Spirit Realty Capital, Inc.

Thank you for standing by. This is the conference operator. Welcome to the Spirit Realty Capital second quarter 2022 earnings conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. I would now like to turn the conference over to Pierre Rival, Senior Vice President, Corporate Finance and Investor Relations. Please go ahead.

Thank you, Operator, and thank you, everyone, for joining us for SPIRIT's second quarter 2022 earnings call. Presenting on today's call will be President and Chief Executive Officer Jackson Shea and Chief Financial Officer Michael Hughes. Ken Heimlich, Chief Investment Officer, will be available for Q&A. Before we get started, I would like to remind everyone that this presentation contains forward-looking statements. Although we believe these forward-looking statements are based upon reasonable assumptions, they are subject to known and unknown risks and uncertainties that can cause actual results to differ materially from those currently anticipated due to a number of factors. I refer you to the Safe Harbor Statement in our most recent filings with the SEC for a detailed discussion of the risk factors relating to these forward-looking statements. This presentation also contains certain non-GAAP measures. Reconciliation of non-GAAP financial measures to most directly comparable GAAP measures are included in the exhibits furnished to the SEC under Form 8-K. which includes our earnings release, supplemental information, and investor presentation. These materials are also available on the investor relations page of our website. For our prepared remarks, I'm now pleased to introduce Mr. Jackson Shea. Jackson.

Thanks, Pierre, and good morning, everyone.

We had another productive quarter with the team performing well across multiple fronts. In the aggregate between acquisitions and dispositions, We completed over 50 transactions, and our operational metrics continued to demonstrate strong performance. Starting with capital deployment, we invested $417 million, including 38 acquisition transactions, of which 31 were with existing Spirit relationships, such as lifetime, zips, and off-lease only, to name a few. Since our last earnings call in May, we have seen cap rates start to move higher, especially for attractive distribution and light manufacturing transactions that meet our underwriting standards, and these higher acquisition yields will be reflected in our third and fourth quarter results. Of the $4.8 billion of assets we have added to the portfolio since I joined as CEO, one-third have been industrial, made up of 52% distribution facilities, 39% light manufacturing, 6% industrial outdoor services, and 3% flex. To give you better insight into our industrial exposure, we have included additional detail on our industrial mix on page nine of our investor presentation. As I mentioned on our Q1 earnings call, Asset recycling and dispositions will be a key part of our strategy going forward, providing an alternative source of accretive equity capital and critical market intelligence, while allowing for portfolio shaping, strengthening relationships within the brokerage community, and demonstrating the quality of our portfolio. During the quarter, we sold 10 occupied properties for gross proceeds of $93 million at an average cap rate of 4.38%. Approximately 43% of the gross proceeds came from assets that our team acquired in 2020 or later. These recent investments were acquired at an average 6.9% cap rate and were all non-investment grade tenants. We were able to sell these investments at an average 4.7% cap rate, cashing in on their value appreciation in just a few short years after enjoying the rent we received. The other assets were sold from the retained portfolio. These properties included an office building leased to a financial services tenant, a home improvement retailer with no escalations for the remainder of its 11-year term, and several other smaller transactions. Two of these smaller transactions were products of our proactive investment management, where we successfully negotiated ground leases with Chick-fil-A and Aldi's after our former tenant Ryan's Buffet vacated in 2016. After receiving ground lease payments for several years, we sold those properties for an average 3.8% cap rate. Finally, Our portfolio continues to perform exceptionally well. We only have four vacant properties at quarter end, and our unreimbursed property costs were only 1.3%. Our lost rent, which represents tenants who are not paying rent, stands at a historic low of 0.03%, and our expected lease escalations over the next 12 months are 2%. We believe our rigorous underwriting focused on industry fundamentals, credit, and real estate strength, use of our heat map, and utilization of our technology tools is paying off. We have built a solid foundational portfolio that continues to perform, and as we look forward, we see market pricing beginning to rationalize and more opportunities for Spirit to deploy capital at meaningful spreads. With that, I'll turn the call over to Mike.

