Essential Properties Realty Trust Q4 2024 Earnings Call Transcript

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Operator

Good morning, ladies and gentlemen, and welcome to Essential Properties Realty Trust Fourth Quarter twenty twenty four 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 three hours after the completion of the call for the next two 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 ninety days. On the call this morning are Pete Mavoides, President and Chief Executive Officer Mark Patton, Chief Financial Officer Rob Salisbury, Head of Capital Markets Max Jenkins, Head of Investments and A. J. Peel, Head of Asset Management. It is now my pleasure to turn the call over to Rob Salisbury.

Robert Salisbury
Robert Salisbury
Senior VP & Head of Capital Markets at Essential Properties Realty Trust

Thank you, operator. Good morning, everyone, and thank you for joining us today for Essential Properties' fourth quarter twenty twenty four 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.

Robert Salisbury
Robert Salisbury
Senior VP & Head of Capital Markets at Essential Properties Realty Trust

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

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thank you, Rob, and thank you to everyone joining us today for your interest in Essential Properties. On our third quarter earnings call, we discussed how our relationship driven investment strategy has positioned us well to execute our business plan in that dynamic market environment. Maintaining relationships with and providing value to operators continues to drive investment activity in the fourth quarter with 79% of our investments generated from existing relationships, underscoring the value of recurring business with our tenant base. Our portfolio also continued to perform well with tenant credit trends and same store rent performance healthy and in line with our expectations. With quarter end pro form a leverage of 3.8 times and liquidity of 1,400,000,000 our balance sheet positions us well to continue to grow our portfolio by continuing to support our tenant relationships and investing in our core industries at attractive spreads, generating sustainably attractive earnings growth for our shareholders.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

The continued strong portfolio trends and the current attractive investment environment remain supportive of our 2025 business plan. As a result, we have updated our 2025 AFFO per share guidance range to $1.85 to $1.89 representing a $0.01 increase at the low end. As we noted on our third quarter earnings call, competition has begun to materialize as capital markets have normalized resulting in modest cap rate compression. We continue to expect our investment cap rates in 2025 to be slightly lower than 2024 reflecting this trend. However, our large and growing investment pipeline is supportive of our articulated investment guidance of $900,000,000 to $1,100,000,000 We ended the quarter with investments in 2,104 properties that were leased to four thirteen tenants operating in 16 industries.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Our weighted average lease term stood at fourteen years at quarter end in line with a year ago, which is 5.8% of our annual base rent expiring over the next five years. From a tenant health perspective, our weighted average unit level rent coverage ratio was 3.5 times this quarter indicating the profitability and cash flow generation by our tenants at the unit level. At a high level, our portfolio credit trends remain benign with same store rent growth in the fourth quarter of 1.4%, occupancy of 99.7%, which is seven vacant properties and collections of 100%. Tenant credit events were de minimis during the quarter and our leasing activity picked up materially in 2024 with 72 leases signed for a recapture rate of 101%, up from 22 leases at a recapture rate of 79% in 2023. The execution of our property management team serves to further mitigate risk by resolving credit events expediently and at favorable rental rates, which ultimately is supported by disciplined asset pricing when we buy properties.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Looking into the first quarter, we continue to expect a constructed tenant credit and portfolio performance backdrop for the company. As noted in recent press reports, one of our car wash tenants, Zips Car Wash recently filed for Chapter 11 bankruptcy protections. At year end, this tenant represented approximately 20 basis points of ABR across three locations in our portfolio, which is a large decline from our peak exposure in 2017 of 16 sites at over 5% of ABR. This material reduction in exposure to an underperforming operator highlights our proactive approach to asset management driven by our proprietary financial reporting, a key underpinning of our differentiated business model. Given the ongoing nature of the bankruptcy, it is premature for us to discuss our expectations around our leases on these three properties.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

I would note that this credit event is consistent with the assumptions supporting our guidance range. On the investment side, during the fourth quarter, we invested $333,000,000 through 37 separate transactions at a weighted average cash yield of 8% in line with our trailing four quarter average. Our investment activity in the quarter was broad based across most of our top industries with no notable departures from our investment strategy. These investments had a weighted average initial lease term of seventeen point seven years and a weighted average annual rent escalation of 2% generating an average GAAP yield of 9.2%. Our investments this quarter had a weighted average unit level rent coverage of 3.4 times and the average investment for a property was $3,300,000 All of the investments this quarter were sale leaseback transactions where we are providing capital to an expanding operator.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Looking ahead, our investment pipeline remains solid reflecting M and A and new unit expansion across a variety of targeted industries. As noted earlier, the current investment climate is characterized by attractive cap rates that have modestly compressed. Our pipeline reflects this trend with pricing in mid to high 7% range and strong contractual escalations, which is supportive of our long term growth trajectory. From a tenant concentration perspective, our largest tenant represents 4.2% of ABR at quarter end and our top 10 tenants now account for just 17.6% 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 offer an expansive opportunity set.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Dispositions in the fourth quarter. Dispositions picked up in the fourth quarter as we opportunistically monetized the number of investments at accretive pricing. We sold 24 properties in this quarter for $60,400,000 in net proceeds. This represented an average of approximately $2,500,000 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 seven point zero weighted average cash yield with approximately 70% of disposition volume in the car watch sector, allowing us to pair this industry exposure to 14.2% of ABR, down from above our soft ceiling of 15% last quarter.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Over the near term, we expect our disposition activity to be slower than the fourth quarter at a level relatively in line with our trailing eight quarter average, driven by opportunistic asset sales and ongoing portfolio management activity. With that, I'd like to turn the call over to Mark Patton, our CFO, who will take you through the financials and balance sheet for the fourth quarter.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

