Greetings and welcome to the NETSTREIT Third Quarter 2023 Earnings Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Amy An, Director of Investor Relations. Thank you. You may begin.

We thank you for joining us for NETSTREIT's third quarter 2023 earnings conference call. In addition to the press release distributed yesterday after market close, we posted a supplemental package and an updated investor presentation. Both can be found in the investor relations section of the company's website at www.netstreit.com. On today's call, management's remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. For more information about these risk factors, we encourage you to review our Form 10-K for the year ended December 31, 2022, and our other SEC filings. All forward-looking statements are made as of the date hereof, and NETSTREIT assumes no obligation to update any forward looking statements in the future. In addition, certain financial information presented on this call includes non-GAAP financial measures. Please refer to our earnings release and supplemental package for definitions of our non-GAAP measures, reconciliations to the most comparable GAAP measure, and an explanation of why we believe such non-GAAP financial measures are useful to investors. Today's conference call is hosted by NETSTREIT's Chief Executive Officer, Mark Manheimer, and Chief Financial Officer, Dan Donlan. They will make some prepared remarks, and then we will open the call for your questions. Now I'll turn the call over to Mark. Mark?

Morning, everyone, and thank you for joining us today for our third quarter conference call. With the recent changes in the capital markets and subsequently the property markets, I want to begin with how NETSTREIT is positioned for what we foresee as an increasingly challenging landscape for the consumer, and by extension, certain retailers. We will also discuss where we see opportunities and how we plan to operate in this environment. The challenges we expect to occur for many retailers center around a consumer that is unlikely to spend at the same level that they have in years past, especially when it comes to purchases by lower income consumers on more discretionary type items. While a small handful of our tenants have a diversified product mix that includes some exposure to discretionary items that may come under some pressure, the portfolio is built around necessity retailers, off-price value merchants, and resilient service providers. We believe this defensive industry focus, coupled with our tenant's strong balance sheets, and ready access to capital, position our portfolio to deliver predictable cash flow generation over the long term. While there may be some headline risk associated with top line performance and gross margin pressures for some of our investment grade tenants, we do not see these pressures threatening their ability to meet their financial obligations, including paying rent. We continue to be vigilant in monitoring our portfolio and where we have seen risk, we have actively recycled and redeployed capital into less-challenged assets at generally higher going-in cash yields. Turning to credit, our watchlist consists of just one tenant, Big Lots, which now represents 1.9% of ABR versus 2.4% last quarter. While we may look to further decrease this exposure over the coming quarters, we do want to highlight the that the nine infill…

Thank you, Mark, and thank you, everyone, for joining our call today. Turning to our third quarter earnings release yesterday after the market close, we reported net income of $4.2 million or $0.06 per diluted share. Core FFO totaled $21.2 million for the quarter, or $0.31 per diluted share. AFFO totaled $21.4 million for the quarter, $0.31 per diluted share -- a 3% increase from the prior year period. Total G&A expense, excluding one-time items, was $5.1 million, which represented 14.9% of total revenues. This compares favorably to last quarter and the prior year quarter, when G&A as percentage of revenues was 16% and 18.2%, respectively. As we look out to next year, our G&A should continue to rationalize relative to our asset base and total revenues, as the company has reached the proper scale to effectively operate our business on a go forward basis. Moving onto the balance sheet, total net debt was $567.5 million at quarter end, and our weighted average interest rate was 3.57%. In addition, when including the impact of extension options, which are solely at our discretion, we have no debt maturing until January 2027. Turning to capital markets activities, we raised $126 million of equity through our ATM during the quarter, which was primarily completed on a forward basis. As of quarter end, we had $98.7 million of ATM equity that remained unsettled. As previously announced on July 3, we closed a new $200 million senior unsecured term loan with delayed draw option, which has a fully extended maturity date of January 2029. The term loan includes an accordion feature that allows the company to increase the total loan amount to $400 million. At closing, we drew $150 million and plan to draw the remaining $100 million in the first quarter of 2024. Before…

[Operator Instructions]. Our first question comes from Todd Thomas with KeyBanc Capital Markets.

