National Retail Properties Inc

NYSE:NNN

Earnings Call Transcript 2024-Q1

[Operator]

Greetings, welcome to the NNN REIT Inc. First Quarter 2024 Earnings Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Stephen Horne, Chief Executive Officer. You may begin.

[Stephen Horn, executive]

Thanks, [indiscernible]. Good morning, and welcome to NNN REIT's First Quarter 2024 Earnings Call. Joining me on the call is Chief Financial Officer, Kevin Habicht. As this morning's press release reflects, the company's performance to start 2024 produced strong results, including continued high occupancy and in-line acquisition volume driven by our proprietary tenant relationships. We are in a position to continue enhancing shareholder value as we move deeper into 2024 and beyond.

Highlights of the first quarter results emphasize our continuous effort actively managing the portfolio. The portfolio of 3,546 freestanding single-tenant properties continued to perform exceedingly well, maintain high occupancy levels at 99.4, which remains above our long-term average of 98% plus or minus a fraction. The leasing department had a terrific quarter, leasing 7 assets to QSR and auto service tenants primarily with a 91% rent recapture from the prior rent.

This recapture is above historical levels of approximately 70%. Remember, NNN works hard not to give TI dollars to buy up rent. Currently, NNN only has 22 vacant assets in the portfolio, which is a testament to working with the relationship tenants to maximize value for shareholders. During the quarter, we also sold 6 properties, which were all income producing raising almost $19 million of proceeds to be reinvested into new acquisitions.

Over the course of the year, NNN sells assets defensively and proactively but overall, we target the blended disposition cap rate to be 100 basis points lower than the deployment of capital pricing. The last point on the portfolio I'd like to mention is with regard to 2024 lease expirations, which we originally had 90 for the year. As of the end of the quarter, there's 39 left to handle, but I'm not expecting a departure from the [indiscernible], 85% renewal at 100% prior rent.

Turning to acquisitions. During the quarter, we invested $125 million in 20 new properties at an initial cash cap rate of 8%. If we were required to straight line, the GAAP rent would be 9.2% with an average lease duration of over 18 years. 8 of the deals were sub-$5 million, meaning we realized that deals -- small deals can contribute to FFO per share growth. 12 of the 13 deals were from relationship tenants, which we do repeat business, creating a barrier to competition to solidify NNN's deal [indiscernible]. It is this business model that allows the team to feel good about pipeline for second quarter.

With regard to acquisition pricing environment, in the last quarter, our initial cash cap rate of 8% was approximately 40 basis points wider than the fourth quarter of 2023 and 100 basis points year-over-year. The 40-point increase was a result of NNN being top of mind, which created a window of opportunity to push pricing mid-fourth quarter last year for the first quarter deal closing. NNN was in a good position because of our calling effort and our strong balance sheet to take advantage of the opportunities.

As I mentioned during the February call, we observed increasing cap rates but as they sit today in May, the peers [ when ] the cap rate increase has started to flatten. I anticipate the second quarter pricing of 2024 to be similar to the first quarter pricing. This suggests cap rates are stabilizing as sellers feel lower cap rates may be in the future. As sellers assume the macroeconomic environment may improve and the higher for longer narrative dissipate in the near future.

NNN will maintain acquisition volume through sale-leaseback transactions with our stable of tenants. Based on our pipeline and dialogue with our partners, we remain comfortable with our ability to meet and hopefully exceed 2024 acquisition guidance of $400 million to $500 million, primarily due to sale leaseback deals on our lease [indiscernible].

Our balance sheet remains one of the strongest in our sector. Our credit facility has plenty of capacity with only a balance outstanding of $116 million, down from $130 million at year-end. We just increased the capacity by $100 million to $1.2 billion this past month. So NNN is well positioned to fund 2024 acquisition [indiscernible].

With that, let me turn the call over to Kevin for more color and detail on our quarterly numbers.

