Essential Properties Realty Trust Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 24, 2024

There are 16 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Essential Properties Realty Trust Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded and a replay of the call will be available 3 hours after completion of the call for the next 2 weeks. The dial in details for the replay can be found in yesterday's press release.

Operator

Additionally, there will be an audio webcast available on Essential Properties' website at www.essentialproperties.com. An archive of which will be available for 90 days on the call this morning are Pete Mahbodis, President and Chief Executive Officer Mark Patten, Chief Financial Officer Rob Salisbury, Head of Capital Markets Max Jenkins, Head of Investments and A. J. Peele, Head of Asset Management. It is now my pleasure to turn the call over to Rob Pellegrini.

Operator

Please proceed, sir. J.

Speaker 1

Pellegrini:]

Speaker 2

Thank you, operator. Good morning, everyone, and thank you for joining us today for Essential Properties' Q3 2024 earnings conference call. During this conference call, we will make certain statements that may be considered forward looking statements under federal securities law. The company's actual future results may differ significantly from the matters discussed in these forward looking statements, and we may not release revisions to those forward looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings press release.

Speaker 2

With that, I'll turn the call over to Pete.

Speaker 1

Thank you, Rob, and thank you to everyone joining us today for your interest in Essential Properties. On our last earnings call, we discussed how our portfolio continued to exhibit strong operating trends against a dynamic market backdrop. This resilient portfolio performance continued during the Q3 with high occupancy, healthy same store growth and improving credit trends. As a long term capital provider focused on owning real estate at a conservative basis, leased under our lease form to growing operators in service and experience based industries, we expect our portfolio to perform at a high level. Maintaining relationships with and providing value to operators continues to drive investment activity as well.

Speaker 1

In the Q3, 79% of our investments were generated from existing relationships, underscoring the value of recurring business with our tenant base. With quarter end pro form a leverage of 3.5 times and liquidity of 1,200,000,000 dollars Our balance sheet positions us well to continue to grow our portfolio by investing in our core industries at attractive spreads, generating sustainably attractive earnings growth for our shareholders. We are establishing our 2025 AFFO per share guidance range of $1.84 to $1.89 which implies a growth rate of over 7% at the midpoint. Our guidance for 2025 reflects continued portfolio performance and a steady pace of investments with cap rates expected to compress modestly over the coming quarters as competition reemerges due to continued normalization of capital market conditions. Specifically, we expect to invest between $900,000,000 $1,100,000,000 in 2025 at approximately 25 basis points below the pricing achieved in 2024.

Speaker 1

Additionally, we expect cash G and A expense to be between $28,000,000 $31,000,000 resulting in continued efficiency gains as a percentage of revenue. As the company is able to invest in its infrastructure while still scaling the platform to generate stronger margins for shareholders. We ended the quarter with investments in 2,053 properties that were 99.9 percent leased to 407 tenants operating in 16 industries. Our weighted average lease term stood at 14.1 years at quarter end, which is up year over year, with only 3.9 percent of annual base rent expiring through 2028. From a tenant health perspective, our weighted average unit level rent coverage ratio was 3.6 times this quarter, indicative of the strong profitability of our tenants at the unit level.

Speaker 1

Same store rent growth in the 3rd quarter was 1.4%. Over the past month, 2 hurricanes hit the Southeastern United States. Our thoughts and prayers go out to the people, business owners and operators impacted by these storms as they rebuild in the aftermath. Looking at our portfolio, we own 103 properties located in areas identified as severely impacted by FEMA, of which 5 properties reported damage causing substantial disruption and warranting an insurance claim. As a reminder, as a condition to providing our capital in a sale leaseback transaction, our tenants are required to enter into our lease agreement, which requires them to maintain property, rent and business interruption insurance.

Speaker 1

This provides an important layer of safety for our portfolio in the event of property damage events such as hurricanes. On the investment side, during the quarter, we invested $308,000,000 through 37 separate transactions at a weighted average cash yield of 8.1%, up slightly from last quarter and up 50 basis points from a year ago. Our investment activity in the quarter was broad based across most of our top industries with no notable departures from our investment strategy. This quarter, our investments had a weighted average initial lease term of 17.2 years and a weighted average annual rental escalation of 2.1%, generating an average GAAP yield of 9.1%. Our investments this quarter had a weighted average unit level rent coverage of 4.7 times and the average investment per property was 4,100,000 dollars The vast majority of the investments in this quarter were originated through direct sale leasebacks.

