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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, hello. And thank you all for joining this Essential Properties Realty Trust Fourth Quarter 2019 Earnings Call. All lines are in a listen-only mode. But instructions on how to ask a question will be shared after today’s presentation.
To get us started with opening remarks and introductions, I am pleased to turn to you the floor to Senior Vice President of Capital Markets, Mr. Dan Donlan. Welcome, Dan.
Thank you, operator, and good morning, everyone. We appreciate you joining us today for Essential Properties Fourth Quarter 2019 Conference Call. Here with me today to discuss our fourth quarter results are Pete Mavoides, our President and CEO; Gregg Seibert, our COO; and Hillary Hai, our CFO.
During this call, we will make certain statements that may be considered forward-looking statements under federal securities law. Company's actual future results may differ significantly from the matters discussed in these forward-looking statements. 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 filing with the SEC in today's earnings release.
Before I turn the call over to Pete, we would like to apologize to investors and analysts inconvenience by the rescheduling of our earnings date and conference call. Unfortunately, with 2019 being our first year as a large accelerated filer, the process of getting through SOX compliance and completing our audit, we acquired additional time relative to our initial expectations.
With that, Pete, please go ahead.
Thank you to everyone, who joined us today for your interest in Essential properties. We are very pleased to report another strong quarter of results. Consistent with past quarters, the fourth quarter saw a solid portfolio performance with same-store rent growth of 1.7% and no vacancy. Investment activity during the quarter was robust with $205 million invested into 94 properties and 41 separate transactions at a 7.3% cash cap rate.
We also had an active quarter on the capital markets front. We closed a $430 million unsecured seven year term loan, which has a $70 million accordion feature. We also raised $103 million of gross equity proceeds via our ATM program. The end result is that we are reporting fourth quarter AFFO per share of $0.30, representing an 11% year-over-year growth rate.
Looking back at the year, we experienced a transformative improvement in our cost of capital, which allowed us to take a more aggressive stance in regards to our investment activity and balance sheet. We invested $687 million into 375 properties in 136 separate transactions at a 7.4% initial cap rate.
We raised $424 million of gross equity to maintain a well-capitalized balance sheet and raised $630 million of senior unsecured term loan debt to further unencumber our asset base extend out our maturity schedule and lower our weighted average interest rate.
In addition, we sold $519 million of secondary shares from our founding capital partner, which allowed us to increase our free float and daily trading volume while further broadening our investor base.
Lastly, we increased our quarterly dividend by 9.5% during the year, while maintaining a conservative payout ratio in the 70% range. We are proud of these accomplishments. And I would like to thank all of our employees, shareholders and other stakeholders for their support, closing out a very successful 2019.
Turning back to the fourth quarter and starting with our investment activity. We invested $205 million at a weighted average initial cap rate of 7.3%, approximately 81% of our fourth quarter investments were directly originated sale leasebacks or mortgage loans subject to sale-leaseback transactions, 41% contain master lease provisions and 99% are required to provide us with corporate and unit-level financial reporting on a regular basis.
On the disposition front in an effort to proactively mitigate risks and exposures, we sold eight properties in the quarter at a 6.9% cash cap rate, which generated $15.2 million in net proceeds.
Looking at the year-end portfolio, we had investments in 1,000 properties that were 100% leased to 205 tenants operating in 16 different industries. Our weighted average lease terms, due to a sector-leading 14.6 years and just 2.7% of our ABR is expiring prior to 2024. Our same-store portfolio work represented 62% of our ABR at quarter-end experienced cash rent growth of 1.7%.
As we have mentioned in the past, when coupling our contractual rent growth with lease rollovers and potential credit loss, we expect same-store cash rent to approximate 1.5% per annum over time. We are pleased to have exceeded this threshold every quarter since coming public, which we believe is a testament to our well-diversified, newly underwritten portfolio. From a tenant health perspective, our portfolio has a weighted average rent coverage ratio of 2.9 times, was 72.6% of our ABR having rent coverage ratio of two times or better.
Looking out over the next 10 years, less than 1.5% of the leases that expire have unit level rent coverage below 1.5 times, which we believe indicates a high likelihood of lease renewal at expiration. Additionally, only 1% of our tenants have both an implied credit rating lower than single B from Moody's risk out and unit level coverage below 1.5 times, which represents a very manageable number of tenants and properties with elevated risk characteristics.
