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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, ladies and gentlemen, and welcome to the Essential Properties Realty Trust Third Quarter 2019 Financial Results Call. [Operator Instruction] At this time, it's my pleasure to turn the floor over to Mr. Dan Donlan, Senior Vice President, Capital Markets. Sir, the floor is yours.
Thank you, operator, and good morning, everyone. We appreciate you joining us today for Essential Properties' Third Quarter 2019 Conference Call. Here with me today to discuss our third quarter results are Pete Mavoides, our President and CEO; Gregg Seibert, our COO; and Hillary Hai, our CFO. During this conference call, we will make certain statements that may be considered forward-looking statements under federal securities laws. 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 are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings press release.
Before I turn the call over to Pete, I would note that our 10-Q and third quarter supplemental are available on the Investor Relations section of our website. Pete, please go ahead.
Thanks, Dan. And thank you to everyone who has joined us today for your interest in Essential Properties. We are pleased to report the strong results of our third quarter, which was the first quarter that we could report comparable per share results. Consistent with our recent quarters, the third quarter saw a solid portfolio performance, with same-store rental growth of 1.7%; accretive investment activity with $174 million invested at an initial cap rate of 7.5%; and active capital markets activity with Eldridge fully exiting their position and the creation of our ATM Program. With all that in mind, we reported third quarter AFFO per share of $0.29, which represents a 16% increase over last year. This impressive growth was achieved on a near leverage-neutral basis as our net debt to annualized adjusted EBITDAre was 4.8x at quarter end versus 4.7x a year ago.
We anticipate our freshly underwritten and newly vintage portfolio to remain healthy; our focused and disciplined investment pipeline to continue to generate accretive and attractive investment opportunities; and the capital markets to offer multiple sources of well-priced capital. Based on these assumptions, we are providing 2020 AFFO per share guidance of $1.27 to $1.30, which implies a 13% increase at the midpoint compared to our updated 2019 guidance. We believe this growth, coupled with our well-covered dividend yield of 3.6%, and our commitment to prudently managing our balance sheet and portfolio risks, offer a compelling total return opportunity.
Turning to the third quarter and starting with the portfolio. As of September 30, we had investments in 917 properties that were 100% leased to 199 tenants operating in 16 distinct industries. Our weighted average lease term was 14.4 years. More importantly, though, only 3.1% of our ABR expires prior to 2024.
Our same-store portfolio, which represents 60% of our ABR at quarter end, experienced contractual cash rent growth of 1.7% and contractual cash NOI growth of 1.6% quarter-over-quarter. As we have mentioned in the past, when coupling our contractual rent growth with expiring leases and potential credit losses, we expect our same-store portfolio to grow at approximately 1.5% per annum. So we were pleased to exceed that threshold again this quarter. From a tenant health perspective, our portfolio has a weighted average rent coverage ratio of 2.9x, with 73.4% of our ABR having rent coverage ratio of 2x or better.
Looking out over the next 8 years, less than 1% of our leases that expire have unit-level rent coverage below 1.5x, which we believe indicates a high likelihood of lease renewal at expiration. Additionally, only 2.1% of our tenants have both an implied credit rating lower than single B per Moody's RiskCalc and unit-level coverage ratio below 1.5x, which represents a very manageable number of tenants and properties with elevated risk characteristics.
Our third quarter investment activity was robust. We invested $174 million at a weighted average initial cap rate of 7.5%, which was up 20 basis points sequentially, representing a very attractive spread to our cost of capital. Approximately 88% of our third quarter investments came from directly originated sale-leasebacks or mortgage loans. And 100% are required to provide us with corporate and unit-level financial reporting on a regular basis.
As we have mentioned in the past, we believe directly originated sale-leaseback investments afford an opportunity to generate attractive risk-adjusted returns by delivering capital to a tenant need and structuring investments on our lease form with our preferred terms.
On the disposition front, in an effort to proactively mitigate risks and exposures, we sold 10 properties during the quarter, including one vacant, for $19.5 million in total net proceeds. As we look out to the balance of the year, we remain focused on growing our portfolio through the origination of sale-leaseback transactions with middle-market tenants in our targeted industries, and we anticipate our level of investment activity to be consistent with our historical averages, with cap rates in the low to mid-7% range.
And with that, I'd like to turn it over to Hillary, our CFO, who will take you through the financials for the third quarter.
