Spirit Realty Capital, Inc.

And welcome to the Spirit Realty Capital 4th Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please limit yourself to one question and one follow-up. Please note this event is being recorded. I would now like to turn the conference over to Pierre Revol, Senior Vice President of Corporate Finance and Investor Relations. Please go ahead.

Thank you, Operator, and thanks, everyone, for joining us for SPIRIT's fourth quarter 2022 earnings call. Presenting today's call will be President and Chief Executive Officer Jackson Shea and Chief Financial Officer Michael Hughes. In addition, our Chief Investment Officer, Ken Heimlich, will be available for Q&A. Before we start, I want to remind everyone that this presentation contains forward-looking statements. Although we believe these forward-looking statements are based on reasonable assumptions, they are subject to known and unknown risk and uncertainties that can cause actual results to differ materially from those currently anticipated due to several 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 specific 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 , which include our earnings release and supplemental investor presentation. These materials are also available on the investor relations page of our website. For prepared remarks, I am now pleased to introduce Jackson Shea. Jackson. Thanks, Pierre, and good morning.

We're pleased to report strong results for 2022, which exceeded the targets we announced in 2019. We achieved AFFO per share of $3.56, surpassing the midpoint of our 2019 Investor Day range by 14 cents. We also increased our total ABR to $681 million. while increasing our industrial exposure to 23%, with both hurdles exceeding our investor day targets. Furthermore, we maintain high occupancy, low lost rent, and stable unreimbursed property costs across our portfolio of 2,115 properties. These results reflect our prudent underwriting approach and well diversified portfolio, leased to sophisticated operators in durable industries. During the quarter, we invested $312.4 million in 24 properties at a 7.27% cash capitalization rate. 88.4% of these investments were in industrial assets, including distribution, light manufacturing, and industrial outdoor storage, with 90.2% of the investments originated through sale-leaseback transactions. We also invested $38.5 million in development and revenue-producing capital expenditures, almost half of which was related to our $67 million investment in a $125 million cutting-edge facility for SunOpta, a leading plant-based food manufacturer. This facility opened for operations in December. Our disposition program also produced great results in the fourth quarter. We sold 21 occupied properties for $110.2 million at a 6.22% weighted average cash capitalization rate, representing a positive 93 basis point spread for a capital deployment cap rate and resulting in a $33.3 million gain. The occupied mix included 42% retail and 47% medical, and only 4% of the sold properties were leased to investment-grade tenants. For the year, we sold $278 million of leased assets at a weighted average cash capitalization rate of 5.47%. representing a 118 basis point spread to our capital deployment cap rate and generating a $94.2 million gain. Only 24% of the sold properties were leased to investment grade tenants. Our capital recycling program, which started early in 2022, has been very successful. It has allowed us to further reshape the portfolio and accretively redeploy capital into asset classes and industries that we find attractive today. We expect continued success with dispositions this year. In total, through acquisitions and dispositions, Spirit has successfully completed more than 150 transactions in 2022, which is a testament to our people and the robust processes we have established. As I previously discussed, The majority of our fourth quarter acquisitions were in industrial assets, which continues to be a strategic focus for us. Given our growing exposure, we have featured notable achievements in this sector in our supplemental investor presentation. On page 13, we spotlight the sales of Shiloh, Sunny Delight, BE Aerospace, and Mac Paper Properties. These were industrial properties that we purchased and later sold, realizing a 85% gain and capturing 312 basis points of cap rate compression since we acquired these assets. On page 14, we highlight the fourth quarter acquisition of a manufacturing facility leased to Wei Interglobal, a top RV appliance manufacturer and supplier. In November, shortly after we closed on our sale leaseback, Way Interglobal was acquired by LCI Industries, a much larger public company and a major credit upgrade for Spirit. On the same page, we feature the development of the 270,000 square foot state-of-the-art Sunopta facility, illustrating how Spirit can partner with industrial tenants to build mission critical facilities. Finally, on page 15, we highlight select industrial acquisitions completed in the fourth quarter, including one distribution and two industrial outdoor storage facilities. We find these investments appealing because they are mission-critical assets leased to strong operators with low in-place rents, and while the acquisition yields are very attractive for us today, we anticipate that these facilities, just like the industrial dispositions, featured on page 13 will appreciate in value over time. One of our earlier investments within the industrial sector was the 129 million sale leaseback transaction for a distribution center and two manufacturing facilities leased to Party City that we completed in 2019. We highlighted this investment at our investor day and have provided an update on page 16 of the supplemental investor presentation. What's important to note is that despite Party City's ongoing bankruptcy, we expect a positive outcome for Spirit, given Party City's dominant position in the party goods sector and our assets' high quality and mission-critical nature. Eighty-five percent of our investment is in the 900,000 square foot distribution center in Chester, New York, which is located in Orange County. This property serves as Party City's primary distribution center, running at full capacity and handling over 45,000 SKUs for clients across the globe. Given its critical role in the company's operations, this facility epitomizes the concept of mission critical. In addition, market rents for distribution centers in Orange County stand at $11 per square foot and are projected to increase by 6% this year. This is significantly higher than our current rental rate of $8.05 per square foot, which grows contractually at 2% per year. Our investment in this facility is well below replacement cost, and should we ever have the opportunity to re-let the asset, there is significant upside in this property due to the high tenant demand for distribution centers, the lack of others of this size, and the difficulty of doing ground-up development in this market. The two other facilities are smaller in terms of investment, but also have great stories. The Eden Prairie site is a manufacturing facility responsible for production of 60% of the world's Mylar balloons. This building is in a strong sub-market and is vital to the Enneagram business, the manufacturing arm of Party City. Like Chester, It is an example of a mission-critical asset. The Las Lunas facility is a high-quality asset in an excellent location. Notably, it has already been subleased to Cupertino Electric at the same rental rate that Party City was paying, showing the versatility and quality of the light manufacturing assets we pursue. As a reminder, our approach to underwriting is based on analyzing industry durations. and our tenant's position within it, examining tenant creditworthiness, and evaluating the real estate's residual value underpinning the facility. While it is important to get all three right when you enter into a sale leaseback, we know that credits can change to the positive or negative for a variety of reasons. So the industry and real estate are paramount. In the case of Party City, the credit deteriorated. but we remain confident in the industry and Party City's position as the dominant party goods supplier and manufacturer and believe the real estate is extremely valuable. We therefore expect a positive outcome for Spirit's investment and believe this will be a good proof of concept for our underwriting approach. As we think about the current year, we remain committed to taking actions that will create the most value for shareholders. We have set forth a fully financed capital deployment plan, utilizing free cash flow, asset dispositions, and in-place debt to produce positive investment spreads in a volatile capital markets environment. Our focus for the upcoming year is to showcase our portfolio strength and highlight our platform's effectiveness, which we expect to result in steady cash flows and dividends for our shareholders. With that, I'll turn it over to Mike to discuss the quarter and our 2023 guidance.