Speaker 1

Looking ahead to the Q4, our investment pipeline remains solid reflecting M and A and new unit expansion activity across a variety of our targeted industries. As we have discussed in the past, we expect the normalization of the capital markets to result in increased competition causing modest cap rate compression in the near term. We have not yet seen this in our current pipeline, which implies cap rates remaining similar to the past 4 quarters. From a tenant concentration perspective, our largest tenant represents 4.3% of ABR at quarter end and our top 10 tenants now account for just 17.7% of ABR. Tenant diversity is an important risk mitigation tool and a differentiator for us and it is a direct benefit of our focus on middle market operators, which offers an expansive opportunity set.

Speaker 1

Dispositions were in line with our trailing 8 quarter average in Q3. We sold 9 properties this quarter for $17,000,000 in net proceeds. This represents an average of approximately $1,900,000 per property, highlighting the importance of owning fungible liquid properties, which allows us to proactively manage portfolio risks. The dispositions this quarter were executed at a 6.8% weighted average cash yield. Over the near term, we expect our disposition activity to remain in line with our trailing 8 quarter average, driven by opportunistic asset sales and ongoing portfolio management activity.

Speaker 1

With that, I'd like to turn the call over to Mark Patten, our CFO, who will take you through the financials and balance sheet for the quarter.

Speaker 3

Thanks, Pete, and good morning, everyone. As Pete detailed, we had a good 3rd quarter highlighted by a strong level of investments at an 8.1% cash cap rate. Among the headlines from the quarter was our AFFO per share of $0.43 That's an increase of 2% versus Q3 2023. On a nominal basis, our AFFO totaled $77,900,000 for the quarter, which is up $11,600,000 over the same period in 2023, an increase of 17%. This AFFO performance was in line with our expectations as reflected in our guidance range provided last quarter.

Speaker 3

A stronger than anticipated investment volume was partially offset by incremental dilution from the treasury stock method on our unsettled forward equity. Total G and A in Q3 2024 was $8,600,000 versus $7,600,000 for the same period in 2023, with the majority of the increase relating to increased compensation expense as we continue to invest in our team. Our recurring cash G and A as a percentage of total revenue was 5.1% for the quarter, which compares favorably to the 5.5% in the same period a year ago. Our total G and A and recurring cash G and A were also in line with our expectations for the quarter year to date. We continue to expect that on an annual basis, our cash G and A as a percentage of total revenue will decline as our platform generates operating leverage over a scaling asset base, enabling us to manage a larger portfolio and invest at higher levels.

Speaker 3

We declared a cash dividend of $0.29 in the 3rd quarter, which represents an AFFO payout ratio of 67%. Our retained free cash flow after dividends continues to build, reaching $26,800,000 in the 3rd quarter, equating to over $100,000,000 per annum on a run rate basis. We continue to view our retained free cash flow as an attractive source of capital to support our investment program. Turning to our balance sheet. With the net investment activity in Q3 2024, our income producing gross assets reached $5,800,000,000 at quarter end.

Speaker 3

The increasing scale of our income producing portfolio continues to build, and we expect to approach and perhaps eclipse $6,000,000,000 by year end. Significant diversity and increasing scale of our asset base continues to improve our credit profile. Turning to Capital Markets. We remained active on our ATM program in the quarter, completing the sale of approximately $312,000,000 of stock, all on a forward basis at an average price of $31.04 per share. With no settlements during the quarter, our balance of unsettled forward equity totaled $626,000,000 at quarterend.

Speaker 3

We expect to begin drawing upon this unsettled forward equity in the 4th quarter as a source of funds for our investment activity and paying down any outstanding balance on our revolver. Similar to last quarter, our current share price remains well above the weighted average price of our unsettled forwards of $27.29 at quarter end. As a result, under the treasury stock method, the potential dilution from these forward shares is included in our diluted share count. For the Q3, our diluted share count of 179,600,000 included an adjustment for 2,700,000 shares from our unsettled forward equity related to this treasury stock calculation. This represents a headwind of approximately $0.01 to AFFO per share this quarter, and we estimate the headwind to AFFO per share for the full year in 2024 will reach 0 point 0 $2 As we begin to settle this equity in the near term, we expect the headwind to shrink to a de minimis amount in 2025.

Speaker 3

During the quarter, we closed on the previously announced $450,000,000 term loan, which was fully drawn and swapped at an all in rate of approximately 4.9%. Our pro form a net debt to annualized adjusted EBITDARE as adjusted for unsettled forward equity was 3.5x@quarterend. We remain committed to maintaining a well capitalized balance sheet with low leverage and significant liquidity to continue to fuel our external growth. As we noted last quarter, our leverage has trended below average levels over the past year as heightened debt costs and capital markets volatility warranted a more conservative posture. With the 1st Fed cut materializing in September and capital markets normalizing, our funding costs have improved.

