms that you're getting, given the lack of alternatives that a lot of these tenants have, you've been able to get longer walls, better bumps. I'm curious if you're able to -- getting any pushback from any of those folks? And could we see those terms get even better near term? Thanks.

[Peter Mavoides, executive]

Yes. Listen, every transaction we negotiate is a negotiated transaction. We've negotiated deals with these people in the past. There's a lease in place and the terms of the prior transaction tend to bias the new transaction. Our investment team has done a great job of improving the overall terms. I look back in the first quarter of 2022, our average rent escalation was 1.4% and last quarter, it was 1.9% and the quarter before that it was 2.0%. I would -- and really, for the whole year, 2.0%, 1.9%, 2.0%, 1.9%. I would not set the expectation that that's going higher, but we continue to negotiate the best terms that we can from these relationships, and we'll see what the market bears. I did make -- I would point out on the prepared remarks, our weighted average lease term at 14 years is the same as it was a year ago, which would speak to the benefit of the long duration leases that we added this past year, which is a good spot to be.

[Operator]

Our next question comes from John Massocca with B. Riley Securities.

[John Massocca, analyst]

Maybe on the pipeline, do you have kind of like a rough number or brackets around the growth side of that today? I know you kind of mentioned it's full, but just maybe number wise what we should be thinking?

[Peter Mavoides, executive]

Typically, we point people to our 8-quarter average as a good indicator of what to expect. And I don't know what that exact number is, but somewhere between 2.50 and 3.00.

[John Massocca, analyst]

That's helpful. And then in terms of volumes, have you seen any maybe reluctance on the part of sale-leaseback partners to kind of come to market or close deals just given some of the interest rate volatility? I mean essentially, are your partners on the selling of the property side maybe holding out for better cap rates or lower cost of alternative financing?

[Peter Mavoides, executive]

Yes, there's some of that. There's clearly overall transaction volume in the single tenant lease -- single tenant net lease market is down 50%. And I think a lot of that are people not choosing -- not to transact in the current market environment. But the flip side of that is these operators are running their businesses, and they have the opportunity to grow their footprints by buying smaller competitors or opening new units and rent is a small part of that overall investment decision for them. And they're aggressively growing and choosing to use us as a capital partner to do that. While there is muted volume across the board, we still see an ample opportunity set to transact.

[John Massocca, analyst]

Okay. And then maybe in terms of the competitive environment for sale-leaseback particularly, I mean, how does that look today? Setting aside kind of the bank financing market or any kind of other types of financing you compete with? I mean, how many competitors are they out there today roughly? And how does that compare to this time last year, or maybe even a couple of years ago?

[Peter Mavoides, executive]

Yes, listen, I don't think it's materially different from where we were a year ago because it feels like the overall capital market environment is about the same, if not improved slightly. But 2 years ago, there was a half dozen to 10 kind of new private capital-backed buyers who are coming to the market trying to build funds and platforms. And by and large, a lot of those guys are kind of not currently investing at the levels that they would have hoped. And so that private buyer is greatly diminished. We also on occasion compete with 1031 buyers, people coming in with large exchanges who are looking to place tax deferred capital. And there's not a lot of people who are generating gains from the sale of real estate assets and that source of capital is largely dried up and not competing. There's plenty of public market participants. You guys follow them and know kind of where they are and what their appetites are, and so we certainly see competition here and there. But overall, it's a diminished level of competition that we're benefiting from.

[Operator]

[Operator Instructions] It comes from Ki Bin Kim, Truist Securities.

[Ki Bin Kim, analyst]

You have Kyle on for Ki Bin. I think on the second quarter call, you guys mentioned approximately 90 basis points maybe are on watch list with more than half of that leaders. Can you just provide an update on how that's trended recently?

[Peter Mavoides, executive]

Yes. Our current watch list, which I'll remind you we define as the intersection of credit risk as a B- or below and coverage risk as 1.5 or below. It's currently 70 basis points, so 20 basis points inside of where it was in the second quarter, and it's still 50% theaters. Operator, we got any more questions?

[Operator]

The next question comes from James Kammert with Evercore ISI.

[James Kammert, analyst]

Pete, you and your team have worked with these middle market credits for a long time obviously, and it seems like the business is pretty well set up with your unit and parent or entity financial reporting requirements. But what are some of the flash points that you monitor or set off sort of warning signs in your mind that something is a problem? Might be a foot with a given credit. I mean is it in coverage declines from original 3.5 to 2.5 or they've been -- you had to round them up and collect the rent 3 months in a row tardy. I'm just trying to -- I'm curious what some of those markets historically have helped you monitor and proactively kind of engage with those tenants?

[Peter Mavoides, executive]

Yes, listen, I think I wouldn't even call it an early warning sign, but late payers or guys who aren't paying timely are certainly top of the list. Guys who are laid on their rent I would say generally that tends to be less than a handful of actors. And historically, it's the same guys that you're arm wrestling with, but currently, that's not a material amount. But more importantly, it's monitoring the trends at the unit level because that's ultimately our collateral and our first form of payments is solid cash flow at the unit level. One of the reasons we provide such disclosure around where our rents are covered and how they're covered. But from our analysis, it's more just tracking trends and anything that's falling off or below sector averages. When you have the amount of data that we have for each of these given industries, average sales per site, margin per site, rent growth per site, sales growth, all of that, trying to see outliers as to performance at the unit and understand that. And to the extent that something arises that's concerning, then you're taking a deeper dive into the corporate credit to understand if our asset fails as a source of rent payment, how solid is the corporate credit that's backing that lease and understanding the risk there. And then ultimately, making a cell decision on assets that you don't think have the durability that you want and expect in the portfolio.

[James Kammert, analyst]

That seems logical. And just one follow-up to that. Do you have like substitution rights in your master leases and whatnot? I mean you said you might obviously for ailing assets maybe look to sell them, but do you have other protections where you could either add other collateral or maybe work with the retailer to put a performing asset in and take a less performing asset out?

[Peter Mavoides, executive]

Yes. Many of our leases do have substitution rights where the tenant would be incented to take and exit a sub-performing asset and substitute it in. I would say more importantly, it's really just having good relationships and working with these tenants. Because our interests are aligned and not keeping a site that doesn't work online and operating. We may re-tenant the site and the tenant makes us whole for the contract rent that was in the lease, the delta between that and the underlying subtenant rent. There's a lot of ways to work through it. I would say one of the benefits of being as granular as we are at the asset level, it's pretty easy and painless to work through individual site level issues.

[Operator]

No further questions at this time. I would now like to turn the floor back over to Pete Mavoides for closing comments.

[Peter Mavoides, executive]

Great. Well, Nate, we're sorry we didn't get your question in. If you want to follow up with Mark or Rob afterwards, we'd gladly answer any questions that you might have had. But generally, congrats to the team for an excellent quarter and an excellent year. We feel pretty proud about the results we posted last year, and we're excited about this year. We're off to a great start. Thank you all for your participation today. We look forward to engaging with you all at the upcoming conferences, and have a great weekend. Thank you, guys.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.