Thanks, Pete, and good morning, everyone. As Pete detailed, we had a good fourth quarter highlighted by a strong level of investments at an 8% initial cash cap rate. Among the headlines from the quarter was our AFFO per share of $0.45 and an increase of 7% versus Q4 of twenty twenty three. On a nominal basis, our AFFO totaled $81,800,000 for the quarter, which is up $14,800,000 over the same period in 2023, an increase of 22. This AFFO performance was in line with our expectations as reflected in our guidance range provided last quarter.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

Total G and A in Q4 twenty twenty four was $8,500,000 versus $7,300,000 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. Importantly, our recurring cash G and A as a percentage of total revenue was 4.8% for the quarter, which compares favorably to the 5.2% in the same period a year ago. Our total G and A and recurring cash G and A were modestly favorable to our expectations for the quarter. Our recurring cash G and A as a percentage of total revenue was 5.4% for the full year and 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. We declared a cash dividend of 0.295 in the fourth quarter, which represents an AFFO payout ratio of 66%.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

Our retained free cash flow after dividends continues to build reaching $30,600,000 in the fourth quarter equating to over $120,000,000 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 representing upwards of approximately 10% of our annual capital needs. Turning to our balance sheet with the net investment activity in Q4 twenty twenty four, our income producing gross assets reached $6,000,000,000 at quarter end. The increasing scale of our income producing portfolio continues to build improving our credit profile. On the capital markets front, we remained active on our ATM program in the quarter completing the sale of approximately $79,000,000 of stock all on a forward basis at an average price of $32.01 per share.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

We settled $325,000,000 of forward equity with a portion of the proceeds utilized to repay our revolving credit facility balance. Our balance of unsettled forward equity totaled $381,000,000 at quarter end, which we plan on utilizing to continue funding our investment program while maintaining flexibility by keeping capacity available on our revolver. Similar to last quarter, our share price remained well above the weighted average price of our unsettled forward equity of $29.03 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 fourth quarter, our diluted share count of 182,300,000.0 included an adjustment for 3,200,000.0 shares from our unsettled forward equity related to this treasury stock calculation.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

This represented a headwind of approximately $0.01 to AFFO per share in the quarter and $0.02 for the full year. Our pro form a net debt to annualized adjusted EBITDARRE as adjusted for our unsettled forward equity was 3.8 times at quarter end. We remain committed to maintaining a well capitalized balance sheet with low leverage and significant liquidity to continue to fuel our external growth. We further bolstered our liquidity at quarter end with the previously announced closing of our amended $2,300,000,000 senior unsecured credit facility. The facility amendment yielded a number of strategic accomplishments for the company, including an upsized revolver commitment of $1,000,000,000 improvements to the rate structure and our financial covenants and an extended maturity date to February 2030.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

We'd like to thank our entire bank group for their full participation and continued support in another successful financing supporting the growth of our business. Lastly, as we noted in the earnings press release, we've updated our 20.25 AFFO per share guidance range to $1.85 to $1.89 implying over 7% growth at the midpoint. Importantly, this guidance range requires minimal equity issuance, 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.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thanks, Mark. In summary, we are very pleased with our fourth quarter and full year results and remain optimistic about the prospects for the business. Operator, please open the call for questions.

Operator

Thank you. We will now be conducting a question and answer session. Thank you. Our first question is from Handel St. Juste with Mizuho.

Operator

Please proceed with your question.

Haendel St. Juste
Haendel St. Juste
Managing Director at Mizuho Financial Group

Hey, good morning out there. Thanks for the question. My first question, Pete, is on tenant credit. I was hoping you could talk a bit more about the Zipps bankruptcy here and the Car Wash segment more broadly. Rents in the Car Wash segment have run up quite a bit and cap rates compressed the last couple of years.

Haendel St. Juste
Haendel St. Juste
Managing Director at Mizuho Financial Group

So I'm curious if 15% is still a level of exposure you're comfortable maintaining or could we see that drift down more over time? And specifically zips, I'm hoping you could add some color on how you envision that playing out. It seems like the risk to your AVR this year could be far lower than the 20 basis points exposure you have. Thanks.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes. Sure, there's a lot embedded in that handout and a good place to start. I would it's too early on zips. Obviously, we're in negotiation with them in bankruptcy. Certainly, we feel like we're in a really good position having paired our exposure down to three properties and 20 basis points ABR.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

And if you look at our historical recoveries at $0.7 to $0.8 on the dollar, but it's an ongoing discussion. More broadly, we have strong conviction in the carwash space. We've been investing in that space for quite some time and really the first bankruptcy we've seen. And it's not one that we didn't see coming obviously as we've been in our exposure. And we have strong coverage across the portfolio.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

One of the benefits of our platform is having deep industry expertise with almost 200 car washes across 54 operators and then ongoing financial reporting where we can see the operators that are adding value, growing sales, improving EBITDAR margins and operators that are not and take corrective action as we manage the portfolio. So car wash will continue to be one of our leading industries. It's been a great industry. We get great risk adjusted returns and we're pretty comfortable with our position as we think about Zipp's bankruptcy.