Thank you, Pete, and good morning, everyone. Starting with the balance sheet. We ended the quarter with $1.9 billion in total undepreciated assets and $666 million of total debt, including $311 million of master funding notes, a $200 million of unsecured term loan and $155 million outstanding on our $400 million unsecured revolving credit facility. We have no major debt maturities coming due until 2024, and our net debt to annualized adjusted EBITDAre was 4.8x at quarter end, which gives us capacity to continue to execute on our external growth strategy while managing within our targeted leverage range. Lastly, earlier this week, we received a BBB- credit rating from Fitch Ratings services, which should further broaden our access to capital as an investment-grade rated company.
Moving on to our capital markets activities. During August, we established a $200 million ATM Program. In the last 6 weeks of the quarter, we used the ATM Program to sell over 3.3 million shares of common stock at an average price of $22.42 per share, raising gross proceeds of $75 million. To date, in the fourth quarter, we have sold over 1.3 million shares under the ATM at an average price of $24.05, raising gross proceeds of $32.7 million.
Given the granularity of our quarterly investment activity, we view the ATM as a highly efficient tool to raise equity and proactively manage our balance sheet.
Turning to the income statement. Our third quarter NAREIT-defined funds from operations, or FFO, was $21.1 million or $0.27 per diluted share. Core funds from operations or core FFO, was $23.9 million or $0.31 per diluted share. And adjusted funds from operation or AFFO, was $22.8 million or $0.29 per diluted share. Of note in the quarter, we incurred $2.7 million of nonrecurring costs and charges in connection with both the Eldridge secondary offering in July and the potential settlement of an ongoing litigation. When excluding these one-time items from G&A this quarter, our G&A as a percentage of total revenues was 13.2%, which is down 60 basis points versus our average over the 4 -- over the prior 4 quarters. Going forward, we continue to expect our G&A to scale as our asset base grows.
Turning to guidance. We are raising our 2019 AFFO per share guidance by $0.02 at the low end to a new range of $1.13 to $1.15. Looking ahead to next year, we are introducing a 2020 AFFO per share guidance range of $1.27 to $1.30, which implies approximately 13% growth at the midpoint of both ranges. We believe AFFO is the most relevant earnings metric, as it closely approximates our recurring cash flow per share. As we have stated in the past, our historical net investment activity, which we provide in a supplement on a trailing 8-quarter basis, is a good goalpost for our future investment potential. With that, I'll turn the call over to our COO, Gregg Seibert.
Thanks, Hillary. During the quarter, we invested $174 million into 28 transactions and 139 properties at a weighted average cash cap rate of 7.5%. These investments were made within 10 of our 16 targeted industries, with Quick Service Restaurants, or QSRs, representing nearly 30% of our investment activity in the third quarter. The weighted average lease term of these properties was 16.6 years, the weighted average annual rent escalation was 1.5%, the weighted average unit-level coverage was 3.2x and our average investment per property was $1.2 million.
Consistent with our investment strategy, approximately 88% of our third quarter investments were originated through direct sale-leasebacks and mortgage loans, which are subject to our lease form with ongoing financial reporting requirements and master lease provisions in most cases.
In addition, due to the ongoing efforts of our origination team to expand our relationships with new operators and counterparties, 57% of our third quarter investment activity was relationship-based, which we define as transactions completed with operators, sponsors, advisers or brokers that senior management has done business with in the past.
From an industry perspective, QSRs remain our largest industry at 14.4% of ABR; followed by early childhood education and C-stores at 11.5%, respectively; car washes at 10.2%; and medical dental at 9%. Conversely, our home furnishings concentration is now just 4.2% of ABR, which is down 40 basis points quarter-over-quarter, and we expect this trend to persist as we see better risk-adjusted returns in other industries.
In addition, we continue to proactively manage our casual dining concentration, which declined 90 basis points in the quarter, through selective dispositions of underperforming locations in order to create capacity to invest in higher-performing brands and properties while managing our concentrations.
From a tenant concentration perspective, no tenant represented more than 4% of our ABR. Our top 10 tenancy represented 25.5% of our ABR at quarter end, which was down 250 basis points quarter-over-quarter. We expect our top 10 concentration to decline further in the coming quarters as we continue to grow our exposures with existing tenants outside of our top 10 and capitalize on newly-developed tenant relationships.
Subsequent to quarter end, Perkins, which today represents 1.4% of ABR, was purchased out of bankruptcy. As part of the bankruptcy process, we negotiated a new 20-year master lease in exchange for slightly lower rents. We are pleased to report our properties are now subject to a long-term master lease with an experienced and well-capitalized restaurant operator.