Thank you, Jackson. Good morning, everyone. Once again, our operations continue to perform at a very high level during the fourth quarter. We achieved a slight increase in occupancy, up 0.1% to reach 99.9%. Our lost rent improved from 0.3% in the third quarter to only 0.1%. Our wait hours lease term remained stable at 10.4 years. Our unreimbursed property costs remained steady at 1.4%. Our ABR increased by $19.9 million. reaching $680.9 million. The increase was driven by net acquisitions of $15.1 million, organic rent growth of $4.8 million. Our forward same-store sales growth has stabilized at 1.6%, as the majority of the movie theaters re-tenanted during COVID, which were driving the slightly higher growth, have largely returned to paying full base rent rather than variable rent. AFFO per share was $0.88 compared to $0.90 in the third quarter. The two-cent decrease was primarily attributable to a reduction of $1.7 million in non-tenant income and an increase of $1.8 million in cash interest expense, reflecting a full quarter's impact of the $800 million in term loan borrowings, which we swapped to a fixed rate of 3.5% in August. Turning to our balance sheet, we issued 1.6 million shares during the quarter under our ATM program, generating net proceeds of $63.9 million. We ended the year at 5.2 times leverage with liquidity of $1.7 billion, comprised of cash and cash equivalents, restricted cash, and availability under our credit facility and delay draw term loan. We expect to draw on the term loan towards the middle of the year. In addition, our deferred rent balance declined by $7.4 million during 2022 to $7.9 million at year end and should decline to $3.5 million by the end of 2023. As a reminder, our deferred rent has already been recognized in earnings. Therefore, the repayment of deferred rent only impacts our balance sheet. Now for 2023 guidance, our AFO per share range is $3.53 to $3.59 with capital deployment of $700 to $900 million and dispositions of $225 to $275 million. To better understand our guidance, we have provided a walk from Q4 2022 annualized AFO per share to the midpoint of our 2023 AF vote per share on page four of our supplemental investor presentation. As we note on page four, we believe that annualized fourth quarter 2022 AF vote per share, equating to $3.52, is the right run rate for analyzing and understanding our 2023 guidance, as the fourth quarter includes the full impact of the aforementioned $800 million of term loans and minimal non-tenant income. Walking forward from the $3.52 per share, we expect about $0.04 from organic rent growth, $0.06 from our 2023 net capital deployment, plus $0.05 from lost rent reserves, which equal 1% of our AVR, and less than another penny for inflationary G&A increases. Keep in mind that, as is usually the case at this point during the year, the lost rent reserve is an assumption and is not specific to a particular tenant. As Jackson mentioned, our capital deployment plan is entirely funded through free cash flow, dispositions, and our existing debt capacity, with no reliance on the capital markets. Should the capital markets turn more favorable or we find compelling risk-adjusted return opportunities, we will certainly consider taking advantage of those situations. But for now, we remain cautiously optimistic and disciplined in our approach to the year. With that, I will turn the call back to the operator to open up for Q&A. Operator?

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. Please limit yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster.

My first question comes from Wes Galladay with Baird.

Please go ahead.

Hey, good morning, guys. Just a quick one on the net investment activity. What type of spread are you looking at for investments this year? I think last year you said you were around 118 basis points.

Hey, Wes. This is Mike. Yeah, I mean, given the way we've sized it and the way that we're going to use capital to acquire, we're looking at about 200 base points of spread.

Okay, fantastic. And then You do have that $500 million delayed draw term loan. Do you have to draw the whole thing? Can you do a partial on that? And what do you think about timing and putting it on swaps? Or do you already have a swap for that?

Yeah, we haven't swapped it yet. That's something we'll continue to evaluate and be optimistic about. As far as timing, contractually, we need to draw that by the middle of the year, July 1st, although there is some flexibility that we can use to negotiate longer-term extensions on some of that if we need to.

Okay, and you have to do the whole thing? Or can you do partial?

Yeah, well, you can do partial up until July 1st. So you can do partial, and then by July 1st, you need to draw the whole thing, unless we contractually get an extension.

Okay, fantastic. Thank you, guys. Yep, thank you.