Haendel St. Juste
Haendel St. Juste
Managing Director at Mizuho Financial Group

Appreciate that. And if I could add a follow-up to that question about Zipp's, curious if you're able to share if they paid January and February rent?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

We're not able to share that. But we did make comments on the call where we're 100% collection collected. So I should give you a hint.

Haendel St. Juste
Haendel St. Juste
Managing Director at Mizuho Financial Group

Okay, fair enough. And then second question is, I guess on the commentary regarding the increased competition you're seeing, I was hoping you could expound on that a bit. Where you're seeing the competition, specific industries, do you think it's sustainable? And what do you think it means for your ability to transact for portfolios or sale leasebacks and cap rates, which I think you mentioned you expect to see compressed near term?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Max, why don't you tackle that question?

Max Jenkins
Max Jenkins
SENIOR VICE PRESIDENT & HEAD OF INVESTMENTS at Essential Properties Realty Trust

Sure. Thanks, Pete. Over the last couple of quarters, we've seen some increased competition both from our peers and there's been a couple of new entrants into the marketplace. But that the only effect to that would just be a slightly modest compression in cap rates, but otherwise transaction environment remains favorable to us. We focus on servicing relationships and providing growth capital to middle market operators across the country.

Max Jenkins
Max Jenkins
SENIOR VICE PRESIDENT & HEAD OF INVESTMENTS at Essential Properties Realty Trust

And there is an ample opportunity set for us to continue to invest and realize those attractive risk adjusted returns. So we're happy with where the pipeline sits and it will support the strong earnings growth that's implied in our guidance.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thanks, Max.

Max Jenkins
Max Jenkins
SENIOR VICE PRESIDENT & HEAD OF INVESTMENTS at Essential Properties Realty Trust

Thank you.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes, I would say as we've said, kind of the eight caps and the 9.2% GAAP yields we saw in last year were kind of as we said all throughout the year kind of felt like the high watermark and we expect to be more in the mid to high 7% s as we think about this year.

Haendel St. Juste
Haendel St. Juste
Managing Director at Mizuho Financial Group

Thank you. Appreciate the color.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

You got it. Thank you.

Operator

Our next question is from Caitlin Burrows with Goldman Sachs. Please proceed with your question.

Caitlin Burrows
Caitlin Burrows
Vice President at Goldman Sachs

Hi, good morning, everyone. I guess maybe just kind of expanding on that, wondering if you could give any more discussion on just like how interest rate volatility has impacted your business recently, maybe on the positive side or more negative side. I mean, if you look at the interest rate moves of 4Q alone, it was like pretty significant. So wondering to what extent you felt that and I guess anything that's happened subsequent to the quarter end?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes, Caitlin, we have what is a sixty to ninety day transaction cycle. So if we're closing the deal today, we probably priced it anywhere from sixty to one hundred and twenty days ago. And we're making twenty year investments. And so the week over week and even month over month volatility doesn't come into our pricing. And then you think about how we've positioned the balance sheet, we're raising capital well in advance of deploying it such that that capital is priced in.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

And so we try to insulate ourselves from those volatile moves and are much move much more slowly. And again, to Mac's commentary in the fourth quarter when people were looking at a 3.7%, ten % year, they were getting more aggressive bidding and then you turn the calendar and you have a 4.7%, they're blown out of deals and we deliberately try to be more consistent and more predictable to that with our counterparties, which is why we think we get premium returns for how we deploy our capital. So overall, I think we expect downward pressure on cap rates as we've consistently said. We saw more of that in the fourth quarter and it's abating a little bit here in the first quarter, but we'll see where the market goes.

Caitlin Burrows
Caitlin Burrows
Vice President at Goldman Sachs

Got it. And then maybe just on the dispositions in the fourth quarter, wondering if you could talk a little bit more about what made you decide to move forward with that deal in particular or maybe it was a couple of deals. And as we think about it or how you think about it from like portfolio management versus like source of capital going

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

forward? Yes. From a source of capital, it's not necessarily accretive to where we're pricing new capital. Certainly at a seven cap, It's more portfolio management, risk management. The fourth quarter was really lightening up on our car wash exposure, bringing that down from our soft ceiling of 15%, which you see we did, I think 65% or 70% of our dispositions in the fourth quarter were in the car wash space.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

So it was mostly portfolio management industry exposure. As we said on the call, we expect the disposition activity to moderate and be more consistent with our August average as we think about this year.

Caitlin Burrows
Caitlin Burrows
Vice President at Goldman Sachs

Thanks.

Operator

Thank you. Our next question is from Rich Hightower with Barclays. Please proceed with your question.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Hey, good morning, everybody. Good morning.

