STORE Capital Corporation

Good day, and welcome to the Store Capital's third quarter 2021 earnings conference call and webcast. All participants will be in a 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 touchtone phone. And to withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Ms. Megan McGrath. Investor Relations for Store Capital. Please go ahead, ma'am.

Thank you, Operator, and thank you all for joining us today to discuss Store Capital's third quarter 2021 financial results. This morning, we issued our earnings release and quarterly investor presentation, which includes supplemental information for today's call. These documents are available in the Investor Relations section of our website at ir.storecapital.com under News Results, Quarterly Results. I'm here today with Mary Fedewa, President and Chief Executive Officer of Store, Kathy Long, Chief Financial Officer, Sherry Rexrode, who will become our CFO on November 8th, Craig Barnett, EVP of Underwriting and Portfolio Management, and Tyler Mertz, EVP of Acquisitions. On today's call, management will provide prepared remarks, and then we will open up the call for your questions. In order to maximize participation while keeping our call to an hour, We will be observing a two-question limit during the Q&A portion of the call. Participants can then re-enter the queue if you have follow-up questions. Before we begin, I would like to remind you that today's comments will include forward-looking statements under federal securities laws. Forward-looking statements are identified by words such as will, be, intend, believe, expect, anticipate, or other comparable words and phrases. Statements that are not historical facts, such as statements about our expected acquisition, dispositions or our AFFO per share guidance for 2021 are also forward-looking statements. Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements. Discussion of the factors that could cause our results to differ materially from these forward-looking statements are contained in our SEC filings, including our reports on Form 10-K and Form 10-Q. With that, I would now like to turn the call over to Mary Fedewa, STOR's Chief Executive Officer. Mary, please go ahead.

Thank you, Megan. Good morning, everyone, and thank you for joining us today. I'll begin the call with an overview of our third quarter performance. Craig will provide an update on what we added to the portfolio and our portfolio management activities. And Kathy, who is retiring after this, her 28th quarterly call, will review our third quarter financial results. Following our prepared remarks, we will open the call to questions. As you all know, Kathy and I have worked closely together for many years, so this conference call feels a bit like the end of an era. I want to thank Kathy for her wise counsel and many contributions to STOR, and especially for building an outstanding finance department. On behalf of everyone at STOR, we wish Kathy all the best in her well-deserved retirement. An ending can also signal a new beginning, and I am very excited to introduce you to Sherry Rexrode, who will assume the role of CFO on November 8th. Many of you know Sherry from her successful career at BlackRock, and with her strong background in finance and capital markets, she will be a great asset to our team. Sherry was also one of BlackRock's top ambassadors in promoting sustainable business practices, and we look forward to her help in advancing the ESG program at STOR. As you saw in our press release, we had a very busy and productive third quarter. Business is back in full swing. We reopened our office in October, and I'm very proud of our team's outstanding execution that resulted in robust acquisition volume and strong growth in our pipeline of new opportunities. We saw a significant pickup in demand for our customized net lease financing solutions as our customers and prospects resumed growth both organically and through M&A activity. During the quarter, we acquired more than $410 million in profit center real estate at a weighted average cap rate of 7.44%, bringing our year-to-date weighted average cap rate to 7.7%. We also delivered AFFO of 52 cents per share, reflecting our strong revenue growth and healthy portfolio operations. We also had strong prospecting activity, and our pipeline grew to $13 billion since the end of last quarter. We believe this is a direct reflection of a healthy operating environment, our unique customer value proposition, and the results of our direct relationship approach. The net lease space has continued to attract new market participants, so we are not surprised that we saw some cap rate compression in the quarter. That said, having been in the net lease financing business for several decades, I've had the benefit of operating across many economic cycles and interest rate environments. This gives me confidence that our business model positions store to continue to deliver above market cap rates and, importantly, to continue to deliver attractive returns in today's operating environment. For example, our most recent master funding debt issuance had a weighted average coupon of 2.8%. resulting in a healthy third quarter investment spread of over 4%. Now I'd like to touch on inflation, which is the current headline macroeconomic topic. For a few key reasons, we believe STOR is well positioned to deliver strong AFFO growth even in an inflationary environment. First, as a triple net lease REIT, STOR does not incur property-related operating expenses. Second, We have average annual contractual rent escalators of nearly 2% built into our leases, which provides a natural hedge against inflation. Third, we have flexible financing options, and our existing portfolio is financed with well-laddered fixed-rate debt and no significant maturities until 2024. Finally, we have a strong pipeline of new opportunities, and given our direct approach to acquisitions, we have the flexibility to structure new lease contracts based on the current operating environment. Now turning to our recent dividend increase. On our last earnings call, I mentioned that our Board would be evaluating our dividend and that a meaningful increase was likely based on our strong operational performance and positive outlook. As expected, in September, our Board approved a quarterly dividend increase of 2.5 cents per share. which brings our annual dividend to $1.54 per share. This represents a 6.9% increase and is the highest per share dividend increase in our history as a public company. Even with this significant increase, our dividend payout ratio remains conservative at 74% of AFFO for the quarter. Before I turn the call over to Craig, as you may have seen, S&P recently raised its outlook on store from stable to positive and affirmed their BBB rating. Their report underscored the resilience of our portfolio during the pandemic and our healthy operating performance, credit metrics, and prudent financial policies. This rating validation is especially significant on the heels of a global pandemic that stress tested our portfolio. S&P also cited other factors for raising their outlook, including stores' high occupancy and above average embedded rent growth. As we have said before, we attribute our outstanding portfolio performance during the pandemic to the strength of our customers who operate in vital industries, the size and diversity of our portfolio, and our portfolio management expertise. With that, I'll turn the call over to Craig.