Our next question comes from Handel St. Just with Mizuho.

Please go ahead.

Hey, good morning. Thanks for taking my question. I guess the first question is... You guys backed out $3.2 million of deal pursuit costs in the quarter. I know you had a little bit last quarter, $470,000, I think. Curious if there's any comment or anything you'd like to share on what drove that big increase or if there's anything, well, any comments you could make, Bobby, on that. Thanks.

Sure. Hey, Handel. Good morning, Jackson. You know, that was kind of a one-off situation. It was a combination of there were It was a large transaction that we were looking to acquire. We spent quite a bit of time on last year. We also had, obviously, a large number of transactions that we completed. We closed over 100 separate transactions. And, you know, as cap rates were moving up throughout the year, you know, we dropped a lot of transactions. You know, if tenants were either delaying or if environmental due diligence or lease terms didn't come back the way we had initially underwrote the transaction and committed to it, We walked away. So I'd say it's a combination of more transactions, more terminated transactions, and a large acquisition that we were looking at potentially acquiring last year.

Okay. Fair enough. Appreciate that, Collar. And maybe just a follow-up on the five cents of reserves embedded in the guide here. I know you guys don't want to get into a conversation around specific tenants, but maybe can you talk a bit broadly about the watch list here? uh exposure to kind of the unknown risk categories uh and then specifically party said you mentioned that you don't anticipate any rent disruption uh during or after emergence for bankruptcies so just curious what scenario um uh is broken so god for for that as well thanks yeah maybe i'll i'll start first uh handle like you know we've we typically you use a one percent reserve just it's just a normal lost rep reserve we've it's been historically what we've done

Last year was slightly less. From what we see today, obviously, Party City is going through a restructuring right now. And we feel, as I talked about in my comments, we're highly confident in that asset, in the cash flows. And if those cash flows change and we're wrong, we think there's actually upside in those cash flows, given the real estate and things I talked about in the prepared remarks. As it relates to watch lists, yeah, we're We're looking at more things. There's more things, obviously, just given the environment that we're sitting in. I can actually tell you today that the realized active things that we're looking at in terms of lost rent are not here right now. So, I don't know, it just seems like to us to be more prudent with that 1% just as we look at it. And obviously, I can tell you our company and team's goal is to do a lot less than 1% in terms of lost rent this year. So... We'll continue to update that as we go through the year to investors. And right now, we just think at the beginning of this year, just given some of the economic uncertainties, we want to be a little bit more conservative as we think about it. Yeah.

And as Jackson mentioned, I mean, that is a normal assumption that we start the year with. And one thing that makes it kind of a headwind to our guidance this year is that last year was just so good. We had very, very little loss rent. So just from a year-over-year kind of laughing-the-year standpoint. that assumption does create a headwind in our guidance.

You know, and one thing, if you look at our unit coverage and corporate coverage, you'll notice that there wasn't much change between the third and fourth quarter. And look, you know, we're seeing good performance in a lot of lines of businesses, you know, the casual dining area, convenience stores, auto services, home furnishings, golf doing particularly well, specialty retail. And obviously there's some areas that have a little bit more pressure, you know, car dealerships right now. are dealing with some additional inventory and floor plan financings going up. So I think in balance, it's basically the same, but we're just obviously being a lot more vigilant, staying close to our tenants right now.

Thank you, guys. Appreciate the call.

Our next question comes from Michael Goldsmith with PBS. Please go ahead.

Good morning. Thanks a lot for taking my question. You went heavy with industrial acquisitions this quarter, which has been telegraphed, but 75% of your activity was in industrial. Industrial penetration picked up 230 basis points. So I guess as you continue to kind of transform the portfolio, you know, have your assumptions kind of been corrected that this is where you want to be? What are you seeing kind of within the industrial category now? And I guess kind of like just generally with this macro backdrop, you know, what are you seeing on the retail side? And is that just considered maybe more risky, just given this, you know, given the economic environment? Thanks.

Michael Heaney Sure. I'll start. Thanks, Mr. Jackson. Look, I think one of the reasons why we were so successful this past quarter in the industrial area is that, you know, just the challenges in the financing, corporate financing markets. Bank debt, high yield has made the sale-leaseback option a more compelling financing option long-term for corporate tenants. And that's particularly the case that we highlighted this past quarter in the industrial space. I mean, for us, you know, we have this three-pronged approach that we talk about all the time, you know, industry duration, tenant credit, real estate. And we're going to stick to that. We've been doing that since we all joined here at this company, since we've reshaped it beginning in 2017. And I think it's going to pay off. Obviously, we talk a lot about Party City. We fundamentally have underwritten assets that way in the industrial sector, as well as retail. And we think that the things that we're buying today in the industrial specter are just super mission critical, especially some of this industrial outdoors storage facilities that we're buying. That doesn't mean that we're not going to do retail. We still like it. We obviously are very close to a handful of tenants and industries that we're particularly still bullish around. But I think that the crack in the financing markets corporately have enabled us to be more competitive in this industrial space. That's why you're seeing it increase. You know, the mortgage financing market has sort of made it more challenging for some of the private equity players, real estate private equity players that compete against us in this sector. So I think we're going to continue to make progress this year. And obviously, as the markets become to normalize and get more competitive again, you know, we may have to shift away from industrial. But right now, we're seeing really good opportunities to sort of fit the things that the criteria that we underwrite to. I appreciate that.