Richard Hightower
Richard Hightower
Managing Director at Barclays

Maybe just to stick to the capital side of the equation. Mark, I think you mentioned minimal equity issuance needed overall this year to hit your investment targets. But maybe just talk about what might be needed? And I know that you also you guys also just said the dispositions obviously will decrease maybe relative to what we saw in the fourth quarter. But just help us piece together any sort of remaining equity capital needs to hit the full year guidance and then obviously we start thinking about 2026 at some point and maybe just to hear your thoughts on that as well?

Richard Hightower
Richard Hightower
Managing Director at Barclays

Thanks.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

You got it. Well, I'll probably leave 2026 out until we actually provide guidance on 2026. '20 '20

Richard Hightower
Richard Hightower
Managing Director at Barclays

I had to try Mark.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

No problem at all. Appreciate it, Rich. Yes, so listen, I think there some of the building blocks as you think about it, and I mentioned one other thing in my remarks about our growing free cash flow. So if you think about that, that's a pretty significant component of our investment ambition for In addition, Pete even mentioned, even if we use our eight quarter average on dispositions that probably delivers a decent amount of capital for that. And we've got $380,000,000 of unsettled property.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

We've got $1,000,000,000 So from our standpoint, the underlying assumption is that our equity issuance in guidance is really sort of you could deploy that you could achieve that with normal kind of ATM activity. So I'll say it a different way and what I mentioned in my remarks is we like to be front footed point of capital raising or equitizing our growth ambitions. So as I think about it, it makes us very puts us in a position of being very opportunistic. So if we actually wanted to do something in terms of a bigger offering execution or otherwise, we could do that and it would just be it would be all the more positive to our expectations. But what I would say, as you look at our liquidity, we're sitting at 3.8 times leverage.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

If you run out, say, the liquidity we have to get to 4.6 times, which is somewhere right around sort of our probably our historic you're pretty much approaching $1,000,000,000 at least $3,550,000,000 of investment.

Richard Hightower
Richard Hightower
Managing Director at Barclays

Okay, got it. Sorry, I

Richard Hightower
Richard Hightower
Managing Director at Barclays

think Mark you were breaking up there on my end, but I think I caught most of that. And I guess just to so that was sources just to check-in on uses for a second. What's the best way we should be modeling the timing of acquisition volume kind of throughout the year at this point? Thanks.

Operator

Rob?

Robert Salisbury
Robert Salisbury
Senior VP & Head of Capital Markets at Essential Properties Realty Trust

Hey, Rich. I think from a cadence standpoint, historically the fourth quarter has been a little bit larger for us in years past, but a ratable over the course of the year would probably be a reasonable assumption for right now. Obviously, where our pipeline sits today, we don't have visibility beyond sixty to ninety days there, but just speaking to our historical

Operator

Got it. Thanks guys. Thanks. Our next question is from Smedes Rose with Citi. Please proceed with your question.

Smedes Rose
Smedes Rose
Analyst at Citigroup

Hey, good morning. This is Maddie Fargis on for Smedes. Do you have any feedback you're getting around consumer behavior from tenants that you're able to share given the current inflationary environment?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes, listen, our feedback is going to be delayed, right. We're receiving unit level financials at our sites on a one quarter lag. And so we're typically seeing inflation and cost pressures come through on a ninety to one hundred and eighty day lag. And if anything, what we're seeing is those factors abating in the current numbers, but it's I would say the data and input you hear on the news is much more current.

Smedes Rose
Smedes Rose
Analyst at Citigroup

Great. Thank you. And then your ABR exposure to tenants under one times coverage ticked up slightly sequentially. Is there anything there to be concerned about?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

No, there's that bucket ebbs and flows and particularly is influenced by sites that we're developing with our partners and putting capital to work before those sites are actually producing positive ABR. So and certainly the uptick is de minimis in our view and nothing to be concerned about. And I would say, if there were credit issues and they would be built into guidance and they are built into guidance. And I think bumping the bottom end of the range of guidance this quarter should give you a sense of where we're thinking at this point.

Smedes Rose
Smedes Rose
Analyst at Citigroup

Great. Thank you. That's it for me.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thank you.

Operator

Our next question is from Eric Bordan with BMO Capital Markets. Please proceed with your question.

Eric Borden
Eric Borden
Vice President at BMO Capital Markets

Good morning. Just noticed that Circle K popped into the top 10 tenant list. I just wanted to wondering if you could talk about the potential opportunity to acquire more there and then more broadly speaking, the appetite to add more C stores to the portfolio?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

A. J, why don't you tackle that?

AJ Peil
AJ Peil
SENIOR VICE PRESIDENT & HEAD OF ASSET MANAGEMENT at Essential Properties Realty Trust

Sure. So Circle K has been in the top 10 in previous quarters. It was really sequencing of just the rental escalation that put it back in. We're very happy with that tenant. Cushard is a great credit.

AJ Peil
AJ Peil
SENIOR VICE PRESIDENT & HEAD OF ASSET MANAGEMENT at Essential Properties Realty Trust

And I think C stores across the board is an area that we've continued to grow over the years ratably and we're really happy with the community source space.