[Kevin B. Habicht, executive]

Thanks, Steve. And as usual, I'll start with the normal cautionary statement that we will make certain statements that may be to be 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 these forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations that are disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release.

Okay. With that out of the way, so yes, headlines from this morning's press release report quarterly core FFO results of $0.83 per share for the first quarter of 2024, and that's up $0.03 or 3.8% over year ago results of $0.80 per share. AFFO results were $0.84 per share for the first quarter, which is $0.02 or 2.4% higher than year ago results. We did have unusually high lease termination fee income of $4.2 million in the first quarter, and that compares with $1.7 million in the prior year first quarter. Over the past 5 years, we've averaged about $3 million of annual lease termination fee income. So this quarter's $4.2 million was well above average. But even with that incremental income overall, another good quarter and in line with our expectations. Occupancy was 99.4% at quarter end. As Steve mentioned, G&A expense came in at $12.6 million for the quarter. That's up 2.7% versus prior year and represent 5.8% of revenues for the quarter, and again, in line with our guidance. Our AFFO dividend payout ratio for the first quarter of 2024 was 67% that resulted in approximate $50.6 million of free cash flow for the quarter after the payment of all expenses and dividends. We currently anticipate this free cash flow amount coming in at approximately $194 million for the full year 2024.

We ended the quarter with $831 million of annual base rent in place for all leases as of March 31, 2024. So that would would take into account all acquisitions and dispositions completed during the quarter. Switching over to the balance sheet, couple of just little items. There was a small amount of equity issuance at a little over $42 a share, generating $21 million in net proceeds during the quarter. Shortly after quarter end, we completed a recast of our bank credit facility increasing capacity by $100 million to $1.2 billion and extending the term out to April 2028. There were no other material changes to the terms of that loan. We greatly appreciate the support of our bank group over many, many years. We maintain a good leverage and liquidity profile with over $1 billion of availability on our bank credit facility. As we've talked about, maintaining our light capital market footprint, we've funded nearly 56% of our first quarter acquisitions of $124.5 million with free cash flow of the $50.6 million I mentioned and the $18.5 million of disposition proceeds.

And then based on the midpoint of our acquisition and disposition guidance for 2024, we should fund close to 65% of 2024 positions with free cash flow and disposition proceeds. Our weighted average debt maturity remains 11.8 years at quarter end, which will help us slow the refinance headwind that all companies are facing in the coming years. Couple of stats. Net debt to gross book assets was 41.6%, debt-to-EBITDA was 5.5x at March 31, interest coverage and fixed charge coverage was 4.5x for the first quarter.

And again, none of our properties are encumbered by [indiscernible]. So we remain focused on appropriately allocating capital, which to us means ensuring we are getting what we believe our appropriate returns on equity while controlling risk through property underwriting and maintaining a sound balance sheet, valuing equity adequately, whether that equity is produced by free cash flow, disposition proceeds or new equity issuances at the heart of growing per share results over the long term in our opinion.

So in closing Q1, a solid start to the year. We believe and we're in a relatively good position to navigate the uncertainties that are out there as we continue to focus on growing per share results, and we are mindful this is a long-term multiyear endeavor as we think about our business. The fundamentals of the business remain in good shape.

And with that, we will open it up to any questions, [indiscernible]. Thanks.

[Operator]

[Operator Instructions] Your first question for today is from Joshua Dennerlein with Bank of America.

[Joshua Dennerlein, analyst]

Just wanted to go over what's in guidance for the year. What do you guys assume as far as bad debt goes? And then is there any additional lease term fee income that you included in guidance? .

[Kevin B. Habicht, executive]

Yes. So as it relates to bad debt, we've assumed 100 basis points of loss -- rent loss in our guidance. That's what we typically do, and we're not strained from that practice. We're trying to signal that we're worried that it should be higher than that. Historically, our realized loss is in some -- less than that, meaning 30 to 50 basis points. And so still feels like we're kind of in that realm, if you will, of normal kind of collections on that front.

