National Retail Properties Inc
NYSE:NNN
Earnings Call Analysis
Q4-2023 Analysis
National Retail Properties Inc
Welcome to the storyline of NNN REIT Inc.'s Q4 and year-end 2023 earnings, where the CEO, Steve Horn, led us on a journey of continued growth and disciplined strategy. The tale begins with a notable 34th yearly increase in dividends—a testament to NNN's consistent performance and commitment to shareholders. The year also heralded a significant rebranding initiative and an optimized executive team geared towards future endeavors.
With a keen focus on growth and stability, NNN REIT expanded its real estate portfolio to encompass 3,532 properties exhibiting remarkable performance. An occupancy rate soaring to a historic 99.5% outdid the long-term average, underscoring the REIT's exceptional management and investment strategies.
In a year marked by over $800 million in strategic acquisitions, NNN REIT stood out as a model of superb capital allocation, prioritizing quality over quantity and boasting an impressive core FFO (Funds From Operations) growth. The company's careful deployment of capital, with little reliance on its credit facility, reflects its intention to maintain discipline and focus on mid-single-digit FFO per share growth.
NNN REIT demonstrated agility amidst fluctuating market conditions with its vigilant approach to pricing assets. Executing dispositions at attractive cap rates and efficiently managing the portfolio, they sold 19 assets at a 6.5 cap rate. Additionally, they plan to continue their strategic approach of reinvesting the proceeds into fruitful new acquisitions.
The financial narrative for 2023 culminated with core FFO per share at $3.26, reflecting a commendable growth of 3.8% year over year. Stripping away some accounting classifications, the FFO per share stood at $3.23, affirming the strength of the company's core operations. With an AFFO (Adjusted Funds From Operations) dividend payout ratio of 68.4%, NNN REIT generated about $187 million in free cash flow, underpinning its sound fiscal status.
As they set foot into 2024, NNN REIT crafts its path with a core FFO guidance of $3.25 to $3.31 per share and AFFO guidance ranging from $3.29 to $3.35 per share. Anticipating acquisitions between $400 to $500 million and dispositions worth $80 to $120 million, the REIT forecasts a sustained commitment to strategic financial management, despite the impending challenge of refinancing $350 million of debt due in June at a rate of 3.9%.
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Greetings. Welcome to the NNN REIT Inc. Q4 and Year-end 2023 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Steve Horn, Chief Executive Officer. You may begin.
Thank you, Olli. Good morning, and welcome to NNN REIT's Fourth Quarter 2023 earnings call. Joining me on the call is Chief Financial Officer, Kevin Habicht. As this morning's press release reflects NN's performance in 2023 produced 3.8% core FFO growth along with acquisition volume over $800 million. In addition, the year concluded with high occupancy of 99.5% and dispositions income-producing assets were 140 basis points lower than our acquisition cap rate, all driven by our best-in-class team here at NNN.
The end of the year served positions the company well in the near term. But a few highlights of 2023 that I'm proud of what NNN accomplished, the 34th consecutive annual dividend increase, the rebranding initiative and the positioning of the executive team for the future. While the name changed in 2023, the core pliability to realize long-term value at below average risk for our shareholders remain in the most simplistic form.
One, we continue to execute our strategy using a bottom-up approach. Continue to increase the annual dividend, maintaining the top-tier payout ratio and focusing on growing FFO per share in the mid-single digits over multiple years. We maintain this core philosophy by keeping disciplined and setting our acquisition activity and our balance sheet management to achieve that objective. Before I get into day-to-day operations and current market conditions, I'd like to welcome [ Gina Steffens ] to the executive team. Gena assumed General Counsel rule late in the fourth quarter. She joins NNN with a fantastic resume from public and private companies, bringing significant transactional experience. I look forward to the partnership going forward as NNN grows.
As I alluded earlier, NNN is in great shape. At year-end, NNN had $132 million drawn on the $1.1 billion credit facility after deploying over $800 million of capital for the year, based on our initial 2020 guidance, NNN has the ability to have minimal capital market activity in 2024. This is accomplished by using a nominal amount of the credit facility. The roughly $180 million free cash flow we generate and $100 million from dispositions to execute 2024 strategy.
