NetSTREIT Corp.

Greetings and welcome to NetStreetCorp 4th Quarter 2021 Earnings Call. At this time, all participants are on a listen-only mode. Any question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Amy Ann, Investor Relations. Thank you. You may begin.

We thank you for joining us for NetStreet's fourth quarter and full year 2021 earnings conference call. In addition to the press release distributed yesterday after market closed, we posted a supplemental package and an updated investor presentation. Both can be found in the investor relations section of the company's website at www.netstreet.com. On today's call, management's remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risk and uncertainties that may cause actual results to differ from those discussed today. For more information about these risk factors, we encourage you to review our Form 10-K for the year ended December 31st, 2021, and other SEC filings. All forward-looking statements are made as of the date hereof, and NetStreet assumes no obligation to update any forward-looking statements in the future. In addition, certain financial information presented on this call includes non-GAAP financial measures. Please refer to our earnings release and supplemental package for definitions, gap reconciliations, and an explanation of why we believe such non-gap financial measures are useful to investors. Today's conference call is hosted by NetStreet's Chief Executive Officer, Mark Manheimer, and Chief Financial Officer, Andy Blocker. They will make some prepared remarks, and then we will open the call for your questions. Now, I'll turn the call over to Mark. Mark?

Good morning, everyone, and welcome to NetStreet's year-end 2021 earnings conference call. Before I discuss our activity for the fourth quarter and full year, I'd first like to take a moment to thank NetStreet's employees for their performance during our first full year as a public company. I am pleased with all that we have accomplished in 2021. While we spent most, if not all, of the past year dealing with the disruption of COVID-19, our employees across all aspects of our business performed seamlessly and exceptionally well. We would not have achieved these results without your hard work and significant contributions And for that, I thank you. Today, I am pleased to share that we have moved into our new headquarters in uptown Dallas, and our entire team is finally together full time. Our new space allows us to better collaborate, grow, and best position us to achieve our goals. In addition, I'm looking forward to promoting an environment where we're all proud and enthusiastic to work together to achieve our common goals. One of our objectives for 2021 was to grow our portfolio with high quality assets and to further diversify our portfolio holdings. The team underwrote and closed over $464 million of gross investment activity in 2021. The portfolio ABR grew to over $71 million, up from $42 million at the end of 2020. During the year, we added 15 new tenants to our roster and three new states to our portfolio. We have stated for our portfolio diversification goals, that we want no state or industry to be more than 15% of our total ABR and no tenant to be more than 5%. And we have made significant progress towards those targets. As of year end, our largest state concentration is in Texas at approximately 11%. Our largest industry is home improvement at 15%, and our top tenant, Walgreens, is at slightly over 7%. During 2021, we sold nine properties for total proceeds of $31.9 million at a cash capitalization rate of 6.5%. The dispositions de-risked the portfolio by decreasing our exposure in casual dining and banking and removed RV sales from our holdings. As of December 31st, 2021, our portfolio was comprised of 327 properties in 41 states with an aggregate of 6.4 million square feet. We had 67 tenants, operating in 23 different industries. Our portfolio experienced no vacancies and had 100% rent collections during all of 2021. The weighted average lease term remaining at year end was 9.9 years. Our portfolio has a combined investment grade and investment grade profile tenancy of 81.6%. During the fourth quarter, we completed a record high quarterly net investment activity of $160 million, which includes $151 million of acquisitions and ongoing development funding of over $9 million. Acquisitions completed in the quarter had an initial cash capitalization rate of 6.5% and had a weighted average remaining lease term of 10.4 years. Acquisitions completed in the quarter were with 39.5% investment grade tenants and 18.4% investment grade profile tenants. While the investment grade percentages in the quarter were lower than typical, this was largely driven by acquisition mix. specifically a larger three-property all-or-nothing acquisition in the Lincoln Park part of Chicago. This included a very well-located floor and decor, a strong-performing Olive Garden ground lease, and an L.A. fitness that we currently hold in our TRS. While we are not looking to add fitness to the portfolio, and this is not likely to be a long-term hold, we were comfortable with the exceptional real estate, replaceable rents, and 18 months of rent escrowed at the beginning of our investment. During the fourth quarter, we provided over $9 million in development funding for five new projects, two of which are with investment-grade tenants, and three were with investment-grade profile tenants. We funded 10 development projects in the year with estimated costs of $40.3 million. We have been pleasantly surprised by the amount of interest and partnership opportunities for development, and we believe this can be a growing part of our growth strategy. We had no dispositions during the fourth quarter, and we expect any future disposition activity to be replaced with additional property acquisitions. While we view the curating of our historic portfolio to largely be complete, future asset sales will occur to the extent we see opportunities arise to accretively improve the credit quality and diversification of the portfolio. Or if we see an opportunity to sell a portion of a larger acquisition in order to own the portion we want long-term, at a better risk-adjusted return, similar to the acquisition of the Florin Decor and Olive Garden in Chicago. Our top 20 tenants include companies with strong balance sheets and excellent management teams, and are tenants that we want to grow with. A great example of this is our relationship with Hobby Lobby, which is the third largest tenant in our portfolio. Hobby Lobby is an industry leader in the arts and crafts business that has an excellent corporate financial performance and falls within our investment grade profile category. In addition, they generally operate in prime locations and dense retail corridors. Before I hand the call off to Andy, I want to affirm that as we look to 2022 and beyond, we will continue to focus on execution and growing our best-in-class portfolio with high-quality tenants. We want to continue our innovative approach in sourcing deals and building the right relationships with trusted partners to grow our business for all of our valued stakeholders. As important as our growth and financial performance, however, is our commitment to the principles of ESG. Last year, we enhanced our ESG disclosure significantly, providing detail around each element. And we will continue to provide additional disclosures going forward. With that, I'll turn the call over to Andy to go over our fourth quarter financial results and 2022 guidance.

