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NNN REIT, Inc. (NNN)

Q1 2024 Earnings Call· Wed, May 1, 2024

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Transcript

Operator

Operator

Greetings, welcome to the NNN REIT Inc. First Quarter 2024 Earnings Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Stephen Horn, Chief Executive Officer. You may begin.

Stephen Horn

Analyst

Thanks, Olli. Good morning, and welcome to NNN REIT's First Quarter 2024 Earnings Call. Joining me on the call is Chief Financial Officer, Kevin Habicht. As this morning's press release reflects, the company's performance to start 2024 produced strong results, including continued high occupancy and in-line acquisition volume driven by our proprietary tenant relationships. We are in position to continue enhancing shareholder value as we move deeper into 2024 and beyond. Highlights of the first quarter results emphasize our continuous effort actively managing the portfolio. The portfolio of 3,546 freestanding single-tenant properties continued to perform exceedingly well, maintain high occupancy levels at 99.4, which remains above our long-term average of 98% plus or minus a fraction. The leasing department had a terrific quarter, leasing 7 assets to QSR and auto service tenants primarily with a 91% rent recapture from the prior rent. This recapture is above historical levels of approximately 70%. Remember, NNN works hard not to give TI dollars to buy up rent. Currently, NNN only has 22 vacant assets in the portfolio, which is a testament to working with the relationship tenants to maximize value for shareholders. During the quarter, we also sold 6 properties, which were all income producing, raising almost $19 million of proceeds to be reinvested into new acquisitions. Over the course of the year, NNN sells assets defensively and proactively but overall, we target the blended disposition cap rate to be 100 basis points lower than the deployment of capital pricing. The last point on the portfolio I'd like to mention is with regard to 2024 lease expirations, which we originally had 90 for the year. As of the end of the quarter, there's 39 left to handle, but I'm not expecting a departure from the norms, 85% renewal at 100% prior rent. Turning…

Kevin B. Habicht

Analyst

Thanks, Steve. And as usual, I'll start with the normal cautionary statement that we will make certain statements that may be consider to be 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 these forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations that are disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release. Okay. With that out of the way, so yes, headlines from this morning's press release report quarterly core FFO results of $0.83 per share for the first quarter of 2024, and that's up $0.03 or 3.8% over year ago results of $0.80 per share. AFFO results were $0.84 per share for the first quarter, which is $0.02 or 2.4% higher than year ago results. We did have unusually high lease termination fee income of $4.2 million in the first quarter, and that compares with $1.7 million in the prior year first quarter. Over the past 5 years, we've averaged about $3 million of annual lease termination fee income. So this quarter's $4.2 million was well above average. But even with that incremental income overall, another good quarter and in line with our expectations. Occupancy was 99.4% at quarter end, as Steve mentioned. G&A expense came in at $12.6 million for the quarter that's up 2.7% versus prior year and represent 5.8% of revenues for the quarter, and again, in line with our guidance. Our AFFO dividend payout ratio for the first quarter of 2024 was 67% that resulted in approximately $50.6 million of free cash flow for the quarter after…

Operator

Operator

[Operator Instructions] Your first question for today is from Joshua Dennerlein with Bank of America.

Joshua Dennerlein

Analyst

Just wanted to go over what's in guidance for the year. What do you guys assume as far as bad debt goes? And then is there any additional lease term fee income that you included in guidance?

