NetSTREIT Corp.

Greetings and welcome to the NetStreetCorp first quarter 2022 earnings call. At this time, all participants are in a listen-only mode. A brief 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 Ahn.

We thank you for joining us for NetStreet's first quarter 2022 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 31, 2021, and our 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 our first quarter 2022 earnings conference call. I am pleased to share with everyone our strong start to the year, completing over $135 million in net investment activity during the quarter, including acquisitions, developments where rent has commenced, and our first ever secured mortgage loan with an option to purchase. We acquired 34 properties for $90 million at an initial cash capitalization rate of 6.3%, and a weighted average lease term of 8.2 years. In addition, rent has commenced on two development projects that had total cost of $7.6 million and had a weighted average investment yield of 7.6%. We also provided $5 million of funding to support ongoing development projects and one new development for an investment grade profile tenant. At quarter end, we had nine projects under development representing $37 million of additional investment. During the quarter, we entered into our first-ever convertible mortgage loan agreement with a developer, a $40.4 million secured loan with an 18-month term and an interest rate of 6%. The loan is collateralized by three parcels of land that include a strong-performing Home Depot located in the Portland, Oregon MSA. At funding, the loan to value was approximately 75%. Upon the completion of the developer's plan to redevelop and reposition the assets, and with certain conditions being met, NetStreet will have the right to purchase the Home Depot at an above-market cap rate equal to the current 6% interest rate. Additionally, we are comfortable with the real estate quality as security for our loan. We do not expect to purchase the other two assets that collateralize our loan. Stepping back, we view this transaction as a demonstration of how we can work with real estate owners to find creative transaction solutions while providing a path to fee-simple ownership of high-quality real estate for NetStreet. In this case, we are providing the seller time to achieve their optimal resolution through a short-term loan while we receive an option to purchase the asset we want at an accretive return and achieve a superior interim yield on a well-secured loan. The investment grade and investment grade profile totals for our investment activities in the quarter, including acquisitions, developments where rent commenced, and the mortgage loan receivable, were 56.5% and 21%. Lastly, we disposed of a casual dining restaurant during the quarter for a sales price of $2.4 million, representing a 5.5% cash cap rate. We will continue to opportunistically reduce our exposure to select categories, including casual dining, banking, and health and fitness. At the end of the first quarter, our portfolio was comprised of 361 properties with 71 tenants, contributing $77 million of annualized base rent. The portfolio had a weighted average lease term remaining of 9.6 years with 80.6% of ABR represented by tenants with investment grade ratings or investment grade profiles, and the portfolio remains 100% occupied. New tenants added in the quarter include a Publix grocery store, a Panera Bread, and a Family Fair grocery store. In addition, we added one new state, Nevada, to our portfolio during the quarter. As we look ahead, our pipeline continues to grow as we source opportunities through various channels and work creatively with tenants to unlock value and provide capital while maintaining our portfolio quality and returns. At this time, we believe we are well positioned to achieve our increased investment target for the year. Before I hand the call off to Andy to go over the first quarter financial results, I want to take a moment to remind everyone of the unique characteristics of NetStreet. Since our formation in 2019, we have curated and built our portfolio strategically. Our investment grade percentage remains one of the highest in the net lease space. Our portfolio is largely made up of tenants and defensive industries, and we have no legacy issues with our assets. We have focused on tenants and industries that will perform very well in any economic environment, with a large capital cushion to respond and adapt to various evolutions in the retail space. With rising inflation and interest rates, as well as global uncertainty, we are confident that our portfolio is well-positioned to deliver the most stable cash flows in our space, even as we seek to meet our increased growth expectations for 2022. With that, I'll turn the call over to Andy to go over our first 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 $0.04, core FFO of $0.28, and AFFO of $0.29 per diluted share for the first quarter. The portfolio's annualized base rent grew to $77 million in the first quarter, up 60% from the first quarter last year, driven by acquisitions and developments since the prior year's quarter. Interest expense increased to $1.2 million from $0.9 million due to our higher average balance outstanding on the revolver compared to the first quarter of 2021. G&A increased to $4.2 million in the first quarter compared to $3.1 million from first quarter 2021, primarily due to increased number of employees as we grew our staff from 20 at the start of 2021 to 26 today, and the opening of our new corporate office. Turning to our balance sheet, at quarter end, we had total debt of $295 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 line. Moving on to our capital markets activity during the quarter, in early January, we entered into forward sale agreements related to over 10.3 million shares of our common stock at an offering price of 22.25 per share. On March 30th, we settled over 3.4 million shares receiving net proceeds of $72 million after deducting fees and expenses. We have until January 10th, 2023 to settle the remaining shares. Also during the quarter, we issued shares in connection with our ATM program for net proceeds of approximately $3.5 million after deducting underwriting discounts and transaction costs of about $100,000. With our successful capital market activities during the first quarter, we have significant dry powder in hand to fund most of our targeted investment activity for 2022. At March 31, 2022, our net debt to annualized adjusted EBITDA ratio was 4.6 times, which was at the low end of our targeted leverage range of 4.5 to 5.5 times. After giving consideration to the remaining shares in the forward sales agreement, our net debt to annualized adjusted EBITDA ratio would be 2.3 times. With regard to our dividend, earlier this week the Board declared a 20-cent regular quarterly cash dividend to be payable on June 15th to shareholders of Rector as of June 1st. Our payout ratio for the quarter was just under 69%. We're increasing our 2022 AFFO per share guidance range to $1.14 to $1.17 per share, and net investment guidance to at least $500 million for the year. Our guidance includes the following assumptions. Increased investment activity in the year, including developments where rent commenced, mortgage loan receivables, and net of dispositions to at least $500 million. Cash G&A to remain 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 is being increased to the range of $5.5 to $6.5 million, reflecting the significant rise in short-term base rates. Non-cash deferred financing fee amortization, which is not included in our cash interest expense, remains unchanged at approximately $600,000. 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. Echoing Mark's earlier comment, we're off to a great start this year. We're highly confident that our investment strategy positions us to continually deliver predictable cash flow in a time of global uncertainty through our ability to regularly source and finance accretive deals to grow our best-in-class portfolio. With that, we will now open the line for questions. Operator?