No, I appreciate that, Jackson. And you kind of led into the second question. It's just, you know, as we think about 23 and the concentration of where you're going to be dealing, like, can kind of this makeup continue through this year? Or is it going to be a little bit more balanced? Like, is 75% industrial sustainable? Or is it just going to be kind of a mix or what? where there's opportunity overall?

Yeah, I mean, I could say like in the first quarter, it's going to probably look similar to that. You know, as we project out through the course of the year, you know, obviously it's harder to predict that. I think a lot of our success is because of where the financing markets are corporately and in the mortgage market as well. That's having a positive impact for us that, you know, the challenge over there in that market. I think as those markets improve, it just, it just will be more competitive for us to be able to keep increasing at this pace. So look, I think like we, we believe that we'll be able to do more in the industrial area. We're certainly going to do it in the first quarter. And as the year, it's hard to predict the rest of the year, but yeah, we, we have the flexibility to invest in both areas, industrial and retail. So we feel like given our guidance and how we're, Thinking about the business plan this year, we feel very comfortable that we'll be able to achieve these results.

Thank you very much. Good luck in 2030. Thanks.

Our next question comes from Greg McInnis with Scotiabank. Please go ahead.

Hey, good morning. So just looking at Q4, were you acquired at a 7.2 cap, 30 basis points higher than where it's generally been. Could we see higher cap rates this year than there, given the current financing environment and tenant demand for sale leasebacks? And then just curious if you could give us some details on where you're seeing more or less competition for assets and whether you're feeling more constrained by capital availability or compelling transactions at this time.

Well, on the cap rate side, I think in the first quarter, you know, you're going to see our acquisition cap rates continue to drift higher. You know, I'd say it's probably going to look somewhere in the seven and a quarter to seven and a half range is where we'll, you know, that's probably a good assumption in 2023. And we're seeing, and one of the reasons I think we're seeing that success is, as I said, you know, corporations are looking at their real estate, especially in industrial companies, monetizing it for long-term financing, just given kind of where non-investment grade companies get trade today. So I think that's going to continue to play out positively for us. Obviously, there's more competition for these types of assets. Some of our public peers do the same investment strategy. So I think we'll see that going forward. And I think the other thing that you'll see this year for us, if you look last year, You know, we did about 100, I think it's like 114, does that sound right? 114 million of CapEx in development. This year, that number will be probably similar, if not a little bit higher. And it's going to be at least a 50 basis point premium to the cap rate I just described, you know, the seven quarters, seven and a half. So it's going to be priced more appropriately. And we've already got a nice pipeline of, you know, I'll call revenue, capital expenditure opportunities that are in the guidance for this year. So, you know, we'll continue to evaluate the market. You know, we think, and then the last piece to your question, Greg, you know, we've been very active on the disposition market. And if you look at the number of transactions that we sold last year, you know, part of it was reshaping, part of it was risk mitigation, part of it was just for, just proof of concept in some ways to how we've invested. So we've got, we feel like we've got a very good handle on sort of where the market is trending right now. You know, 40% of those sales, like in the fourth quarter that we completed were 1031 buyers, 60% were what I call private sort of institutions or individuals. So, you know, we'll continue to monitor the, the markets as we are buying and selling as part of the plan dictates for the operating plan for 2023. So I think we've got a pretty good handle on what pricing is right now.

Thanks. Maybe just touching on your revenue-producing CapEx comments. Is that built to suits or is that just investing in current portfolio with the tenants that are there right now?

It's a combination of the two. It's probably more biased to existing tenants that are looking to either improve the facility or increase the size and score footage of the facility. I think as time goes on, you'll see us start to highlight this year, you know, a tenant has XYZ space, you know, they want to increase the facility by 30%. You know, we're in an ideal position to provide that financing because we're sitting there with the lease. They kind of need our approval, actually, in some cases, to deal with the additional space that are on our sites. So there's kind of a win-win opportunity for us to reprice, in some cases, some of the capital that are going in to enhance the overall lease economics. So that'll be an interesting part of the story as we talk about that in the coming year.

Okay, thanks. If I could just add one quick one here. Just looking at the recent Ann Taylor acquisition, how do you get comfortable with that or other private equity-backed retailers as tenants? Historically, I've been more prone to bankruptcy. And we're in a currently healthy environment, but looks like it might get more challenging in the near future here. So just curious how you go about evaluating those opportunities.

Yeah, Ken, we're excited about that facility.

Well, you know, Jackson's mentioned, we look at those opportunities actually like we look at any of the opportunities that we come across. It's a three-legged stool, the industry, the tenant, and the real estate. In this particular situation, We're very comfortable with the industry. Women's apparel, it's not going away. It's actually revenue for that market is higher now than it was in 2019. And the particular customer, the segment that our tenant targets has actually got a, the expectations are for continued growth. So we're very comfortable with the industry. For the tenant, obviously this, our tenant operates both Ann Taylor and Loft. You know, we've got limitations on how much we can go into the credit, but it's north of a billion dollars of revenue, solid EBITDA, very low leverage. And one thing that we like about this retailer is they are the very omni-channel competent. A substantial portion of the revenue is through e-commerce, so we like that aspect. The third piece is the real estate. These are absolutely mission critical. This is the DC, the main distribution center for both of these brands. The also handles all of the e-commerce fulfillment. You've got one in the Columbus MSA, great facility below replacement costs, inline rents. All the aspects you would want in the D.C., the 36-foot clear heights, things like that. The other facility is just to the west of Indianapolis, the e-fulfillment. Again, this sets a major part of their revenue, so this is mission critical to them. But, you know, we're thrilled with all aspects, all three legs of the stool. The biggest one being the below replacement costs, substantially below replacement costs. So we're very happy with this acquisition.

