NetSTREIT Corp.

Greetings and welcome to NETStreetCorp Third Quarter 2024 Earnings Conference call. At this time, all participants are in the 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, Ms. Amy Anne in Mr. Relations. Thank you, Ms. Anne. You may begin.

We thank you for joining us for NETStreet's Third Quarter 2024 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 .netstreet.com. On today's call, manager'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 end of December 31, 2023, 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 of our non-GAAP measures, reconciliations to the most comparable GAAP measure, and an explanation of why we believe such non-GAAP financial measures are useful to investors. Today's conference call is hosted by NETStreet's Chief Executive Officer Mark Mannheimer and Chief Financial Officer Dan Donlon. 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.

Thank you, Amy, and thank you all for joining us this morning on our third quarter 2024 earnings call. I first want to congratulate the team on an outstanding quarter as we completed $152 million of gross investments, our highest quarter on record, at a blended cash yield of .5% or 8% on a straight line basis, which has been our average on a -to-date basis. Similar to last quarter, a greater portion of our third quarter investments were salee specs, as we have seen more attractive risk-adjusted returns emerge from our opportunity set within that marketplace. Additionally, by sourcing more volume from this channel, our quarterly acquisitions had a longer weighted average lease term at 12 1 1 2 years, with more attractive rent growth profiles. While our percentage investments leased to investment grade and investment grade profile tenants was below our portfolio average this quarter, we have continued to adhere to our stringent underwriting standards, which require healthy tenant credit profiles, strong unit level cash flow, generic single-tenant boxes, above average foot traffic, and replaceable rents among many other attributes. Included in this activity were four development projects totaling over $18 million that commenced rent in the quarter. As of today, our development pipeline consists of eight projects with a total estimated cost of $22 million, which includes estimated remaining funding of $7 million. Turning to the portfolio, we ended the quarter with investments in 671 properties that were 100% leased to 93 tenants operating in 26 industries across 45 states. From a credit perspective, over 75% of our total ABR is leased to investment grade or investment grade profile tenants. Our weighted average lease term remaining on the portfolio is nine and a half years, with less than 3% of ABR expiring through 2026. In addition to a robust quarter of investments, we also saw continued progress on the asset management front, which is indicative of the strength of our industry relationships and the speed of which our team can move when asked to perform. This was evidenced by our third quarter disposition activity as we executed on various strategic asset sales that reduced select tenant concentrations while accretively recycling the proceeds into investments with longer leases and better rent escalations. All told, we completed eight dispositions in the quarter for total proceeds of $24 million at a weighted cash yield of 7.3%. Turning to our industry concentrations, while the pharmacy and dollar store industries have garnered a number of less than positive headlines over the past few months, we remain eminently comfortable in the long-term productivity of our assets within these industries. Due to the in-depth analysis that we complete at underwriting, coupled with consistent dialogue we have with these operators, we do not currently foresee any discernible economic impact to our earnings stream from these industries, which represent just 50 basis points of total expiring ABR between now and 2028 year-end. As it pertains to Walgreens, we continue to believe that their planned store closures, which are likely to focus on near-term lease expirations and unprofitable locations, should have minimal to no impact on our occupancy. Amongst many other factors, our conviction in this view is driven by the fact that more than two-thirds of our stores were purchased pursuant to blend and extend transactions, which is not only indicative of Walgreens' long-term commitment to our sites, but also supports our view that our rents are more replaceable versus market. However, we've felt it prudent to demonstrate that we can quickly and meaningfully reduce tenant concentrations, even those that are perceived to have challenges, while simultaneously reinvesting the proceeds at an accretive level. As outlined in the supplemental, we have reduced our Walgreens concentration from .9% at second quarter end to its current concentration of 4.8%. While we endeavor to have all tenant concentrations below 5% longer term, our Walgreens concentration should decline further in coming quarters. Our weighted average lease term with Walgreens is approximately 10 years, with just one lease expiring before 2030, which we believe has virtually zero renewal risk, given its exceptionally high front-end sales and its 99th percentile national ranking on placer for foot traffic. Lastly, while there is nothing to report on this front as of today, we have received a fair amount of inbound interest in our Walgreens locations, largely from large format convenience store operators who are currently willing to pay high rents for high quality locations, similar to the properties that we own. We're also nearing a highly positive outcome as it relates to our big lots, which currently stands at 80 basis points of total ABR. As a reminder, prior to 2024, we decreased our big lots concentration from 11 stores to eight stores in order to protect our cashflow in the event a financial restructuring occurred, which indeed happened this September. Of the eight locations, one was assigned to Ali's Bargain Outlet, an existing investment grade profile tenant of ours. Another site is being marketed for lease in Bowie, Maryland, where we have received a number of attractive LOIs from major retailers and grocers. And the remaining six locations have all been assumed by big lots. As part of the negotiation, we extended the lease term to an average of seven and a half years, albeit we did agree to provide some short-term rent relief during the bankruptcy process, which we expect to conclude sometime in December. Looking out to 2025, we should experience little to no loss in our rental stream from the eight assets while gaining longer lease terms from better credit profiles at proven rents. While we prefer not to have any noise around the health of our tenants' credit, we believe it is important to demonstrate that our underwriting of assets proved to be sound and resulted in minimal disruption to our cash flows. As a reminder, we view corporate credit, unit-level cash flow production, and the fungibility of our real estate as modes of protection around our rental streams. We are not simply buying high-credit quality assets and hoping for the best. Our strong underwriting and asset management capabilities have, and we believe will continue to help us generate extraordinarily consistent portfolio cash flow for our shareholders. Lastly, before I hand the call over to Dan, I'm pleased to share that effective October 1st, Lori Whitman was appointed the Chair of the Board of Directors. Lori has been a valued member of our board going back before our IPO, and she has consistently demonstrated a deep understanding of our business and a commitment to our success. Her continued service will be instrumental as we execute on our strategic vision and long-term growth. With that, I'll hand the call to Dan to go over a third quarter of financials, and then open up the call for your questions.