Thanks, Jackson. For the quarter, our ABR increased $24 million to $647 million, with 90% of the increase attributable to net acquisitions and the remainder driven by contractual rent escalators. Six of the seven theaters released during COVID are now fully open. The seventh theater is still undergoing extensive improvements and is slated to hold the largest screen in Illinois, with an anticipated opening next spring. With the strong summer blockbuster season, the ramp-up of these theaters is going very well. During the second quarter, we received 915,000 in rent from seven theaters, representing 65% of the scheduled rent at stabilization. Also, as Jackson mentioned, all of our portfolio metrics, including occupancy, unreimbursed property costs, and lost rent, delivered pristine results, resulting in our adjusted cash NOI increasing by $23 million to $647 million. Turning to expenses, our cash G&A margin, excluding prior year COVID costs, improved, falling 60 basis points to 5.2% compared to the second quarter of 2021, driven by the scalability of our platform as our revenues grew 6.3% compared to the same period. For the second half of the year, we expect cash G&A to be between $19 and $21 million, which compares to $19 million in the back half of 2021. Our cash interest expense increased $1.3 million since last quarter, driven by higher revolver balance and a 44 basis point increase in our revolver borrowing rate. Subsequent to quarter end, we received commitments for an $800 million term loan facility, structured as a $300 million three-year term loan and a $500 million five-year term loan. In anticipation of closing the new facility, we entered into interest rate swap agreements that would effectively fix the three-year term loan coupon at 3.59% and the five-year coupon at 3.45%. We anticipate the new term loan facility to close in a couple weeks. During the quarter, we issued 2 million shares of common stock to settle certain forward contracts, generating net proceeds of $90 million. As of quarter end, we have unsettled forward contracts for 1.1 million shares and maintained leverage of 5.2 times and a fixed charge coverage ratio of 5.8 times. With our expanded credit facility, outstanding forward equity, and cash on hand, we had $594 million in total corporate liquidity as of quarter end which will increase upon closing of the anticipated term loan facility. Turning to guidance, we are maintaining our AFO per share range of $3.52 to $3.58, our acquisition target of approximately $1.5 billion, and our disposition range of $200 to $300 million. From a capital recycling perspective, we believe dispositions will continue to be a good source of funds as we see robust demand for many of our properties. To echo Jackson's comments, the ability to sell over $90 million of real estate at a 4.38% cap rate in a rising interest rate environment speaks to the quality of our portfolio. With that, I will turn the call over to the operator to open it up for Q&A.

Operator?

Thank you. We will now begin the question and answer session. To join the question queue, you may press star then 1 on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star, then two. The first question is from Handel St. Just with Mizuho. Please go ahead.

Hey, guys.

Good morning. Jackson, I was wondering if maybe you could quantify for some of the higher cap rates you alluded to in your prepared remarks, maybe across some of the major archetypes that you're looking at here.

Okay, thanks, Pandal. Just to clarify, these are deals that were in our pipeline and what we're seeing today, right? Yes, yes.

I think you had mentioned that you were expecting higher cap rates in the back half of the year. And maybe as part of that, you can share some thoughts on the pipeline and what some of the pricing there looks like. Thanks.

Okay, great. Look, if you remember on our last quarterly call, you know, I referenced we were seeing cap rate increases. I think I used the range of 25 to 50 basis points generally. We were seeing that on that call last quarter. The difference today is there's just more volume of opportunity. I can tell you in the last three weeks in our acquisition pipeline meetings, we're seeing really interesting opportunities that are really at meaningful spreads where we think versus say earlier in the year or last year. And what that translates into is I'd say generally like in the retail assets that we're looking at evaluating, cap rates have increased 25 to 50 basis points if you compare it to, say, late last year. In the industrial and light manufacturing opportunities that we're evaluating now, I would say the range of cap rate increase is 50 to 100 basis points as compared to what we were seeing last year. And like I said, in the last three weeks, we've seen a high volume of interesting opportunities, particularly in the industrial subset. So I would expect that If that trend continues, you'll start to see more significant percentage of industrial assets acquired in the fourth quarter. You didn't ask, but I'm going to tell you, like, one of the reasons why I think this is happening is this concept of FOMO is gone. You know, people that need to close transactions want certainty of close versus price. I think it's really critical. And one of the reasons why we are so insistent on this disposition program going forward is it's super informative, gives us a lot of visibility real time as to how bidders are responding in the marketplace. And that gives us better information on how to lean in or lean out. So if you look at our disposition results from this past quarter, You know, we had two assets that were acquired by what I'll call dedicated industrial funds, small funds. We had three buyers that were 1031 buyers that bought some of the industrial and some of the retail. And then we had three buyers that were just kind of all cash, either high net worth or just people that didn't really need financing to close on those purchases. You know, in those industrial opportunities that we were selling on a couple of those cases, you know, in the final bids, you know, we had like five bidders on one case, you know, close to that on another situation. So those are kind of very interesting pieces of information for us. You know, we were not successful in selling some of the other things that we were looking at from a pricing standpoint that required more CMBS debt. So... All in all, like I said, that sort of gives us some visibility as to how bidders are handling things. I'd say the other thing that we're seeing handle is – gives me a lot of encouragement – is we're seeing deals come back around that were sort of failed. Deals that we looked at earlier in the year went away to a higher bidder at a higher price, and things have come back around saying, oh, we're going to look to three to four what we believe – credible buyers and see if we can get a deal done. And I'd say some of those opportunities are probably 50 basis points wider. The other thing that we're seeing is in some cases, especially where there's a broker involved in the industrial area, we're seeing like, as opposed to best and final bids, they're taking rolling offers. So that kind of tells you, it should inform you that maybe the bidding is not as robust. I'd say that Overall, what gives me the most encouragement today is that, you know, a lot of the larger private equity firms that were dedicated in this space, particularly industrial side, last year, and they were driving down cap rates based on access to, you know, cheap, low-rate, flowing-rate CMBS debt. Like, those guys are basically taking the summer off at this point. So the people that are showing up at these situations as we're showing up, I'd characterize probably five to seven people people that can kind of write a check, don't necessarily need mortgage debt. Because obviously if you're borrowing mortgage debt today, you're doing a floater, you're looking at 5% to 6% probably on a short-term floating rate debt instrument. But if they lock in CMBS fixed rate loan, it's definitely north of 5%. So I think that kind of gives us a bit of advantage relative to how we borrow and fund ourselves. And I also believe fundamentally that long-term rates are going to come down. So we kind of put that all together. Looks pretty interesting for us right now. That's why we made that point.