Using these 3 sources I mentioned leaves NNN with potentially 0 equity requirements for the year. This strategy continues NNN discipline of being selective while deploying capital and opportunistically raising capital over the years. Management takes great pride in being best-in-class capital allocators, not asset accumulators. And that is a distinction that should not be overlooked for the company to execute in the long run.
As we stand here in February, given the macroeconomic forces in the current state of the sector's equity markets, it makes sense for NNN to maintain its operational discipline while deploying capital. That being said, if there's a change in the market as we progress throughout the year, NNN is well positioned and will capitalize on the right opportunities. Shifting to the highlights of the fourth quarter financial results.
The portfolio now contains 3,532 freestanding single-tenant properties that continue to perform exceedingly well. Occupancy levels reached historic highs of 99.5%, which is well above our long-term average of 98%. The fourth quarter bankruptcy filing of Rite Aid will have minimal to 0 impact on NNN at the time of the filing, NNN was the owner of 6 assets. And as of the end of January, 2 of those leases had been rejected by the tenant.
In any event, the rent on those assets are near market, so I expect the rent recovery is in our historical averages. Turning to the acquisitions. During the fourth quarter, invested nearly $270 million in 40 new properties, an initial cap rate of 7.6%, with an average lease ratio of 19.6. Nearly all the capital deployed for the quarter was provided to our relationship business partners. In addition, the long-term projected yield on those acquisitions is 8.9%, which is a reflection of the sale leaseback acquisition model versus buying existing shorter-term leases.
2023, the market was constantly in price discovery mode with the bid-ask spread fluctuated but we continue to maintain our thoughtful and disciplined underwriting approach. Throughout the year, NNN picked up 20 basis points for the last 3 quarters in acquisitions. That trend continued with pricing of deals in the fourth quarter that will close in the first quarter. There is a moment within the last 60 days that passing through cap rate increases became more challenging.
As despite the pressure from our competitors' acquisition needs hindered that cap rate expansion to a certain extent. Slowing down the cap rate expansion is resulting in the second quarter cap rates being similar to the first quarter. So that change could continue as we move through the quarter. Also during the quarter, we sold 19 assets at a 6.5 cap, which included 14 vacant assets, raising $26.5 million of proceeds to be reinvested in new acquisitions.
For the year, we raised approximately $115 million of proceeds from the sale of 45 properties at 5.9%, which included 21 vacant properties. The 5.9%, as I stated in the opening was 140 basis points inside where we deployed capital for 2023, which proved NNN's excellent execution with managing the portfolio. Job 1 is always a release to vacancies but we'll continue to sell nonperforming assets, and we don't see a clear path to generating rental income within a reasonable time period.
With that, let me turn the call over to Kevin for more detail and color on our quarterly numbers and 2024 guidance.
Thanks, Steve. And as usual, let me start with the cautionary statement that we will make certain statements that may be considered to be forward-looking statements under federal securities law. The company's actual future results may differ significantly from the matters 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 this morning's press release. With that out of the way, headlines from this morning's press release report quarterly core FFO results of $0.85 per share for the fourth quarter of 2023.
That was up $0.05 or 6.3% over year ago results of $0.80 per share. I will be quick to point out, as detailed in the footnote below the earnings table on Page 1 of the press release that the fourth quarter included $0.03 of accrued rental income in connection with the reclass of one tenant from cash basis accounting to accrual basis accounting as a result of continued improvement in that and its financial condition post pandemic.
So with AFFO's $0.03 per share, the fourth quarter core FFO would have been $0.82 per share or 2.5% over a year ago result. For the full year, as Steve mentioned, full year 2023, we reported core FFO of $3.26 per share, which was 3.8% over a year ago results. Now if we exclude the same $0.03 from the accounting reclass, full year results would have been $3.23 per share or 2.9% over year ago results, which was at the top of our guidance range last provided.
AFFO results, which are not impacted by accrued rent were $3.26 per share for the full year or 1.6% over prior year results, again at the top of our guidance range. As we've disclosed since 2020, the last page of our press release provides details of the pandemic deferred rent repayments. And so as those tenants fulfill their deferred rent obligations the repayment amounts are slowing from $14.5 million in 2022 to just $3.1 million in 2023.