Looking at the portfolio more broadly, approximately 93.5% of our ABR is derived from tenants that operate service-oriented and experience-based businesses, which has been a deliberate focus for Essential since we started investing over 3 years ago. We believe tenants in these industries, and more importantly, real estate occupied by these tenants, are more recession-resistant and heavily insulated against e-commerce pressures.
Moving on to asset management. Our portfolio remains healthy, with a weighted average rent coverage ratio of 2.9x and approximately 73.4% of our ABR having a rent coverage ratio of 2x or better. In addition, with approximately 98% of our tenants required to report unit-level financials to us, we have near real-time transparency into the health of our tenancies, which is an important component to managing risk in our portfolio. Similarly, with an average unit investment per property of $2 million, our portfolio remains highly liquid from a sales perspective and readily fungible from a leasing standpoint.
Turning to dispositions this quarter. We sold 10 properties from 5 different industries for $19.5 million in net proceeds. Despite these dispositions being derisking sales, the 9 leased properties were sold for a blended cash cap rate of 6.7%.
With that, I will turn it back to Pete for his concluding remarks.
Thanks, Gregg. Our portfolio remains in excellent shape with no vacancy, healthy coverage, coupled with strong transparency, excellent property-level liquidity and de minimis near-term lease expiration. Our investment pipeline is full, our balance sheet is well-positioned to fund our growth objectives and we look forward to continuing to execute on our business plan.
With that, operator, let's open the call up for questions.
[Operator Instruction] And we'll take our first question from Christy McElroy with Citi.
This is [ Parker Decrani ] on for Christy. Just wanted to sort of understand, with your team's access to capital being relatively easier than it's ever been and overall, a very strong pipeline in terms of opportunities in the deal pipeline itself, how are you guys thinking about the likely pace of acquisitions moving into 2020? And should we expect volumes to be similar to as we've seen over the past few quarters, particularly in Q2 and Q3?
Sure. As I've said in the past, the way we invest is very granular. It takes a lot of work, a lot of investment in single assets and direct negotiations of transactions. And as a result, really, the constraint on investment activity really becomes staffing and infrastructure, and we staffed and organized this organization to transact at our current level. For the past 3 years, we've invested approximately $500 million, and we would anticipate, given our staffing and our organization, to be able to do that going forward.
These last 2 quarters were somewhat elevated as we found some larger transactions to transact on, but I wouldn't anticipate that to be indicative of a higher run rate.
And then just another question, real quick. We had noticed a sequential pickup in terms of notes receivable. Can you guys just talk about sort of what drove that increase?
Sure. During the quarter, we did a couple of loans with some of our existing tenants. In general, we'll do loans from time to time as an accommodation to our tenants. Typically, we structure those loans to have similar characteristics to our sale-leaseback transactions. It's not going to be a big part of our business, but it will be a small part.
Okay. And just a quick follow-up. And I'm just curious, what sort of industry verticals did you guys, particularly during the quarter, sort of, written -- write those loans with?
We did a loan in this past quarter in the quick-serve restaurant industry as well as the child care industry.
We'll take our next question from Ki Bin Kim with SunTrust.
This is Alexei Siniakov filling in for Ki Bin. A couple of questions related to tenant credit profiles? Well, first of all, you mentioned that Perkins today stands at 1.4% of your total ABR. I just wanted to clarify, is that the same 12 stores that you had last quarter? Or has that store count changed? And maybe if you can disclose a number around the differential between the old rent and the new rent? Like is it 10% lower, 20% lower?
Sure. And without getting too into the specifics of that lease renegotiation, the rent is -- the rent concession we ended up giving the tenant is less than 10%. And that 1.4% represents 11 assets in that we sold an asset during the quarter. And then recall you have both the numerator and the denominator moving around. But at the end of the day, it was a, in our view, a very reasonable rent concession to get a much stronger, longer-duration lease with an emerging tenant that we have good confidence in.
Okay, great. Thanks for that color. And then my second question relates to Town Sports International. Maybe you can give some color around what the status of the tenant is and what percentage of ABR the tenant is? I know it was within the top 10 tenants last quarter, but it looks like it's no longer in the top 10 this quarter?