I'd just say one thing, you know, we, we do have a meaningful percentage of private equity backed, you know, tenancy in our company. And, and we were very positive on Sycamore. They're very, very high quality sponsor. And, you know, just like Hellman and Freeman is over at home, you know, we just, these are very, very high quality, very predictable operators of businesses that, you know, run business as well. And, ultimately sometimes monetized through IPO or merger. So once again, we like that Ann Taylor opportunity.

Thanks for the additional color.

Our next question comes from Brad Heffern with RBC Capital Markets.

Please go ahead.

Yeah, morning, everyone. Can you talk about the terms that you're seeing in the sale-leaseback market right now? Are you seeing concessions from buyers besides the higher cap rates, like higher escalators, longer terms, better lease protections, et cetera?

I mean, I could sort of tell you that the things that we're looking at in the first quarter, you know, the industrial assets that we have have two plus percent annual escalators. So we're seeing better opportunity on escalations, particularly in, say, leaseback opportunities in the industrial area. Look, it's still competitive. I mean, we look at a lot of different things before we kind of land on, hey, this has all three of the three underwriting pieces that are meaningful for us. So we tend to find that once we kind of lock those down, it is competitive. There are other people that look at the world the same way we do. So I'm not going to suggest that we're just out here not competing with people. But I would say generally in the In the industrial area, you know, companies are looking at sale-leaseback, high-yield bank financing as a means to an end. And so, you know, if the terms get too egregious in the sale-leaseback, you know, then all of a sudden, you know, they look at corporate debt as an alternative. You know, in retail, it's – you know, retail has got – it's just a little bit more commoditized. You're not seeing – we're not seeing – you know, escalations change in any meaningful way or lease terms change in any meaningful way. I would say the other thing that we've seen that's been a dramatic change in some of the industrial sale e-spikes that we're looking at, you know, a year ago, you know, terms and conditions were really competitive as it relates to buyers. Tenants had a lot more leverage over buyers. over buyers in that conversation. I just think there were just more buyers, more private buyers, kind of willing to not look at some of this stuff because I think they're not as long-term oriented in terms of hold periods. You know, for us, you know, we're buying these assets, expecting to hold them for a whole lease term. So we're, you know, environmental matters. Lease term matters. Assignment matters for us. You know, so that's where we are, I think. in the current market. We're finding good opportunities, still competitive when we get down there, but it's not as rambunctious as it was, say, a year ago.

Okay. Thanks for that, Jackson. And Michael, I just wanted to clarify on the unidentified reserves. Are we purely talking about lost rent when we're talking about that, or is there some accounting reserve that you're planning to take? I'm just so confused about the terminology.

Yeah. No, we're purely talking about lost rent reserves. So just an assumption around things that could happen to the portfolio throughout the year that could cause rent to go away. So it's just an assumption. It's not an accounting reserve. It's not anything that we've identified or is planned or that we have to take. It's just an assumption. Again, it's consistent with how we've approached it in all the other years.

It's just a reserve for the unknown. Okay. Thank you. Yep.

Our next question comes from Josh Dennerlein with Bank of America.

Please go ahead.

Yeah. Hey, guys. Just one follow-up on the reserve and guidance. Sorry if I missed it, but how many cents was it in 2022?

It was about the same at the beginning of the year, Josh. It might have been a little bit slightly less. A little bit less than 1%. You know, we typically look at 1% of AVR, so our AVR was less. So from a dollar standpoint, it was certainly less. But generally, we target that 1% of AVR when we give our guidance.

Oh, okay. But where did it end up? I guess how many cents was in 2020?

Oh, yeah. Where it ended up, you know, I think we ended up at about, I mean, 0.3% for the year, somewhere around there. About 30 bps for the entire year, I believe, if you average it out. So obviously much less than what our assumption is for this year. We ended up for the year.

Okay. Okay. And then I guess over the years, what's kind of the range? Is that 30 bips the lowest you kind of ever saw? And then like maybe what's kind of the highest trying to think through a cycle?

Yeah, that was definitely the lowest. I mean, since the spinoff, it's generally been lower than 1%. I'd say the exception to that would be 2020. Okay. I have to go back and look. I think it was a little above 1% in 2020. I would say that was a rough year. But in all years since the spinoff outside of the COVID year, it's been sub 1%. But last year was definitely the best year we've ever had.

Okay. Okay. Awesome. And then maybe just kind of turning to competition for assets, I guess, are you guys seeing more or less competition out there for assets that you're looking at?

Um, I w I would say right now, um, you know, in the fourth quarter, obviously you can see the results first quarter. We feel really comfortable with our current pipeline. Um, it seemed like there's a little bit of drop in, in deal flow, to be honest with you. Like I, uh, you probably heard that from other management teams when we're still picking and finding opportunities that the volume of things that, that kind of meet our criteria. just seem to be less than, say, last quarter. I'm not sure if that's, I'm not sure what's causing that right now. But that being said, I think we're really comfortable with the guidance that we put out here that we'll be able to achieve, you know, really good, good opportunities in that seven quarter, seven and a half range. And like I said, we've got a good runway of revenue producing CapEx that we have already buttoned down basically this year, through the course of this year. So we feel very comfortable with that right now. And look, if things change where there's more opportunity, more attractive cap rates, obviously we haven't factored any capital markets activity in our guidance. Obviously we can pivot if that happens, if that makes sense. But right now, we think we've sized the right opportunity for our targets this year, given kind of what's happening in the market.