Eric Borden
Eric Borden
Vice President at BMO Capital Markets

Okay. And then we just noticed that occupancy slightly moderated 20 bps quarter over quarter. I was wondering if you could have a comment there. And then if you could talk about your current watch list outside of zips, what do you guys have built into guidance for bad debt?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

All right. Well, that one is jumping around the room. On occupancy, I wouldn't read too much into going from three vacant properties to seven. That's certainly natural ebbs and flows in the portfolio. We did went through our releasing stats on the call, which I think are positive.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

So those seven properties will be brought back online and run through our releasing stats and certainly any specific assumptions around those sites would be built into guidance. In terms of bad debt, Rob, why don't you tackle that?

Robert Salisbury
Robert Salisbury
Senior VP & Head of Capital Markets at Essential Properties Realty Trust

Yes. So our guidance range includes a wide range of assumptions including for credit. We haven't quantified the specific range in the past, but maybe just as a frame of reference, we have said that historically our portfolio has experienced about 30 basis points. So when we construct our guidance range, we go through a combination of top down and a bottom up process where we identify individual tenants as well as vacant at general reserve. And so typically that results in an assumption that's well in excess of that 30 basis points number

Robert Salisbury
Robert Salisbury
Senior VP & Head of Capital Markets at Essential Properties Realty Trust

if that's helpful.

Eric Borden
Eric Borden
Vice President at BMO Capital Markets

I'm sorry, I think you're breaking up a little bit. I don't know if I heard the last bit of your question. Happy to take it offline though.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thanks.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Great. We appreciate that. Thanks. Sorry for breaking up.

Operator

Our next question is from Michael Goldsmith with UBS. Please proceed with your question.

Michael Goldsmith
US REITs Analyst at UBS Securities LLC

Good morning. Thanks a lot for taking my question. First question on the car wash industry again. Given what you have visibility into, is the pressure on this group broad based or is it more focused on a narrow range of operators within the Zips filing? They noted that they've seen roughly 900 new car wash sites open every year for the past five years.

Michael Goldsmith
US REITs Analyst at UBS Securities LLC

So just trying to understand if this is industry wide or is this just kind of specific operator? It can seem to just kind of specific operators. Thanks.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes, we certainly think it's a specific operator trend. Obviously, there is new competition in the car wash space and we're monitoring that and trying to deploy our capital with guys who do it right and guys who do it well. Across our overall portfolio, sales are flat and EBITDA is roughly flat with margins in excess of 50% and coverage in the mid-2s. So we certainly feel good with our exposure and we monitor it on a quarterly basis and take corrective action where we see sites that aren't working, but I don't think there's something systemic to the entire carwash space that gives us concern.

Michael Goldsmith
US REITs Analyst at UBS Securities LLC

Appreciate that. And then as a follow-up, keep up the good work with the acquisition guidance, but you did guide to $1,000,000,000 at the midpoint this year down from $1,200,000,000 last year. Is that a reflection of lack of visibility into the transaction market or some other factors that would potentially lead to a more challenging year this year? Because it did sound like you were relatively optimistic at the start of the call? Thanks.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes. I think it's really conservatism and the recognition that 2024 was a great year for buying assets at super high cap rates. And we were aggressively looking to take advantage of the dislocation in the capital markets that was allowing us to deploy capital at historically wide spreads and historically wide rates. And we expect in 2025 a normalization of the capital markets and a resumption of competition will drive cap rates down and thus making us a little less acquisitive. But it's early in the year, right?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

And the ten year remains volatile as we discussed earlier in the call and we'll see things where things shake out. But obviously, there's not a huge difference between where we ended up in last year and the midpoint of our guidance. So, we'll continue to transact, continue to service our relationships and see what the year brings.

Michael Goldsmith
US REITs Analyst at UBS Securities LLC

Thank you very much. Good luck in 2025.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Okay. Thank you.

Operator

Our next question is from John Alachowsky with Wells Fargo. Please proceed with your question.

Cheryl Rollins
Cheryl Rollins
Director at Wells Fargo

Hi. This is Cheryl on behalf of John. I was just wondering what were the drivers for the plus 1¢ raise on the low end of AFFO guide? And how have you seen acquisitions trend year to date? What does the pipeline look like?

Cheryl Rollins
Cheryl Rollins
Director at Wells Fargo

And have you seen any cap rate compression recently?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes. As we said in our prepared remarks, the pipeline is full, albeit with modest cap rate compression. As I said, we do expect to transact in the mid to high 7% s, which is down from an 8%. The range of guidance is driven by a bunch of assumptions, both around investments, around credit experience and around the cost of capital. Obviously, I think the cost of capital is not going to be a huge driver given where we're positioned currently and the price of that capital, but it's really cap rates and credit experience and performance of the portfolio.

Cheryl Rollins
Cheryl Rollins
Director at Wells Fargo

Thank you. And then just one last one. We see that the credit coverage picked up in the 1.5 times to 1.99 times category. What kind of assets drove the pickup in that bucket?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

It's going to be broad based across the portfolio. I don't think there's anything specific to industries or tenants that's going to kind of drive the increase in that bucket.

Cheryl Rollins
Cheryl Rollins
Director at Wells Fargo

Got you. Thank you.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thank you.

Operator

Our next question is from Farrell Granite with Bank of America. Please proceed with your question.