Yes. The guys are digging up the exact percentage now. Clearly, Town Sports is a public company. So I think people can form their own view on the credit and what's going on there. As we've said in the past, they have their challenges, and those challenges are very public. From a -- a credit perspective, we did a deal with Latitude Fitness (sic) [ Latitude Sports Clubs ], which was a 4-unit operator. We did a 3-unit sale-leaseback, which was a master lease. That was subsequently acquired by Town Sports. So we kind of bought into the Town Sports. And we remain confident in the assets that we bought and the coverage of our master lease. And as we sit today, that Town Sports is just around 2% and just out of our top 10.
I see. Are you noticing any kind of slippage in rent coverage on those former Latitude Fitness (sic) [ Latitude Sports Clubs ] stores?
No. They remain stable and healthy.
Okay. And just to clarify, was that part of the original GE Seed Portfolio? Or was that underwritten after that?
That was a sale-leaseback that we originated subsequent to GE.
We'll take our next question from Brian Hawthorne with RBC Capital Markets.
I have a question on Ladybirds. Was that a tenant that you had owned an individual property with and then added more assets into? Or is this a brand-new relationship?
Gregg, why don't you tackle that relationship?
Sure. We had some Ladybirds. We've had them in our portfolio for some time. So this was an incremental addition to assets we already owned. It's someone that we've known about 10 years and have done business with in the past. So again, it's a long-standing relationship. And this past quarter was just an incremental addition to prior assets we have done in past years.
Okay. And then are these properties all part of a master trust -- or master lease?
They're a master lease structure, not a master trust. Yes, master trust would be a securitization, right? But they're master lease assets.
Right. Okay, great. And then one other one on competition. Are you guys seeing any increased competition out there from the other triple net REITs? We've seen kind of all of them raise investment guidance this year, throughout the year.
Sure. I think as you go through earnings seasons, it seems like everyone has had heightened investment activity. And that certainly results in increased competition at the margin. During the quarter, 88% of our deals were direct sale-leasebacks and 67% of our deals were deals with people that we've dealt with in the past. And so we believe we have a good set of relationships and a well-differentiated investment model that allows us to still generate attractive risk-adjusted returns. But the improving cost of capital across the sector, not only public and -- but private is driving some incremental competition, certainly.
We'll take our next question from Sam Choe with Crédit Suisse.
So I know you guys, like, just tightened the guidance for 2019. But just wanted to get some color on what you've seen in the October investment pacing?
Sure. I would say in our 10-Q that we filed last night, we reported subsequent events, which updates our investment activity through November 6 and kind of quarter-to-date, we've invested $74.1 million.
Great. Okay, that's great. And then I think Gregg mentioned that there was some capital rotation away from the casual dining space. I'm assuming that was more location specific, but just wondering if there was anything general that you saw?
Yes. I think -- and this may be a bit nuanced, but Gregg's commentary was more around rotation within the casual dining space and rotating from operators and concepts that weren't performing up to our expectations to free up capital to invest with guys that are relatively performing better. And that's always the case. And that could be -- that can be as it relates to brands within our portfolio or with specific operators. But one of the things we like about casual dining is that the properties tend to be very liquid and allow us to fine-tune the portfolio to be able to move out of guys that aren't performing up to expectations and redeploy into sites where people are performing well.
We'll take our next question from Sheila McGrath with Evercore ISI.
Yes. Acquisitions in the quarter had the lowest average investment per unit that I guess were a lot of units, 139. Just wondering if there was 1 transaction with multiple units, bringing that average lower?
Yes, there was a -- that loan we did in the quick-serve restaurant space really brought that down. I think absent that loan, we would have been closer to our historical average of, call it, 2 million, Sheila.
And the loan, is it a similar yield as acquisitions? Or how should we think about pricing of that?
Yes, you should -- consistent with my earlier comments around our loan program is that we seek to create an economic profile similar to our sale-leaseback investments and do loans solely as an accommodation to certain tenants. And so it's generally consistent with where we're deploying capital, regardless of structure.
Okay. And then guidance on 2020 looks pretty attractive for growth. Can you remind us what -- how you think about the dividend? Are you targeting an AFFO payout ratio? Or just remind us how we should think about dividend growth.
Yes. I think what we've generally said is that the Board will evaluate it quarterly, probably look to adjust it biannually and that we would endeavor to maintain a payout ratio in the 70% range.
We'll take our next question from Alan Wai with Goldman Sachs. Alan, please check your mute button. Hello, Alan, are you still there? All right.
Moving on, we'll go next to John Massocca with Ladenburg Thalmann.