With that in mind, a key element of our investment strategy is to take calculated tenant risk to achieve what we believe are superior risk-adjusted returns. We seek to mitigate these risks through a structuring process, which focuses on direct sale leasebacks on our lease form with master lease provisions and contractual tenant reporting requirements.
We further reduced risk by owning granular and fungible real estate properties that are highly liquid in the sales market and readily fungible from a leasing perspective. We believe, we are well compensated to these risks. Namely, we have invested at a 7.6% weighted average cash cap rate since inception. The collateral benefits of our attractive initial yields are a lower basis in our real estate, and the ability to execute de-risking sales of individual properties at cap rates that are nearly 100 basis points lower than our initial investment. This runs contrary to paying significantly lower cap rates for properties leased to investment-grade tenants, which often results in an inflated basis, inferior lease structures and limited unit level visibility, thereby providing little margin for error in our view.
With all that said, subsequent to year-end, Art Van Furniture, our third largest tenant at 2.5% of ABR, publicly commented that they are actively exploring a variety of options with creditors, investors and landlords to ensure the company's future. We have remained in constant dialogue with Art Van and their advisers, but it is still too early us – for us to opine on the eventual outcome.
As a reminder, we own four properties leased to Art Van, representing roughly 241,000 square feet. We acquired our Art Van exposure in a five unit sale-leaseback transaction in March of 2017. And after selling one property in the second quarter of 2019, our yield on cost is 7.9%. Per our disclosure, Art Van is currently paying approximately $16 per square foot in rent at our properties and the range of potential outcomes can be readily calculated when looking at market rent comparable.
Keeping that in mind, we are managing an increasingly diverse and granular portfolio of net lease properties. No tenant represents more than 3.4% of ABR and our average ABR per property is approximately $152,000, which is among the lowest in the net lease sector. As such, our portfolio is built to withstand the impact of episodic tenant issues like Art Van, and we are reiterating our 2020 AFFO per share guidance of $1.27 to $1.30.
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 the call over to Hillary Hai, our CFO, who will take you through the financials for the fourth quarter. Hillary?
Thank you, Pete, and good morning, everyone. Starting with the balance sheet, we ended the quarter with $2.1 billion of total un-depreciated assets and $735 million of total debt. We have no significant debt maturities before 2024 and our net debt to annualized adjusted EBITDAre was five times at quarter-end.
However, when adjusting for the impact of our January follow-on offering, which raised $192 million in net proceeds, our pro forma quarter end net-debt-to-annualized adjusted EBITDAre was 3.6 times. This gives us ample capacity to continue to execute on our external growth strategy while managing within our targeted leverage range.
Moving on to our capital markets activities. During the quarter, we utilized our ATM to sell over four million shares of common stock at an average price of $25.23, raising gross proceeds of over $103 million. On the debt front, we drew down $250 million on our $430 million seven-year unsecured term loans facility, which has an additional $180 million of available borrowing capacity and $70 million accordion feature.
Turning to the income statement. Our fourth quarter may redefine funds from operations, or FFO, was $25.3 million or $0.31 per diluted share. Core funds from operations or core FFO was $26.2 million or $0.32 per diluted share, and adjusted funds from operations or AFFO was $24.4 million or $0.30 per diluted share. Of note, in the quarter, we wrote off $887,000 of deferred financing costs, which resulted from the voluntary prepayment of $70.4 million of Series 2016-1 Secured ABS Notes.
Turning to the expense front. Our G&A as a percentage of total revenues was 13.5%, which was on par with our trailing four-quarter average. Going forward, we continue to expect our G&A to grow on an absolute basis, but to decline as a percentage of total revenues. As Pete mentioned, we are reiterating our 2020 AFFO per share guidance range of $1.27 to $1.30, which at the midpoint implies approximately 13% growth year-over-year.
As we have stated in the past, our historical investment activity, which we provide on a trailing eight-quarter basis and our quarterly supplemental is a good goal post for our future investment potential.
With that, I'll turn the call over to COO, Gregg Seibert.
Thanks, Hillary. During the quarter, we invested $205 million into 41 transactions and 94 properties at a weighted average cash cap rate of 7.3%. These investments were made within nine of our 16 targeted industries, with the carwash, medical/dental and QSR industries representing over 70% of our investment activity in the quarter.