Jackson, if I... Reading into your comments, is that kind of lighter kind of flow right now for things you're interested in imply that guidance is more back half loaded for acquisitions?

I'd say, I think we're probably like, it's probably equally weighted. I mean, from what we can tell right now, I mean, look, it's, you know, interest rates are still pretty volatile right now, right? As we started the year, you know, the forward curve has continued to increase. You know, when that happens and, sort of the corporate markets get more indigestion, I think that kind of gives us a better opportunity to lean into industrial sale leasebacks. You know, if corporate debt becomes more favorable, that creates competition for us, as well as just people that compete with us on the sale leaseback front. So I think right now, we feel pretty comfortable with our pipeline and, you know, what we've put out there. And, you know, if things changed, So the positives that make us accelerate acquisitions, you know, we'll clearly take advantage of that if the opportunity presents itself. But we think this is a reasonable way to approach the marketplace given some of the economic uncertainty that's still out there.

Thanks.

Our next question comes from Rob Stevenson with Jannie. Please go ahead.

Good morning, guys. Can you talk about how the theater assets are performing today, given the box office? And are there other looming near-term operator issues beyond Regal? And if you need to re-tenant anything today, how is the market for that today versus when you did the last batch of re-tenanting that you did well on?

Yeah, this is Ken. You know, the theaters had a phenomenal third quarter. Fourth quarter was not as great, but they held the line. What not, 2023, a big driver, excuse me, a big driver for the theaters is the release slate. 2023 looks pretty good and consistently throughout the year. Right now, that slate, you don't see any big gaps. So they've got a consistent release dates for the tentpole films. And that's what's the big driver for theaters nowadays. You know, it's interesting on the reuse front. It's, you know, it's public knowledge. Regal did reject one of our theaters. We've been pleasantly surprised with the inbound activity we've seen right now. It's very early days on that front, but it's not crickets there, whether it's other operators or other uses for that real estate. So, you know, we'll see as the year unfolds, but right now we're very, see a very stable outlook.

Okay. And then how are you guys thinking about indoor farming and the potential returns and risks there versus owning the traditional 500 acres of farmland leased to a large farmer?

I mean, Robbie, we don't have any farm exposure right now. And, you know, I think right now we've, To be honest with you, our current lines of business are keeping us really busy right now.

So I have a really comment on that. Okay. Thanks. Appreciate the time.

Our next question comes from Harsh Himnani with Green Street. Please go ahead.

Thank you. Michael, you mentioned targeting a 200 basis point spread for 2023. Can you give us A rough ballpark estimate for what kind of nominal cap rate you would have to achieve on your acquisitions to roughly make that spread?

Yeah, I mean, as Jackson mentioned, we're targeting seven and a quarter, seven and a half cash cap rate for 2023. So at that cap rate, we can achieve that 200 base points of spread based on the way we're funding, which is free cash flow, accretive dispositions, and balance sheet debt.

That's helpful. And then, Jackson, in the past couple quarters, you mentioned that this is really the most, the best opportunities you're seeing in a long time in the net lease space. Is that still the case in what's played out in your pipeline over the first part of this year? And just, you know, given the favorable market environment, given how good the sale leaseback market is for you today, why do you think the public market is giving you not the best cost of capital relative to your peers who aren't even as focused as you are and I guess in internal discussions what can you do to maybe improve that cost of capital to be able to capitalize on this opportunity that might be upcoming in 2023 because it seems like you're more constrained on the cost of capital side than, you know, you're able to source deals, but maybe not have it be accretive because of the cost of capital.

Yeah, I think it's, you had a lot of questions, but I'll try to start with this one, with this answer. You know, since 2019, you know, post the windup of SMTA, you know, if you look at the midpoint of our AFFO guidance for this year, You know, our CAGR has been close to 5%. And that's been, you know, with a lot of economic, you know, macro headwinds, you know, COVID and invasion, you know, inflation, increase in interest rates. So we've been able to accomplish, you know, I think a reasonable growth rate since 2019. I think if you look at our tenancy, you know, look, I think people have, for whatever reason, associated a higher risk to our tenancy. You know, Party City is going to prove out. We're very, very confident we're going to be able to show proof of concept there. And the asset's worth a lot of money, more than what we paid for it. We think that at home, there's another tenant that is top five tenant. You know, they're headquartered in Dallas. We just, we meet with them. We just have recent meeting with them. We're very confident about what that company is going to do. Our real estate that we own. And we believe in that credit. And we believe that we'll be able to, that'll be another good proof of concept. So I think, of course, like what we have to do this year, the best thing that we can do to, I think, try to improve our cost of capital is to basically outperform that lost rent number that we've highlighted as 1% this year. We think we can do it. We think it's reasonable to put that out there. But I think if we're able to beat that number this year. Certainly from a tenant risk standpoint, people would not necessarily associate our portfolio in that way. We're originating more industrial opportunities. I think we're going to continue to keep pace with that, just given some of the dislocation in the corporate financing markets. So we're just going to make this company from a portfolio standpoint better. And look, we've, We've gone big and now we're playing a little bit smaller in terms of number of transactions and volume. And I think this year will be a really good year for us to show kind of proof of concept what this company can really do. I mean, we acquired an extraordinary number of transactions relative to what we've historically done last year. This year, it's like half of that, right? But I think one of the most important things that we're going to be able to show is that the you know, how credit worthy this portfolio is given some of the sort of comments that we've gotten in the past about risk of potential tenancy.

That's helpful. Thanks so much.

Our next question comes from RJ Milligan with Raymond James.