Speaker 3

Thus, we expect to carefully and prudently increase our leverage from here to levels more consistent with our average over the past several years. Lastly, as we noted in the earnings press release, we have reiterated our 2024 AFFO per share guidance range of $1.72 to 1 $0.75 and established, as Pete mentioned, our 2025 AFFO per share guidance range of 1 $0.84 to $1.89 representing over 7% growth at the midpoint. Importantly, both of these guidance ranges require minimal equity issuance in 2025, which we believe is a testament to our front footed approach to capital raising. With that, I'll turn the call back over to Pete.

Speaker 1

Thanks, Mark. We are pleased with our Q3 results and remain optimistic about the prospects for the business. Operator, please open the call for questions.

Operator

Thank you. We will now conduct a question and answer session. Our first question comes from Hansel St. Jude with Mizuho Securities. Please proceed.

Speaker 4

Hey, good morning guys. Thanks for taking my question and also for the early read into 2025. My first question is on the guidance, which includes acquisitions and acquisition guidance for the first time ever, I think. So I guess I'm curious, why now in providing that acquisition guidance and what gives you the confidence to put out a forward year acquisition guidance at this point? And then do you think the upper single digit 7%, 8% implied AFFO growth in that guide is a sustainable multiyear growth rate?

Speaker 4

Thanks.

Speaker 1

Great. Thanks Haendel. Listen, I think providing the acquisition guidance really just is a natural evolution in the maturation of the company. We've grown our tenant base expansively from 100 tenants to 400 tenants. Our acquisition team has now been in their seats and seasoned over 5 years.

Speaker 1

And there's just more predictability in our forward pipeline than we've seen in the past. We also have a much more stable cost of capital that allows us to look at deploying capital more consistently and reliably. And so I think it's just it's a natural evolution. I think as you've been following us for many years, you've seen we've been pretty predictable. We've been pretty transparent.

Speaker 1

And I thought supporting the guide with some acquisition guidance was appropriate. As we think about the out years, it's early, right? We're just guiding for 2025 and I would say we have a very robust business plan. We have a very differentiated investment strategy that allows us to deploy capital accretively and are well positioned to continue to do that. But I would stop short of trying to give growth rates beyond next year.

Speaker 4

Well, I had to try. Appreciate the color there. One more maybe, I was hoping you could talk about your bad debt or tenant credit assumptions embedded in the outlook for next year. I'm curious if there's any potential opportunity for upside or conservatism baked in and maybe you can add some color around the watch list and categories you're monitoring today? Thanks.

Speaker 1

Sure. Well, the watch list is easy. As we define that, the intersection of tenant credit risk of B and below and the unit level coverage of 15 continues to be under 100 basis points and continues to be in a good spot historically. Generally, as I hope you've seen, there tends to be conservatism in all of our guidance and all of the assumptions that support guidance. And in past years, as we've indicated, as we tighten guidance or increase guidance throughout the range, one of the main drivers is the lack of the materialization of credit events that we've budgeted for or provisioned for.

Speaker 1

We provided some good credit loss statistics in our NAREIT deck, up 30 basis points per annum is our historical experience. You can assume guidance has some conservative assumptions starting from there. And so we'll see how the year plays and how we work through these scenarios that may come at us or if they come at us. But we feel like we're in a good spot and certainly have the appropriate level of conservatism built into our guidance.

Speaker 4

Great, great. Thank you. I'll yield the floor.

Speaker 1

Thanks. Thanks, Haendel.

Operator

The next question comes from Caitlin Barnes with Goldman Sachs. Please proceed.

Speaker 5

Hi, good morning everyone. Maybe on the funding side, you guys were active with your ATM in the quarter despite already having unsettled forward shares that you went through. So could you just go through the thought process of when to use the existing forward shares versus continue to issue more?

Speaker 3

I think so when to use the existing forward shares, I think we may have mentioned in the remarks that our expectation in the Q4 will begin to settle a fair amount of that equity going into the end of the year. That's both to address our investment pipeline as well as to pay down anything we have outstanding on the revolver. I think from there, I probably referenced it as well in the remarks that that gets we've got a fair amount of dry powder. That dry powder is probably a good 3.5 quarters worth of liquidity to execute and still stay at the low end of our leverage range. So call it 4.6.