Great. No, that's great color. So another one perhaps on transactions, but from a different angle. You had a bit of a slowdown in activity in the second quarter versus the first quarter. Your guidance seems to imply deceleration in the back half. But you've also alluded a few times to really interesting opportunities. So I guess I'm curious how you're feeling about your liquidity and your cost of capital today and your ability to pursue these opportunities. Thanks.

Sure. I mean, I've got to mention, like, one of the things that we look at really carefully, look, when we do a sale-leaseback, to me, the competition is obviously other people that can provide a sale-leaseback, but it's also the high-yield market and the leveraged loan market, you know, because we particularly focus on double-B and single-B credits. If you look at the high-yield index today, it's widened overall by about 375 basis points. Leveraged loan default levels are at record lows, you know, if you look at that. If you look at year-to-date high-yield issuance, it's standing at around $70 billion. If you compare that to last year year-to-date, those volumes were $300 billion. Last year in total, there was $461 billion of high-yield issuance. So this year is going to be dramatically low from an overall comparison basis. But as you know, in this high-yield market, the way it works is when things reopen, the most liquid, big issuers come first. Then there's kind of price discovery. And eventually what trickles down is small single B, double B credits get access to the market. And basically they don't get access today. That's just the way it's working. If you look at single B spreads, look at that single B index and the triple C index, high yield index, that's very directionally informative about the kinds of yields that we can get, especially in the industrial area, right? For the things that we're targeting. Today, the single B spread index is 573 basis points. The triple C index is 1,122 basis points. That may seem high, but that's in line with the 20-year average for issuance levels across those credit tranches. The all-time tight spreads were back in late 2021, and single B spreads were 354. Triple Cs were 585. So if you look at sort of what we've been buying, it's no mystery that we were really heavy in industrial as a percentage in the first two quarters of 2021, starting to lighten up in 21, back half. I suspect you'll start to see us get much heavier as a percentage of industrial versus retail in the fourth quarter. And if this yield differential continues, spread differential continues to stay wide, it'll stay low. It'll be a higher percentage of industrial. That's all I'll say, I guess, I might say. As a realist, I guess the cost of capital, Mike, maybe you can tackle that.

Yeah, look, I think we don't feel constrained by capital. And we think that for the right opportunities, we think there's capital available for them. So I think we just want to stay right now disciplined on what we're seeing. I think what Jack is talking about, we're seeing in real time. And if more opportunities present themselves, then we'll lean into it.

The next question is from Harsh Hemnani with Green Street.

Please go ahead.

Hey, I noticed about 30% of this quarter's dispositions, this quarter's occupied dispositions came from office assets. And that's notable just given the low cap rate that these dispositions took place at. I want to check how the market, what does the biopool look like for these office assets, and how were you able to get a low cap rate, you know, despite a property type that seems like today is not in favor?

Okay. Thanks, Harsh. You know, I kind of made that statement earlier, this concept of FOMO is gone. The reason I say that is, like, if you were trying to sell anything in the third and fourth quarter of last year, pretty much anything, or finance anything, you could pretty much get it done at some kind of basis. If you look at our success in dispos, I kind of wanted to mention, like, it was funds, it was 1031, it was like rich people. The office building that we sold, you know, it was leased to a financial institution, had several years left on the lease. The buyer was a billionaire. You know, he had some, you know, he's local. He knew the market well. I think he has bigger designs for that asset, maybe when that lease renews. So I wouldn't say that all assets would trade like that. But, you know, one of the things that we do when we look at our disposition strategy is you really think through, especially because there's no more FOMO, you got to figure out who your targeted buyer is. and try to get the best execution. When you see us selling assets going forward, we're going to be extremely disciplined and we'll have a selling strategy as to who will buy and why they'll buy. When you have a super competitive market like we saw late last year, you just kind of throw stuff out there and send 100 books out and see what kind of comes in and all kinds of different people show up. That's not the kind of environment we're in right now. So, you know, we have, you know, that particular asset was a very targeted selling process. I'm not suggesting we'd be able to replicate that cap rate with other office buildings, but I would say at the end of the day, the underlying real estate quality of that particular location was just a phenomenal location in spite of the lease that was in place. That's what,

That's what helped us get that sale done.

Great.

And then one more.

The other thing I would say is like another example of a similar sale that we did was when we sold that Sunny Delight deal in New Jersey last year. Remember, recall that that was a deal that we had bought when I first got here. It's like a 7-7 cap rate. It's around $27 million that we paid for it. We ended up selling it for a 3.9 cap rate at a price of $59 million. Sunny Delight has roughly seven years of remaining lease term. But the buyer there sort of had different ideas about possibly redeveloping it, maybe expanding it. But you had a tenant that could still exercise a lease option. So we look for opportunities within our portfolio where Maybe we're not going to redevelop it or do something like that, but we can still extract a really high price for it and return. So that was kind of a long way of saying. Not all assets will trade like that, but obviously we have things in our portfolio that are pretty unique.