In terms of lease termination fees, we didn't have $4.2 million in our guidance for first quarter. We did have some amount, but not that amount, not that much. And those things kind of come up a little bit more sporadically. And so historically, on a longer-term project, meaning a full year projection, 12, 15 months out into the future, we don't assume very much of that happening. So it really comes about by a function of just kind of working the portfolio as we come across particular cases of particular properties, in particular circumstances that there's an opportunity to create some value, [ BOE ] termination income possibility than we pursue it.

And so we understand that it's lumpy and it's not particularly in notice. Like I said, we typically run around $3 million a year. So in some sense, it has some degree of regularity to it. But it varies quarter-to-quarter. And to answer your question, we have -- we assume we'll get some more this year just because we always assume we'll get some more. But we don't give any guidance around that just because it's a little too tough to predict.

[Joshua Dennerlein, analyst]

Appreciate that color. And then sorry if I missed it, but did you say what the lease term fee related to, like what tenant? .

[Kevin B. Habicht, executive]

No. Yes, we really -- I mean, we're not -- rather not get into the details of that, but it's -- we think it's value enhancing activity for us. And so it always involves a tenant and either potentially a new tenant or potentially a buyer of the property. And so it's a bit of a tri-party kind of negotiation we're trying to work out. But yes, we don't planning to go in the details on which tenant or tenants. And usually, it's not just one, it's 1 or 2 or 3 that we have some level of dialogue with on that front. And like I said, the amount is going to be small, the amount can be larger. But yes, we don't have any details to give them that.

[Joshua Dennerlein, analyst]

And then maybe if I could just sneak 1 more in. Just on the top tenants, I saw some looks like [indiscernible] has closed some stores recently. What's the latest with them? And are you guys having any dialogue with them on potentially closing stores? .

[Kevin B. Habicht, executive]

Yes. So I mean we've talked about fishes on our Watch list. They have been for a period of time. We don't have any news to report there. There's no rumblings of restructuring per se, in our minds it conform somewhat to our history of any tenants that have some challenges. It's kind of the 80-20 rule where 80% of the stores are fine and 20% have challenges. And so you -- so those are the ones I think that they just need to get to work on. And I think that's the case with them as well. And so -- but yes, no news there. And so we're just kind of working through that with time and don't really have anything new to report.

[Stephen Horn, executive]

Yes. Just kind of carrying out that thought we're working with all our tenants if they want to work on a site to get out of it or what may be the reason. And [indiscernible] we're working day-to-day with them. But today is the first and rent is due. .

[Operator]

Your next question is from Brad Heffern with RBC Capital Markets.

[Brad Heffern, analyst]

Kevin, on that lease termination commentary, I'm not sure I really understood that. So are you saying that you proactively reach out to tenants and suggest that they might want to terminate their leases so that you can release the properties or sell them to someone else? Or can you just explain how that works? .

[Kevin B. Habicht, executive]

Yes, every circumstance is different. And so it varies all over the lot. And so because we get store-level performance, we know how stores are performing or not performing. And so it's a potential -- and we're in dialogue with our tenants. And so we know have a feel for what their thoughts are as it relates to particular properties. And so we're we're just actively involved with our tenants and the properties. And if there's an economic -- a good economic outcome that might include lease termination income, then we're going to pursue it despite the -- it's not [ annuitous ] income, but it's -- we're not going to turn our back on it because it's not. But it's really case-by-case specific and the devil is always in the details, but it comes from working the portfolio, maintaining relationships with tenants and trying to extract value from 3,500 properties as best we can.

[Brad Heffern, analyst]

Okay. And then you talked about [indiscernible], but can you go through the others on the watch list? I'm specifically wondering about Joan's but a quick sound bite on the usual suspects would be great, too. .