Thank you, Mark. And once again, thank you for joining us on today's call. In our earnings release published yesterday after market close, we reported net income of 5 cents, core FFO of 25 cents, and AFFO of 27 cents per diluted share for the fourth quarter. For the full year 2021, we reported net income of 8 cents, core FFO of 87 cents, and AFFO of 94 cents per diluted share. At year end, our balance sheet had total debt of $239 million outstanding, of which $175 million is from our fully hedged term loan, with the remaining balance from our revolving line of credit. We have no debt maturities until the maturity of our revolver in December 2023, which is subject to a one-year extension option to align with the December 2024 maturity of our $175 million term loan. Our net debt to annualized adjusted EBITDA ratio was 4.2 times at year end, below our targeted leverage range of 4.5 to 5.5 times. Moving on to our capital markets activity, We strengthened and fortified our balance sheet through a series of financing activities last year and early this year. On April 12, 2021, we completed our first follow-on equity offering, issuing nearly 11 million shares of common stock at a price of $18.65 per share. We received gross proceeds from the offering of approximately $203.6 million. In September, we simultaneously filed our universal shelf registration with the SEC and entered into a $250 million ATM program, which allows us to sell shares of our common stock from time to time in an efficient manner. During the fourth quarter, we issued nearly 3.9 million shares of common stock at a weighted average price of $23.36 per share in connection with our ATM program for gross proceeds of approximately $90 million. The vast majority of this volume came as a result of a reverse inquiry from a high-quality rededicated investor. In January, we completed a public offering of 10.4 million shares of our common stock at a price of 22.25 per share under a forward sale agreement. We did not receive any proceeds from the sale of these shares, and we will have until January 10, 2023, to physically settle the forward sale agreements and receive the proceeds. With these recent equity deals and reasonable expectations for ATM usage and leverage, we have sufficient dry powder to fund our targeted investment activity through this year. In addition, the flexibility of the forward positions NetStreet to better benefit from leverage as we can draw down our forward commitment as needed rather than a one lump sum and effectively remove the key financing risks for 2022 projections. With regard to our dividend, earlier this week, the board declared a 20 cent regular quarterly cash dividend to be payable on March 30 to shareholders of record as of March 15. In our January business update, we established our 2022 AFFO per share guidance in the range of $1.13 to $1.17 per share. Our guidance includes the following assumptions. Net acquisition activity in the year including completed developments and net of dispositions to be at least $480 million. cash G&A to be in the range of $14.5 to $15 million, which is inclusive of transaction costs. Non-cash compensation expense is expected to be in the range of $5 to $5.5 million. Cash interest expense, also to be in the range of $5 to $5.5 million, with approximately $600,000 of additional non-cash deferred financing fee amortization. And full year 2022 diluted weighted average shares outstanding, which includes the impact of OP units, to be in the range of 52 to 54 million shares. Before we move on to your questions, I want to echo Mark's sentiment. I'm very proud of the team at NetStreet and all that we accomplished in 2021. Our team is now fully back in the office. There is a degree of collaboration and camaraderie that is impossible to emulate while working remotely. While I've been impressed with what we've accomplished working apart over the past roughly two years, including acquiring over $750 million of assets, executing our IPO and two follow-on offerings, building out our team from 9 to 23, and establishing a successful control environment that allows us to seamlessly become an accelerated filer. I know that the increased communication and collaboration we have started to see in the few weeks we have all been back in the office will position us not just to succeed, but to reach our full potential. With that, we will now open the line for questions. Operator?