Speaker 3

And I think the good news embedded in that as well is that we have a lot of assumptions around equity needs in 2025 and they're pretty low amount of equity needed, in fact, very low and that's something we think we could address on a focus.

Speaker 5

Got it. You're kind of breaking up for me. I don't know about for everybody else. Can you still hear me?

Speaker 3

Yes, I can hear you.

Speaker 5

Okay. And then maybe just moving over to the disposition side, maybe also like the watch list. As you guys are looking to sell properties, I guess, what's driving you to dispose of the properties you choose to pursue? Kind of who are the buyers? How deep is that pipeline of buyers?

Speaker 5

And is it generally other third parties?

Speaker 1

Yes. It's always other third parties. On occasion, it may be tenants coming back to us, but mostly it's 3rd parties. Really there's three reasons we're going to sell an asset. 1 is to manage industry concentrations.

Speaker 1

As you can see, our car wash exposure has been high and so we've been industry

Speaker 3

exposure,

Speaker 1

really to create some more capacity, continue to invest in that industry, lightening up on individual tenants. In the quarter, we sold an equipment share. And again, we really like that tenant, but to the extent that we're able to sell some assets off in the low 6s, mid 6s, we can redeploy that capital accretively to continue to support that tenant relationship. And then lastly, just selling assets that don't work for whatever reason. And we see risk of tenant continuing to be able to pay the rent or a lack of probability that they wouldn't renew as we see through the unit level coverage.

Speaker 1

And so selling those assets is important to our business plan. Granularity and fungibility in our real estate is an important fundamental of our portfolio. So we have good liquidity in our assets and there's a deep pool to for us to dispose into local and regional sometimes 1031 motivated buyers. And we've demonstrated that since coming public and we'll continue to do that.

Speaker 5

Got it. Thanks. Maybe just as an update, I could hear that response much better. So I don't know if you guys are together or sitting in different places or what, but that was very clear. Thank you.

Speaker 1

Great. I tend to be more clear than Mark anyway.

Operator

The next question comes from Eric Gordon with BMO Capital. Please proceed.

Speaker 6

Hey, good morning guys. Thanks for taking my question. Maybe just on the remainder of the 2024 acquisitions, you mentioned some possible M and A opportunities, maybe some singles and doubles. You've closed a little over $50,000,000 today, which is above where you were the same time last year. And so investments seem to be tracking well.

Speaker 6

Maybe if you could talk about how much you have under LOI or PSA?

Speaker 1

Yes. We listen, it's there's a lot of time left in the quarter and the Q4 tends to it has some volatility. It could be a lot of deal volume or few or a little. And so I think our general guide to the 8 quarter average is probably a good indicator and kind of 2.50 ish, but it's really too soon to put a pin in that. When we go out to NAREIT, we'll update our investor deck and give a good snapshot then, but it shouldn't be materially different from that.

Speaker 1

And to be clear on the M and A, it's really supporting our tenant relationships in M and A, not us seeking to endeavor in any M and A transactions.

Speaker 6

All right. Thank you. And then looking to the 2025 acquisition guidance that you provided, if we square that with your trailing 12 or trailing 8 quarter average, it seems to be implying that acquisitions are a little lighter than expected. So is there something that you're seeing in the market that is preventing you to acquire more? Or is it potential conservatism given that we're 1 month after closing the 3 quarter books?

Speaker 1

Yes. I think consistent over the last kind of 3 or 4 quarters, we've indicated it's been a unique buying environment with the dislocation in the capital markets and a lack of competition where we really have been pressing our advantage to put capital to work at rates and levels that really are historic highs in my 20 year plus career of investing. And so we've been aggressive this year. And so I think that's part of it. Another part of it is, as we've always said, we want to communicate a business strategy that's derisked from an execution perspective.

Speaker 1

And so supporting guidance with flat investments, I think, is conservative and appropriate. We're not going to come to the market with guidance that's predicated on us growing our activity 25%, 50%. We just don't think that's prudent. So there's a number of factors going on there. I would also say, as we've said, with the normalization of the capital markets, we expect competition to return to the market, which could lead to the missed pricing of risk by aggressive competitors.

Speaker 1

And to the extent that deals get priced away from us, we want to be in a position where we can be patient and prudent and conservative. And so we put a lot of thought into building this 2025 business case to support guidance and we believe it's imminently achievable and conservative.

Speaker 6

All right. Thank you for the time. I'll leave it there.

Speaker 1

Thank you.

Operator

The next question comes from Smedes Rose with Citi. Please proceed.