[Kevin B. Habicht, executive]

Yes. And the size and composition of the list really hasn't changed. We've talked about [indiscernible] in recent quarters. We've obviously -- everybody is talking about theaters for many, many quarters. And we've mentioned [ Joanne ], which did file for bankruptcy. We only have 2 stores with them. So it's a [ point 1 ] less than 0.1% tenant of ours. And they have since kind of worked through actually that bankruptcy process and both of our stores will be [ affirm ], those leases will be affirmed. And so we're not looking at any loss exposure there. The other ones we've mentioned in recent quarters is big lots. Again, we have 3 stores. We'll see where that goes, 0.1% kind of tenant. We talked about at home stores, which is a larger exposure for us at 1.1% of our rent. We have 12 stores with them. And the challenge with those potentially is that they're just bigger boxes. So if you get one of those back, it's a little more work. But again, they're current on rent, and it feels like they have some runway to continue with that. So we don't have any news to really report on that. Those are the names we've kind of talked about in recent quarters that haven't changed and the situations don't feel like they've changed notably.

[Operator]

Your next question is coming from Smedes Rose with Citi. .

[Bennett Rose, analyst]

We were just wondering, I think you have some debt maturities coming up later this year. I'm just wondering what is -- what are you assuming in your guidance around those maturities?

[Kevin B. Habicht, executive]

Yes. I mean it's -- we don't give any guidance on capital markets activities, but I'll say this, we have optionality. And so we love that. And so that's 1 of the things we try to position our balance sheet to create that optionality. And so meaning we can issue debt long-term 10-year. We've not issued anything less than 10 years in my tenure here. And so today, that would be kind of priced in the mid- to high 5s. And -- but we also could park it on our bank line because we have such availability there, for a period of months, we could leave it there if we had a view that maybe rates would be ticking lower later. So that would be an option. And that cost today is, call it, in the low 6s. And so there's not a huge material cost difference at the moment between 10-year debt and our bank line. And so whichever option we end up choosing won't have much impact on the bottom line between those 2 alternatives. And so we'll see how that plays out and stay tuned, yes.

[Bennett Rose, analyst]

Okay. And I just wanted to ask, sort of bigger picture, when you're out looking at acquisition opportunities, any change in kind of the pool of other providers of capital or where you maybe feel like you have a distinct advantage relative to them? Or are things sort of eroding on that side? Or maybe just if you could just sort of speak to that.

[Stephen Horn, executive]

On the acquisition side, we're really mining with our current portfolio. The vast majority of the acquisition volume has come from our current tenant roster. And our current tenant roster, believes in the sale-leaseback model not owning the real estate. So they're not really out there looking for other sources of capital that we're competing against. They're just looking at sale leaseback providers and what the going rate is. So yes, no, we're not seeing any other buckets of money coming into our sector for what we're looking to do.

Now if we had to do $1.5 billion or $2 billion, we would probably have more competition. But at current guidance we're not seeing any competition in our ability to execute.

[Operator]

Your next question for today is from Spencer Allaway with Green Street.

[Spenser Allaway, analyst]

Maybe with just continuing on the tenant health topic. And Kevin, you mentioned receiving unit level operations. Can you just comment on whether there have been any changes to rent coverage levels or if there's been anything notable that's come up in negotiations with tenants in recent months? .

[Kevin B. Habicht, executive]

Yes. No, the answer is no. I mean there's been a little bit of softening in coverages, but not notable. And so, so far, our tenants really have been able to generally hang in there, if you will, and maintain a reasonable margin, if you will. And so from an ability to pay rent standpoint, it's our concerns have not grown at all. And so we still feel good on that front.

[Spenser Allaway, analyst]

Okay. And then specifically on the property insurance side, and I realize your tenants bear that cost. But just given the spikes in insurance premiums nationwide, is this something that's been brought to your attention in terms of this line item becoming burdensome at all for any tenants? .

[Kevin B. Habicht, executive]

I mean we're aware of that issue. But yes, but we're not hearing that as a big impact on their business. I mean, for many of our tenants rent, I mean, rents are a real expense, but it's not the driver of their profitability and property insurance to a lesser degree, and because we deal with tenant, they operate hundreds, if not thousands of stores, they generally are pretty sharp on getting those coverages, the property insurance coverage across a large number of properties. And so I think that helps them a bit at the margin to get reasonable kind of rates or as best they can be. But yes, the whole property insurance market is very hard enough to bid.