The average lease term of these properties was 16.3 years. The weighted average rent escalation was 1.3%. And the weighted average unit level coverage was 3.1 times, and our average investment per property was $2 million.
Consistent with our investment strategy, approximately 81% of our fourth quarter investments were originated through direct sale leasebacks and mortgage loans, subject to a sale-leaseback transaction, which are subject to our lease form with ongoing financial reporting requirements.
In addition, 78% of our fourth quarter investment activity was relationship-based. From an industry perspective, QSRs remain our largest industry at 14.2% of ABR, followed by carwashes at 12.5%, early childhood education and C-stores at roughly 11% each and medical/dental at 10.6%. Conversely, our home furnishings concentration is now just 3.5% of ABR, which is down 70 basis points quarter-over-quarter and down 260 basis points year-over-year. We expect this trend to persist as we see better risk-adjusted returns in other industries.
From a tenant concentration perspective, no tenant represented more than 3.4% of our ABR at quarter-end. Our top 10 tenants represented 23.4% of our ABR, which was down 210 basis points quarter-over-quarter. We expect our top 10 concentration to decline further in the coming quarters as we continue to grow our concentrations with existing tenants outside of our top 10.
Looking at the portfolio more broadly, approximately 94.4% of our ABR is derived from tenants that operate service oriented and experience based businesses, which is a 680 basis point increase since our IPO. We believe tenants in these industries, and more importantly, real estate occupied by these tenants are more recession resistant and better insulated from e-commerce pressures.
Moving on to asset management, our portfolio remains healthy with a weighted average rent coverage of 2.9 times, and 72.6% of our ABR, having a rent coverage ratio of two times or better. In addition, with 98% of our tenants, required to report unit level financials to us we have near real time transparency into the health of our tenancy, which is an important component to managing risk in our portfolio.
In terms of dispositions this quarter, we sold 8 properties with five different industries for $15.2 million, net of transaction cost. Despite having 1.7 unit level coverage, we achieved a 6.9% weighted average cash cap rate on the seven leased properties that we sold, which equated to an 8.5% realized gain versus our allocated purchase price.
With that, I will turn it back to Pete for his concluding remarks.
Thanks, Gregg. Our portfolio remains in excellent shape today with healthy coverages, coupled with strong transparency, high property level liquidity and de minimis near-term lease expirations.
Our pipeline is healthy with over $90 million of closed investments through February. With our January equity offering, our balance sheet is extremely well-positioned to fund our growth objectives as we look forward to continuing to execute our business plan.
Again, I would like to apologize for any inconvenience caused by our earnings call being unexpectedly pushed back. We look forward to meeting with many of you in the next several days at the Citigroup REIT conference.
With that, operator, please open the call for questions.
Pete, thank you, and thank you to each of our presenters for your remarks today. [Operator Instructions] We'll hear first from the line of Greg McGinniss at Scotiabank. Please go ahead. Your line is open.
Hey good morning, everyone. Gregg, if you -- actually, let's start with Pete. So we appreciate the update on Art Van. I was just wondering if you could clarify what the impact from that tenant is that's embedded in guidance?
Listen, we have a range of guidance, and we have a range of scenarios around the Art Van resolution in guidance. And regardless of those scenarios, the guidance holds, and so it's really too early to speculate on specific impacts. But our guidance holds independent of the resolution of Art Van.
Okay. So at the very least, we can assume that there is some impact at least embedded into that lower end of guidance?
Sure. Yeah.
Okay. And then, Gregg, so in Q4, there was a few shifts in top tenant list. We had Town Sports rejoin, R-Store, Ladybird selling off. Could you just give us some details as to what drove those changes?
Yes. We had a -- one property for the Ladybird transaction, which was a temporary loan that they paid off. So it was a -- we did a portfolio, and there was one short-term property, we -- they intended to exit from. And they executed on that. So they just dipped down slightly.
And then R-Store was acquired by GPM during the quarter.
Right, okay. Thank you.
Next, we'll take a question from the line of Ki Bin Kim at SunTrust. Please go ahead. Your line is open as well.
Thanks. I know you guys addressed this in the morning, comments about changing the date of the earnings release. But I just want to make sure that there is all the details that are out there. Was there anything that came out from the delayed earnings release and the 10-K?
No, no. If you -- we filed the 10-K this morning, and it was purely just a getting through that process as a first year SOX compliance.