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please 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 keys. Your first question comes from Nate Crossett with Barenburg. Please go ahead.

Hey, good morning. was wondering maybe you could just comment on the deal flow so far in Q2, your visibility into the pipeline and what you're seeing in terms of pricing.

Yeah, sure. The pipeline is probably a little bit more robust than what we typically see at this point in the quarter. So we're feeling pretty good about second quarter and a few transactions that I think will likely leak into the third quarter. And then as it relates to what we're seeing on pricing, you know, we certainly are seeing a number of buyers, you know, kind of falling out of contract on some of their deals and pushing back as their financing costs have increased. So seeing a little bit more opportunity on some deals that have come back to us.

Okay, that's helpful. And then maybe just one on the mortgage loan. Are there more of those in the pipeline yet? And maybe you can just talk to this specific transaction. How did it come about? Was it off market? Are there other opportunities with this developer? Things like that.

Yeah, sure. So specific to that opportunity, we just viewed that as a really good opportunity to come in, provide capital to that developer that needed to do some work, reparcel off the Home Depot that we'd like to own long term and then sell off a couple of out parcels at much lower cap rates than what we would like to acquire assets at. So at a 75% LTV type situation and some pretty clear goals that they needed to accomplish that we think are pretty achievable in the short term, it was a good way for us to get our hands on an asset sometime in the next 18 months at a very aggressive cap rate. It's a Home Depot that has Some of the best foot traffic in the country, so typically a location that we'd have a lot of trouble getting our hands on. Now, I think we'll likely do more business with this particular developer. Likely won't look quite like this. Not to say that we wouldn't do a similar type of transaction, but I think the circumstances here were pretty unique where we could come in with a very low-risk option to come in and take down a property at very attractive pricing.

Okay, that's helpful. I'll leave it there. Thank you.

Thank you. Next question comes from Todd Thomas with KeyBank Capital Markets. Please go ahead.

Hi. Thanks. Good morning. Just following up first on the investment environment, Mark, what's driving the increase in the investment pipeline that you cited? And then can you comment on whether you anticipate any change in pricing or cap rates as we move further forward? throughout the back half of the year?