Hi, thanks. Good morning. Mark, first question -- you mentioned that you're seeing attractive capital still available as you look at recycling capital. What's the spread look like today between disposition and acquisition cap rates that you're seeing?

Yes, sure. So I mean, we're focused on really trying to find a trade buyer in 1031 exchanges. So in kind of one-off type situations, we're selling assets anywhere from, call it a five cap to seven cap depending on lease term and where we think we can redeploy that capital. I'm always hesitant to give a real concrete number on where we're going to go with dispositions just because we're relying on other parties to complete the transaction, and that's out of our control. So the mix could really swing that one way or the other, but for like kind -- types of assets, we think we're picking up anywhere from typically 50 basis points to 100 basis points.

Okay. And then it sounds like you're starting to see investment yields improve a little bit on new deals that you're looking at. Can you just describe a little bit more about what you're seeing there in terms of price trends? You know, I guess sort of vis-a-vis you know that the sort of 2023, you know, cash yields that you've achieved and sort of the 7% in the third quarter?

Yes, sure. No, absolutely. We are seeing cap rates move up, and so we, at one point, were acquiring assets at kind of the low-sixes, and that kind of trended up to mid-sixes year end of the year last year, and early this year up into the high sixes, and now a seven cap in the most recent quarter. We would expect the fourth quarter to be even higher than that. We're certainly not looking to transact really anything in the sixes. So I would expect to see 20 plus basis points in the fourth quarter. Some of that's really just going to be dragged down by some developments that we had signed up in the past that were already already funding. I think on new transactions that are likely to close more inin the first quarter are likely to pick up even another 20 basis points, 30 basis points beyond that.

Okay. And then just last question, I guess. I realize conditions are sort of fluid here, but I was just wondering if you can maybe provide a little bit of insight around how you're thinking about investments and maybe dispositions as well? So net investments, you know, really heading into 2024 just given the current environment today?

Yes, sure. I mean, I think with where we're seeing the acquisition market, while it's getting better, it's really I don't think we're getting enough spread to go out and raise equity and deploy capital where we see it today. We do see opportunities like we mentioned on the disposition, and then redeploying through capital recycling, and see some pretty attractive opportunities there. But we'd really need to see a material improvement in our stock price, or see cap rates really move into the eights, for us to consider turning on the spigot of acquiring assets and raising equity.

Okay. All right. Thank you.

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

Hi. This is on behalf of Josh. Just a quick question about as you had mentioned, the headlines -- pharmacy specifically -- I was curious about with your current acquisition, are you seeing a change in competition for the assets that you're going after? Kind of like the higher credit quality assets?

Yes,I mean, I think we've really kind of seen this most of the year and probably even more so today where the private buyer is more or less gone. The opportunity standpoint has really never been better in my entire career. That being said, the cost of capital is also a challenge, so we need to kind of balance that, but really developers and tenants trying to grow, even sale-leasebacks, certainly seeing a lot of opportunity there. It's really gone from a full-blown seller market to a full-blown buyer market -- with no bids really in the private market other than the occasional 1031 buyer -- which we're trying to take advantage of the disposition market. And so it's really looking at the overall trends of our transaction market is likely down 70%-80%, but competition is down really 90%-95%.

Great. Thank you.

Our next question comes from Eric Wolfe with Citi.

It's actually Nick Joseph here with Eric. Just back to sourcing of investments, just kind of curious your thoughts and kind of the rationale of issuing equity in the mid-$16s given the NAV, at least street NAV, in the nineteens, where you've talked about investment spreads and transaction cap rates historically. So just trying to understand the thought process there and kind of a value creation calculation.

Yes. Hey Nick, it's Dan Donlan. When you think about that price and you include the de minimis net price of that, and you think about where we raised the recent term loan, and then the impact to free cash flow, we got to have basically a 100 basis point spread relative to where we saw our pipeline shaping up into the fourth quarter. So, that's really kind of -- we focus on earnings growth. We obviously look at implied cap rate as well. And it was probably, marginally dilutive to implied cap rate by 10 basis points or so. So that's the way we looked at it, and it certainly was accretive to our AFFO per share.