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. If you'd like to ask a question, you may press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Greg McGinnis with Scotiabank. Please proceed with your question.

Hi, this is Jason Wayne on with Greg. So Q4 was a strong quarter for acquisitions and you're strong guidance this year over 400 million. I'm just wondering if you could provide an update on your investment activity quarter to date, the size of the acquisition pipeline and kind of cap rate trends you've been seeing in the quarter.

and it's a little bit more you know back-end weighted so I think we've closed about half of the 120 so far so maybe a little bit more than that including development but you know we really only have about 90 days of visibility into what will be closing but with that being said we're you know we're pretty comfortable with the pipeline likely to add maybe a few new tenants in this portfolio some grocery that we're pretty excited about, and so we feel pretty good about the pipeline in the first quarter.

Great. And then, so you have the forward equity offering is about 230 million this year. ATM has 160 million remaining. I'm just wondering if you're looking to issue debt this year for any of your funding?

Yeah, I mean, that's something that we've been talking about is potentially terming out some of the credit facility balance towards the end of the year. We'll have to see what the markets look like. Obviously, we feel really good about the execution that we got on the forward. There's a notable difference in the guidance why the numbers are the same from when we put it out the first week in January relative today to today is just significantly less funding risk associated with hitting those numbers than we would have had otherwise. So, you know, as I said in my remarks, I feel like with the undrawn capacity on the line, with the undrawn forward and reasonable expectations with respect to ATM usage and leverage, I feel very confident in our ability to fully fund the $480 million that we're talking about for the year.

Okay. Thank you.

Our next question comes from the line of Todd Thomas with KeyBank. Please proceed with your question.

Hi, thanks. Good morning. Mark, what are the, I'm curious if you could talk a little bit about the 2022 goals for portfolio diversification. I'm just curious what we should anticipate during the year if we, you know, think about the retail categories or tenant exposures today, where you'd like to be at at year end.

Yeah, sure. So, you know, we've set out our kind of longer term goals. So, you know, we think about that as being more kind of north of $2 billion of assets, which we wouldn't expect to happen until probably the end of the following year. But, you know, we've already hit some of those targets. So, you know, we don't want to have any states with more than 15% concentration. We don't want to hit any industries with more than 15% concentration, both of which we have met. And then as it relates to tenants, you know, we'd like to have all of our tenant concentration down below 5%, you know, by the end of 2023 is really how we're thinking about that. We've made a lot of progress there. You know, you've got, you know, Walgreens at 7.3%. So you've kind of really seen quarter, you know, quarter after quarter of us ratcheting down some of that diversification, which is really, you know, just increasing the asset base. But it is something that we're, you know, we're very mindful of.