Speaker 7

Hi, thank you. I appreciate the guidance around the acquisitions outlook. And you mentioned that you expect cap rate compression, I guess, over the course of the year, but you're not seeing it yet. And I was just wondering, could you just talk a little bit about sort of cap rate sensitivity on the short end versus maybe what we're seeing with an upward movement in the 10 year at this point? And maybe how you think that will play out for cap rates maybe over the sort of the first half of twenty twenty five?

Speaker 1

Yes, sure. We compete against alternative forms of capital on the short end of the curve, bank debt and the like for our tenant relationships. More of our competitors on the investment side and the sale leaseback and net lease side are really competing against we're competing against them based on the long end of the curve kind of 10 year and long term financing as they match funds these long dated assets. The 10 year has been volatile. I guess 3 weeks ago it was in the mid-3s, now it's in the low-4s and that's pretty volatile.

Speaker 1

I think a high tenure supports us and limits competition, but to the extent that you see tenure in the mid-3s, I think the leveraged private buyer is going to be more aggressive and be creating competition and downward pressure on cap rates. So it's going to be a while before the banks come back and the low end is really in play as an alternative form of competitive capital. I think we're more sensitive to the 10 year and what that does for our private competitors.

Speaker 7

Okay. Then I just wanted to ask you on your ABR coverage levels. The coverage under one times declined sequentially to 3% from I think over 4% last quarter. Can you just talk about what's going on there if anything? And is 3% sort of where you think it would sort of stabilize in terms of ABR under one times?

Speaker 1

Yes. I would stop short of saying that that's our expectation to stabilize there. There's always going to be idiosyncratic ebbs and flows in that bucket. It's going to be less than a dozen of tenants. And when you have master leases, it could be multiple properties.

Speaker 1

Specifically in the quarter, we had an early childhood education operator that was of size, I. E. 1% ABR that was executing a turnaround play on some sites and we were glad to see him finally get traction and get those sites open and operating and profitable. It was a strong credit. We supported multiple times over the years.

Speaker 1

So it wasn't really a credit concern for us. It just took them some time to get those sites to the spot where they're out of that sub one bucket and glad to see that. But it's going to be idiosyncratic. It never really gives us too much pause because generally it's backed by strong credits and solid real estate and we're likely to see some noise in that bucket.

Speaker 7

Great. Thank you

Speaker 1

guys. Thank you, Smedes.

Operator

The next question comes from John Kielychowski with Wells Fargo. Please proceed.

Speaker 8

Hi. Thank you. So I'll start on the investment activity side. Just looking at the terms here, so cap rates ticked up a bit, really strong on the lease escalations at 2.1 and then great rent coverage. What allowed you to kind of get those terms here, especially the rent coverage step up versus your trailing quarters?

Speaker 1

Yes. I wouldn't read too much into the rent coverage step up. That number is really an output of kind of the mix of industries that we do in any given quarter. And so some of our industries have higher coverage just by the nature of the industries like medical, dental, equipment rental and things like that and some have lower like gyms and things like in that sort of entertainment bucket. So I wouldn't read too much into that number.

Speaker 1

That's really just an industry mix. I'd say big picture, as has been the commentary, there's just not a lot of capital providers out there in the middle market sale leaseback space currently and we're able to drive attractive terms with our counterparties and that's what you see going on.

Speaker 8

Got it. And then maybe just jump into your top 10 tenants. There seems to be a fair bit of shake up there quarter over quarter. Maybe if you could just talk about strategically the new entrants and the exits and how you think about shaping your book moving forward?

Speaker 1

Yes. We always want to maintain diversity. And I think the bigger picture from my perspective is having 17 0.7% in our top 10 represents good diversity and more importantly having kind of 1% to 2% exposures through a bunch of tenants is good diversity, but also creates a good opportunity set to continue to invest. The names that came into our top ten are operators that we've been investing with in a series of transactions over multiple years or years. And as we continue to invest, they grow.

Speaker 1

And as they grow, other guys where we've not invested just fall out. So every quarter, we're going to have ebbs and flows in that. Undefeated Tribe, the Crunch Fitness operator is a great operator. We've been doing deals with him for a long time and has done a great job and we continue to see opportunities to grow with him and do that. And so it's been nice to see them up there and certainly a name that we like and are comfortable with.

Speaker 1

But just given our diversity, it's natural to see movements in that top ten.

Speaker 8

Got it. Thank you.

Speaker 1

Thank

Operator

you. Our next question comes from Ben Kim with Truist Securities. Please proceed.