Thank you, Mark. Looking at our third quarter earnings, we reported a net loss of $5.3 million, or 7 cents per diluted share. Core FFO for the quarter was $24.9 million, or 32 cents per diluted share, and AFO was $24.8 million, or 32 cents per diluted share, which was an over 3% increase versus last year. Turning to the expense front, total recurring G&A declined 16% year over year to $4.3 million, while recurring cash G&A declined 24% year over year to $2.9 million. In addition, with our total recurring G&A representing 10% of total revenues in the quarter versus 15% of total revenues in the prior quarter, our G&A continues to steadily rationalize relative to our revenue base. Turning to the balance sheet, our total adjusted net debt, which includes the impact of all forward equity as of quarter end, was $569 million. Our weighted average debt maturity was 3.3 years, and our weighted average interest rate was 4.46%. Including extension options, which can be exercised at our discretion, we have no debt maturing until January 2027. At quarter end, our liquidity was $464 million, which consisted of $29 million of cash on hand, $250 million available on a revolving credit facility, and $185 million of unsettled forward equity. Turning to leverage, our adjusted net debt to annualized adjusted EBITDA RE was 4.0 times at quarter end, which remains well below our targeted leverage range of 4.5 to 5.5 times. Moving on to guidance, we are maintaining our 2024 APO for sure guidance midpoint and updating the range to $1.26 to $1.27 from our prior range of $1.25 to $1.28. Lastly, on October 18th, the board declared a quarterly cash dividend of 21 cents per share. The dividend will be payable on December 13th to share it as a record as of December 2nd. Based on the dividend amount, our AFF pay ratio for the third quarter was 66%. With that, operator, we will now open the line for questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on the telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your questions from the queue. For participants using speaker equipment, it may be necessary to pick up your handsets before pressing the star keys. As a reminder, please restrict yourself to one question and run for loss. One moment please while we poll for questions. The first question comes from the line of Wes Coladay with BED, please go ahead.