Farrell Granath
Farrell Granath
Equity Research Associate at Bank of America Merrill Lynch

Hi, good morning. Thank you for taking my question. I wanted to ask about your dispositions that you spoke about that there may be a slowing, but there was a key focus on the reduction in car washes. Is there any other industry that would be a focus going into 2025 or would it be just the rebalancing of the portfolio?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes. So, we have the soft ceiling for any given industry of 15%. And so when we crest that, we look to pair that exposure and create the ability to continue to invest within those industries, really to be able to service our relationships. Beyond that, I think most of the disposition activity is going to be property level and tenant risk based, where we see risks either at a tenant level or an individual asset level and really moving those risks out of the portfolio and nothing really systemic to hang your head on there.

Farrell Granath
Farrell Granath
Equity Research Associate at Bank of America Merrill Lynch

Okay. Thank you. And also, sorry to bring go back to the bad debt and credit assumptions. I just wanted to understand compared to your initial guide on the 20 basis points of exposure for zips, was that initially included into the bad credit assumption or is there an additional assumption that is maybe baked in now into new guide of that additional 20 basis points?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes. So you got to think about what happens in a credit event. You have a tenant file for bankruptcy and then a lease stops paying and then you take your assets and you reposition those assets and you have a recovery on those assets. So really when you're building in the credit assumption, you're going to have the downtime of the assets and then the recovery of experience of those assets assuming a specific downtime whether it's thirty, sixty, one hundred and eighty days depending upon the asset to market. Our credit assumption in guidance goes through all our tenants and all our assets and make specific assumptions around what we think is going to happen based upon our experience and our visibility into the unit level performance of those sites.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

And then on top of that has a unknown assumption to on top of that to account for things that we don't know that we can't see. And so without speaking specifically to ZEVs, I would say our credit loss assumptions for the year have not changed materially in the ninety days since we initially provided guidance.

Farrell Granath
Farrell Granath
Equity Research Associate at Bank of America Merrill Lynch

Okay. Thank you so much.

Operator

Our next question is from Daniel Guglielmo with Capital One Securities. Please proceed with your question.

Daniel Guglielmo
Daniel Guglielmo
Equity Research Analyst at Capital One Financial

Hi, everyone. Thank you for taking my questions. I appreciate The U. S. Map on Page nine of the supplement and there weren't many major changes in diversification by state quarter to quarter.

Daniel Guglielmo
Daniel Guglielmo
Equity Research Analyst at Capital One Financial

But I know you all have a large forward pipeline of deals. So thinking about that map one year from now, are there certain states or regions where you'd expect material changes?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

We often say geographies and output of where our tenant relationships bring us, such that I would expect our geographical diversification to grow ratably and I would not anticipate a material materially different Page nine twelve months from now.

Daniel Guglielmo
Daniel Guglielmo
Equity Research Analyst at Capital One Financial

Okay, great.

Daniel Guglielmo
Daniel Guglielmo
Equity Research Analyst at Capital One Financial

And then as a follow-up to that, we looked through kind of The U. S. Wage data and it looks like some of the southern cities have had some like reacceleration in wage growth, Atlanta, Miami, Dallas, Houston. And you mentioned it's kind of where your partners take you. Have you been getting more inbounds from partners and tenants trying to kind of expand in those parts of the country?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes. I mean, our relationships are bringing us into those markets and given that we're heavy in those markets, currently, I would say our inbound demand for capital has been proportionately similar to our geographic diversity.

Daniel Guglielmo
Daniel Guglielmo
Equity Research Analyst at Capital One Financial

Great. Thank you.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thank you.

Operator

Our next question is from Jay Kornrich with Wedbush Securities. Please proceed with your question.

Jay Kornreich
VP - Equity Research at Wedbush Securities

Thanks. Good morning. Just going back to industry allocations, beyond lowering car exposure, car wash exposure below 15%, it looks like you've increased exposure to casual dining 80 basis points to 7.5% and that's an industry that's faced some headwinds lately. So just curious if you can provide any thoughts around your conviction to increasing exposure there and if there's any other smaller industry exposures you have that you would like to see increase going forward?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes, I would say, and generally I have said expect our pie to grow and much like the geographic discussion I just had, our industry diversification is driven by our relationships and where we have deep relationships and they are the ones that bring us the opportunities. Certainly, some industries are there is more opportunities than others given where they are in consolidation like car washes, early childhood and automotive service and other industries like the restaurants are more consolidated. ABR. And that conviction is really more driven by the fungibility of the real estate and our recoveries experience around that real estate and our credit loss experience around casual dining credit events that gives us that confidence. And so we continue to invest there.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

We've been I've been investing in restaurants for twenty plus years in the specific casual dining space and it remains a core investment industry for us.

Jay Kornreich
VP - Equity Research at Wedbush Securities

I appreciate that. And then just one more. In terms of where your transaction is coming from, they typically come the bulk of them typically comes from existing tenants. And so I guess I'm just curious how sticky or I guess loyal do you feel like your existing tenants are to valuing your platform and your relationship and continuing to transact going forward versus as new capital providers come into the market really just chasing the best cost of capital they can?