Thank you, Mary. I'll take a few minutes to cover our acquisitions and portfolio management activities for the third quarter. We originated 412 million of acquisitions at a weighted average cap rate of 7.44 and a weighted average lease term of 16 years. This elevated level of activity was from both new and existing customers who selected STOR for our tailored financing solutions to address their capital needs. More than half of our volume for the quarter was used to facilitate M&A transactions, and the remainder was used for either balance sheet recapitalizations or growth capital. In the quarter, about 75% of our acquisitions were from new customers, highlighting not only pent-up demand in the broader economy, but also the strong new customer relationships our acquisitions team has been cultivating over the past several years. About a third of our acquisition volume each quarter is from existing customers. Therefore, Each new customer represents an important source of future growth as we collaborate together to identify new opportunities for repeat engagements. Our transactions this quarter reflect our commitment to maintaining a diverse and granular portfolio, spanning a wide range of industries, including restaurants, early childhood education, auto service, and food manufacturing. This quarter, the majority of our acquisitions were in the service sector, consistent with our broader portfolio. Now turning to our portfolio. Maintaining a diverse portfolio is one of the hallmarks of our business model and positions store to deliver consistent and attractive risk-adjusted returns across all economic cycles. At quarter end, our overall portfolio mix was 66 percent in the service sector, 19 percent in manufacturing, and 15 percent in service-oriented retail. Our portfolio consists of 538 national and regional customers across 2,788 properties operating in 119 industries. More than 85% of the portfolio was comprised of businesses that individually represent less than 1% of our annual base rent interest. Taken together, our top 10 customers account for only 19% of base rent interest. Overall, our customer's financial performance remains strong and our portfolio continues to perform well. Our weighted average unit level fixed charge coverage ratio is 4.4 times, slightly higher than last quarter. Our occupancy rate remains high at 99.4%. Reflecting greater confidence in their near-term outlook, many of our customers are focused on growing their businesses. They are seeing M&A opportunities created by valuation dislocations in their sectors and are taking advantage of opportunities to expand or vertically integrate. Our strong relationships with customers strengthen through constant communication with them as we review and monitor their financial health. Most recently, our customers are focused on the changes in the macroeconomic environment, such as labor pressures, supply chain disruptions, and inflation. We are encouraged that they are telling us they are managing and adapting through these changes successfully. Moving on to our portfolio management activity. Dispositions are a source of operating cash flow that can be deployed toward accretive opportunities, and they continue to play an important role in our portfolio management strategy. During the quarter, we sold 25 properties that had an original cost of about $104 million. This included one property we sold opportunistically for a 15% gain over cost, which equated to a gross sale cap rate of 6%. The remaining properties were sold either strategically or as part of our ongoing property management activities. The remaining 24 dispositions achieved net proceeds of 90% of our original cost. I'll now turn the call over to Kathy to discuss our financial results.