Speaker 9

Thank you. Good morning. I was wondering if you can just provide some data points on the ABS market and CMBS market pricing. And typically, in a normal year, how much of these capital sources are competitors to your business in terms of like a market share?

Speaker 1

Yes. Generally, in my experience in the ABS market is structured bonds that are rated are going to trade anywhere from 25 to 50 basis points wide of similarly rated corporate unsecured. So if you assume the BBB REIT index at 1.5, ABS is through a similar level should be 25 to 50 basis points wide to that. And then you got to talk about attachment points and valuation and the like, which is beyond my expertise. Certainly a lot of people are more active in that market and have better insight than we do at this point.

Speaker 1

So that said, we see those guys as competitors an elevated 10 year and wide spreads are less competitive. As that market becomes more robust and tightens, they've become more competitive and really it ebbs and flows. I would say there's been a trend of more and more capital supporting net lease investing as the asset class has matured and demonstrated great cash flow stability. So there is more and more capital organizing to come into the space. So it's not a static competitive set.

Speaker 1

It's very dynamic. But it really just depends. They tend to be more competitive on the bigger transactions, which is why we're staffed and organized to transact at the $10,000,000 $8,000,000 to $10,000,000 chunks that we transact.

Speaker 9

Thanks. And on the cash G and A guidance for $25,000,000 the flight increase, is that driven by just more hiring on staffing or kind of inflationary pressures? Just curious what's driving that?

Speaker 3

Yes. Thanks, Ki Bin. I think if you look at our the guide on cash G and A, it's really a reflection of us investing in our platform, continuing to invest in our platform. It's clearly going to season into a as a percentage of our total revenue obviously continue to season favorably. So we think about investing in really non executive hires, sort of an embedded normal inflation for a lot of the other G and A elements, even though we don't have a lot of G and A levers outside of our infrastructure.

Speaker 3

So I think, if you think about the range, it's going to be issues around timing of the higher or hires and some of those normal kind of puts and takes.

Speaker 10

Okay. Thank you, guys.

Speaker 1

Thanks Ki Bin.

Operator

The next question comes from Josh Stenderlane with Bank of America. Please proceed.

Speaker 11

Yes. Hey, guys. I just want to follow-up on Mark's comments that there's, I guess, some dilution from the treasury stock method. I guess it's like $0.01 now, but reaching $0.02 I guess, can you just kind of give us more color on how that's showing up in the guide for this year? And it sounds like, if I heard correctly, 2025 assumes no kind of dilution from that?

Speaker 11

Just trying to think through kind of like the trajectory of how this kind of fades out.

Speaker 2

So, yes, as Mark noted in the prepared remarks, the treasury stock method on our forwards was about $0.01 headwinds. Based on our current share price, it's likely to be around that same level in the 4th quarter. So that's what's assumed. As we look out into 2025, of course, the calculation is based in part on where our share price will be, which is inherently hard to project. But as we continue to settle these forwards into year end, we would expect our year end forward unsettled balance to be a lot smaller.

Speaker 2

And so as you start the year in 2025, we would expect that headwind to be a little bit more weighted. Based on our expectations, I think a 0 point $1 to $0.02 range is probably reasonable. And I think maybe from a modeling standpoint, dollars 0.02 might be a good starting point as you think about building your 2025 estimate. But again, we'll continue to update you as the share price fluctuates and we'll go from there.

Speaker 11

Okay. Sorry, Rob. It's a little hard to hear you breaking up. I'll follow-up offline. So appreciate that.

Speaker 11

And then Pete, you mentioned lightening up on car washes. Is that just a pure diversification play or something kind of specific to maybe your existing car wash portfolio or maybe just the industry in general?

Speaker 1

Yes. It's just portfolio management, portfolio construction. We generally have a soft ceiling of 15% for any individual industry concentration and our washes ticked above that given the opportunity set. There's nothing inherently challenging in that industry that we see and we have plenty of opportunities to continue to invest, but it's just it's more portfolio construction than anything else.

Speaker 11

Okay. Appreciate that. Thanks, Pete.

Speaker 1

Thanks, Josh.

Operator

The next question comes from Michael Goldsmith with UBS. Please proceed.

Speaker 12

Good morning. Thanks a lot for taking my questions. First question is just on the acquisition guidance. You've done $300,000,000 a quarter over the last 4. You're kind of pointing to $250,000,000 ish for the 4th quarter and the guidance implies $250,000,000 ish a quarter going forward.