That's interesting.

I guess, so at these low yields, this is, of course, a very attractive source of capital for you. And given the guidance that you've put out there for dispositions, it seems like there's about 150 million more, maybe a little above that, coming through in the back half of the year. Do you think, given that cap rates are increasing, you can still get these kinds of yields or dispositions? What are you expecting in the back half? I would say, like,

Yeah, I mean, look, I think it's going to really – it's highly dependent on what we obviously decide to sell. You know, it's not necessarily just trying to get the lowest possible cap rate. I mean, if you look in this quarter, you know, Anthony Pallone put out a neat little note that said our net acquisition yield this quarter was a seven cap based on what we bought and what we sold. It's an interesting way to think about it. When we look out as to what we think we're going to be putting out in the market, it's probably going to be a little bit higher. There's going to be some risk mitigation issues. assets that go in. It also depends on the mix of things that we're selling. I mean, look, I think you've heard us say one of the things that we've tried to create is a very liquid portfolio. And our portfolio is extremely liquid. You know, like on a Mac paper deal that we sold two Mac paper properties, right? When we acquired that portfolio, which was 14 properties, Remember that we acquired that in late March, 2020. So we already saw COVID sort of starting to creep in and spreads are widening still closed. Didn't we negotiate anything with that sponsor? Cause they were, they were buying the business. It was part of an acquisition financially of the company. You know, selling those two properties at 27.5 million at that four and a half cap rate increases the effective cap rate on the remaining 12 properties in that portfolio and to 6.92%. So it's a 67 basis point increase on our investment yield, on our original investment. So the way I would sort of describe what's happening is we're not just looking at a creative recycling. Obviously, yeah, we acquired all these properties on a net yield basis at a seven cap. But remember what this is doing to things that we buy, it's boosting those going in yields as well. So kind of get a twofer out of it.

Thank you.

The next question is from Wes Gulliday with Baird. Please go ahead.

Hey, good morning, guys. Justin, I think you mentioned that certainty of close is getting valued a lot more these days. Are you starting to see a lot of retrading? And then when you look into your pipeline, you mentioned the new volume was high. Are you going to see a lot of new relationships coming into the pipeline in the next few quarters?

I would say it's going to be a combination of existing and new relationships. I'll give you a good example, like on golf. We had a meeting with Club Corp recently, the senior management team. And look, we got a lot of questions about that golf acquisition that we did. But I can tell you about that portfolio, the portfolio that we acquired. If you compare fiscal year 2019 results to second quarter results 2022 TTM. So it's kind of like over like periods. The revenue in that portfolio is up almost 20%. EBITDA is up 7%. Unit coverage is up 7%. And rent to sales is down 200 basis points. So pretty good, right? After meeting with that management team, there's way more upside still in this portfolio as they upcharge different membership categories within that private club portfolio. And look, I would tell you right now, we're going to do more golf acquisitions with club court going forward. Expect to see that in the pipeline. And it's going to have a range of acquisition as well as some redevelopment opportunity with them. We've been talking to other operators as well, but you know, we're, look, we're going to leverage the relationships we have in the, lines of trade that we think make the most sense today, where we can get the best risk-adjusted return. So yeah, I think it's clearly going to be a focus on repeat business, which was a high percentage this past quarter. And we're being very selective in what we're buying right now. And like I said, the most encouraging thing I've seen is the things that make the most sense to buy are starting to Turn up now, maybe there's some price capitulation. People just need to close. They need to go forward, move forward.

Got it. And then you guys are in the past and you have a lot of examples of where you found something in your portfolio that gets a value a lot higher in the private market. And I guess where the equity is today is it's recovered. But to say if we're not as favorable, would you just dial up more of these opportunistic dispositions in any way to quantify, you know, how big this bucket could be for you of assets where if you find the right buyer, which you have done many times in the past, you can just get an abnormally low cap rate?

Yeah, I mean, we have – You know, if you looked at, like I've used an example, three of what I'll consider some of the best transactions, or not best, but just really interesting ones that we could monetize. Mac paper would be in there, right? We've already proved that. Shiloh, which we acquired in 2021. One of the sales this quarter was the Worthington Steel Building. That was one of the acquisitions within the Shiloh opportunity. You know, we bought that whole portfolio at an 8.2 cap rate. And we ended up selling Worthington at a five count. I mean, it just gives you some idea of the latitude. Service King, I mean, I got a bunch of questions about that last quarter. It's one of the best transactions we've done. I'm telling you right now. That was a 21-store portfolio, very attractive going in yield, very, very good lease. Since we bought that sale lease back and we did that directly with the company, Third Lake Capital has invested $200 million in and remove $500 million of debt and merge it with another company they own called Crash Champions, credit's totally different, completely upgraded. Now it's 550 units. And like MacPapers and Shiloh, we've already gotten reverse inquiry for units in a high forecast. We're not even selling yet, just reverse inquiry. So we're just going to kind of keep doing that. We have an ability to identify this stuff. And whether we sell these things one-off or do a joint venture or whatever, or lop off bigger pieces, we're just going to keep making good real estate investments. That's what we do. And we're going to find the best source of capital to attack it.