And so at the bottom of Page 13 of the press release, we have provided pro forma or adjusted per share amount, excluding these repayments in both 2022 and 2023 and to provide a look at what the recurring fundamental per share performance was. And so these adjusted results show full year 2023 per share growth of 4.9% for core FFO and 3.5% for AFFO, both notably better than the reported headline number.
We think this gives a better picture of the core fundamental operating results of our business but overall, a good quarter, in line with our expectations. And as can be seen, again on Page 13, those deferred rent repayments are now 93% completed. And so they will have a much smaller impact in 2024 and beyond. All right. With that, moving on, our AFFO dividend payout ratio for 2023 was 68.4%, and that resulted in approximately $187 million of free cash flow for the year, and that's after the payment of all expenses and dividends.
Occupancy was 99.5% at year-end. G&A expense was $10.5 million for the quarter and $43.7 million for the full year, representing 5.3% of revenues for the year, which again was in line with our guidance. We ended the year with $818.7 million of annual base rent in place for all leases as of December 31, 2023. Today, we also initiated our 2024 core FFO guidance at a range of $3.25 to $3.31 per share and 2024 AFFO guidance with a range of $3.29 to $3.35 per share.
Page 7 of the press release gives you some details on the key assumptions underlying the guidance, and they include $400 million to $500 million of acquisitions, $80 million to $120 million of dispositions G&A expense of $46 million to $48 million and property expenses net of tenant reimbursements of $9 million to $11 million. We do have $350 million of 3.9% debt coming due in June of this year 2024. And so the refinance of that debt will create nearly a couple of pennies of headwind on 2024 results.
Hopefully, as the year progresses and consistent with -- as we've done in the past, we will have the opportunity to drift our guidance higher. Switching over to the balance sheet. We maintain good leverage and liquidity profile with $968 million of availability on our $1.1 billion bank credit facility. And as Steve mentioned, despite near-record high acquisition volume in 2023, we funded approximately 37% of our $820 million of acquisitions with free cash flow of $187 million plus the $116 million of disposition proceeds.
We continue to be sensitive to our external capital market footprint in this environment. Based on the midpoint of our acquisition and disposition guidance for 2024, we should fund approximately 60% of our 2024 acquisitions with free cash flow and disposition proceeds. Our weighted average debt maturity remains 12 years, which will help us slow the coming refinance headwind that all REITs are phasing in the coming years.
Net debt to gross book assets was 42% at year-end. Net debt-to-EBITDA was 5.5x at December 31. Interest coverage and fixed charge coverage was 4.5x for 2023 and all of our properties owned by NNN are unencumbered by mortgages. We remain focused on working to appropriately allocate capital, which to us means ensuring we are getting what we believe are appropriate returns on equity while controlling risk through property underwriting and maintaining a sound balance sheet.
We believe it's one of the more fundamental issues for any REIT or, frankly, any company, valuing equity adequately whether that equity is produced by a free cash flow or disposition proceeds or new equity issuance is at the heart of growing per share results over the long term, in our opinion. So in closing, I think we're in a relatively good position to navigate the economic and capital markets uncertainties and to continue to grow per share results, which we view as the primary measure of success.
And we are mindful that this is a long-term multiyear endeavor. But the fundamentals of our business remain in good shape. With that, we will open it up to any questions, Olli. Thank you.
Certainly. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Your first question for today is coming from Spencer Allaway at Green Street.
Can you plus talk about how cap rates are trending thus far into '24? And similarly, how deal volume is trending just based on what you've sourced and what you can see maybe looking out the next 30 to 60 days.
Spencer, Stephen here. Yes. So going into 2024, as I alluded in the opening remarks, we were picking up 20 basis points each quarter. And then I expect that, if not a little bit higher from the first quarter for the deals that got priced in the fourth quarter. But we kind of noticed it felt like there's the other REITs put some pressure to the [indiscernible] have to do acquisition volume, which kind of plateaued the cap rates. That we're seeing that might close in the second quarter.
So I kind of see the first half of the cap rates being the same, but they're definitely trending up for the first quarter. As far as deal volume, there's definitely not as much deal volume out there as there was kind of in the second and third quarter. And I think that's more from the seller side, the supply side, when there is discussions of rate cuts coming that some sellers are holding off hitting the market, anticipating better cap rates in the near future.