Okay. And, um, you know, in terms of, uh, Walgreens exposure, I guess, um, you know, being the, the, the stand out there, um, you know, will that be accomplished, uh, mostly by, by growing, um, through acquisitions with, with other, with other tenants, uh, or are you, would you look, you know, to, to make some selective dispositions and, and are there any dispositions really? I know the, The guidance is $480 million of net investments, but can you talk a little bit about dispositions as well?

Yeah, sure. So Walgreens will continue to acquire those into the portfolio, likely at less than 7% of our acquisitions on a given quarter, which will allow that number to slowly decrease significantly. There is always the possibility that we have an opportunity to sell a Walgreens at a very aggressive cap rate. Really, the way that we're thinking about dispositions is if we sell something, we need to replace that on the acquisitions side, as you mentioned. And yeah, I mean, I think we likely sold more than what we really planned around the time of the IPO, both pre-IPO and post-IPO, and feel like the portfolio's in really good shape. So kind of the major culling the inherited portfolio is largely done but that being said I think you'll see maybe a you know 10 million a quarter is probably a good good run rate you know some quarters like this quarter will have zero other quarters we may have a little bit more a little bit less and then there's always the possibility that we look at a an acquisition that comes in portfolio form where the only way to get our hands on certain assets that we want to keep long term is to Take some that might not be long-term holds and then move to sell those out of the portfolio. Similar to the floor and decor and Olive Garden ground lease, which we think are really good assets, came along with an LA Fitness. The first 18 months are sitting in escrow, so we have just been drawing on that. We've got some time there. It's also exceptional real estate in the Lincoln Park part of Chicago. That's a pretty good example of something that we might not have been thinking about selling because we hadn't acquired it yet, but it allowed us to get our hands on some more attractive assets that are good long-term holds at attractive pricing.

Okay, that's helpful. And Andy, can you just remind us what the expected cap rate is that's embedded in the guidance for the 22 investments?

Yeah, I mean, you know, I think that we're looking at, you know, cap rates, you know, similar to what we saw, you know, in 2021.

Yeah, so we'll have some quarters that are on the low end of that, some that are on the high end of that. You know, I think we range kind of between 6.2 and 6.7, 6.8, something like that. So kind of blend it to about a 6.5. I think that's probably a good way to think about it. On a go-forward basis, maybe a hair below that, as we have seen a little bit of cap rate compression, so maybe 6.4, 6.5.

Okay. All right, great. Thank you.

Our next question comes from the line of Joshua Dennerlein with Bank of America. Please proceed with your question.

Yeah. Good morning, everyone. Mark, I think it caught out when you were talking about the first question about the pipeline. So, maybe if I could just re-ask, you know, what are you seeing in the pipeline outlook?

Yeah, absolutely. I would expect us to continue to add similar names that you've seen. We have a couple of new tenants in the quarter coming in on the grocery side that we're pretty excited about, either investment grade or investment grade profile type grocery operators and another quick service restaurant tenant that we like a lot. I think just overall, the pipeline is strong. We're feeling like we're going to come out with a fairly good print in the first quarter that should set us up for the rest of the year and be able to hit the target of the $480 million of net acquisitions for the year.

Okay, awesome. Thank you. And then I wanted to ask about maybe how you think about using the different tools to raise equity. How do you feel about overnights versus ATMs and forwards? Do you have any preference?