And for that service scheme, I believe, Justin, you bought that one. It was a little bit more, I guess, unclear story on the capital structure. Is there any way you can disclose that cap rate that you bought it at, or is it something that they're maybe sensitive about?

Yeah, there's some confidentiality things around it. But what I would tell you about that acquisition, like Shiloh, it had a lot of complexity, really good real estate, really good unit coverage, really good lease. And when we spent time with the company, we believed that there was a path for them to get on the other end of success. And that's what gave us a lot of conviction to move aggressively on it. Um, so look, we look at a lot of things like that and don't do them, but when we find them, we lean into them pretty hard. You know, Shiloh was, was in the middle. No, go ahead.

Sorry about that, Jack. I'm good.

Yeah. Remember, you know, Shiloh, if you recall, was a, was a company that was also in bankruptcy coming out and the restructuring. And we did the sale lease back in combination with that, that kind of restructuring process. And, um, Look, just because a company is filing doesn't necessarily mean your real estate assets are going down in value. When you think about bankruptcy, senior debt converts to equity. If you've got really good real estate and the company restructures, your property's just got a whole lot better and your business got better. So remember how we underwrite. We look for critically long-term robust industries. We look for really good real estate, and we look for management and operators that we believe are sophisticated and are large that can kind of manage through complexity. And we just keep repeating that over and over again. And that's what, you know, this $4.8 billion of properties that we've bought since we got here, we continue to apply the same underwriting credit strategy to all the stuff we buy.

Yeah. Thanks a lot.

The next question is from Mitch Germain with JMP Securities. Please go ahead.

Thank you. Jackson, you seem to be pretty positive about deal flow.

Hey, by the way, Mitch, can you speak a little louder?

We can't really hear you. Maybe your headset's off. Oh, come back in the queue or something. Yeah. Sorry.

Okay. The next question is from Rob Stevenson with Jamie. Please go ahead.

Good morning, guys. Jackson, how are you feeling about gyms these days? Are you positive there or are you just positive on Lifetime given the expansion there in the quarter?

Look, I'll say it's a very specific answer. We love Lifetime given what they do. I mean, they are the category killer in their space. high-end country club experience. Now, look, they're a public company. I don't have to say any secrets. They have not gotten back to pre-COVID levels yet. But for instance, if you look at our gym that we just acquired up in Frisco, we bought two assets this quarter, one in Frisco, one in Plano. When Frisco opened, they already had a waiting list. So just think about that. Those are two of the probably best suburban locations in the country, definitely in the top top probably 10% or core top. Those gyms are awesome and they will do well. I believe that they will do well and it will continue to improve in their membership. If you go to the other end, Vasa Fitness, which we love, that's a high volume, low price operator in the gym space. They're already exceeding pre-COVID levels. So they've recovered from the unit coverage and profitability and revenue they've actually exceeded pre-COVID levels. So I think that, I guess what I'd say is, you know, this is just my own impression, but like Lifetime's going in price is a little higher obviously than Abasa. It's more of a financial commitment. But the offering and product and services and opportunity that they provide membership is just a much more phenomenal experience. Look, we like the subscription business, like the car wash business, the golf business, health club business. I just think for the higher end gym operators, you know, people have kind of started to do different things, but I do believe they'll come back to Lifetime. You know, Lifetime offers tennis, pickleball, you know, water, great pools, great programming. It's just great facilities. So we're very comfortable. That's the end. But I'd say we're very selective about the operator and the price points that we're getting into, not all gyms. We're very focused on what I'll call that lifetime space and then the high-volume, low-price provider like Abasa that we think is best in class.

Okay. And then are you guys seeing any price discovery on decent performing movie theaters yet? It seems like vacant and adaptive reuse theaters are the ones that are trading out there. So just curious if you're seeing anything to put a price point on – you know, lease theaters at this point?

We heard of a couple of them, but, yeah, we're obviously not selling movie theaters right now.

Yeah, I'd suggest that the answer is no, there's not been enough transactions to say where pricing is shaking out. It's interesting, we've seen some large, well-known concept theaters on the market for nearly double-digit cap rates. But I've also seen some regional players in pretty good real estate locations on the market in the five and six cap. Not that they're going to get that, but I'd say the answers are just not enough transaction volume to figure out where pricing is for theaters right now.

Okay. And then last one for me. Jackson, how did you and the board think about the potential to buy back stock when you were trading in the mid-30s and mid-June? Or did you?

We didn't really look at it. If you remember since I've been here, we bought back a lot of stock. At one point, I can't remember the percentage of the float, but north of $300 million while we were going through that whole FMTA spinoff. I'm glad we didn't buy back stock because I guess I put it this way. If we were in a prolonged period and we didn't see opportunities to deploy capital at what I call really attractive levels in attractive real estate investments, then yeah, buyback stock makes total sense. But when I can buy a Service King or Shiloh or Mac paper, and I'm not competing with 20 people and people want certainly a close, and I can get, and I got high yield. I have the single B index and triple C index trading at the 20-year average, spread average, and the underlying base rates are going up. Yo, man, I got to buy. I'm going to buy. I'm going to make good investments. Because, you know, buying back stock is just a moment in time. You know, if I, you know, MacPapers is going to be the gift that keeps giving if we want to. Same with Shiloh and same with ServiceKit. You know, the assets are going to continue to improve. We're going to continue to get rent bumps. We're going to continue to get cash flow. So, yeah, but we do look at buybacks, but we never really seriously considered it, even at the dip, because we didn't want to lose opportunity to kind of continue to deploy. And we're seeing it now. I'm telling you, the last three weeks, the happiest I've been.