Speaker 12

Now typically, the 4th quarter is when you've acquired the most and you're expecting kind of a lower run rate coming going forward. So like is this kind of like the turning point where acquisition volumes will start to slow due to competition? Or is this just again, you kind of baked at the end of the call is just being thinking like a prudent conservative approach just given the lack of visibility and a lot of moving pieces in the market today?

Speaker 1

Yes. I think it's certainly the latter. As we've always said, we generally don't have visibility in our pipeline beyond 90 days as that's the normal transaction cycle. And we do think we are at an inflection point in the capital markets. It's going to change the competitive landscape.

Speaker 1

And given that dynamic, we wanted to be conservative relative to our investment volumes. And historically, we haven't provided investment volumes. So it's safe to assume when we do start providing them, it's going to have appropriate level of conservatism baked in.

Speaker 12

Got it. And then one thing we noticed that there was a decrease in the percentage of sale leaseback transactions this quarter. Is there anything changing specifically within the market there? Is that the reflection of like the greater competition? Just trying to get an understanding of the market overall.

Speaker 1

No, nothing. I mean, it's not material. At 89%, we're 90%. We're still kind of vast majority of sale leasebacks. We just happen to have the opportunity to do some existing lease transactions that made sense during the quarter.

Speaker 1

I think if anything, that's probably a more normalized level and that we've been heavy into sale leasebacks given the dislocation in the capital markets in the past quarters. And so there's nothing really to read into that number is changing materially.

Speaker 12

Thank you very much. Good luck in the Q4.

Speaker 1

Thank you much. Thanks.

Operator

The next question comes from Greg McGinniss with Scotiabank. Please proceed.

Speaker 13

Hey, good morning. I guess given that 10 year treasuries are back to levels not seen since July, What are you seeing in the capital markets or amongst your competitive set that's leading you to believe you're going to have greater competition next year?

Speaker 1

Yes. Listen, it seems like the 10 year is high. It backed up 3 weeks ago in the mid-3s. And so there's certainly volatility. And I would expect it to level out.

Speaker 1

And so we're being conservative and we're assuming that the 10 year is going to move around and may move against us I. E. Lower such that competition reorganizes. I think the other part of it is spreads. Spreads have come in to historically tight levels across all fixed income instruments, which is an equally important component of that.

Speaker 13

So if the 10 year were to stick around this level or potentially move higher, do you think that leads to a more favorable competitive environment for you?

Speaker 6

I do. Yes.

Speaker 13

Okay. Just last one for me. Implied Q4 AFO guidance fairly wide, dollars 0.03 Is that just potential treasury share dilution and equity issuance timing or are there other factors being taken into consideration there?

Speaker 1

I think that that's going to be the biggest driver. With $600,000,000 of unsettled forwards and being not really sure about the timing when that's going out, you can assume there's some decent volatility in that.

Speaker 13

Okay. Thank you.

Operator

The next question comes from John Massocca with B. Riley. Please proceed.

Speaker 10

Good morning.

Speaker 14

Good morning.

Speaker 10

On the competitive environment, are you seeing anything kind of tangible at this point? I mean, you mentioned it's not impacting the pipeline, but are there competitors either bidding for deals or talking to tenants that maybe weren't in the space for the last couple of years or that weren't even maybe the space before that that have now entered just given I know volatility in the tenure, but maybe expectations of where rates are going to go?

Speaker 1

Yes. It's an overall feeling and sense. When you're doing you're negotiating 37 transactions in a quarter, there's a lot of different competitive dynamics in each of those transactions and we're dealing with 37 different counterparties who are out there sourcing capital through a variety of different sources and it's not any one data point, but just the overall sense of the market. And I think you can see that and feel it when spreads come in and the treasuries are in the mid-3s, people are feeling a lot more bullish and bidding more aggressively. And when spreads gap out and treasury rates gap out, they back up.

Speaker 1

And so there's certainly natural ebbs and flows and competition in the capital markets and we live it on a day to day basis.

Speaker 10

Okay. And then maybe on the tenant partner side, I mean, what's kind of broadly speaking the general driver of them seeking your financing today? I mean, is it more kind of refinancing existing liabilities or is it kind of growth still?

Speaker 1

It's the vast majority is going to be growth, either supporting them in individual M and A activity or them developing new sites and providing development capital. Very little of it is refinancing past liabilities. There's some but not a ton.