[Spenser Allaway, analyst]

Okay. And then last 1 for me. I know you mentioned the 22 vacant assets. And sorry if I missed this, but have you guys kind of laid out a plan yet in terms of which portion or like what portion of the 22 assets have been earmarked for sale versus re-tenanting? Or can you just provide some commentary on the plan for those assets?

[Stephen Horn, executive]

So out of the 22, they're all earmarked for retenanting. That's the first thing we always try to do that after a certain time frame, if we're not getting acceptable rental rates, at the end of the day, we just do a present value analysis, retenant it, sell it, scrape and rebuild it. And truth at told more times than not, the economic decision as you would sell a vacant asset because of the time delay to get these tenants into it. But we first always try to get the reoccurring revenue by [ retenanting ] it.

[Operator]

Your next question is from Linda Tsai with Jefferies.

[Linda Yu Tsai, analyst]

Can you talk a little bit more about what you're seeing on the QSR and automotive services front in terms of cap rate expansion?

[Stephen Horn, executive]

Yes. I mean given we had a [ 8 ] cash cap rate for the quarter, and we did a little bit more auto services this past quarter that we're seeing -- the bandwidth is pretty tight around the 8, I mean, high 7s, low 8s is what we're seeing currently in today's market in car wash and kind of collision repair in the car auto service sector. But all cap rates, just on the sequential increase we've had really for 5 straight quarters that we're starting to see the 8. Now do I see it going above 8 for the second quarter, I think it's right at there, the pricing is on top of the first quarter or too far out [indiscernible] for the third and fourth quarter. But if the higher for longer narrative continues, I would expect to see an 8 in the third quarter as well.

[Linda Yu Tsai, analyst]

And then just for any tenants on a cash basis, does that include Frisch's AMC at home, big lots?

[Stephen Horn, executive]

Yes. It includes AMC and Frisch's. Those are the primary ones.

[Linda Yu Tsai, analyst]

But at home is not really something [indiscernible].

[Stephen Horn, executive]

No. No. I mean, it is a judgment call. And to be honest, it's something we look at quarterly and we evaluate. We're not adverse to be quite honest, [ candid ], about putting tenants on cash basis, I think, at a better accounting method. But right now, it's about 5% of our tenants, which is mostly AMC and Frisch's make up that cash basis.

[Linda Yu Tsai, analyst]

Got it. And then just a clarification on Frisch's. To the extent you have any of those 20%, you talked about the 80/20 stores that would close and you don't think they're restructuring and the rent is due, if they do move out, do you think they're mostly better as backfills? Or would they get sold vacant?

[Stephen Horn, executive]

I think the being a restaurant asset, it's a well-located piece of real estate with a drive-thru. So I think we would have an easy time retenanting the Frisch's assets. For the most part, it's really good real estate.

[Linda Yu Tsai, analyst]

Last question. On lease term fees, should we model something similar in the future quarters? .

[Stephen Horn, executive]

Yes. I mean we don't give guidance on that. And in no small part because like I said, it's very kind of episodic and hard to predict how and when that's all going to play out. But I wouldn't encourage you to annualize $4.2 million in the first quarter as a run rate. That's for sure. And that's why I really kind of drew attention to that. Our annual average is $3 million. So this was an unusual quarter. We obviously may have more term fee in the future, but it's not -- we're not going to give guidance around it and generally don't anticipate large sums of it.

[Operator]

Your next question for today is from John Massocca with B. Riley Securities.

[John Massocca, analyst]

So maybe kind of building on that last answer, was that kind of [indiscernible] lease termination fee income known when you guys contemplated your initial guidance. And I guess if it was the case that it wasn't known, then maybe why not -- why wasn't that additive to the year-end number that you guys are anticipating? .