Thank you, Craig. I'll begin by discussing our financial results for the third quarter, followed by a review of our capital markets activity and balance sheet. Then I'll provide our updated guidance for 2021, and I'll introduce our 2022 guidance. All comparisons are year-over-year, unless otherwise noted. Beginning with our income statement, third quarter revenues increased 14% from the year-ago quarter to $199 million primarily reflecting the growth in our real estate portfolio. Revenue for the third quarter of 2021 includes $1.8 million of lease termination fees collected in connection with properties we sold. Interest expense increased by $1.3 million from the year-ago quarter, reflecting higher average debt outstanding, as well as a non-cash charge of approximately $550,000 for accelerated amortization of deferred financing costs related to the prepayment of debt in July. Property costs totaled $4.3 million for the third quarter and $14.1 million year to date. Excluding amounts reimbursed by our tenants, property costs represented about 13 basis points of our average portfolio assets during the first three quarters of the year down from 16 basis points for the same period a year ago. We expect that G&A expenses will rise in some measure as our real estate investment portfolio grows. However, G&A expenses as a percentage of the portfolio will generally decrease somewhat over time due to efficiencies and economies of scale. Excluding the non-cash stock-based compensation and the severance expenses recognized last year, G&A expenses as a percentage of average portfolio assets were relatively flat quarter over quarter at about 43 basis points. During the third quarter, we recognized an aggregate $3.4 million impairment provision on properties we're likely to sell. This amount was more than offset by a $10.7 million gain recognized on properties sold during the quarter. Third quarter AFFO on a per share basis increased 13% to 52 cents per diluted share from 46 cents a year ago. And total AFFO increased to $140 million from $119 million. The increase in AFFO primarily reflects higher revenue from our real estate portfolio growth. Now turning to the balance sheet and our capital markets activity. We collected $8 million of rent receivables during the quarter that were originally deferred under our COVID rent relief program. As of September 30th, we had just $34 million remaining in net COVID receivables, and we continue to expect the vast majority of this to be collected by the end of 2022 as scheduled. We funded our third quarter acquisitions with cash from operations, borrowings on our revolving credit facility, proceeds from dispositions of real estate, and proceeds from the sale of equity through our ATM program. During the quarter, we issued approximately 500,000 shares of common stock under our ATM program at an average price of $35.98 per share, raising net equity proceeds of $19 million. In July, as planned, we prepaid without penalty $83 million in store master funding debt that had a coupon of 5.33%, using proceeds from our June issuance of store master funding debt. This latest issuance of master funding debt bears a weighted average coupon of 2.8%, so we were able to take advantage of an opportunity to lower our cost of capital with this prepayment. Our debt maturities are intentionally well-laddered, and we have no significant maturities until 2024. Another series of master funding notes will be available for prepayment without penalty later this month. These notes bear an interest rate of 5.2%, giving us another opportunity to further lower our debt costs. With the flexible prepayment windows under our master funding program, we will have the opportunity to prepay additional series during 2022 and in future years. At September 30th, we had approximately $4 billion of long-term fixed-rate debt outstanding with a weighted average interest rate of about 4% and a weighted average maturity of about seven years. Leverages at the low end of our target range at 5.6 times net debt to EBITDA on a run rate basis or around 39% on a net debt to portfolio cost basis. Approximately 63% of our gross real estate portfolio was unencumbered, and the ratio of net operating income to interest expense on our unencumbered portfolio remains exceptional at more than seven times. We closed the quarter with a strong balance sheet. We have ample access to a variety of favorably priced debt and equity options to finance our growing pipeline of acquisition opportunities at very attractive spreads. At quarter end, we had $37 million in cash, approximately $600 million available under our ATM program, and nearly $500 million of borrowing capacity available under our revolving credit facility. Now turning to guidance. We are raising our 2021 ASFO per share guidance from a range of $1.94 to $1.97 to a range of $1.98 to $2, an increase at the midpoint of 8.7% over 2020's ASFO. We're maintaining our 2021 annual real estate acquisition volume guidance net of projected property sales at $1 to $1.2 billion. Based on our 2021 acquisition activity to date and the overall cap rate compression we're seeing in the net lease sector, we expect the weighted average cap rate on new acquisitions for the year to be closer to 7.5%. Finally, I'll turn to our initial guidance for 2022. We currently anticipate 2022 AFFO per share to be within a range of $2.15 to $2.20. That represents a 9.3% increase over 2021 projected results using the guidance midpoint for both years. This AFFO guidance is based on our current projections for net real estate acquisitions for the remainder of 2021 plus projected 2022 annual real estate volume net of projected property sales of approximately $1.1 to $1.3 billion. Before turning the call back to Mary, I want to take a minute to thank the many investors and analysts I've met over the past seven years since DOOR went public. Your thoughtful questions and observations gave me important perspective of what it takes to drive value for our shareholders. While it's hard to step away from decades of working side by side with many talented colleagues, I can confidently retire knowing that I'm passing the baton to Sherry Rexrode, an experienced, results-oriented leader with financial foresight and a deep understanding of the REIT space. I wish her every success. And finally, I want to express my sincere thanks to Mary. It has been a great privilege to work with you these past years in helping to build Store into the powerhouse company it is today, and I'm proud to call you both friend and colleague. I'm confident that your strong leadership and vision, combined with the talents of Sherry and our outstanding team, will lead the next chapter in Store Capital's success. With that, I'll turn the call back to Mary.