Kevin B. Habicht

Analyst

Yes. So as it relates to bad debt, we've assumed 100 basis points of loss -- rent loss in our guidance. That's what we typically do, and we're not strained from that practice. We're trying to signal that we're worried that it should be higher than that. Historically, our realized loss is in some -- less than that, meaning 30 to 50 basis points. And so still feels like we're kind of in that realm, if you will, of normal kind of collections on that front. In terms of lease termination fees, we didn't have $4.2 million in our guidance for first quarter. We did have some amount, but not that amount, not that much. And those things kind of come up a little bit more sporadically. And so historically on a longer-term project, meaning a full year projection, 12, 15 months out into the future, we don't assume very much of that happening. So it really comes about by a function of just kind of working the portfolio as we come across particular cases of particular properties, in particular circumstances that there's an opportunity to create some value via lease termination income possibility than we pursue it. And so we understand that it's lumpy and it's not particularly in notice. Like I said, we typically run around $3 million a year. So in some sense, it has some degree of regularity to it. But it varies quarter-to-quarter. And to answer your question, we have -- we assume we'll get some more this year just because we always assume we'll get some more. But we don't give any guidance around that just because it's a little too tough to predict.

Joshua Dennerlein

Analyst

Appreciate that color. And then sorry if I missed it, but did you say what the lease term fee related to, like what tenant?

Kevin B. Habicht

Analyst

No. Yes, we really -- I mean, we're not -- rather not get into the details of that, but it's -- we think it's value enhancing activity for us. And so it always involves a tenant and either potentially a new tenant or potentially a buyer of the property. And so it's a bit of a 3 tri-party kind of negotiation we're trying to work out. But yes, we don't plan to go in the details on which tenant or tenants. And usually, it's not just one, it's 1 or 2 or 3 that we have some level of dialogue with on that front. And like I said, the amounts can be small, the amounts can be larger. But yes, we don't have any details to give them on that.

Joshua Dennerlein

Analyst

And then maybe if I could just sneak one more in. Just on the top tenants, I saw some looks like Frisch's has closed some stores recently. What's the latest with them? And are you guys having any dialogue with them on potentially closing stores?

Kevin B. Habicht

Analyst

Yes. So I mean we've talked about Frisch's on our watch list. They have been for a period of time. We don't have any news to report there. There's no rumblings of restructuring per se, in our minds it conform somewhat to our history of any tenants that have some challenges. It's kind of the 80-20 rule where 80% of the stores are fine and 20% have challenges. And so you -- so those are the ones I think that they just need to get to work on. And I think that's the case with them as well. And so -- but yes, no news there. And so we're just kind of working through that with time and don't really have anything new to report.

Stephen Horn

Analyst

Yes. Just kind of carrying out that thought we're working with all our tenants if they want to work on a site to get out of it or what may be the reason. And Frisch's, we're working day-to-day with them. But today is the first and rent is due.

Operator

Operator

Your next question is from Brad Heffern with RBC Capital Markets.

Brad Heffern

Analyst

Kevin, on that lease termination commentary, I'm not sure I really understood that. So are you saying that you proactively reach out to tenants and suggest that they might want to terminate their leases so that you can release the properties or sell them to someone else? Or can you just explain how that works?

Kevin B. Habicht

Analyst

Yes, every circumstance is different. And so it varies all over the lot. And so because we get store-level performance, we know how stores are performing or not performing. And so it's a potential -- and we're in dialogue with our tenants. And so we know have a feel for what their thoughts are as it relates to particular properties. And so we're just actively involved with our tenants and the properties. And if there's an economic -- a good economic outcome that might include lease termination income, then we're going to pursue it despite the -- it's not [indiscernible] income, but it's -- we're not going to turn our back on it because it's not. But it's really case-by-case specific and the devil is always in the details, but it comes from working the portfolio, maintaining relationships with tenants and trying to extract value from 3,500 properties as best we can.

Brad Heffern

Analyst

Okay. And then you talked about Frisch's, but can you go through the others on the watch list? I'm specifically wondering about JOANNs but a quick sound bite on the usual suspects would be great, too.