Yes. I guess one of the advantages that you have is that you're smaller and so you can kind of grow off of that base. And so how do you think about the 100 basis points investment spread off of that and kind of taking away some of that advantage versus putting pencils down and waiting for better opportunity?

Yes, sure. I mean we'd like to get back to more normalized spreads, which I think we've said before, is kind of in the 150 basis point to a 175 basis point spread. But yes, we feel like 100 basis points is adequate and provide some growth in there. Scaling into the G&A is also something that is we view it as helpful.

Thanks. And maybe just finally, if you if you did put pencils down, and did no deals going forward or beyond what's in the pipeline today, what would that imply for growth in 2024?

Yes. Hey, Nick. It would basically imply kind of low single digit year-over-year AFFO growth. The building blocks of that is internal rent growth of about 1%. Credit loss is around 30 basis points. Reinvestment of our free cash flow after dividends, let's call it, $32 million of free cash flow after dividends. Obviously the full year impact to 2023's investments and leverage in at around the midpoint of our range. What I'd say is if we fixed our $175 million 2024 term loan to -- we push it out to 2027, had we not done that, we probably would be looking at more mid single-digit AFFO growth year over year, but we thought it was prudent given the environment we were in May and June to push off that term loan and swap it to a fixed rate. So we're glad we did it.

Thanks. That's very helpful.

Our next question comes from Greg McGinniss with Scotiabank.

Well, everyone, thanks for taking the question. So obviously, it takes time for sellers to recognize reality, and for cap rates to increase. So how are you weighing deploying capital today at these seven, low seven cap rates, versus holding back, potentially collecting some cash interest income, and investing in a few quarters once cap rates move higher? Based on our math, long run IRR tends to really appreciate another 25 to 50 basis points of investment yield.

Yes, sure. That's a good question. We're, really for the fourth quarter, largely done with the acquisitions. Yes, we -- the guidance, I think -- the slight tweak there really relates to we've got some properties that we're looking at selling and we're relying on other buyers to come through. So if they don't come through, then that number might be a little bit higher than $450 million. If they all come through, that might be a little bit less, but that's somewhat out of our control. But yes, we have some time to deploy the capital from the most recent equity raise. And we do feel like cap rates are likely to be higher early 2024 than where they are today. How much higher they go -- a little bit difficult to say -- but we certainly want to reserve some dry powder for early next year.

Fair enough. And then year to date, you've had $189,000 of earned development interest, which has been offset by the near $700,000 of capitalized interest expense through AFFO. Is it possible for that to current AFFO headwind to turn into a positive, or a tailwind, into 2024?

Yes. I mean, it should continue to grow. That's really the interest we receive from developers as we're funding their development. You should see it start to tick up some over time. I don't think it's ever going to eclipse the capitalized interest.

Is that part of maybe some of the headwinds on a deal that you agreed to perhaps before cost of capital increased this much?

Yes, look, I mean, some of the developments that we entered into were in the first and second quarter, and the yields on those on were low sevens, high sixes. I would note that they had much longer lease terms than what has historically been achieved with those retailers, as well as annual bumps, which you know has not also been historically recognized as well.

And so sorry, last follow-up here.

Go ahead.

Yes, I can appreciate how you guys were able to change some of those lease terms that we hadn't seen in the past, which definitely is a positive for those. In thinking about here going forward, have those same retailers been open to further increasing potential yields on those investments?

I mean, I think some of the retailers are really pressed to grow their store count. They really need institutional capital to come in. They can't rely on the 1031 market like they had in the past through their developer network. So hard to say exactly where all those negotiations go as they're ongoing, but I think if you need institutional capital, most institutions like us like to have annual increases in the leases. So I would expect that to continue on the margin.

Great. Thank you.

Our next question comes from Haendel St. Juste with Mizuho.

Hi Good morning. This is Ravi Vaidya on the phone for Haendel. Hope you guys are doing well. During the quarter, you issued equity when the stock was at $16.50. Can we consider this a watermark as to when you'd consider issuing equity again?