Thank you, Kathy. We are excited about the momentum in our business Our customers are healthy and growing, and so is our pipeline. Our cap rates remain at attractive levels, supported by our unique business model. Our cost of capital is low and spreads are wide, allowing us to deliver excellent AFFO growth and returns. So it's a great time to be in the net lease business. Our team remains focused on executing the three-pronged growth strategy I outlined last quarter, and we look forward to updating you on our progress in the coming quarters. Finally, I want to mention that plans are well underway for our sixth annual customer conference, the InsideTrack Forum, in February. This much anticipated event provides an opportunity for us to come together with our customers to network, share ideas, and draw inspiration from many success stories. Our customers are valued stakeholders, and our conference is one of the ways we thank them for their trust and collaboration. This year, we're excited for the event to be back in person. And with that, I would like to turn the call over for your question.

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're using a speakerphone, please pick up your handset before pressing the keys. And to withdraw your question, please press star then 2. And at this time, we'll pause momentarily to assemble our roster. And the first question will come from Sheila McGrath with Evercore ISI. Please go ahead.

Yes, good morning. You mentioned 16 new customer relationships. I was wondering if you could give us a little bit more detail on what type of tenants these are, and is it the result of adding new acquisition personnel or perhaps widening the funnel of types of tenants that you would consider?

Hi there. Yeah, this is Tyler. I'll take that one. Yeah, so first of all, our Q3 volume, the mix of that was across service and manufacturing, about 80% service, about 20% manufacturing. And on the service side, it was in typical industries like restaurants, auto service, car washes, early childhood education, and specialty medicals. Manufacturing side tends to be a wide range of industries, but in Q3 it was for food processing and then manufacturers of specialty metal products. So that's kind of the span of it, and it was just a result of the continued relationships that we're cultivating and the pipeline that we have been building since the beginning of the year and prior.

We didn't have any new salespeople, Sheila, in this quarter.

Okay, great. And then a question for Kathy. Congratulations, Kathy, and Sherry also. But just a question. You mentioned an upgrade from the rating agencies to positive. If you were to get upgraded to BBB positive or plus, how would that impact financing costs?

Well, first of all, thank you, Sheila. So for financing costs, if you recall, On our revolver, there is an investment-grade pricing grid. So if you do pop up to BBB+, that would pull your rate down a little bit on the revolver. Plus, we are issuing every year debt in both the senior unsecured market as well as the ABS market. And the ratings there on the senior unsecured side would certainly allow our spreads to come in. and a lower cost of capital keeps those spreads wide. So even though you may have seen cap rate compression this quarter, being able to lower our cost of capital, you know, maintains the spreads. And we put a chart, in fact, in our deck this quarter on page 10 that talks about how spreads have been able to maintain over all the many years we've been in this business. So, you know, that's kind of how we think about it.

That's great. Thank you.

Thank you. The next question will come from Caitlin Burrows with Goldman Sachs. Please go ahead.

Hi, team, and yes, congrats, Kathy, and welcome, Sherry. Maybe we'll start with Mary. Earlier this year you mentioned the possibility of doing larger deals in the future, but looking at the 21 net acquisition guidance and the 22 guide, it looks like the acquisition guidance does not assume meaningfully higher volumes next year or maybe even a deceleration. So just wondering if you could discuss your pipeline today and also whether there's anything different about its composition versus maybe a normal pre-COVID time.

Yeah, you bet, Caitlin. So I would say that actually, you know, when we gave guidance for volume for 2021 this year, last November, we actually came out really with 2019 sort of guidance, and that included acceleration throughout the year, and we're on track to achieve that. I talked a lot about the three-pronged approach. And you're specifically probably talking about the portfolios. Although we've been active in evaluating a couple portfolios, there's nothing really to report right now. We're not in any hurry. We're going to be selective, and we're going to continue to look at things. But you're correct. The 2022 guidance does not specifically include any portfolio acquisitions.

Okay, got it. And then Kathy mentioned that you have master funding available to prepay in 4Q. So I was just wondering if you were to move forward with prepaying that and or other debt in 22, what do you think it could be replaced with? Would that be new master funding, unsecured, some of both?