Please go ahead.

Hey, good morning, guys. I wanted to ask you about the $60 million that was issued on the ATM this quarter. Can you talk about the thought process in issuing equity at those levels, and can we expect more ATM issuance in 2023?

Yeah. Obviously, it's just a small amount. We wanted to make sure we kind of entered 23 at a good leverage level. There were still decent spreads. In the fourth quarter, when you look at that sliver amount of equity, so I think we ended at a good spot. produce good spreads last year, finish out the year in a good place on the balance sheet. And that sets us up well for 23 based on our capital deployment plan. Right now, you know, where the stock price is, you know, we're not planning to issue any more equity. If the equity price improves materially and we see good acquisition opportunities that, you know, where the cap rate is at a place where we think the spreads are there, you know, we could certainly hit the ATM. That's definitely not off the table. You know, we could do something even bigger and accelerate later in the year if that makes sense. But for now, We feel like we ended 2022 in a good spot on the balance sheet to set us up for a capital deployment plan this year without needing to access the capital markets. So, you know, if the status quo stays the same, I wouldn't anticipate any activity. But certainly, you know, if the opportunity presents itself and something makes sense, whether it's from a cap rate standpoint or acquisitions or stock price improvement or a little bit of both, you know, we could become active again.

That's helpful, and I know that – or the midpoint of the guidance, I think, assumes that you're funding from pre-cash flow dispositions and then increasing debt, and I'm just curious, based on that guidance, where do you anticipate leverage ending the year, assuming no more equity issuance?

Yeah, I think our leverage will continue to be in that mid-fives range that we typically target. We're always going to maintain conservative leverage and obviously maintain our triple B rating, so – you know, that mid-five range is where we're comfortable. Obviously, we ended 2022 a little bit below that, so I think we have some flexibility there to kind of migrate into the mid-fives.

That's it for me. Thanks, Chris. Thanks. Thank you.

Our next question comes from Ronald Camden with Morgan Stanley. Please go ahead.

Hey, just a couple quick ones. Just looking at the DAC, the bridge for the guidance is really, really helpful. So I see the six cents from net deployment. Presumably that includes sort of the interest cost headwinds. I was just wondering if you could break out what the interest cost headwinds is in 23.

Yeah, so that includes any incremental interest on any incremental debt we're using to fund the acquisition. So that's built in there. You know, the interest expense headwind for 23 on the debt that we issued in 2022 is is built into the Q4 2022 annualized AFO per share. And that's why we went off that, because that Q4 88 cents that we annualized had the full impact of the $800 million term loan, which essentially was all the debt that we ended up issuing in 2022 that we fixed at 3.5%. That's what made that walk easier. If you were to think about that debt from a year-over-year basis, so we put that debt in place in the middle of August, fixed it, And that was obviously cheaper debt earlier in the year in 2022. So if you were kind of walk from the full year 22 to the full year 23, just on that debt, that would be about a 5 cent headwind year over year. But the way that we've kind of designed this walk for you was to incorporate the interest rate headwind on the debt we issued in 22 in that Q4 annualized number. So when you look at the net capital appointment, that does have the impact of higher interest rates on the incremental debt we would use to acquire properties throughout 23. Does that make sense?

Got it. Makes a ton of sense. And just my second one, just going back to sort of the acquisition guidance. So I guess the first one is just, are we supposed to understand that sort of 800 million at the midpoint? It sounds like the messaging is it's more sort of opportunity constraints. than capital constraint at this point, or is it both? Just trying to get a sense of that number.

I would just say it's a little bit of both. I mean, you know, look, for us, look, we talked about our cost of capital. It's not at the place where I believe it should be. And, you know, for us to issue capital and do larger amounts of volume, I don't think that makes a lot of sense. I think I think to me what makes sense is really prove out what we've been doing the last few years, which we believe we will this year. And at that point, you know, we can look at potentially increasing, you know, volume with a more effective cost of capital. I mean, so I'd say it's a combination of both. I mean, the opportunity set that we see is still there, but, you know, we don't think it makes sense to obviously keep acquiring at a billion plus rate given our current cost of capital and And we think we'll get – it'll be better for shareholders for us to kind of prove out all of the deals that we've transacted are really good, which we believe they are.

Great. And then my last one, if I may, just sort of sticking with that cost of capital point, just because I don't think I've heard this question asked on the call yet. I think in the past you talked about, you know, number one, potentially looking at JV Capital, right, and partnering with JVs as a source, and then maybe being open to sort of more strategic actions in the space with maybe others having a better cost of capital. Just curious where your head's at today. You know, the interest rate environment seems to have more staying power here. So both on the JV and sort of strategic actions, any comments you can share would be helpful.

Yeah, I would say probably on the JV side, you know, I don't probably not, we're probably not going to pursue that, you know, this year. There's clearly opportunity for us to do it. I think it just complicates the story for us. And in terms of strategic, I mean, look, I think if we found a compelling transaction that could redefine what we're doing, increase growth, obviously we would pursue that and finance it accordingly. My guess is we're going to end up just, it may seem kind of boring, but just sort of stick to this basic plan. And when we get to the end of the year, say, hey, look, everyone, you know, we've, bought close to $5 billion of real estate, really good real estate's performing really well, and we see more opportunity to do more. And I think that that's going to be... I think that'll be an important aspect of what we do to try to get this cost of capital in the right place. I mean, look, I can tell you our senior management team is very aligned long-term with shareholders. I mean, if you look at our 2020... performance stock awards that were issued, I mean, basically those were completely surrendered because of performance. So, you know, that's, and if you look at our 2021s, 22s, and 23s, you know, our senior management team is, executive team is basically 100% PSA. There's no restricted stock awards, time vested that we receive. So we are really aligned with shareholder performance. And that's all we're, and so we believe that what we're doing will, will basically improve our cost of capital and put us in a good position.