But that being said, we're NNN, our acquisition guidance there's plenty of deal volume out there for NNN to hit its numbers.
Okay. Great. And then just any specific industry within your existing tenant base that's showing more appetite to grow? Or maybe on the flip side, downsize their current footprint just based on discussions you've had?
The latter part of the question, no, we're not hearing anybody who wanted to downsize in our sectors. Everybody is always reevaluating their business models. But as far as growth through M&A or adding stores, there's still a big push in the auto service center from our client base is still growing and we're certain to see a little bit of the QSR momentum pick up. And then lastly, there is some activity in the C-store market again that we're kind of filtering through opportunities.
Your next question is coming from Joshua Dennerlein with Bank of America.
This is [ Daryl Granith ] on behalf of Josh. I was wondering if you could elaborate on any bad debt assumption in the especially compared to historical.
Yes, sure. This is -- yes. So as usual, for us, we have assumed in our guidance 100 basis points of rent loss baked into our guidance. And that -- I would say what is typical and what included in 2023 is that we typically run kind of 40 to 50 basis points a typical year. So yes.
Okay. And can you walk me through maybe some of the internal external drivers of growth given your lower acquisition guidance?
Yes. For us, in one sense, it's a fairly simple kind of model. Rent growth. We assume and our portfolio is going to be -- internal growth will be about 1.5%. So that would add about $12 million, 1.5% of $818 million or whatever the number was, call it, $12 million. But we've assumed we'll lose 100 basis points of rent loss, which I like we've indicated it's probably hopefully a conservative assumption. So that's negative $8 million. And then you got $3 million to $4 million G&A creep. And then as I mentioned, we'll have interest expense for the year, we'll probably be about $5 million to $6 million higher as it relates to the refinance of that $350 million.
And so that -- and then you layer in acquisitions if you assume midpoint $450 million then those are kind of the pieces I think that got us to where we are in terms of our guidance. And like I said, hopefully, we'll have an opportunity to drift that higher, that guidance higher as the year progresses and consistent with what we've done in the past. But that's where we were comfortable starting out guidance.
Your next question for today is coming from Smedes Rose at Citi.
I just wanted to go back for a moment to the acquisitions outlook. It just was a little bit light, at least relative to our expectations, and I think maybe relative to some of your commentary, and you mentioned earlier that sellers are kind of holding off maybe looking for better pricing for them later in the year. I was just wondering, is that something that sort of changed maybe over the last since your last call? And maybe you could just talk a little bit more about the opportunities on that front.
Yes. I mean as far as the outlook, our acquisition volume I think we've been pretty consistent over the course of the last 6 months that we are looking at a light capital markets footprint. So the $400 million to $500 million range of acquisition is pretty consistent. What has changed from the last call was the market was expecting rate cuts coming in March. That was the probability but during the last call, that was not on the table. That was more kind of a mid-December discussion item. And at that point is where we felt that sellers weren't coming to the market expecting those future rate cuts, but now they're being delayed.
And Smedes, this is Kevin. One other thing I'd add is that that's our style in our approach. I think if you look back over history, I'm guessing our initial acquisition guidance has always looked like. relative to where the year ended up 2023 included. And so it's funny in our business, as we've said, you really have 3 months, maybe 4, but not very much look into the future in terms of the pipeline, I mean, a real pipeline.
And so it's -- we tend to be probably a little more cautious on the front end going in until we have a better sense of how the year is going to play out.
And then I just wanted to ask you on the tenant that moves back to accrual rents from I guess, cash payments. Is that sort of just, I guess, more or less unusual or it's something that you might expect more of as we move through the year.
Yes. Yes. It's unusual. It was unusual due to the pandemic for us to actually go from accrual to cash basis and then it's unusual to reverse it and its gap accounting unusual that you would recognize revenue or income when you do always do this. And so we currently have about 5% of our base rent is still on a cash basis.
So there's the potential for more of that in the future. Now that 5% consists -- 90% of that 5% is 2 tenants, AMC and [indiscernible] And so I don't sense -- in the near term, there's going to be that reclassification that we just did. So I'd say in the near term, I don't -- I wouldn't expect anything on that front.
Your next question is coming from Alec Feygin with Baird.