It could be both. We are committed to both markets. So on the master funding side, as you recall, we can issue AAA debt. on that side, and the pricing there is usually quite tight. And then in the senior unsecured market, we are still seeing attractive rates. You know, if we were to issue debt today, you know, on a 10-year basis, you could be talking 125 basis points over the 10 years, so still, you know, sub-three rates.

Got it. Thank you.

The next question will come from Todd Thomas with KeyBank Capital Markets. Please go ahead.

Hi. Thanks. Good morning out there, Kathy. Best of luck in retirement and congratulations, Sherry. First question, just about the investment yields and the cap rates that you discussed that came in a little bit in the quarter at 7.4%. It sounds like you're anticipating that yield to compress a little bit further. in the fourth quarter based on the full year cap rate expectation. Is that right? And then can you speak to what we should expect in terms of investment yields moving forward in 22 and what's embedded in the guidance?

Yeah, so this is Mary. I'll start, Todd. First of all, yes, you're correct. We've seen some, as Kathy just mentioned, some initial pressure on our initial cap rates. But as Kathy mentioned, we've worked really hard to reduce our weighted average cost of capital, and our spreads have actually widened. And we would also encourage you, I would encourage you, too, to look at page 10 in the corporate presentation. We are expecting that cap rates may compress a little bit more in the fourth quarter and maybe even early into 2020. although I would say that the general consensus out in the marketplace from our perspective and what the front lines are telling us, our front line is telling us, is that we could be seeing the bottom of a cap rate compression right now. The cost of capital is at an all-time low, and more or less this is probably the lowest the interest rate could go that would make sense for most buyers. So we think that, you know, we'll see a little bit more, you're correct, but we could be getting towards the bottom. Kathy guided, we guided to 750 for 2021, and we'll probably be in that range 2022, as the 2022 guidance as well.

Okay, great. And then the, in terms of the guidance for 21, which was revised higher and, you know, thinking about 22, So year-to-date AFL failure at $1.49, that implies $0.50 in the fourth quarter at the midpoint, so a $0.02 decrease from the third quarter. I realize there was about a half a penny or so of lease term fee income realized in the quarter, but can you just provide some detail around the drivers of the sequential decrease before re-ramping to, I guess, $0.54 per quarter in 22? It's Kathy.

Fourth quarter, sometimes you have some seasonality and expenses, so that could take up a little bit in fourth quarter, so that'd be part of it. Also, fourth quarter volume, as you remember, gosh, at year end, everybody wants to close deals on the last minute at year end, and so the revenue impact that you have of fourth quarter acquisitions is generally very small in the fourth quarter, it will provide a lot of boost into 2022, but we won't reap a lot of revenue generally in fourth quarter from fourth quarter acquisitions, just because year end is when people, you know, sort of look at doing real estate transactions, whether they're tax motivated or, you know, M&A motivated. And so I think that's part of what you're going to see is not having that necessarily big revenue lift timing-wise.

Okay. All right. That's helpful.

Thank you. Yeah. The next question will come from Ki Bin Kim with Truist. Please go ahead.

Thank you, and congratulations, Kathy. Thank you. Just a quick question. You're welcome. So a quick question on your fixed charge coverage ratio. I noticed that you got an improvement on the average fixed charge coverage ratio, but the median stayed the same. Can you just help me understand what's driving those two differences?

Are you speaking of the weighted average in the median?

Yeah, that's right. The median fixed charge coverage ratio was flat quarter over quarter, but your average increased just trying to understand what's happening there.

Yeah, so the calculation on the median, it's a median, so that pretty much stayed the same when you think about quarter to quarter. The weighted average is just a function of just our coverages with some larger investments pulling that up. So it's a weighted average.

Right, but I guess what I'm getting to is that Was there a certain group of tenants that's doing better that's driving the weighted average higher but the median being flat?

Right. Okay. So in regards to just the composition or the industries that might be pulling that up, I mean, it's, you know, our tenants are really in very good financial health. You know, they have strong balance sheets. They've adjusted their operations. You know, so they're reducing expenses. you know, introducing technology and automation. So, you know, overall coverages are improving across the board. You know, so there's always a wide dispersion across industries. You know, movie theaters are continuing to lag, but we are seeing a lot of improvement in industries like pet care, especially medical restaurants. So those are kind of dragging or pulling the coverages up.

Okay. And just a question on guidance. Your 2022 guidance was fairly above consensus numbers. And, you know, I don't pretend to know what everyone has in their models, but given your commentary about net acquisition volume being pretty similar to 2021 and cap recompression, I'm just curious, like, what are the, is it interest expenses that you're assuming that you're going to save some money on? Or are there any other line items that we should just be aware of?