Hey, good morning guys. As you look into the fourth quarter and maybe the first quarter next year as you're shedding some of your non-core assets, do you still expect to maintain a creative acquisition spread for your disposition?

Yeah, we do, Wes. I think just looking forward to the fourth quarter and maybe early in the first quarter where we have some visibility, we expect cap rates to stay pretty close to where they are. Right now, maybe slightly below where we've been for the first three quarters. But the dispositions that we're looking at currently are at lower cap rates than what we achieved in the third quarter.

Okay, then how do you see your dollar general exposure progressing over the next year or so? And then can you comment on the quality of your locations? You gave a nice little analysis about your Walgreens being blended and extends and high foot traffic, but can you maybe unpack the dollar general exposure?

Yeah, sure. So the dollar general portfolio that we have I think is a little bit unique. In that we were able to partner with the tenant and get most of our leases extended and then really the ones that weren't extended, we've gone out and sold the vast majority of those. So we're left with just under 15 years weighted average lease term with an average of 1% annual increases in the leases. So a little bit unique when you compare our dollar store portfolio to others. But yeah, there are a number of loans in there so I think those will get paid off here in the next year so that really kind of brings the concentration down below 10% just with that. And then we are looking at a handful of dispositions just to try to get that concentration down a little bit which I think will certainly be well below 10% here in the next

couple of quarters.

Okay, thank you.

Thanks, Wes.

Thank you. Next question comes from the line of Handel-Sengers with Mizuho, please go ahead.

Hi, good morning. This is Ravi Vaid in the line for Handel. Hope you guys are doing well. So the drug store and pharmacy exposure decreased 160 bits sequentially. Can you offer some comments on the disposition market and maybe also the element of seller financing when addressing the Walgreens disposition? Is this something we should be expecting going forward? Thank you.

Yeah, thanks, Ravi. Yeah, I mean, I'd say the dispositions market has gotten a little bit better as I think a lot of you are aware. The 1031 market really did kind of dry up over the past year, but is starting to come back a bit. So we're seeing more interest in our assets. And as you mentioned, the success that we've had in pretty quickly reducing our exposure in the pharmacy sector. We did use seller financing on a couple of the transactions in the third quarter. And kind of really the thinking there was we were able to get an interest rate slightly higher than the cap rate that we sold the assets at. So it kind of maintains a healthy yield. But those were assets that we felt like the rent was a little bit above market. So reduced our exposure by more than the error that we felt like was in the rent. We do not think that we're gonna be using seller financing much more in the future, but it is a tool that we reserve the right to use in the event that it gets us to a better outcome. So, specifically around those Walgreens, we sold in the third quarter, the average cap rate was about a seven two and the interest rate was slightly higher than that. So I think seven two and change. So certainly felt like that was a pretty good outcome. But in the fourth quarter, we've been able to sell some assets without using seller financing and think that's likely gonna be the path that we go on a forward basis.

Got it, that's helpful. Helpful color there. Just one more here. What would you say is a steady acquisition run rate for the next five, six quarters on a longer term basis, particularly given the fact that outstanding equity has decreased and the current

WAC has been elevated?

Yeah, look, I mean, I think if, given what cost of capital is today, we're not able to achieve sufficiently accretive spreads to acquire at the pace that we're acquiring at today. So I think it just remains to be seen what our run rate would look like. I think the team is certainly built to do anywhere from net investment activity of 100 to certainly 150 million. Right now though, we do have plenty of capacity continuing to invest. And I think as we see our cost of capital season of the next couple quarters, we'll think about how that impacts our ability to grow on a go forward basis.

Thank you. Thank you. Next question

comes from the line of Smitty Ease Rose with Citi. Please go ahead.

Thanks, it's Nick Joseph here with Smitty. Sorry if I missed it, but just on the big lots, understand the additional term there, but from a cash rent perspective, what's the rent difference going forward versus what was in the previous leases?