All right. Thanks, guys. Appreciate the time.

The next question is from Michael Goldsmith with UBS. Please go ahead.

Good morning. Thanks a lot for taking the questions. Your cash capitalization rate for acquisitions in the second quarter was slightly lower than the first quarter. And previously you talked about the cap rates moving higher. So when should we think about this being reflected in the numbers? And then given cap rates moving higher, does this make you less likely to maybe move up the risk curve for higher yields?

Good question, Michael. I mean, the first two quarters were largely done at a very early part in what I call the life cycle of a quarter. I think in the third quarter, you'll start to see an increase in the cap rate, but not the same kind of volume as you saw in the first two quarters. Because as I said, the volume of opportunity just wasn't there. People were still hoping for, hey, I want the low, I want the six cap. I don't want the seven cap. But look, I'm offering a 7 or a 6.25. So I think what you've seen today is real price capitulation, particularly in that industrial light manufacturing area. In retail, no. So I think what you're going to see from us is higher yields, lower volume in the third quarter, and I suggest that you'll see higher yields and much more industrial and hopefully much more volume in the fourth quarter and going forward.

And then to follow up on that, you talked about industrial cap rates up 50 to 100 basis points. How does that compare for distribution versus manufacturing?

I mean, distribution is obviously tighter. It's really, that's a hard question because it really depends on the nature of the distribution of the market and the particular manufacturing subsector. I think that has a lot to do with it. I don't care if you want to try to give... There is a difference, but... Yeah, there is a difference.

Jackson mentioned distribution tends to be a tighter cap rate, but when we say light manufacturing, that just means the majority of the space is dedicated to light manufacturing. I would say typically those buildings do have distribution capabilities and whatnot, but relatively speaking, those cap rate increases that Jackson referred to would, I'd suggest, apply equally to both of those asset classes.

Got it. And then as a follow-up, you know, cap rates starting to move higher, you know, maybe the spread's kind of compressing a bit. So, you know, you've been focused on dispositions as funding, but I guess what would you need to see from here where you can kind of switch to move away from dispositions to other sources for funding?

Well, I mean, I think first, no matter what our stock price is or cost of capital, we're always going to be disposing. Maybe it's a smaller amount, but I think that we get strategic information out of that. It's real time. Obviously, when we're trying to sell something, we see who's bidding, how they're bidding, the number of bidders. That's super informative for someone that's a company that's buying so much to be able to figure out when to lean in. I would say that, you know, we'll look at the equity markets if things continue to go. Like I said, the last three weeks have been great. It's been kind of, to be honest with you, it's been pretty crappy since, you know, since the invasion and spreads widened. There hasn't been, you know, product. People are not really price capitulating on cap rates. But I believe it's happening now. And I just don't know how long it's going to continue. If you remember, you know, after COVID, you know, in the middle of 2020, like we got all in, you know, in the third quarter and the fourth quarter of 2020, you know, we picked up off lease. That was a failed transaction with another buyer. Got a great deal with those guys. We're doing more follow-on business with them. But then, you know, in 2021, you know, too many people came in. Debt markets got crazy and it crushed the business. It got really hard to do stuff. Today, Portfolios, in my opinion, are trading at a discount. It's harder to finance them. So, look, if we found a really interesting, large portfolio, we'd do it, totally, at this point. It's not a criteria, and we thought we'd be able to pay properly.

Thank you very much.

The next question is from Joshua Dennerlein with Bank of America.

Please go ahead.

Yeah. Hey, guys. Just kind of curious on the term loan you did post-quarter.

Just kind of thinking through just the potential accretion it might offer you guys and kind of how you think about debt needs going forward.

Yeah.

I mean, Josh, it was a good execution for us. I mean, it's not closed yet. It's going to close in a couple weeks. But, you know, obviously the rates are swapped, so that's locked in. Yeah, we felt it was a better cost of capital than where the bond market was today. I think we'll get back to doing bonds in the future. I think when we looked at the bond market today, it was very disrupted, and we don't think it made sense to go into a disrupted market. So I think it's good when we have a balance sheet our size and a credit rating like ours that you can pivot to different pockets of capital, whether it be debt or other types of capital. So I think you'll continue to see us take advantage of the right types of capital to fund our business, but that was definitely a good execution for us at this particular time.