Sure. Yes, that is true. We are going to reap the benefits of lowering our cost of capital because we were able to do that starting mid-year this year, and so we didn't really get a full year's worth of the lower interest rates. And we're talking quite a bit lower, right, because the master funding transactions that were done many years ago were at greater than 5% interest rates, and we've replaced that with interest rates that are sub-three. So, you know, that impact is quite large. And you'll get a full year of that impact next year. As well as just, you know, earlier this year, we had thought that coming out of the pandemic, we would have lift in the second half of the year. And then last quarter, we had talked about seeing the lift a little faster than we expected to. But we're still getting lift. in the second half of the year from people, for example, who were paying a percentage of their sales. Well, their sales have increased quite a bit, and so you're getting higher rents. We were able to move more people off of cash basis accounting. So, you know, whereas last quarter it was about 4% of our annualized base rent and interest, it's now under 2.5% that are the cash basis group. So you're seeing all of those lifts that we were expecting happening, and that's going to push into 2022. And as well as that all gives you a growing free cash flow after dividends. And remember, with a payout ratio right now that's 74%, but that'll trend lower as we go along, all that excess cash flow is being able to be reinvested in new properties for internal growth. And so you're not having to raise as much equity as, you know, by having stronger free cash flows. So that provides additional boost to ASFO. Does that help?

Yeah, that's helpful. Thank you. And just a quick one here. How much equity are you assuming in your 2022 guidance?

We're keeping the same leverage target. So as a reminder, we do funded debt to EBITDA. at five and a half to six times in that range. And we're going to continue to do that. But remember, a big part of what you do, you know, you're using debt financing and that free cash flow, which is reducing how much equity you need.

Okay. Thank you.

Yep.

The next question will come from Ronald Camden with Morgan Stanley. Please go ahead.

Thanks for the question. Congrats, Cassie and Sherry. I appreciate providing the guidance, which is just great transparency. Just sticking on that line of questioning, do you remind us, what are you assuming for, what does the 22 assume for bad debt maybe relative to 2021 and also maybe relative to pre-COVID? Thanks.

We are pretty much at pre-COVID levels now. So if you even look at cash collections and things like that, we're back to pre-COVID levels. We're probably looking at maybe 1.5% today that we're not reporting revenue on. People who are in process of being re-let or things like that. And that, you know, will probably come down some. So you could think about it that way.

Got it. So 1.5% is sort of a right ballpark.

Or less, yeah.

Or less, got it. And then, you know, just switching gears a little bit, just, you know, the pipeline obviously grew. Just we're looking for more color on that. Is that strictly because of the new tenant relationships and adding some of their, some of the opportunities there? Is there any specific sectors or industries that we can call out? Just any color on the pipeline that hit $13 billion this quarter? Thanks.

Sure. Yeah. Hey, this is Tyler. So, yeah, so generally, I'd say the pipeline is an evolving thing. It's a result of our acquisitions team out there, you know, kind of cultivating relationships in all the industries that we address. Generally, you know, the composition is consistent with where it's been in terms of industry composition. There was an uptick in the family entertainment industry. industry in particular. But overall, you know, that's consistent with businesses returning to growth due to business reopenings and pursuing M&A opportunities. So it's really just, you know, continued, you know, like, you know, businesses back, you know, as Mary mentioned, and the pipeline is dynamic and our acquisitions teams is always out there cultivating those relationships. And fluctuations can be driven by, you know, timing, not necessarily indicative of anything beyond that, but it's really just – you know, our teams out there trying to find opportunities for us to pursue.

Great. And then last one from me, if I may, and it's a small one, just the equity and income that came in through the quarter. I think you guys have taken equity in a bit in a tenant. Maybe can you just remind us of what that is that came in through the quarter and how we should think about that?

Sure. I believe you're talking about the equity investment that we got last It was last year, wasn't it? So what that is, we have a mortgage outstanding with a tenant and was able to, as additional collateral, basically, for that mortgage, we were able to get an equity interest in an affiliate of theirs that is in the amusement industry or water parks and things like that. We valued it last year. based on discounted cash flows and things like that. It was about $3.5 million of value that we put on our books as an asset. We're maintaining that now on equity method accounting. At the end of last year, they had some small losses, and we picked up our share of those losses. But this year, they are actually ahead of budget and are reporting income, and we're picking up our share of income. We did see a small amount of cash distribution during the quarter, but it was only a couple hundred thousand, so we didn't really mention it. But that appears to be doing really well. We do not include that, by the way, in AFFO. We just subtract that from AFFO.