Max Jenkins
Max Jenkins
SENIOR VICE PRESIDENT & HEAD OF INVESTMENTS at Essential Properties Realty Trust

Thanks Jay. This is Max. I'll take that. I think you can probably look to the repeat business and existing relationship percentages that we post quarter over quarter and it always kind of adds around that 80% give or take. And so that just kind of tells you that the repeat business continues to drive the majority of our pipeline, but then we're always actively out there sourcing new relationships.

Max Jenkins
Max Jenkins
SENIOR VICE PRESIDENT & HEAD OF INVESTMENTS at Essential Properties Realty Trust

And I think the strongest driver for new relationships would be referrals. At the end of the day all these operators and tenants talk to each other, they're exchanging ideas and when you continually transact with our tenants over and over and you build that relationships and that relationship continues to

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

unsophisticated and they certainly are going to do a price check on any capital that they source, but they do place a high reliability, a high priority on reliability and predictability and being the incumbent having docs negotiated, having underwritten the credit in advance certainly gives us an advantage over new capital coming into that system.

Jay Kornreich
VP - Equity Research at Wedbush Securities

Okay. I appreciate that. That's it for me.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thank you.

Operator

Our next question is from Greg McGinnis with Scotiabank. Please proceed with your question. Greg, is your line on mute?

Greg Mcginniss
Director at Scotiobank

Sure is. Good morning. Sorry about that. Cash releasing spreads were positive for the first time in a while. Was there anything unique about the expirations or anything handled differently from the portfolio management standpoint that helped cross that threshold?

Greg Mcginniss
Director at Scotiobank

And do you expect a similar outcome or is a similar outcome achievable in 2025?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

A. J, you want to tackle that?

AJ Peil
AJ Peil
SENIOR VICE PRESIDENT & HEAD OF ASSET MANAGEMENT at Essential Properties Realty Trust

Yes, I don't think there was anything unique to the quarter on the recovery rates. Some of the lease renewals had some larger bumps than usual, which led to some of that positive rela. And if you look at just kind of the breakdown of the number of leases renewed, this particular trailing twelve month period, we had 42 leases renew with larger than usual bumps, which led to the total leasing stats being positive. So I think this particular quarter was more just episodic of the fact that we had 42 leases renew in the trailing twelve month period. But it's really kind of two different buckets.

AJ Peil
AJ Peil
SENIOR VICE PRESIDENT & HEAD OF ASSET MANAGEMENT at Essential Properties Realty Trust

One is just contractual renewals and the other is repositioning assets whether it's through a vacancy or without a vacancy. But I think the stats should be pretty consistent as we move forward.

Greg Mcginniss
Director at Scotiobank

Okay, thanks. And I can understand that the sorry, go ahead.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Greg, I would just add, listen, as I look at those rates, the recovery rate, I would anticipate those percentages to be relatively consistent and the ultimate weighted average is really just going to depend on how we're renewing an asset. Is it an as of right in the lease, Are we renewing an asset without vacancy? Or are we having to take it back and repurpose it and with the downtime? So it's really just a factor of we had a bunch of renewals, not a bunch of vacant asset re lets.

Greg Mcginniss
Director at Scotiobank

Okay. That makes sense. And then follow-up is on the tenant credit. And I recognize that rent coverage remains healthy and will move quarter to quarter. But we did see what appears to be kind of a doubling of the CCC plus tenant credit to around 4% from last quarter.

Greg Mcginniss
Director at Scotiobank

Was that due to acquisitions or is that tenants dropping down into that bucket? Any color is appreciated.

AJ Peil
AJ Peil
SENIOR VICE PRESIDENT & HEAD OF ASSET MANAGEMENT at Essential Properties Realty Trust

A. J? Yes, it was tenants were up and down within the portfolio. And the thing to remember oftentimes in that particular cohort is, it's an implied credit rating. It's something we pay attention to.

AJ Peil
AJ Peil
SENIOR VICE PRESIDENT & HEAD OF ASSET MANAGEMENT at Essential Properties Realty Trust

But what we really look for is if it's migrating down to the CCC plus bucket or even B- bucket, what's the unit level coverage look like? And more than half of that particular bucket is still greater than two times coverage, which gives us a lot of confidence. And that's really what we're paying attention to is the marriage of those two categories, which is the implied cover trading as well as the unit level economics.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes, Greg. And you can assume we're not deploying a lot of fresh capital into CCC credits.

Greg Mcginniss
Director at Scotiobank

Fair enough. Thank you.

Operator

Our next question is from Spencer Glumacher with Green Street Advisors. Please proceed with your question.

Spenser Glimcher
Managing Director at Green Street Advisors, LLC

Thank you. Just one for me on the acquisitions pipeline. So you guys commented that the pipeline remains robust, reflecting continued M and A activity as well as new unit expansion. Are you able to share which industries you're seeing the most activity from in terms of that new unit growth that's far into the year?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Max, what do you see in there?

Max Jenkins
Max Jenkins
SENIOR VICE PRESIDENT & HEAD OF INVESTMENTS at Essential Properties Realty Trust

Spencer, I think it's pretty ratable to historical trends and there's really nothing that draws a conclusion. It's both new unit M and A, a lot of add on follow on transactions with existing tenants, but the pipeline looks pretty consistent as it has been in the historical periods.