So I want to ask about the size of the development pipeline right now and how you see it trending?
I would say 2023 was a bit, what we call split-funded program. Just to be clear, we don't develop assets. We're more of a funding source to our current tenants on that. So we're not having any speculation, permits and leases all in place by the time we deploy capital. Now that being said, the 2024 pipeline currently is not as large as 2023, but 2023 was a historic high for us, and that was a result of the banking market where our tenants on the regional banks weren't deploying capital, so they came to us for money. So we had a really strong year in 2023.
Okay. Got it. And the second question is, what are you thinking for capitalized interest in 2024?
Yes. And so based on that activity in our split-funded program, we'll continue to have capitalized interest and so for last year, it totaled $4.3 million for 2023. I think it will be somewhat less than that. So let's call it around $3 million maybe. But we'll see how it plays out. I will now just for everybody. And as a reminder, we do deduct capitalized interest in our calculation of AFFO. I don't think that's probably -- I don't think everybody does that. And so I just wanted to kind of highlight that.
Your next question is coming from Linda Tsai with Jefferies.
Could you discuss some of the trends you're seeing in the sale-leaseback market?
Linda. Yes, the trend is pretty much similar to the way it's been the last few years. I think with the banks pulled back, there is more of an opportunity for sale leaseback funding. I'm not going to say 2024 is going to be a larger opportunity in 2023 because the regional banks are starting to lend a little bit more. But the cap rate -- it's always a pricing question as you know. And the bid-ask spread was fairly large throughout 2023. It has narrowed substantially just a case in point of us doing nearly $270 million in the fourth quarter.
But we're being very selective going into 2024 until the capital markets on the equity side as we feel are a little bit more open. But the sale-leaseback market, again, there's plenty. It's undefined by size, and there's plenty of opportunity out there to do deals.
And then the delta between acquisition and disposition cap rates, where do you think that trends each quarter?
Historically, it's always been kind of 100 basis points for us we try to get a little bit more than that. 140 basis points was a significant year for us, and that's kind of why we kind of highlighted on the call. But in our model, we look at 100 basis points.
Just one last one. I know bad debt expectations are low, but could you just compare the tenant watch list for you today versus a year ago?
To think about a year ago. But I'd say it's pretty -- the list is consistent. There's no real new names popping up. A couple have dropped off for better or worse in terms of -- we had 3 Bed Bath & Beyond. We've got a handful of Rite Aid. And so they'll die a natural death, I believe. But others that we've talked about in recent quarters are still on the list. The at homes. We got 2 big lots our 3 big lots and 2 JoAnne. We also own some [indiscernible] restaurants, which is a restaurant come Big Boys, Midwest Big Boy hamburger concept that we have concerns about and we've talked about.
And then, of course, the theater exposure, but that's kind of -- I put in a separate bucket a little bit. And to be honest, I don't feel we feel pretty good about where they are at the moment in terms of their liquidity and the ability to pay us rent in the near term. So but yes, so all that to say is, yes, no real change in the list or the composition or size of the list.
Your next question is coming from Ronald Kamden with Morgan Stanley.
Just staying on the tenants a little bit. I know you get sales with a lag, obviously, from the tenants, but are you sort of seeing anything suggesting that, that low-end consumer is slowing. I think we hear a lot about it, but curious if any of your concepts or tenants are showing sort of softness there.
From the debt exactly, it is stale. It takes time to get it in and process it and not every tenant devolves it quarterly, sometimes it's annually but more through discussions, I think, is more live, real-time data that we obtain is we're not seeing the sales of our tenants dropping. So not thinking it's getting soft by any means currently. They're all performing if I can say, killing out of the park, but they're performing well.
We do see some margin expansion within the QSR meaning that they still can get the price through and their labor costs are not eating them up. But overall, we're not seeing a significant softness within our tenant base.
Great. And then just switching gears to the acquisition market a little bit. Maybe talk a bit more about the competition today versus previously? I know you mentioned some of the REITs maybe in your opening comments, but curious about 1031 private buyers just today versus 6, 12 months ago, what is that -- who are you competing now.