The next question will come from John Masaka with Lattenberg Thelman. Please go ahead.

Good morning.

Hey, John. Hey, John.

First off, congratulations, Kathy, and congratulations, Sherry. It's just our first question. On the guidance, should we assume disposition activity, you know, is going to kind of run at about that 25% of investment volume or, sorry, acquisition volume that it kind of has historically, or could there be some variation from that as we look out to 2022? That's Kathy.

So, baked into guidance, How we think about it is looking at the beginning balance of the portfolio and then assuming anywhere from 3% to 5% of that would be the amount we would dispose of in any year.

Okay, but so it's not really going to be related to the actual deal volume or just the in-place portfolio? That's correct.

That's correct.

Okay. And then in terms of the pipeline, it was kind of notable, you know, obviously there's movement within the pipeline every quarter, but entertainment really seemed to jump up as a percentage of the pipeline. Can you remind us, you know, maybe what type of assets are in that bucket? And then also just any color as to why it's moved up. Is it just, you know, timing of deals hitting? Is there just more activity in that tenant industry? Just any color there would be helpful.

Hey, John, it's Mary. I'll just touch on that briefly. So as Tyler mentioned, it's really the result of, you know, coming out of COVID and these industries, this one in particular, that is now looking to grow and do some M&A activities. And it can be things, you know, like adventure parks or, you know, laser tag places or Whirlyball or, you know, other things along that line where families go and have a lot of activity. That's really the type of asset class it is in particular.

Okay, just one quick one, sorry to tack on, but is that a competitive cap rate environment right now, or is there potential to maybe get some outside yield in that particular tenant industry?

It's in line with what's happening with cap rates today, so I would say it's not anything outside of the normal range that we're seeing.

That's it for me. Thank you all very much.

The next question will come from Linda Tsai with Jefferies. Please go ahead.

Hi. Congratulations to you, Kathy, and then also to you, Sherry. In terms of the 8 million rent receivables collected as of September 30th, you mentioned you have 34 million remaining, and the vast majority will be collected by the end of 2022. How should we think about the remaining amount coming online? Is it pretty evenly until the end of next year?

Yes, I think so, because most of the tenants are on a payment schedule that we try to spread the amount that they owe fairly evenly over a time period. So, yes, I think if you kind of bake that in, that's probably fair.

Thanks. And then you've had success in writing in rent escalators, 1.8% this quarter, 1.9% last quarter. How easy or difficult is it to get this from your tenants right now when they're also experiencing an inflationary environment and wage increases?

This is Mary. We've actually been able to get the rent increases. We haven't seen any any difference or any change in that. And we'll continue to get what the market will bear on rent escalations with our direct approach and asking for those rent escalations. And as it relates to labor and inflationary prices, I could have Craig comment a bit on that for you, which I think you might find interesting as we talk to our tenants.

Sure. Yeah, so the overwhelming sentiment based on our conversations with our tenants is, You know, they're managing and adapting, and demand actually remains very strong, and it's driving businesses across all of our industries. You know, from a labor pressure perspective, I think, you know, everyone is doing more with less. You know, automation is a key capital investment today. In the restaurant space, there's a movement, obviously, for ordering online and to go pick up. So you're able to do more or less with there, and that's very profitable for our restaurants. you know, reduced menu sizes. So they're, you know, they're managing and adapting from a labor perspective. You know, from specialized labor, you know, our customers are telling us they're tapping employment pipelines early. You know, they're establishing relationships with secondary or trade schools. And, you know, everyone's looking to creating incentive programs to obviously retain labor. You know, from a supply chain perspective where they're procuring labor alternate sources if possible, adapting, you know, to more efficient manufacturing processes to, you know, for their current capacity. You know, and, you know, for example, from our furniture retailers, we're hearing that their procurement practices or their switching to procurement practices, you know, that what is shown on the showroom is immediately available instead of, like, taking special orders. So they're winning businesses by having less lead time. And then just from the inflationary to your question, a lot of our customers are able to pass on these inflationary increases to their customers, and actually some of them are realizing they have more pricing power than they actually realize and are ending up much more profitable in that case. So hopefully that kind of gives you some color on that.

The next question will come from Hindle St. Just with Mizuho. Please go ahead.

Hey, good morning. And Kathy, it's been a pleasure. Best of luck to you in your next adventures. And Sherry, welcome. So my question is, I guess, on recovery rates on the fourth quarter dispositions. Can you talk about what they were and how they compare historically?