Kevin B. Habicht

Analyst

Yes. And the size and composition of the list really hasn't changed. We've talked about Frisch's in recent quarters. We've obviously -- everybody is talking about theaters for many, many quarters. And we've mentioned JOANNs, which did file for bankruptcy. We only have 2 stores with them. So it's less than 0.1% tenant of ours. And they have since kind of worked through actually that bankruptcy process and both of our stores will be affirm, those leases will be affirmed. And so we're not looking at any loss exposure there. The other ones we've mentioned in recent quarters is big lots. Again, we have 3 stores. We'll see where that goes, 0.1% kind of tenant. We talked about At Home stores, which is a larger exposure for us at 1.1% of our rent. We have 12 stores with them. And the challenge with those potentially is that they're just bigger boxes. So if you get one of those back, it's a little more work. But again, they're current on rent, and it feels like they have some runway to continue with that. So we don't have any news to really report on that. Those are the names we've kind of talked about in recent quarters that haven't changed and the situations don't feel like they've changed notably.

Operator

Operator

Your next question is coming from Smedes Rose with Citi.

Bennett Rose

Analyst

We were just wondering, I think you have some debt maturities coming up later this year. I'm just wondering what's -- what are you assuming in your guidance around those maturities?

Kevin B. Habicht

Analyst

Yes. I mean it's -- we don't give any guidance on capital markets activities, but I'll say this, we have optionality. And so we love that. And so that's one of the things we try to position our balance sheet to create that optionality. And so meaning we can issue debt long-term 10-year. We've not issued anything less than 10 years in my tenure here. And so today, that would be kind of priced in the mid- to high 5s. And -- but we also could park it on our bank line because we have such availability there, for a period of months, we could leave it there if we had a view that maybe rates would be ticking lower later. So that would be an option. And that cost today is, call it, in the low 6s. And so there's not a huge material cost difference at the moment between 10-year debt and our bank line. And so whichever option we end up choosing won't have much impact on the bottom line between those 2 alternatives. And so we'll see how that plays out and stay tuned, yes.

Bennett Rose

Analyst

Okay. And I just wanted to ask, sort of, bigger picture, when you're out looking at acquisition opportunities, any change in kind of the pool of other providers of capital or where you maybe feel like you have a distinct advantage relative to them? Or are things sort of eroding on that side? Or maybe just -- if you could just sort of speak to that.

Kevin B. Habicht

Analyst

On the acquisition side, we're really minding with our current portfolio. The vast majority of the acquisition volume has come from our current tenant roster. And our current tenant roster, believes in the sale-leaseback model not owning the real estate. So they're not really out there looking for other sources of capital that we're competing against. They're just looking at sale leaseback providers and what the going rate is. So yes, no, we're not seeing any other buckets of money coming into our sector for what we're looking to do. Now if we had to do $1.5 billion or $2 billion, we would probably have more competition. But at current guidance we're not seeing any competition in our ability to execute.

Operator

Operator

Your next question for today is from Spencer Allaway with Green Street.

Spenser Allaway

Analyst

Maybe with just continuing on the tenant health topic. And Kevin, you mentioned receiving unit level operations. Can you just comment on whether there have been any changes to rent coverage levels or if there's been anything notable that's come up in negotiations with tenants in recent months?

Kevin B. Habicht

Analyst

Yes. No, the answer is no. I mean there's been a little bit of softening in coverages, but not notable. And so, so far, our tenants really have been able to generally hang in there, if you will, and maintain a reasonable margin, if you will. And so from an ability to pay rent standpoint, it's our concerns have not grown at all. And so we still feel good on that front.

Spenser Allaway

Analyst

Okay. And then specifically on the property insurance side, and I realize your tenants bear that cost. But just given the spikes in insurance premiums nationwide, is this something that's been brought to your attention in terms of this line item becoming burdensome at all for any tenants?

Kevin B. Habicht

Analyst

I mean we're aware of that issue. But yes -- but we're not hearing that as a big impact on their business. I mean, for many of our tenants rent, I mean, rents are a real expense, but it's not the driver of their profitability and property insurance to a lesser degree, and because we deal with tenants, they operate hundreds, if not thousands of stores, they generally are pretty sharp on getting those coverages, the property insurance coverages across a large number of properties. And so I think that helps them a bit at the margin to get reasonable kind of rates or as best they can be. But yes, the whole property insurance market is very hard enough to bid.