Yeah, so we've got the one location that is being marketed for sale. We do think that there is, it's likely, For lease. Yeah, for lease, sorry. Yeah, likely not telling that. So, up for lease, we're talking to a number of different retailers and grocers. We do think that the rent is likely to be at early even a little bit higher. So when it's all said and done, we think the rent is gonna be equivalent to where we are today or where we were going into the bankruptcy.

Thanks for the existing leases. We'll continue with big lots.

Yeah, there is a small amount of rent decrease there, including we're not collecting rent here during the bankruptcy period, but I think that the increase in the rent that we're likely to get the Boobie site will likely offset that.

Got it, thank you. And then just on the acquisitions, obviously the proportion of IG came down in the quarter. You mentioned on the sale lease back, what are the expectations for that percentage going forward? Would you expect to see more IG acquisitions kind of in the future quarters? And if so, how are you thinking about cap rates there that would make them more attractive versus what you saw this previous quarter?

Yeah, Nick, and that's exactly what was really kind of driving our decisions around what we were acquiring in the second and third quarter. We just saw much more attractive risk adjusted returns on the larger operators that might not have an investment grade rating, certainly not going out and doing a lot of the small deals with four or five unit operators, but still larger operators that we're comfortable with where we're getting really strong unit level economics and replaceable rents. And so that has been an area where we've been pretty successful with. I would expect the fourth quarter to see that investment grade kick up a little bit higher than it's been in the second and third quarter.

Thank you very much.

Thank you. Next question comes from the line of Kibin Kim with Two Securities. Please go ahead.

Thank you. Good morning. Just going back to the Walgreens and Family Dollar topic, can you just maybe provide a high level view on what you think the remaining asset sales, what those cap rates could be? And is your ultimate goal, I guess, what is your ultimate goal? Like how much to lower the percentage of ABR from those types of

centers? Yeah, thanks, Kibin. So yeah, I mean, as it relates to Family Dollar, as you're aware, we've been selling down that exposure over the past couple of years, really starting with the assets that we felt like were not either not profitable or not very profitable. And so we're really currently left with a portfolio of Family Dollars that generate positive cashflow. We think they're good stores. That being said, we're likely to continue to sell that exposure down over the next year or so. And so that's down to a little bit more than 1% of ABR. And then as it relates to Walgreens, as I mentioned in the prepared remarks, we've gone from five, nine to four, eight in a pretty quick, pretty quickly. I would expect to see us continue to sell that down, maybe not quite as quickly as we did in the third quarter, but I think kind of a target of getting that below 3% is achievable here in the next six or seven quarters.

And on pricing, if you can provide some parameters, please.

Yeah, sure. So, I mean, we were able to sell the Walgreens in the third quarter at a lower cap rate than our disposition cap rate. And so that is encouraging. We just know that we're gonna have to take our time to find the right buyers, understand that these are stores that are unlikely to be closed. And we feel like we can continue to see pricing, certainly inside

an eight. Okay, thank you. Thank you.

Thank you. Next question comes from the line of Katherine Greaves with UBS, please go ahead.

Hi, good morning. Thank you for taking my question. So, acquisitions obviously accelerated in the quarter. I was wondering if you could speak a little bit on how you're characterizing the current transaction environment, especially compared to the first half of 2024, both as far as maybe increasing opportunities, but then on the flip side, maybe increased competition for deals.

Yeah, sure. So we've certainly seen the opportunities that pick up quite a bit from earlier in the year. The competition, we were expecting that to kick up, but really haven't been running into much competition when we're out looking for locations. Really, the competition for us has really been seller expectations for the past year plus, and that continues to be the case. But we're seeing great opportunities on the investment grade side, sales back side, on the extent side, on the development side. So we're pretty excited about what we're seeing out there. It's just gonna be a matter of where our cost of capital is.

Got it, that makes sense. And then my second question, you mentioned in the prepared remarks about sort of getting ahead of big loss prior to 2024. I'm wondering if you can speak to any current consumer trends or other components of proactive portfolio management that you're monitoring right now.