Okay. And obviously, I don't want you to negotiate against yourself on a conference call, but what do you think are some of the likely scenarios to come out of Art Van?
Yeah. And then -- listen, I'm barely addressing hypothetical scenarios here, but it could be a liquidation. It could be someone buying a portion of that company and assuming our lease with the lease amendment. Or it could be a Chapter 11 restructuring and it's really – all three those scenarios are currently in play as we continue to have dialogue with that company.
Could you talk about the real-estate quality for the couple of boxes that you have?
Yeah. We own four furniture stores in Michigan. There are Art Van furniture stores and we have a couple of very good ones, and a couple of average ones. They're all subject to a master lease, as I said in the prepared remarks, 214,000 square feet with about $16 a square foot in rent, so.
And if I can squeeze the last question in here. I guess, more importantly though, is there any lessons learned from the Art Van scenario?
Every time you go through one of these, you learn some lessons, I think. We saw the declining performance in Art Van coming. We try to sell the properties. They had been listed for a long period of time and then – one of the key lessons, and we often talk about our granularity and our liquidity and given the size of these assets, they were a little less liquid than our average assets. And so that's a lesson, we continue to reinforce in our investment process.
Okay. Thank you.
You’ve got, Kin Bin. Thanks.
Our next question will come from Douglas Harter at Credit Suisse.
Hi. This is actually Sam Choe on for Doug today. So I'm seeing that the experience sectors kind of consists of 14% of your portfolio. And I'm just kind of thinking through more of the macro picture, if there is some sort of impact with the pandemic. I'm just curious as to how you guys see the tenant credit trending, if you have any commentary on that?
Yeah. I would say, clearly, and if you think about our entertainment sector comprising bowling alleys, and movie theaters, and places where people congregate, if the pandemic spreads and people elect not to use those facilities, it's going to impact the profitability of our tenants. And the magnitude of that really, it depends upon the depth and the breadth of that change in customer behavior. We believe it would be temporary. And certainly, as a landlord with healthy coverage, and master leases and healthy tenants, we would expect our tenants to be able to kind of withstand that temporary dislocation. But it's certainly something, we're going to watch very closely in the coming quarters as we get unit level profit and loss statements that come in and monitor our tenant health, which is an important part of our credit discipline.
Now, do you have the – like the average tenant credit for these sectors versus other segments in your portfolio?
We do. That's not something we necessarily disclose. I would say that, generically, the coverage and the credit profile of our entertainment tenants is very similar to our overall portfolio.
Okay. That's helpful. Thank you.
Thank you, Douglas – excuse me. Our next question will come from Nate Crossett at Berenberg.
Hey, good morning, guys. I appreciate the color on Art Van. Are there any other tenants on the watch list that we should be aware of?
No, nothing material. Clearly, American Blue Ribbon has been a name that people have been talking about. And we have a – seven properties with them, but we don't expect to experience any kind of rent loss through that process. But overall, the portfolio is in great health, really attributed to being a recently underwritten with fresh diligence and we feel good about where we're sitting.
Okay. And what about just like furnish – home furnishing in general. I know, this is kind of an Art Van-specific issue, but it looks like there's maybe three other locations, not Art Vans that you have that are home furnishings. Maybe what are those? And how do you feel about them?
Yeah. Listen, I think our home furnishing exposure has been coming down quarter-over-quarter since – really since 2017, as we haven't been investing in that sector. We don't love the sector and really think, there's a surplus of big-box retail spaces in our country that provides competition for our real estate. And so we have very modest furnishing exposure, and modest and just decreasing. And clearly, the three sites we have, we're comfortable with, some good sites. And one is in Dallas, Plano Metro, which is a really strong submarket. And other is in Fort Worth, which we feel really good about. And the third one is more of an upscale site outside of Kansas City. So the exposure we have, we feel good about. It's very modest. But overall, it's an industry that we have not been adding to.
Okay. Thanks.
Our next question will come from the line of Brian Hawthorne at RBC Capital Markets.
Hi. Your exposure to tenants with credit ratings of CC, C+ and B increased this quarter. What drove that change?
That was largely driven by Art Van and their year-end financials coming in weaker and getting a credit downgrade for the model.
That's it?
There’s another – there's about another 100 basis points in there and they're all just kind of small operators.