Spenser Allaway

Analyst

Okay. And then last 1 for me. I know you mentioned the 22 vacant assets. And sorry if I missed this, but have you guys kind of laid out a plan yet in terms of which portion or like what portion of the 22 assets have been earmarked for sale versus re-tenanting? Or can you just provide some commentary on the plan for those assets?

Stephen Horn

Analyst

So out of the 22, they're all earmarked for re-tenanting. That's the first thing we always try to do that after a certain time frame, if we're not getting acceptable rental rates, at the end of the day, we just do a present value analysis, re-tenant it, sell it, scrape and rebuild it. And truth they told more times than not, the economic decision as you would sell a vacant asset because of the time delay to get these tenants into it. But we first always try to get the reoccurring revenue by re-tenanting it.

Operator

Operator

Your next question is from Linda Tsai with Jefferies.

Linda Yu Tsai

Analyst

Can you talk a little bit more about what you're seeing on the QSR and automotive services front in terms of cap rate expansion?

Kevin B. Habicht

Analyst

Yes. I mean given we had a 8 cash cap rate for the quarter, and we did a little bit more auto services this past quarter that we're seeing -- the bandwidth is pretty tight around the 8, I mean, high 7s, low 8s is what we're seeing currently in today's market in car wash and kind of collision repair in the car auto service sector. But all cap rates, just on the sequential increase we've had really for 5 straight quarters that we're starting to see the 8. Now do I see it going above 8 for the second quarter, I think it's right at there, the pricing is on top of the first quarter or too far out Linda for the third and fourth quarter. But if the higher for longer narrative continues, I would expect to see an 8 in the third quarter as well.

Linda Yu Tsai

Analyst

And then just for any tenants on a cash basis, does that include Frisch's, AMC, At Home, Big Lots?

Kevin B. Habicht

Analyst

Yes. It includes AMC and Frisch's. Those are the primary ones.

Linda Yu Tsai

Analyst

But at home is not really something...

Kevin B. Habicht

Analyst

No. No. I mean, it is a judgment call. And to be honest, it's something we look at quarterly, and we evaluate. We're not adverse to be quite honest, candid about putting tenants on cash basis, I think, is a better accounting method. But right now, it's about 5% of our tenants, which is mostly AMC and Frisch's make up that cash basis.

Linda Yu Tsai

Analyst

Got it. And then just a clarification on Frisch's. To the extent you have any of those 20%, you talked about the 80/20 stores that would close and you don't think they're restructuring and the rent is due. If they do move out, do you think they're mostly better as backfills? Or would they get sold vacant?

Kevin B. Habicht

Analyst

I think the being a restaurant asset, it's a well-located piece of real estate with a drive-thru. So I think we would have an easy time re-tenanting the Frisch's assets. For the most part, it's really good real estate.

Linda Yu Tsai

Analyst

Last question. On lease term fees, should we model something similar in the future quarters?

Kevin B. Habicht

Analyst

Yes. I mean we don't give guidance on that. And in no small part because like I said, it's very kind of episodic and hard to predict how and when that's all going to play out. But I wouldn't encourage you to annualize $4.2 million in the first quarter as a run rate. That's for sure. And that's why I really kind of drew attention to that. Our annual average is $3 million. So this was an unusual quarter. We obviously may have more term fee in the future, but it's not -- we're not going to give guidance around it, and we generally don't anticipate large sums of it.

Operator

Operator

Your next question for today is from John Massocca with B. Riley Securities.

John Massocca

Analyst

So maybe kind of building on that last answer, was that kind of outsized lease termination fee income known when you guys contemplated your initial guidance? And I guess if it was the case that it wasn't known, then maybe why not -- why wasn't that additive to the year-end number that you guys are anticipating?