Josh, I'd make a pitch to all of our companies, companies that compete in this space, the other public net lease REITs. You've seen a number of us access the term loan market. If you had an acquisition strategy that was reliant on CMBS or secured mortgages, you'd be basically taking the summer off, honestly. If you were a buyer that was really reliant on high-yield debt or high-yield single-B term loans, you'd probably be taking the summer off. There's just no LBOs going on right now. For us, being able to pivot into investment-grade term loans, I mean, I'm not suggesting that's going to be there forever, but it's there right now, and that's why people are taking it. There's a lot of volatility in the swap markets. You can sort of hedge rates at this moment in time. It's not great, 3.5%. Wish it was better. Maybe I wish we would have hedged earlier in the year, but still pretty good. It works for our model. And, you know, we'll just keep punching out term loans if that's what it takes. Because I do believe long-term rates are coming down. That's a fundamental point of view right now, today, based on what I believe is happening. Could be wrong, but believe that, then the strategy makes sense.

Are there any kind of limits on how much term loans you can have or just not as familiar with the market?

Yeah, I mean, there's not really a limit. There's plenty of bank capacity out there, and we have a lot of banking relationships. You know, I think that it's just, you know, it's a piece of capital you want to constantly do. I mean, look, we can do as long as we need to. So I think it is a place you can go back to. All of our peers have done it. There are some companies out there that use really exclusively term loans. And there's a term loan A market is what we access with a small banker. There's a term loan B market, which is a whole other universe of investors that So there are different markets out there, and we'll evaluate those in the future when we have future debt needs. But I think that's the good thing about, as Jack was saying, being a large investment grade company, we have different pockets of capital we can go to on the debt side, for example, that a lot of competitors out there don't have. And I would argue right now that us and a lot of the other big public companies, we have the best cost of capital around right now because we can access these different pools of capital.

And also access at large scale. But I would tell you, like, you know where our equity multiple is, and it's not great. Our cost of capital is, look, we just have a longer putt vis-a-vis our peers as it relates to cost of capital. So we're just going to try to be as nimble as we can. If we've got to sell more assets at low cap rates to execute, we're going to do that. If we've got to do more term loans, we're going to do that. Bond market opens up, we'll do that. But right now, if I keep seeing what we saw in the last three weeks and it continues, we'll figure it out.

The best solution.

Let me just one quick follow-up on that. You mentioned equity. What do you have to see to start tapping the equity markets again?

It's really just this continued what I saw in the last three weeks. High volume of quality things that we would like to buy that meet our criteria. We have not seen that I'd say in the past several months. I don't know if that's going to continue. Like this is three weeks. I don't, it's one of the reasons why we didn't increase guidance. Cause like, Hey, if this kind of, this was just a three week blip and you know, we're kind of good. We're okay with our guidance. If this, if this trend continues, guess what? We'll do more than our guidance on the acquisition front. I'll tell you that. But like, it's hard for us to, shift to make a change because I'll tell you right now, we'd like to do more industrial because we're getting paid for it based on the credits and the nature of the real estate we're seeing right now in the industries. If it continues, like I said, into the fall, we expect to do a lot more.

But I just can't tell you right now if this three-week trend is going to continue. That's great, Collin. Appreciate it.

Yeah. I mean, I would tell you, I gave you those high-yield indexes. Like, if things stay at that 20-year average from a spread basis, I would tell you we'll do more. Just going to say that. If you see that index compress back to lower levels like we saw in 2021, probably more challenging for us to do the volume that I suspect we'd be able to do.

The next question is from Ronald Camden with Morgan Stanley.

Please go ahead.

First one is on Kohl's. Obviously, they've been in the news about potentially looking to do sell lease back and so forth. Just maybe can you comment just your relationship there and more appetite to do more there? Thanks.

Yeah, thanks, Ronald.

We bought some Kohl's this past quarter. We like Kohl's. or one, sorry. We bid on some other ones too. Wasn't a success. But yeah, we like Kohl's. One of the things that we like about them is that they're not in mall locations. They're freestanding generally. They have some mall locations, but majority are freestanding or in shopping centers. What they're doing with Sephora seems to be getting traction. I'd say of all the department stores, in my opinion, they're doing... They're doing really good work right now. And so, yeah, I think if they were going to go sell some properties, I'm sure we would show up and bid on them. Just simply come out on the price and rent structure and price per foot, all that kind of stuff, and locations, obviously. But we like them.

Great. And then just the second question is just piggybacking on sort of the, um, the questions on sort of the debt, um, you know, obviously the 800 million that is presumably supposed to fund and so forth, just in terms of leverage levels, just how high would you be willing to go before, um, sort of considering coming back to the equity markets and so forth? Like, how do you think about that trade off?

Okay. Well, we, we want to stay within our, our leverage man at five, five and a half times, you know, into the quarter of five to, uh, I think if you look out the rest of the year, you know, with our current guidance in place, you know, we could not fund any additional equity other than what we have on the forward and still stay below that five and a half times range. But, you know, that's what Jackson earlier mentioned. If we see opportunities, we're happy to lean into and initiate equity if needed. So we'll figure that out.

Yeah. I mean, Ron, I would say like, you know, if you look at, just kind of look at our, I think we have that one schedule in our, in the investor presentation that talks about quarterly or capital deployment performance. And if you look back in Q3 2020, Q4 2020, Q1 2021, Q2 2021, a good majority of the acquisitions were in the industrial space. And then you look at what happened in Q3, Q4, Q1 of 2022, we were just getting priced out. We were getting outbid by other people. You know, if we start to get some success on some of the things I just talked about that we're seeing in the past three weeks, we'll issue equity for sure. We will. And if we see more, we'll issue more equity. But, you know, we're kind of, like I said, it's been sort of a three-week phenomenon in terms of volume, credit, and opportunities at a cap rate that we think makes sense for a risk-adjusted return.