Yeah, I mean, you know, look, I think that, you know, it's all, you know, conditions based at a point in time. You know, we were, you know, I don't want to say lucky, but, you know, we were fortunate that in the fourth quarter we were approached by a very large rededicated investor while we were active on the ATM that was very interested in taking a large block of stock that we were able to raise a little bit of equity around, which really drove to that fourth quarter 90 million. I would not anticipate that to be an ongoing thing. That was a little bit of right place, right time. With respect to the forward raise going into the year, we felt very good about the results that we reported yesterday, feel really good about the pipeline on a go-forward basis, and really saw some of the geopolitical and financial market risks as being a potential overhang to the equity market, so wanted to take that risk off the table. That's what we did. I think what's the difference there is that puts us in a far better position to be offensive as opposed to defensive go forward. But I think, I mean, look, we can't count on block trades through the ATM. I think regular way issuance is kind of what's in there. And if the block trade comes around, hey, that's awesome. But it'll be a combination of ATM, either for cash or forward, You know, I do see some of the forward sales being a larger portion of what we do on a go-forward basis just because of the efficiency of us being able to draw it down as we need it as opposed to one long sum and paying off low-cost debt. But all those pieces are part of the puzzle. It just, you know, some of it's just dependent on the market conditions that we see at that point in time and, you know, the opportunity set that, you know, Mark and his team are putting out in front of us.

Awesome. Thanks, guys.

As a reminder, ladies and gentlemen, it is star one to ask a question. Our next question comes from the line of Katie McConnell with Citi. Please proceed with your question.

Great. Thank you. Just wanted to follow up on the lighter investment grade exposure in 4Q and wondering if you can share what you're targeting for investment grade status on future deals. and how that's factoring into your cap rate assumptions for this year's pipeline.

Yeah, absolutely. So I think this particular quarter, the fourth quarter, we had a chunkier portfolio transaction that we really thought was going to close in the third quarter and then leaked into the fourth. And so that was largely not investment grade. So I think that had something to do with that mix, which is always going to kind of move around a little bit. I think long-term we're thinking kind of between 60% and 75% is a good way to kind of think about what our actual investment grade will be, although we will continue to try to drive the investment grade profile bucket, which again is tenants with more than $1 billion of revenues and less than two times debt to EBITDA. So in our mind, typically those are going to be tenants that don't have any debt, so they don't have a reason to have a rating. and are in some cases even better credits than our investment grade bucket where we can get a little bit better pricing. So we'll continue to try to drive that bucket a little bit.

Great, thanks. And then just wondering if you could provide some more color on the development projects that you have underway and maybe expand on your opening comments about seeing more partnership opportunities going forward that could maybe drive development to be a greater part of the external growth strategy.

Yeah, absolutely. So, you know, we've been pretty fortunate to be able to find some pretty good partners very, very early on as a public company. We had really expected that to take a little bit longer. And then once you have a development agreement done with a developer, it makes it much easier to do kind of a second, third, fourth deal. So really kind of seeing that feed on itself a little bit. And I'd expect for us to, at least in terms of when we're expecting rent to commence on those development projects, we think we'll have two or three of those come online per quarter. So feeling really good about that particular bucket where we can pick up a little bit more yield. We have a little bit of negotiation into the lease so we can kind of clean some things up a little bit better. And also buying brand new buildings with fresh new leases with tenants that we're trying to grow with, we think is a great complement to our acquisitions pipeline.

Great. Really helpful. Thanks, everyone.

Thank you.

Our next question comes from the line of Keebin Kim with Truist. Please proceed with your question.

Thanks, Don. Good morning, guys. Morning. Just going back to your balance sheet, I think the last couple of quarters ago you mentioned that you're expecting about 3.5% for future debt raises, all in cost. How's that changed, if at all, given what's happened with the kind of inflation and rates overall?

Yeah, great question, Keevan. And to clarify, I think I said 3.5% to 4%. You know, I mean, you know, we haven't gotten a fix, you know, in the last couple of days. I think we're probably, you know, if we were to go to the 10-year private placement market, we may be a little bit north of that. You know, we are evaluating our strategies for later in the year with respect to terming out some of the credit. And that could be through that private placement market or what appears to be a pretty vibrant term loan market as well. But, you know, I don't know that I've seen any indicators that would put it significantly above the top end of the range that we talked about previously.