[Stephen Horn, executive]

Yes. I mean if you back [indiscernible] on our lease termination fee income in the first quarter, I think our guidance is appropriate, meaning I shouldn't say that. If you don't annualize the first quarter lease termination fee income, I think you might feel that our guidance is reasonable. And we may have opportunity for the high end of that guidance. But yes, that's -- I mean, that's our view of it is that, yes, we really didn't feel like it warrants in moving guidance based on that onetime income in the first quarter.

[John Massocca, analyst]

Okay. And then on occupancy, [indiscernible] split [indiscernible] here at 99.4%, but does that include any kind of leased but dark boxes. And to the extent -- what's the spread maybe between leased and true occupancy in the portfolio today roughly? .

[Stephen Horn, executive]

Yes. So no, our occupancy is always based on leased properties. And so that's the way we report it. And we also we also track it based on dollars investment costs that lease as well. And so -- but there's always a component of dark properties out there, but they're least encountered as occupied or counted as leased yes.

[John Massocca, analyst]

Do you know kind of roughly how large that is in the portfolio today? .

[Stephen Horn, executive]

The dark properties? I mean the dark properties for us historically are probably in the 1% kind of range.

[John Massocca, analyst]

Okay. And then sorry if I missed this in the kind of prepared remarks, I had a little connectivity issue there at the beginning of the call. But did you have any color on the cadence of acquisition volume over the course of the remainder of the year, sorry?

[Stephen Horn, executive]

Yes. I mean what we're seeing in the second quarter, it feels going to be kind of in line with the first quarter. But again, John, as you know, the third and fourth quarter, we don't have any clarity currently on that. One reason we leave our guidance at the $400 million, $500 million because we don't know on the macroeconomic changes that could occur. But given the discussion we've had with our tenants, I feel very comfortable in that $400 million to $500 million range of hitting that number this year.

[Operator]

[Operator Instructions] Your next question for today is from Ronald Kamdem with Morgan Stanley.

[Ronald Kamdem, analyst]

Just 2 quick ones. Just starting with the sort of the cap rates. Obviously, you had the 8% mark that's ticked up this quarter. Maybe can you just talk about, is that sort of the right number we should be looking for given sort of this interest rate environment? Are there other opportunities to sort of even get higher cap rates than that and what you're hearing from tenants?

[Stephen Horn, executive]

No. I think for right now, as we said, that's probably the right cap rate to use currently. Now that being said, there's -- you hear a lot about the markets down 50% but bear in mind, that's the [ 1031 ] market. So you're dealing with a lot of unsophisticated sellers and buyers for that matter. But the sale-leaseback market, we're dealing with highly sophisticated tenants and companies that understand that cost of capital has increased. And if they want to continue to grow, they accept that. So if the higher for longer persists, I would see some further cap rate expansion possibly in the back half of the year. But for modeling purposes, going into the unknown and not wanting to take a bet on either side, I feel comfortable that the 8% should continue.

[Ronald Kamdem, analyst]

Great. And sorry if you touched on, have you hit on what the plan is for the maturities and where you could issue that right now? .

[Stephen Horn, executive]

Yes. Yes. So new issuance, 10-year debt today is kind of mid- to high 5s today. And then the other option that we have is given that we have an unused bank line, we could park it on our bank line, which is the low 6s. And so really the delta between those 2 options is not very large. And so in terms of modeling out this year, you can choose either one and not and be relatively close to how it will play out. We don't give guidance on capital markets activities, [indiscernible] we try to be opportunistic and take advantage of what the best options are at the moment. So we'll see how it plays out. But that's the way I think about our [indiscernible] it's a June $350 million, 3.9% coupon that's coming due.

[Operator]

We have reached the end of the question-and-answer session, and I will now turn the call over to Steve for closing remarks.

[Stephen Horn, executive]

Thank you guys time this morning. We look forward to executing for the second quarter, and we'll see you guys in the upcoming conferences. Thanks.

[Operator]

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.