Yes, hey, Ravi. Look, where you raise equity is highly dependent upon the opportunities that you see. Right now, the opportunities that we see relative to our cost of equity as it is, there's not adequate spread there. So we're not going to ever put a number on where we would raise capital or not raise capital. It's ultimately going to depend upon the opportunity set where that's priced, and where are we trade relative to that opportunity set.

Got it. And you ended the quarter with leverage at 4.2, and inclusive of the forward. What are you willing to let leverage tick up to in order to execute on your capital deployment goals?

So our stated leverage range is 4.5 times to 5.5 times, and I think you should expect us to operate within that range in 2024 and beyond. Obviously that we're mindful of the range, and I think you're probably likely see us shake closer to the midpoint of that range over time.

Got it. Thanks, guys.

Thanks.

[Operator Instructions]. Our next question comes from Alec Feygin with Baird.

Yes, thank you, guys for taking my question. Quick question, just on dispositions, solid slight uptick in that. Do you guys plan on continuing to dispose of some properties in the portfolio and what's the opportunities up there?

Yes, we do. I would expect the dispositions to ramp up a little bit here in the fourth quarter, and potentially beyond the fourth quarter. We do see a pretty attractive opportunity to not only accretively recycle capital, but also extend out lease terms by replacing those assets with longer lease term assets with better rental increases and potentially better properties, and we believe we can do that accretively.

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

Thanks.

Our next question comes from Linda Tsai with Jefferies.

Hi. Last quarter, you didn't have any shares outstanding under your forward equity program, but then this quarter you have about 6 million shares?

Yes, yes, that's correct.

Oh. Just wondering what happened during the quarter.

Yes, we um, we sold those shares during the quarter through a forward block.

Okay, got it. And then just on Big Lots. Are there any updates there on -- you know, I know they are on your watchlist but is there any overall view on what's happening with them?

Yes, sure. I mean, obviously, they've had a less-than-great run over the past several quarters, but they are making some efforts to try to improve their free cash flow, which was neutral last quarter. But that was really driven by cuts to their working capital and you really can't do that for several quarters in a row. So we're really kind of trying to look to see them improve their operations and get the positive EBITDA after CapEx to start to feel better about their tenant health, but we are expecting to see some improvement in their gross margin here in a month when they announce earnings. So we'll be looking forward to that.

Thanks.

Our next question comes from Ki Bin Kim with Truist Securities.

Thanks. Good morning. If you had to go raise new debt in the bank markets today, what are you getting quoted?

Yes, hey Ki Bin, we're getting quoted in the mid-fives, but to be frank, already we have, you know, $100 million basically of unsettled equity. We have $100 million that we have yet to draw down on the existing term loan. There really isn't any need right now to pull down any type of -- to do any incremental long-term debt issuance if you can call term-loan debt, long-term debt.

Okay. And in terms of drug stores, if you look at the closure plans that have come out recently, any kind of broader common themes that you're seeing? Or is it just four-wall coverage? And when you overlay that with your tenant exposures, any kind of impact that you might see longer-term?

Yes. I mean, we don't think we're going to have any impact with the locations that we have. We've got a very good, really good relationship, both with CVS and Walgreens. We do not have any rated exposure. And so we talk to them before we're acquiring assets, and really get updates as we see news like this, and call them up. And fortunately, they've been very open with us, and telling us that the stores that we have are not on any closure list. But yes, as it relates to the ones that they are closing, some of those are leases that are rolling over where they already have a presence in some of those markets. You know, they've grown through some mergers over the years, and really have multiple stores in the same markets. And they feel like they don't really need that number of stores in those markets. And then there are obviously some locations that just don't generate positive cash flow, so those are the ones that they look to close.

Okay. Thank you.

We have reached the end of our question-and-answer session. I would now like to turn the floor back over to Mark Manheimer for closing comments.

Thanks, everybody, for joining us today. We look forward to seeing you in the next few weeks at the conferences and appreciate everybody's time. Thanks.

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