Got it. And, you know, how do you think about forward rate agreements here and to lock in some of the, at least the base rates going forward? Does that economically make sense or does the cost of that kind of swap make it easier?

Yeah. I mean, I think that it depends on, you know, the specifics of, you know, the agreement. You know, where we sit right now, based on what I said earlier, we don't have, you know, a public rating, right? You know, senior unsecured rating where you feel like that 10-year option is always available to you. So for us, if we're evaluating private placement versus term loan, you know, I don't want to lock in a 10-year and then end up doing a 5 or a 7 and have to deal with hedge-in effectiveness or, you know, advanced settlement of that option. So I'm not sure that it makes sense for us as we sit right here today, but could absolutely make sense for us at some point in time in the future.

Got it. And implicit in your 2022 guidance, what are you expecting for bad debt leakage?

Yeah, so, you know, just our generic model, you know, we model 50 basis points of bad debt off the top line. You know, our actual to this point has been, you know, zero. So, you know, we'll see, you know, how that, you know, plays out on a go-forward basis.

Just to clarify those 50 basis points is what you're starting with, at least for now?

Yeah, that's kind of our generic corporate modeling assumption.

Got it. And you don't see anything that might feed into that? What does your watch list look like today?

Yeah, no, we feel pretty confident that there's nothing in the short term that will pop up there. But, yeah, we're feeling pretty good about the portfolio.

Okay, great. Thank you, guys.

Thanks, Kevin.

Our next question comes from the line of Nate Crossett with Berenberg. Please proceed with your question.

Hey, good morning, guys. Good morning, Nate. Hey, just on the development stuff, how much higher are the yields than the straightway acquisitions? And what, I guess, kind of should be modeling for this year in terms of the volume, I guess, from the developments?

Yeah, sure. So, you know, we're taking, you know, as close to no risk as possible on those types of transactions. So, you know, we have a lease already signed by the tenant and all cost overruns are borne by the developer that we've underwritten. So, you know, it's a more conservative, you know, approach to development, but we're picking up 40, 50 basis points on those transactions versus going out in the open market and trying to acquire those assets. And then in terms of Quantum, you know, right now we're kind of in the $40, $50 million range. I could see that increasing a little bit, you know, over the year as we, you know, kind of get into the warmer months of the year.

Okay, that's helpful. What about just thoughts on the dividend here? I think it's been $0.20 since you initiated. So, like, how should we be thinking about how that moves and when it moves?

Yeah, I mean, so obviously the ultimate decision on the dividend lies with our board. You know, Mark and I make a recommendation. You know, our target had been, you know, two-thirds to three-quarters of our AFFO per share. You know, still early in the year to tell, but feel like we're on a, you know, pretty good path to, you know, get some line of sight on dividend increases in the future. Don't want to get into specific timing just yet, but Kind of feel like, you know, a lot of the risks that we've taken out of the portfolio, what we see with the acquisition and development pipeline, you know, puts us in a pretty good place to start thinking about that on a go-forward basis.

Okay. Maybe just one on, you know, just the size of the team. Is there any other hires that need to be done at this point to kind of achieve what you want to do? Or are you guys basically fully ramped in that sense?

Yeah, I mean, we're pretty fully ramped up. There will be, you know, a few hires through the year just as we scale the business on, you know, acquisitions, underwriting, asset management, and potentially in accounting. So as you'd expect, but I think it'll be, you know, the senior team is fully in place.

Okay, that's it for me. Thanks. Thanks, Nate.

There are no further questions in the queue. I'd like to hand the call back over to Mark Manheimer for closing remarks.

Thank you, everyone, for joining us today. We look forward to speaking with many of you soon at the upcoming investor conferences. Take care.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.