So I guess maybe touching again on the QSR properties you acquired in 3Q '19, could you maybe provide some color on the mix of restaurant properties in terms of franchisee versus corporate credit and then maybe national versus kind of regional brands? Just any kind of general color there would be helpful.
As I said, a good chunk of it was the loan that we did, but it was generally, I would say, largely national brands with the franchisor is probably the majority of it.
Okay. That makes sense. And then can you maybe provide some additional color on dispositions in the quarter? Specifically, the 6.7% cap rate on the disposition of assets with 1.1x coverage just seems pretty attractive, but it's a small sample size. So were there any kind of characteristics of those properties that made that possible? And I don't think you're going to repeat those numbers exactly maybe going forward, but that maybe it's kind of a little bit of an outlier?
Yes. Listen, John, and I think we provide pretty good disclosure on a quarter-over-quarter disposition activity. Looking at our disposition list, there were 5 casual dining restaurants, 2 car washes, 1 child care and 1 auto service with a range of cap rates from 6.5% up to 7.1%. As you think -- as we think about it, if you get your basis right and you have an attractively priced piece of real estate from a basis perspective, investors are willing to pay for that. And so coverage is an important metric, but having the appropriate basis in a piece of real estate is equally appropriate. And if you have a low basis, people are willing to buy that.
So there's nothing specialized in terms of like a redevelopment opportunity or repositioning of a property that maybe someone found attractive?
No. No outliers. As I said, it's across all -- across those 4 industries with a range at a low of 6.5% and a high of 7.1%. So it was -- nothing kind of driving that.
Okay. And then you mentioned the car washes you sold in the quarter, was that driven by a view on the industry or the tenant? It looks like they were both Zips. Or was it just property specific?
We continue to like the car wash industry, start there. We continue to like Zips, it's a top 10 tenant, and they've done a great job of operating their business and growing their business. From time to time, we will sell exposure purely to create capacity to continue to invest with our tenants that are growing. And so it was an opportunistic sale to kind of free up some capacity.
[Operator Instruction] We'll go next to Caitlin Burrows with Goldman Sachs.
It's Alan Wai on for Caitlin. Sorry about that earlier, we were facing some technology issues. So on your acquisition cap rates, 8.2% this quarter, it's down a bit from last year in the mid-8s. I was wondering why there's been a decline in cap rates? And do you expect this downward trend to continue into 2020?
Yes. Listen, and I would say it's -- our cap rates over the last 8 quarters really have ranged from a 7.8% down to a 7.3%. And last quarter was a 7.5%. I think you're quoting more GAAP cap rates, which incorporate the escalations, and they've ranged in a pretty tight band from 8.1% to 8.7%. Clearly, there's been multiple expansion in the space as well as the 10-year Treasury has moved materially. As we've said in the past, you should expect us to transact in the low to mid-7% range on a cash cap rate basis. And I would say that movement in any given quarter is more a reflection of the individual deals that we do during a quarter in the industries and the tenancies than the macro trend.
That's helpful. Because of your exposure to non-investment-grade tenants, we've gotten some feedback from investors who were concerned with the risk in your portfolio in case of a downturn. Could you go through some of the more important aspects of your strategy that would potentially mitigate this perceived risk?
Yes. And I can take about an hour doing that. We firmly believe that our non-rated strategy of originating direct -- directly originated sale-leasebacks on our lease form offers a more compelling risk return investment and mitigants of not investing with investment-grade tenants are really reflected in our unit-level coverage. And the disclosure we provide around that in our supplement is pretty robust and compelling, in our view. It's also reflected in the fact that we get unit-level profit and loss statements for 98% of our portfolio. It's reflected in the fact that nearly 70% of our portfolio is lease subject to master lease provisions, where we're able to mitigate individual site risks and couple sites together. And it's also reflected in the fact that we're buying in the mid-7.5% range, which, one, provides a margin for safety; but two, allows us to have an entry point into the real estate that isn't inflated and have a better basis in our properties to the extent that some of these credits have issues. But we are firm believers that investment-grade tenancy does not equate to a more safe investment.
And at this time, there are no further questions left in the queue. Mr. Mavoides, I'd like to turn the call back over to you for any closing comments.
Great. Well, we're really happy about the quarter we just reported. We're excited for 2020, as reflected in our guidance, which we believe to be compelling. And we're looking forward to meeting with investors at the upcoming NAREIT. So thank you all for your time today.
Ladies and gentlemen, this does conclude today's teleconference. We appreciate your participation. You may disconnect at this time, and have a great day.