Yes, because we go after the sale leaseback approach, that's our model. We think it's a lot better of a risk-adjusted return. That we don't play in the 1031 market. So we don't run into the 1031 guys at all to speak of but we would run into the private equity buyers that have been on the sidelines for a while. We are hearing rumblings that they're starting to thinking about getting back in the market but they're not the groups I would lean on that were hurting the price cap rate expansion. It was more our competitors.
But Ron, to be honest, that happens typically in the late in the fourth quarter, early in the first quarter. when companies are coming out with their guidance for the year. They feel the pressure to do the volume. So we see that year-over-year.
[Operator Instructions] Your next question is coming from Connor Siversky with Wells Fargo.
A quick question for Kevin on the balance sheet. I'm just looking at this $350 million maturity in June. I'm wondering how the swaps are set up. Can you just roll that over and keep the same rate in? Or should we expect the kind of cash outlay associated with paying down that stack.
Yes. So yes, we have no derivatives or swaps connected to that debt or any debt at the moment. And so any swaps that we had derivatives that we use were only pre issuance, if you will, and those were terminated at the time we issued the bond. So any cost or gain associated with those get amortized over the life of the bond. But like I say, all of those derivatives get terminated at the time of debt issuance. So nothing outstanding there.
So yes, you should think about that as a true $350 million debt maturity. We'll see what we want to do in terms of accessing the debt markets. They're obviously open right now. They are, I would say, reasonably priced at the moment. For us today, we're probably kind of a mid-5% for a 10-year kind of issuance would be my guess. But we do love the optionality, and this may or may not be plan A, but we can use our bank line, too.
We have sufficient capacity on our bank line that if the markets weren't aware we might like or we wanted to wait, we could easily pay off that maturity just using our bank credit facility.
Okay. That's all for me.
Your next question is coming from John Massocca at B. Riley.
Sorry if I missed some of the responses to earlier questions, but do you have like brackets around the amount of contractual rent you have in place from cash basis tenants today, just given the movement of 1 tenant to an accrual basis?
Yes. So yes, we have 5% of our annual ABR, annual base rent is on a cash basis. And like I say, really 90% of it really consists of 2 tenants, AMC and fishes. And -- but we -- through the year, 2023, they are all current. And so there was no delta between cash and book basis or booked revenue as it relates to that.
And again, as I mentioned, we don't expect -- I don't expect either of those tenants moving from a cash basis to accrual basis in the near term. And so they'll remain cash basis. But it has no real impact really on the way we operate or the way we think or frankly, and I wouldn't include it in the way we model things. And so we assume they'll continue to pay rent going forward. Having said that, we created 100 basis point rent loss assumption baked into our guidance to hopefully account for any kind of hiccups on the tenant rent side.
Okay. And then I know we're dealing with small sample sizes, but what's the plan for the Rite Aids you're getting back or might potentially get back? And do you think there's a market out there to release them as pharmacy or that they need to be kind of repositioned for I guess, higher and better use, if you will.
Yes. Currently, the 2 that were rejected out of the 6, we have a lot of interest if it not surprising the car wash, but we have some QSR interest as well. So I'd expect those 2 to be redeveloped and put on a ground lease the other 4 as far as Rite Aid performed fairly well. So we'll see what happens if and when we get those back. But again, kind of what I stated in the opening remarks, they're well positioned. They're near market rent. So I'm not expecting anything outside our historical averages as far as a recapture rate.
And then just in terms of kind of modeling and AFFO, anything to be aware of in terms of rent bumps us -- given a good portion of the portfolio has kind of 5-year look backs on bumps. Just is there any seasonality here? Or last year, just to be aware of as we're kind of updating your models.
Yes. No, in terms of rent increases, while we have a variety of one year annual increases or increases every 3 years or increases every 5 years, we have a sample size that's sufficiently large that it all pencils out to be about 1.5% a year despite those varying terms for rent increases. So the way I would think about it is a 1.5% rent increase for this year and going forward.
That makes sense. And that's it for me.
We have reached the end of the question-and-answer session, and I will now turn the call over to Steve for closing remarks.
Thanks, Olli. Thanks for joining us this morning. Just to kind of reiterate and then we're in good shape as we head into 2024. We're willing to pivot if market conditions change. We look forward to telling the story to many of you guys kind of in the upcoming conference season. Take care. Thanks.
Thank you. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.