Speaker 10

Okay. And then, given some of the broad pressures we're seeing in the restaurant industry, especially among smaller operators, how is tenant performance and coverage looking in the restaurant portion of the portfolio, both kind of on the QSR side and the casual

Speaker 1

Red Lobster, the TGI Fridays, these large systems that are able to get unsecured corporate debt, which really becomes the catalyst that trips a lot of these companies. The smaller regional operators that we see are less likely to have that debt lever and really are capitalized mostly with debt with equity capital and real estate financing. That said, we are seeing some pressures in the restaurant space, but I would say that you're seeing top line sales pressures. So this top line sales are off, but they are seeing some expansion in margins as the fast inflationary pressures of labor and cost of goods fall off such that I would expect overall our restaurant exposure to be roughly flat to maybe down 10 or 20 basis points on coverage.

Speaker 10

Okay. I appreciate the color. That's it for me. Thank you.

Speaker 1

Thanks, John.

Operator

The next question comes from Jim Kammer with Evercore ISI. Please proceed.

Speaker 15

Thank you. Good morning. Perhaps just building on the last topic, if possible, it looks like your overall at the portfolio level coverage, unit level coverage has drifted down modestly, let's call from the 3.9x4x to 3.6x here at 9.30x. And were there other does that imply basically that the unit level cash flows are growing a little slower than your average 1.7% escalator across the portfolio? Or is it that's too generic and it's more specific to certain industries?

Speaker 15

I'm just curious which sectors are doing a little better and which might be feeling a little more pressure?

Speaker 1

Yes, I think it's going to be specific to specific industries particularly like building supply which can go from a 20 to a 10 and really have an impact or equipment rental sales, equipment rentals and sales like equipment share, they can go from a 12 to a 10 or something along those lines. Generally, in car washes, they're flat to down 10 basis points. Early childhood is up 10 basis points coverage. Medical dental is flat. QSRs are down 10 basis points.

Speaker 1

I'm just ticking down our industry list here. And so mostly you're going to see it flat to up flat to either down 10% or up 10%. But some of those different industries like building materials and equipment supply are going to have more volatility.

Speaker 15

That's interesting. Thank you. And then just real quickly to let you go. Obviously, 711 has been reported to be out there and marketing a large portfolio. Do you feel you've added to your consistently to your convenience store segment?

Speaker 15

Do you think there's more just a 711 issue regarding maybe their health of those particular stores and not much of a read through to the C store industry overall? Just curious what color or thoughts you might have there. Thank you.

Speaker 1

Yes. I think the 711, I think that's more just capital allocation for that company than anything going on systemically in the C store space. Yesway is a community store operator that populated our top 10 that's growing and seeking capital to facilitate their growth. PopSmart is a C store operator that has been in our top 10 and They're growing. And so I don't there's nothing going on in the space that gives me concern and we continue to deploy capital there.

Speaker 1

I think the 711 opportunity is more specific to that tenant.

Speaker 15

Great. Thank you.

Speaker 1

Thank you.

Operator

The next question comes from Spencer Allaway with Green Street. Please proceed.

Speaker 14

Thank you. You noted the lion's share of your deals completed in the quarter was from recurring business. Can you just talk about some of the newer relationships in the quarter? What industries were these in? And based on our current portfolios, do you suspect that they're also going to become a source of recurring business?

Speaker 1

Yes, that's our business model is sourcing new relationships and continuing to grow with those relationships. And as I've said in the past, relationships over time tend to outgrow us and find alternative sources of capital as they grow larger and have more diverse funding options. We generally source in all our industries. We conduct sourcing activity. We attend industry conference events and seek to build relationships and deploy capital in those industries.

Speaker 1

And so those sourcing efforts are really what brings the incremental investment opportunities. Over time, we expect that to kind of be an eightytwenty sort of mix. And so it's good to see 20% new relationships coming into the portfolio because there's certainly a cohort of tenants that are going to move on and transact it somewhere else.

Speaker 14

Okay, great. That makes sense. And then just as your asset base continues to grow and you're underwriting more and more deals each quarter, as you mentioned, it's quite an arduous endeavor. How comfortable are you with your current headcount? Or does the acquisition and underwriting team need to keep growing?

Speaker 14

And when do you think that you're underwriting team need to keep growing and when do you think that new headcount would be added? Yes, that's a constant process, Spencer. We're

Speaker 1

always hiring, training, bringing new people online to build the organization to both underwrite and process close and manage a larger portfolio. So it's very much a dynamic organization and infrastructure that we're constantly investing in and I think that I think you see that in our G and A guide.

Speaker 5

Thank you.

Speaker 1

Awesome. Thank you very much.

Operator

Thank you. There are no further questions

Speaker 1

month. And thanks very much. Have a good day.

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Earnings Conference Call
Essential Properties Realty Trust Q3 2024
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