Yeah, sure. So I mean, certainly the lower income consumers have been under pressure. That's kind of really creeped up into the middle income consumer. Even job growth has slowed. So we're being pretty cautious around the consumer and making sure that not only are we investing in businesses that we think have a mode of protection around what's going on with the consumer, but then also making sure that the companies have balance sheets that can withstand some disruption and unit level economics where we've got a pretty solid cushion there. But yeah, I mean, I think it continues to just be maybe slightly worse than it was a quarter ago with really kind of the same

issues.

Got it, thanks so much.

Thank you. Next question comes from the line of Opal Runner with KeyBank Capital Markets. Please go ahead.

Great, thanks for taking my question. Mark, you talked about the relative strength on your remaining Walgreens. How does that differentiate from the two assets you did sell in the quarter?

Yeah, sure, I mean, the assets that we sold, we think are good assets, maybe a little bit shorter in lease term. And so we know that not only will there likely be a focus on the total ABR that we have with Walgreens, but then also what does the lease expiration schedule look like? And so really kind of pushing out, as we mentioned, we don't have any leases expiring until 2030 other than one that generates phenomenal sales on the front end and has phenomenal put traffic where we think it's extraordinarily unlikely that they would close that door. So really continue to strengthen that portfolio, push out, have longer-weighted average lease term. We went from nine to 10 years during the quarter as well. So I think upgrading the quality is important. Walgreens continues to face pressures on reimbursement rates on the drugs that they provide. And so we're keeping an eye on that. We wanna be prepared for the event that things get worse. We don't know if they're gonna get worse or better, but we feel like we're pretty well positioned in the event that things get a little bit worse.

Okay, great, that was helpful. And then how would you describe sellers at this point in the cycle? We've had a 50 basis point rate cut already, and there's a likelihood of another 25 basis point cut this week. And then we've all seen the 10 years sort of climb higher by over 60 basis points. So we're not gonna get your sense on where sellers are at this point.

Yeah, I think the move back up on the 10 year has really calmed down some of the sellers. And really there's a lot of brokers that were thinking that it was last call for the cap rates that you could get before, they're all about to fall. And obviously that just really isn't happening with the increase in the 10 year. So if anything, I think it's become a little bit easier to find sellers willing to transact.

Okay, great, thank you. Thank

you. Next question comes from the line of Greg McInnis with Squashabank, please go ahead.

Hey, good afternoon. Are you able to give us maybe a few more details around the non-investment grade acquisitions that you completed this quarter, whether that's the names, the tenants, or some of the deal terms, just so we can better understand what you guys were doing with those.

Yeah. Yeah, sure, I mean, you saw that, the weighted average lease term maybe a little bit longer, a little bit in the C-Source space, a handful of retailers that are kind of double B or double B plus, so I guess potential that they could get upgraded one day. But one of the big focuses that we've had over the past really couple of years has been to increase the internal growth of the portfolio. I think we started out the IPO at 65, 70 basis points, something like that. And we're now over 1% of internal rent growth. So I think that's certainly been a focus in this past quarter's acquisitions, certainly help with that.

Okay, and just a couple clarifying points, one on the big lots rent relief. So is that the full 80 basis points just not paying for what, this month, last month, and then expected to start paying again in December, or how should we think about that?

We expect them to start paying again in January.

January, okay. Last one for me, there's already been a lot of focus on Walgreens on the call, but CVS is closing stores as well. Have you heard anything from them regarding potential store closures, or how do you feel about those assets in the portfolio?

Yeah, I mean, we feel very strongly that we've got a great relationship with CVS. A lot of the CVSs that we acquired were blended extend transactions as well, and we've got a pretty good understanding as to how they're doing within the four walls of the assets that we own, and feel like we've got an exceptionally strong CVS portfolio. And I think the stores that they announced that they were closing, I think, was really about two and a half years ago where they said they're gonna close 900 stores over the next three years, so that should really be winding down here in 2024.

Okay, thank you. Thanks, Ray.

Thank you. Next question comes from the line of Josh Denline with Bank of America. Please go ahead.