Kevin B. Habicht

Analyst

Yes. I mean if you back [ out ] our lease termination fee income in the first quarter, I think our guidance is appropriate, meaning I shouldn't say that. If you don't annualize the first quarter lease termination fee income, I think you might feel that our guidance is reasonable. And we may have opportunity for the high end of that guidance. But yes, that's -- I mean, that's our view of it is that, yes, we really didn't feel like it warrants in moving guidance based on that onetime income in the first quarter.

John Massocca

Analyst

Okay. And then on occupancy, [indiscernible] split here at 99.4%, but does that include any kind of leased but dark boxes. And to the extent you know, what's the spread maybe between leased and true occupancy in the portfolio today roughly?

Kevin B. Habicht

Analyst

Yes. So no, our occupancy is always based on leased properties. And so that's the way we report it. And we also track it based on dollars investment costs that leased as well. And so -- but there's always a component of dark properties out there, but they're leased and counted as occupied or counted as leased yes.

John Massocca

Analyst

Do you know kind of roughly how large that is in the portfolio today?

Stephen Horn

Analyst

The dark properties? I mean the dark properties for us historically are probably in the 1% kind of range.

John Massocca

Analyst

Okay. And then sorry if I missed this in the kind of prepared remarks, I had a little connectivity issue there at the beginning of the call. But did you have any color on the cadence of acquisition volume over the course of the remainder of the year, sorry?

Kevin B. Habicht

Analyst

Yes. I mean what we're seeing in the second quarter, it feels going to be kind of in line with the first quarter. But again, John, as you know, the third and fourth quarter, we don't have any clarity currently on that. One reason we leave our guidance at the $400 million, $500 million because we don't know on the macroeconomic changes that could occur. But given the discussion we've had with our tenants, I feel very comfortable in that $400 million to $500 million range of hitting that number this year.

Operator

Operator

[Operator Instructions] Your next question for today is from Ronald Kamdem with Morgan Stanley.

Ronald Kamdem

Analyst

Just 2 quick ones. Just starting with the sort of the cap rates. Obviously, you hit the 8% mark that's ticked up this quarter. Maybe can you just talk about, is that sort of the right number we should be looking for given sort of this interest rate environment? Are there other opportunities to sort of even get higher cap rates than that and what you're hearing from tenants?

Kevin B. Habicht

Analyst

No. I think for right now, as we said, that's probably the right cap rate to use currently. Now that being said, there's -- you hear a lot about the markets down 50% but bear in mind, that's the 1031 market. So you're dealing with a lot of unsophisticated sellers and buyers for that matter. But the sale-leaseback market, we're dealing with highly sophisticated tenants and companies that understand that cost of capital has increased. And if they want to continue to grow, they accept that. So if the higher for longer persists, I would see some further cap rate expansion possibly in the back half of the year. But for modeling purposes, going into the unknown and not wanting to take a bet on either side, I feel comfortable that the 8% should continue.

Ronald Kamdem

Analyst

Great. And sorry if you touched on, have you hit on what the plan is for the maturities and where you could issue that right now?

Kevin B. Habicht

Analyst

Yes. Yes. So new issuance, 10-year debt today is kind of mid- to high 5s today. And then the other option that we have is given that we have an unused bank line, we could park it on our bank line, which is in the low 6s. And so really the delta between those 2 options is not very large. And so in terms of modeling out this year, you can choose either one and not -- and be relatively close to how it will play out. We don't give guidance on capital markets activities, and part we try to be opportunistic and take advantage of what the best options are at the moment. So we'll see how it plays out. But that's the way I think about our [indiscernible] in June, it's a June $350 million, 3.9% coupon that's coming due.

Operator

Operator

We have reached the end of the question-and-answer session, and I will now turn the call over to Steve for closing remarks.

Stephen Horn

Analyst

Thank you guys time this morning. We look forward to executing for the second quarter, and we'll see you guys in the upcoming conferences. Thanks.

Operator

Operator

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