Yeah, so from the strategic and property manager perspective, we almost broke even at cost, and that actually includes some vacants. So now we can actually go and reinvest those funds, and that is well above our historical recovery. And then, as you saw, we made 15% over cost on our one opportunistic sale.

Got it. Okay, thank you for that. On the impairments in the quarter, lots of talk about cap rate compression. I guess I'm curious why impairments now and maybe which tenants or property types they're tied to. Thanks.

It's Kathy. So the impairments were generally in the restaurant sector, and those are properties we're likely to sell. So normally they're not impaired if you want to spend the time to re-let the properties, but you have to do the analysis to say, are we better off holding on to the property and bearing some costs on property taxes and things like that? Or are we better to sell the property at a slight loss and then reinvest it in a new property and get revenue right away? And so when you make that analysis on occasion, there are some restaurant properties you just want to sell. And so we took the impairment on those. Does that help?

Appreciate the comments there. Last one is on the cap rate compression story. We've heard all around us in the quarter here from you and your peers. I guess I was under the impression that was a bit more acute for larger deals and better credits, I guess. So I guess I'm curious, are you seeing anyone enter your sandbox? I thought there was a bit more of a, of an insulation from competition, given what you guys are doing versus some of your peers?

Yeah, this is Mary Handaw. You're correct. I think on larger deals, we're probably seeing a little bit more compression, and we're seeing quite a bit of compression in the manufacturing space. So we're still able to originate near seven and a half, and we're pleased with that.

And new competition, I guess, that's both on the larger side, but also how about on the direct side where you've normally your bread and butter going direct to the tenant?

You know, Handel, there's been across space, there's been a lot of new entrants into the space. I would say, and obviously it's driven by a low interest rate environment and it's just a good place to find, to have yield. But we do have the niche, you know, we have the average deal size of $9 to $10 million and we find ourselves in a nice place there. to continue to grow the portfolio, and we don't see as much competition there. That's correct.

The next question will come from Nate Crossett with Barenberg. Please go ahead.

Hey, good morning. Question on funding sources for 22. Maybe you can just remind us the mix that you target for master funding versus unsecured. And then I was just wondering if you've ever priced out preferred equity and what that might look like. I think one of your peers did their first preferred offering this quarter, and I was just curious if that was something you've ever considered.

Yes, Kathy. So we haven't done any preferred equity to date, but we do always evaluate equity. any opportunity and strive to get the most flexible and efficient capital stack that we can. So it's not as though we would rule that out. When we're looking at master funding versus doing a senior unsecured deal, you know, we're committed to both markets, so chances are we would do one of each during the year. In particular, because master funding has the ability to have prepayment, without penalty, when you have some more tranches coming up that are going to be at higher interest rates, we will take advantage of that and likely just refinance that with new master funding debt at a lower price. And then fill in the rest of the debt stack with, you know, the senior unsecured market, which has been a very robust market with attractive rates. That helps.

Yeah, that's helpful. Thank you. And then I just had one on, maybe you can just remind us on your tolerance of tenant concentrations. I think you have a new top tenant this quarter. You know, maybe just how do you balance those concentrations versus opportunities with those tenants like LBM or Spring or Cadence?

Yeah. Hey, Nate. It's Mary. So you're right. We have a new top tenant. It's USLBM, and they actually acquired one of our customers that we had already here at the store, which popped them up to the top there. So we're going to stay disciplined at around 3% of ABRI. And that'll, you know, we can manage that by, you know, we might, by maybe selling some stuff or maybe, or as we grow the portfolio, they'll grow into it a little bit and so on. So it tends to work itself out right around 3%.

The next question will come from Sheila McGrath with Evercore ISI. Please go ahead.

Yes, one last one for me. Kathy, I apologize if you already said this, On the deferred COVID paybacks of $34 million, can you remind us how that will flow through FFO or AFFO next year?

Yes, it does not flow through AFFO. So what we did was we were reporting revenue, and whether it was a receivable or in cash, we were reporting the revenue. If we didn't think it was collectible, we didn't report the revenue at all. So, if we were reporting the revenue, it was in AFFO. So, that is not a boost to AFFO.

Okay. Thank you.

Yeah. This concludes our question and answer session. I would like to turn the conference back over to Ms. Mary Fedewa for any closing remarks. Please go ahead.

Thank you. And thank you all for participating in our call today and for your continued support and interest in store. We look forward to seeing some of you at NAERI next week. Please feel free to reach out to us if you have any additional questions, and have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.