Hi, good afternoon. This is Pharrell Granith on behalf of Josh. I was curious, in terms of bad debt, kind of considering your previous levels that you've been assuming, would you ever consider maybe even next year increasing assumptions of bad debt, just given headlines and current risk associated with pharmacies and retail in general?

Hey, Pharrell, it's Dan. The answer is no. And I would note that we didn't necessarily have credit losses this quarter or this year. We simply had a temporary rent relief. So as you think about kind of our expectations coming out of 2024 for the core portfolio, the prior model would assume that these credit losses would have stayed in perpetuity when in fact they're only temporary in nature. So as we think about the core portfolio coming out of 2024, it's actually in a better position than what we envisioned when we set guidance in January.

Great, thank you. And also one more about, also given current headlines, I know you went through a lot of the underwriting parameters that you set, but I was curious, is there anything that you're being more scrutinous about or either requiring more P&L reports among tenants kind of just going forward in your underwriting?

Yeah, thanks, Pharrell. So yeah, I mean, I think we've had a pretty good understanding as to how the tenants are doing within the four walls of the boxes that we own. And I think we were very careful about what we put into the portfolio. I think if there is maybe a lesson learned, it would be just having some higher concentrations with publicly traded companies where there's just a lot of news and noise, potential noise around their performance on a quarterly basis can then turn around and impact us. And so, yeah, we certainly feel very strongly that the assets that we put in the portfolio are gonna continue to pay rent and are gonna be good performers

for the company.

Okay, thank you very much.

Thank you.

Thank you. A reminder to all the participants that you may press star and one to ask a question. Next question comes from the line of Kevin Kim with True Securities, please go ahead.

Hey, thanks, just a quick follow up on Walgreens. So, how do you gauge the health or performance of those Walgreens compared, I mean, I guess you can't really compare to the entire chain because it's different locations, but how would you describe the quality of the Walgreens or family dollar stores that you have remaining?

Yeah, I think that we've got locations that are gonna stay open and continue paying rent and that are profitable locations for each of the tenants. And so, we get some information from the tenant that's required on lease, and then we've got a very strong relationship with both of those tenants. We have pretty open conversations about what they're thinking about doing within the, with the stores that we own. And so, that's allowed us to get out ahead of some potential closures and some potential risk, which is, I think, really imperative is not only when you acquire the asset having those conversations, but an ongoing basis with our asset management department with the tenants. And so, that's really what gives us so much confidence that we've got locations that are going to continue to perform well.

And I'm not sure if the front end sales is the primary driver versus pharmacy sales. I'm just curious about that, but.

Yeah.

Would you, do you have a view on the four-wall profitability of those locations?

Yeah, I mean, we certainly are very confident that the locations that we own are profitable. When you think about the, you know, what's, you know, where the profitability is coming from, their issues really are more related to the pharmacy, you know, side of the house. And the reimbursement rates that they're getting have decreased. Some due to Medicare, you know, Part D, and some just from insurance companies. And so, that's been not only timing, but also the rates that they're getting reimbursed have been more difficult on pharmacies. So, not only are you seeing, you know, Rite Aid gone from what, 2,400 to 1,200 stores that cut in half. We mentioned earlier, CVS closing 900 stores. You know, looking at where Walgreens was, you know, a few years ago to where they are now. All told, you're talking about the three largest chains closing 4,000 stores. And then there's also, it's an even worse situation for the independent pharmacies, which are likely to see about more than a third of their stores close. So, you know, I think, you know, it's really been driven by the reimbursement rates, you know, mostly from the government, but also insurance companies. And the front end, you know, that's only 25% of the revenues really coming from, a quarter of the revenues coming from the front end of the store, that's under pressure, but that's not what drives the profitability of pharmacies.

Okay, thank you very much.

Thank you. Ladies and gentlemen, we have reached the end of question and answer session. I would now like to turn the floor over to Mark Manheimer for closing comments.

Thanks everybody for joining today. We certainly appreciate everybody's interest in the company and look forward to seeing many of you at the upcoming conference season.

Thank you. This concludes our today's teleconference. You may disconnect your lines at this time. Thank you for your participation.