Makes a lot of sense. Thanks so much.

Our next question comes from John Misaka with Ladenburg Thalman. Please go ahead.

Good morning.

Good morning. Please go ahead. maybe just go back to disposition market um quickly you know as we're kind of two months into the year here what are you seeing in terms of the mix between institutional buyers and kind of more 1031 or um individual buyers for the assets you're trying to capital recycle out of and you essentially had that 1031 buyer held up in kind of a new tax year if you will hey yeah this is ken i you know the

The overall answer is that it's a mix of all those. Yes, the 1031 buyers are still there. They may not be there in the numbers they've been a year, two years ago. But it's safe to say that there are 1031 buyers out there looking to transact. About 40% of our dispos were individual buyers, 1031, some cash buyers. about 60% were institutional. So we're seeing what we like, which is a healthy mix. We're not relying on one specific segment to complete dispositions. Okay, that 40, 50.

I think some of the buyers, I also think like some of the buyers, you know, were focused on accelerated depreciation too.

Yeah.

Not until last year. So some of the car washes present really good opportunities for that. So my guess is as the year progresses, People will look to take advantage of accelerated depreciation and some of the assets types that we own that can provide that depreciation.

Okay, that's very helpful. And then just a quick line item one, impairments were a little elevated in the quarter. Just wondering if there was something specific driving that or if that was just tied to dispositions or kind of future capital recycling. Yeah.

Yeah, I mean, about half of that was related to Regal. Initially, we had a couple of properties on the rejection list. One's come off for now. One's been rejected, so we've been paired a few there. And then a few are just related to some future non-Regals.

Okay, that's helpful. Thank you very much. Thanks.

Our next question comes from Linda Tsai with Jefferies. Please go ahead.

Hi, good morning. Did you indicate what percentage of your investment guidance is due to revenue-enhancing CapEx? And is the idea that as long as you're more focused on industrial revenue-enhancing CapEx remains elevated?

We didn't give an exact number. I kind of gave this number that, you know, we did, what, about 114 last year. It's going to be in that, probably going to be a little bit north of that. And it's going to be a mix of industrial retail. I mean, it's going to be sort of very specific. So I would just say it's very tenant-specific right now, less industrial or retail oriented.

Got it. And then within industrial, how do cap rates vary, you know, whether it's distribution, manufacturing, industrial, and, you know, where are you seeing the best opportunities?

I mean, you go ahead, Ken, first. Yeah.

Right now, the acquisitions that we do tend to be a mix of those. If you compare a pure distribution to a pure light manufacturing, I'd suggest distribution is going to be a little lower cap rate. A lot of the facilities that we end up investing in typically have a mixture of those. It's a manufacturing facility with, as part of the real estate, is the ability to do distribution. But We're seeing great opportunities in all three of those. In addition to that, we mentioned it earlier, the industrial outdoor storage has been a nice little sector that we've found some great opportunities in.

Great. Thank you. Thank you, Amanda.

Our next question is a follow-up from Handelstein.

Just with Mazuho, please go ahead.

Hey, guys. I wanted to come back. I don't think you gave it. Forgive me if you did, but can you outline what's in the pipeline as of today and any color on categories and range of cap rates? Thanks.

Yeah, we didn't talk about pipeline, but I think generally I would just say our pipeline in the first quarter looks really good. I'd say cap rate is also better than the fourth quarter. And It's a good mix of industrial, once again. We're finding those opportunities.

Okay. And then, Michael, for you, a follow-up. The 200 basis points of spread you mentioned you're targeting, maybe you could walk us through the math a little bit here, because just looking at traditional WAC, I can't quite get there, given where your cost of capital is versus the deals you're seeing and the cap rate. So maybe walk us through a bit more of the color on how you're arriving ballpark at that 200 basis points. Thanks.

Sure. Well, you know, we have, I mean, you have our disposition guidance, you know, which you can sign whatever cap rate you want to, but we look at the cap rate as part of our cost of capital. We have about 125 million in free cash flow that we're deploying.

And then we're using our delay draw term loan as the debt piece of it. which is so for plus 95 base points. Got it. Got it. Okay. So I think we can follow up offline, but I appreciate it. Thanks. Yep.

Our next question is a follow-up from John with Lundberg Vellman. Please go ahead.

I know we're over the hour mark here. So I'll be quick, but just as kind of a follow-up to my prior question, you know, what are you expecting in terms of, recoveries or renewals for the leases that are expiring in the quarter? Just kind of anything that's either baked into guidance or just kind of general thoughts would be helpful.

Yeah, yeah, this is Ken. What we, for 2023, what we think as far as, you know, there's two primary metrics, renewal and recapture. We do think renewals are going to be a little bit lower than historic, which was around the 90% mark. On the recapture, we think we're going to be in the same range as historic, which is the mid-90s. Okay.

Very helpful. Thank you.

This concludes our question and answer session.

I would like to turn the conference back over to Jackson for any closing remarks.

All right. I want to thank you all for participating on our fourth quarter earnings call. We're very confident in our portfolio, its tenancy, and our associates. And we look forward to meeting many of you next week at the Citi Global Real Estate Conference. So thank you very much.

The conference is now concluded.

Thank you for attending today's presentation. You may now disconnect.