Okay. And then can you provide an update on the performance of the Perkins assets you have?
We really just kind of restructured that. And in the fourth quarter, and I haven't really got through their kind of year-end numbers yet. But we would imagine the sales at the sites we had, we're stable going into the restructuring. And one of the reasons why our lease was extended and affirmed and I wouldn't anticipate any issues there. But a recapitalized tenant with a firm lease is not something that gives us a lot of concern, but certainly something we're watching.
Okay. Thank you for taking my questions.
You've got, Brian. Thank you.
[Operator Instructions] Next, we'll hear from the line of John Massoca at Ladenburg Thalmann. Go ahead your line is open.
Good morning.
Good morning, John.
So what types of carwashes were kind of in the acquisition activity in 4Q, just because the two tenants you have in the top 10 didn't seem to increase at all?
Gregg, why don't you give some color there for him?
Sure. We -- I mean, we're adding on the carwash side, we have a lot of regional operators that perhaps have the dominant market share in their market in a lot of parts of the country. So we have a few groups in that 10 to 35 store dominant local player operators that we've been able to do a lot of direct sale leasebacks with. So that's kind of the profile.
Yeah. I'll just add some color there, John. You look at these big national guys, when they get to a couple of hundred units. So they get pretty efficient in the sale leaseback market and start charging cap rates in the low sixes. And we prefer to go with the regional 10 to 50-unit guy and get that extra 100 basis points and just add a little more value there. And so that's part of our investment methodology.
Your total exposure?
Say again? You broke up on us.
Sorry. Just broadly speaking, how kind of big are these operators in terms of the total number of units they are operating?
As Gregg said, it could be a 10 to a 50-unit operator.
Okay. And then -- hello? Sorry guys, I'm having a little trouble with the headset. Can you hear me?
Yes. We can.
Okay. And then last question. Does the current macro backdrop and the volatility in the capital markets change how you guys view leverage and maybe the pace of capital deployment?
Sure. I mean listen, we see what's going on with a pro forma year-end leverage sub-four. We feel pretty comfortable and as we deploy this capital and we look out and we continue to invest. We'll certainly be cognizant of the volatility and our own individual cost of capital, and certainly we feel like our balance sheet is positioned to weather a storm. And we just need to be cognizant about how long that storm may last.
Okay. That's it for me. Thank you guys very much.
Thanks, John.
[Operator Instructions] We'll take a follow-up from Ki Bin Kim at SunTrust.
Thanks. So excluding this past week, you guys were trading at a pretty healthy valuation level at one point, sub-5% implied cap rate. Obviously, that gives you the ability to raise some efficient -- debt and equity. But it also gives you a little more leeway in terms of maybe not having to buy a mid-7% cap rate, maybe it gives you the ability to increase the quality of acquisitions. Has that translated all into the type of assets you're targeting for investments?
Yeah. Listen, we buy what we believe to be the best risk-adjusted assets that we can source through our relationships and sale-leaseback transactions and get the most attractive cap rates. And we reject the notion that investment quality is solely equated to cap rate.
Clearly, our cap rates have come down from a year ago, we were transacting in the mid to high six. Now we're -- excuse me, mid- to high sevens. And now we're transacting in the low to mid sevens. But our investment discipline and the way we view risk is really an output of our collective 50 years of missing in this space, not the output of our cost of capital. And so what we buy is really the best stuff we can find with the -- at the most attractive yields.
Okay. And a question for Gregg, I know it's early, but is there any discernible trends you're seeing from the investment landscape for assets that are up for sale? Maybe in particular that relates to experiential or restaurants? Any kind of hesitancy or change in cap rates at all?
I mean, not yet. I mean, we don't -- we have, as you probably know, a few -- a number of assets on the market. We have people under -- buyers under some purchase contracts to purchase those? And I mean, we haven't seen anyone like fallout or try to re-trade because of what's going on in the stock market.
Okay. Thank you.
And at this time, we have no further signals from our listening audience. I'll turn it back to our leadership team for any additional or closing remarks.
Great. Thanks, Jim. Thank you all for participating today. Thank you for the questions. Again, we apologize for the -- any inconvenience, and we look forward to talking to you all in the future. Thanks again. Bye now.
Ladies and gentlemen, this does conclude today's update, and we do thank you all for joining. You may now disconnect your lines, and we hope that you enjoy the rest of your week.