Yeah, sure. I mean, always difficult to predict exactly where cap rates are going to go, but we do anticipate cap rates moving up a little bit on the margin. And I think what's really driving our pipeline is we've seen a number of different types of buyers that have really had trouble getting their financing. And so, as you're aware, kind of our approach is We'd look for the investments that really fit our criteria, and then we'd try to get the pricing that works for us, the second part being the more challenging of the two. And so with a lot of buyers kind of blowing out of contracts and not being able to perform, that's allowed us to get back involved with a lot of these transactions. And I think always tough to predict exactly how this plays out, but we've seen more portfolio opportunities, which historically we've done very few. We've done a couple of deals over $50 million, but Typically, that's not what we're focused on. But when you think about the buyers that were really driving the cap rate compression overall in the net lease retail space, those are going to be your higher LTV portfolio buyers that can no longer get the financing to drive their cash on cash yields that they were really trying to solve for. So seeing them kind of pull back out of the market, there's a number of wholesale to retail type portfolio buyers that would go in and try to take advantage of the 1031 pricing, they've become very uncomfortable that they're gonna be able to flip those properties accretively, and so we're seeing some of those deals potentially come back to us. There are other public buyers that are still aggressive in the market, so we're cautiously optimistic that we may be able to do some more chunkier transactions, but I think we're gonna continue to stick to our bread and butter, which are kind of the smaller portfolios and one-off transactions.

Okay, and then, And then thinking about dispositions, you mentioned that you would continue to look to reduce exposure to casual dining, banking, and I think health and fitness. Where do you want those exposures to be, and what's the timeline to get to those target exposures? And if you are seeing some smaller or medium-sized portfolio deals, is there an opportunity to – you know, rotate capital, recycle capital a little bit sooner.

Yeah, absolutely. So, you know, we're always opportunistic when we're thinking about dispositions. You know, we added a portfolio within this quarter, which included a bank, so we're looking to sell that pretty quickly. We think we can do that pretty accretively. And then casual dining, you know, we've gotten it down under 1%. I think that's probably a healthy area to stick around. Uh, for us, you know, we did add one location that Chili's, uh, that does over $4 million in sales. So we're a little bit less concerned about that particular location with, with really low rents. So, uh, each situation is kind of, you know, we underrate, uh, to its individual characteristics. Uh, but I think, you know, I, you know, I would think about casual dining likely to hang around that 1% of our portfolio, uh, but really be very selective of what we're willing to keep in the portfolio. And then banks, I think you'll likely see that eventually get down to zero.

Okay. All right. Thank you.

Next question comes from Greg McGinnis with Scotiabank.

Please go ahead.

Hi. This is Jason Wayne. I'm with Greg. Good morning. So you mentioned last quarter about potentially raising debt in the back half of this year. I was just wondering if that's still the expectation and what kind of rates you would anticipate achieving on that?

Yeah, Jason. Yeah, from our perspective, we do continue to anticipate, you know, raising additional debt in the back half of the year. It's really to kind of term out what's going to be a more permanent line balance on our revolver. You know, we had been talking about doing a 10-year private placement, you know, in the 4% range. That You know, that market is in pretty significant disarray, increased base rates, widening out spreads. You know, the indicative levels on that now are somewhere probably between five and five and a quarter. We do have other attractive options that allow us to get term, five and seven year term through the bank market. I would anticipate that, you know, once we are able to put, you know, this quarter's earnings in the rear view mirror, you know, Randy and myself will go out to the market and start evaluating alternatives for a recast of the line of credit. while maintaining as much optionality as we possibly can to lock in term into the future. So the increase in interest expense expectations that you saw in our guidance is really reflective of the opportunity set that we see as of today.

Right. Yeah, that's all from me. Thank you.

Next question comes from Josh.

Denerlene with Bank of America. Good morning. This is Lizzie Duyken on for Josh.

I just wanted to blow up again on what you're seeing in the transactions market. Is there any sign of seeing, you know, leveraged buyers or just given the current volatility in the debt market impacting, you know, certain markets? opportunities for you all to take on. If you could comment on seeing that or potentially seeing that as an issue as you consider transactions.

Yeah, sure. So, yeah, we are seeing some of the higher leveraged type buyers, higher LTV buyers that are relying on call it, you know, 75% type LTV transactions more or less pull out of the market, especially in some of the portfolio deals. to give you an idea of how we typically operate when we see larger portfolio transactions that are marketed. We'll typically bid on those and then just never hear back from the broker on those types of deals because we just aren't really that competitive on pricing because we can find better risk-adjusted returns with smaller types of deals that get a little bit less attention. We are getting calls back, which is certainly a pretty big change. I still don't think, I think now we're rather than being seventh or eighth in line for pricing, I think we're probably third or fourth in most cases. So I still wouldn't anticipate us to be doing a lot of larger portfolios, but I think it is indicative of the fact that there aren't as many private buyers that are relying on more leverage when they're transacting.