Spenser Glimcher
Managing Director at Green Street Advisors, LLC

Okay. And then actually maybe one just on the dispositions for 2025. I know you commented that some of this would obviously be driven by opportunistic asset sales. Have there been any assets in this particular bucket that have already been earmarked for sale that you guys think might be a compelling divestment either because of cap rate compression in the industry, good real estate or are these just kind of ad hoc from inbounds or as they come up throughout the year?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Yes. It's we're mostly going to sell because we see an asset that we don't like the risk profile. Generally, if our phone rings and someone trying to buy an asset that they are not going to be the most competitive, running an auction and finding the most competitive capital is generally how we do it. So we tend not to respond to unsolicited inbounds on our properties. And it's more just deliberate risk management activities that we take and that's what's driving the volume.

Spenser Glimcher
Managing Director at Green Street Advisors, LLC

Okay. Thank you.

Operator

Our next question is from John Massocca with B. Riley Securities. Please proceed with your question.

John Massocca
Senior Research Analyst at B Riley Financial

Good morning. On the 2025 investment volume done year to date, maybe even on the pipeline that's kind of in PSA or LOI, I mean, are you seeing that cap rate compression in those investments or potential investments? Or is it more just a theoretical view

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

living it. And particularly if you think, we negotiated those deals back in November and December where there was a much more constructive ten year. And so our current pipeline I think is in that mid to high sevens cap rate that we discussed.

John Massocca
Senior Research Analyst at B Riley Financial

Okay. That's helpful. And then, were there any zips in the 4Q twenty twenty four disposition activity?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Was there any what, John?

John Massocca
Senior Research Analyst at B Riley Financial

Zips carwashes. I mean, it's because there's a big bucket of carwashes in 4Q and I just was curious about

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

No, we unloaded and that's the key here is when something when it becomes apparent, something's going to break, it becomes illiquid and the price to transact becomes pretty steep. And as sophisticated institutional investor, we're not going to sell individual assets that are imminently going to break. We'll fix them first and then sell them. So there was no Zipp's car wash in the fourth quarter.

John Massocca
Senior Research Analyst at B Riley Financial

Okay. And then just the car wash sales in the fourth quarter more generally, I mean, how much of that was driven by individual risk at those assets or with those tenants? And how much was just kind of getting below that 15 number and some breathing room to maybe be aggressive on the investment side again for the remainder of this year?

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

It's both, right. We want the breathing room. So we're going to look at our portfolio and choose the assets that we don't want to own for the next twenty years.

John Massocca
Senior Research Analyst at B Riley Financial

Okay. That's fair. That's it for me. Thank you very much.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thanks, John. Take care.

Operator

Thank you. Our next question is from Caitlin Burrows with Goldman Sachs. Please proceed with your question.

Caitlin Burrows
Caitlin Burrows
Vice President at Goldman Sachs

Hi, again. I don't think it's come up, so I figured I'd ask. Just as you guys think about the leverage and funding going forward, I think you made a point earlier on given where your leverage is today, you obviously have a lot of capacity. But from here, like near term, how are you guys deciding between using equity versus debt?

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

Thanks, Caitlin. I guess what I'd say is, as we think about it just generally, the split between debt and equity had historically been about 60% with our growing free cash flow that's really turned into more 60% equity, 30% debt, 10% free cash flow. So as we look at it, we would continue to utilize that. We'd also orient ourselves to where our leverage stands. So that obviously is a data point for us as we think about when to deploy, when to access equity, when to utilize debt issuance.

Mark Patten
Mark Patten
EVP, CFO & Treasurer at Essential Properties Realty Trust

I think from the debt standpoint, as I mentioned, we don't have any near term demands on liquidity for us to do either. In our case, we can be opportunistic on the equity front, but we can also be opportunistic on the debt front. And hopefully the tenure will accommodate in some fashion. But for us, we're thinking that the fees we have for 2025 really starts with our revolver and then term it out with unsecured bond deal.

Caitlin Burrows
Caitlin Burrows
Vice President at Goldman Sachs

Thanks. That's all.

Operator

Thank you. There are no further questions at this time. I would like to hand the floor back over to Pete Mavoides for any closing remarks.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Great. Well, thank you all for participating in today's call. Obviously, we'll be on the road at various conferences and in non deal roadshows in the next couple of months. And so we look forward to meeting with you all in person. Have a great day.

Pete Mavoides
Pete Mavoides
CEO & President at Essential Properties Realty Trust

Thanks.

Operator

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

Executives
    • Robert Salisbury
      Robert Salisbury
      Senior VP & Head of Capital Markets
    • Pete Mavoides
      Pete Mavoides
      CEO & President
    • Mark Patten
      Mark Patten
      EVP, CFO & Treasurer
    • Max Jenkins
      Max Jenkins
      SENIOR VICE PRESIDENT & HEAD OF INVESTMENTS
    • AJ Peil
      AJ Peil
      SENIOR VICE PRESIDENT & HEAD OF ASSET MANAGEMENT
Analysts
Earnings Conference Call
Essential Properties Realty Trust Q4 2024
00:00 / 00:00

Transcript Sections