Excellent. And then my last one was just on the comments on the experiential sectors, obviously looking to do more golf. Were there any others either in the pipeline or on the short list, whether it's theme parks, marinas, it could be whatever? Was there anything else that was sort of really interesting, really attractive that were sort of in the pipeline or that you were looking at?

No, I mean, not really.

I mean, we look at a lot of different things, but, you know, pulling the trigger on something like, you know, like main event Dave & Buster's, obviously that was a great thesis for us with how that ended up, you know, the combined companies. You know, golf, we have a lot of interest in golf, and we'll pick our spots, pick our operators, pick our real estate. You know, we look at theme parks, we look at gaming, we look at marinas. haven't gotten there yet for either price or credit or whatever. Not to say we'd never do it, but we do look at a lot of different things, but it's got to have that real staying power and upward trajectory from a demand and user standpoint for us to really get there. That's the best way to put it. And we're looking at things that make, trying to find opportunities where we think there might be some cap rate compression in the future.

Thank you.

The next question is from John Masoka with Leidenberg Talmud.

Please go ahead.

Good morning. Just a quick one for me. The guidance that was maintained, is that including the impact of the new term loans and the swap? Just thinking, I know that the swap's locked in, but the transaction's still a little bit ongoing there, and so I don't know if that was kind of contemplated in your per share guidance?

Yeah, it does. It has the new term one built into it, which, you know, obviously has rates going up in the third and fourth quarter.

Okay. That was it for me. Thank you very much. Great.

The next question is from Greg McGinnis with Scotiabank. Please go ahead.

Hey, good morning. So just to clarify on that last point, midpointed guidance implies just a touch of a pullback from the 90 cents a share in Q2. Is that primarily driven by higher interest expense?

Yeah, interest expense is a line share that if you think about it, we're using the revolver primarily in Q1 and Q2. And the average revolver rate, I think, in Q1 is about 1.1% when it's about 1.6% in second quarter. And we're swapping $800 million of debt to 3.5%. And then, you know, we'll be using some revolver in the fourth quarter. And of course, you know, those rates are going to 3.5%, 4% by the end of the year. So definitely some higher interest expense in the back half of the year that's affecting the midpoint of our guidance range.

Any other items to consider or really just that?

Well, no, the other thing, of course, is our lost rent and leakage reserves. You've seen, obviously, year to date, we've had no lost rent and our property cost leakage or unreimbursed property cost has been a historic low. you could assume that in our forecast, we're a little more conservative, and we do forecast some reserve for that. And so that also is built into our guidance.

Okay, thanks. And this final question from me is, how are you thinking about exposure to some of your top tenants, such as Lifetime, in terms of where are you comfortable bringing that exposure? Similarly on retail versus industrial, is there any diversity level or exposure that you're targeting there?

I guess I would sort of overall, I mean, no one asked, but the way we think about it, we think that obviously this is, we're going to be in a Fed-induced possible recession. We think it's going to be shallow, not deep. We think that the housing industry is kind of right in the crosshairs of what Fed's focused on. We think this interest rate cycle will be short-lived and people are going to start trading down and You know, going back in the office, to be honest with you. So I think that what that sort of means is earnings are going to slow down for a lot of the businesses that we invest in. So we're spending a lot of time looking at industries that we think will continue to perform at the high rate of growth. There are some industries that will continue but will slow. We think there will be some industries in our portfolio that might deteriorate a bit. And then we think there are some industries that will be counter-cyclical on the way up because of the trade down with consumers. So rather than answer it like in our top 10, we have a kind of point of view on each of these industries. And we're going to probably be thoughtful on rebalancing some of that as we move forward based on what I described to you as our view of the economy over the next several months or quarters. And probably the dispositions that we do will follow suit with how we feel about some of those, you know, where things go. I mean, I think it's, you know, we use that heat map. We've spent a lot of time talking about it. We've reevaluated it. We adjusted it. So, yeah, I would rather not get so tactical about individual names when we look at sort of industries. Industry exposure, for instance, is a big one.

Okay. Thank you.

This concludes the question and answer session. I would like to turn the conference back over to Jackson Shea for any closing remarks.

Thank you, operator. Well, look, hopefully from this call you'll conclude that our portfolio is performing great, our operating platform doing a great job doing 50-plus transactions. We think there's a lot of underlying value in our real estate that's not reflected necessarily in our NAVs that are out there. And we think that with these debt spreads staying at widened 20-year levels on the averages, we think there's going to be more opportunity for us to deploy capital at better spreads, being cautious about where we think the economy's going. And from a funding standpoint, having basically no debt on a revolver after this term loan closes, I think we're poised to get some interesting stuff done through the balance of the year.

Appreciate your support and interest.

This concludes today's conference call. You may disconnect your lines.

Thank you for participating and have a pleasant day.