Okay, great. And I just wanted to dig into your process of being more selective on certain industries as you look to expand. Could you talk about your strategy if that kind of remains the same with respect to screening new tenants or opportunities? Is there anything in particular with Publix that was new to kind of your approach in considering opportunities?

Yeah, sure. I mean, I think as it relates to publics, I think we've always wanted to add them to our portfolio. It's just difficult to make the pricing work in most situations. And so this is a transaction that we have worked on for quite some time. I had a few out parcels, which included a Wells Fargo bank, which we're taking on. We put in the TRS and then we're going to sell. So it had a couple of moving pieces that allowed us to get in front of it and close on it. So We'd love to do more of those types of transactions, but I don't think that our investment criteria has changed really in any way. When we formed the company back in 2019, we really wanted to focus on tenancy that's going to do very well in any economic cycle. And certainly what we're seeing and what we're predicting here for the next several quarters is there's going to be some pressure on the consumer. I think anything discretionary is going to be a little bit more difficult. We went through our entire portfolio and really tried to think through what's the most discretionary within our portfolio. Fortunately, most of it's going to be necessity-based and really defensive types of categories. So I think the thesis at the time that we really started adding to the portfolio back in 2019-2020 has really held. And, you know, I think, you know, Netflix, you're seeing their subscriber base decrease, which to us is an indication that, you know, people's budgets are getting squeezed and they're looking at their monthly budget and saying, what do I really need and what don't I need? So we feel like we're really well positioned, you know, to be able to collect all of our rent. And we think that'll be a differentiator for us.

Great, thank you. That's helpful. Just to follow up, so would you say, you know, your focus is, there's kind of a higher focus on the defensive category?

Yeah, I mean, I think that's been our DNA from day one. But I think it's, you know, even though that's our DNA, we wanted to take a hard look at the portfolio and really assess not only the underwriting that we did at the time of the acquisitions, but kind of what things look like today. and really feel very comfortable with the portfolio. There will be some things on the edges that, you know, we may look to sell. Casual dining is certainly an area that we spoke about a little bit earlier. You know, if you've got a consumer that's under pressure, that's an area that we've seen get squeezed in the past. So we're going to be extraordinarily selective with some of the categories that we're in.

Okay, great. Thank you.

Once again, if you would like to ask a question, please press star 1 on your telephone keypad. Next question comes from Nicholas Joseph, Citi. Please go ahead.

Thanks. For the development spend, what's the exposure to rising construction costs and how does that impact the targeted yield?

Yeah, it's a great question. So there's a lot of different ways to attack development. We've chosen to take a very conservative approach where you know, we're underwriting the developer and all cost overruns are borne by the developer. So we need a lease in hand and not be responsible for any cost overruns. And so we haven't had any issues there, but I do think it's going to have a negative impact on future developments in terms of being able to make the numbers work, where the retailers are either going to have to pay more rent or the developer is going to have to, you know, take less profit. So which is already pretty thin, so I would anticipate that part of our pipeline coming under some pressure and maybe not growing quite as quickly as it would have absent the increase in construction costs and labor costs.

Thanks, but the existing development pipeline is pretty locked in from your standpoint in terms of the yield. Right. That's right. Awesome. Thank you.

Thank you.

Next question comes from Linda Tsai with Jefferies. Please go ahead.

Yes, hi. The mortgage loan receivable, that was a creative way to achieve your capital deployment target. Are there other examples that you could point us to in terms of creative solutions to achieve capital deployment?

Yeah, sure. I mean, I think really from our inception, we've looked to figure out the most creative ways to get better cap rates and better yields for higher quality assets. And so And some of those work today, some of them don't. I think a good example was where we had a Walmart and a Sam's Club in Tupelo, Mississippi last year, where there was a shopping center wreath that was selling an entire shopping center. We put a bid in for that Walmart and that Sam's Club, and they came back and said, hey, look, we're really looking to sell the entire shopping center, not really just trying to sell the two things that are easy to sell. And so we brought in a partner that was able to kind of take on the junior boxes and shop space and the more difficult part of the transaction for us and manage the center and allowed us to come in and buy the Walmart and Sam's Club 12 years of lease term at a 6.6% cap rate. So I think we're always looking for creative ways to get in front of transactions in a very low risk way. And that's essentially a big piece of our underwriting and acquisitions process which I think is a little bit different than what you see with some of the other REITs.

Thank you. Thank you. I will now turn the floor over to Mark for closing remarks.

Well, thanks, everybody, for joining us today, and we look forward to keeping the dialogue going. Have a good day.

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.