Spirit Realty Capital Inc (SRC) 2022 Q3 法說會逐字稿

Good day, and welcome to Spirit Realty Capital Third Quarter 2022 Earnings Conference Call. (Operator Instructions)

Please note that this event is being recorded. Now I'd like to turn the conference over Mr. Pierre Revol, Senior Vice President of Corporate Finance. Please go ahead, sir.

Thank you, operator, and thanks everyone, for joining us for Spirit's Third Quarter 2022 Earnings Call. Presenting on today's call will be President and Chief Executive Officer, Jackson Hsieh; and Chief Financial Officer, Michael Hughes. Our Chief Investment Officer, Ken Heimlich will be available for Q&A.

Before we get started, I would like to remind everyone that this presentation contains forward-looking statements. Although we believe these forward-looking statements are based on reasonable assumptions, they are subject to known and unknown risks and uncertainties that can cause actual results to differ materially from those currently anticipated due to a number of factors. I refer you to the safe harbor statements in our most recent filings with the SEC for a detailed discussion of the risk factors relating to these forward-looking statements.

This presentation also contains certain non-GAAP measures. Reconciliation of non-GAAP financial measures to most directly comparable GAAP measures are included in the exhibits furnished the SEC under Form 8-K, which include our earnings release and supplemental investor presentation. These materials are also available on the Investor Relations page of our website.

For our prepared remarks, I'm now pleased to introduce Jackson Hsieh. Jackson?

Thanks, Pierre, and good morning, everyone. Our third quarter results continue to demonstrate the validity of our underwriting approach highlighted by low lost rent, stable property cost leakage and occupancy over 99%.

Our portfolio benefits from diversification across 346 tenants. Operating within 34 industries and 12 distinct sub asset types, allowing us to produce a reliable stream of cash flow for our shareholders, and once again, increase our quarterly common dividend.

During the quarter, we invested $268 million in capital expenditures at a weighted average cash capitalization rate of 6.86%, a 49 basis point increase over last quarter and a 133 basis point spread to the capital we raised to fund this capital deployment.

Our capital deployment included 51 properties, which have approximately 15 years of weighted average lease term, average annual escalators of 1.8% and a weighted average economic yield of 7.76%. These acquisitions consisted of 46% industrial and 54% retail and other.

I'm pleased to announce that our other bucket was our first add-on acquisition with Invited, formerly ClubCorp since our initial transaction last year. We partially funded these acquisitions with $74 million of disposition proceeds, predominantly from the sale of leased retail assets with a weighted average cash capitalization rate of 5.7%, resulting in net capital deployment of $194 million at a blended cash yield of 7.29%. We sold 5 QSRs and Gardner School in the low 5 cap area, 2 Mac Paper properties in the high 4 cap area, and 2 smart and final grocery stores, formerly Haggen properties in the low 6 cap area.

As you will notice, the percentage of industrial acquisitions rose meaningfully since last quarter from 18% to 46%. And I anticipate that percentage to rise materially higher in the fourth quarter as the industrial segment is where we are seeing attractive sale-leaseback opportunities, with new and existing customers. Many of our customers that operate light manufacturing, distribution and iOS facilities need funding to meet their growth objectives. And with other forms of corporate financing becoming less available or attractive, sale leasebacks as a financing alternative becoming a more attractive option.

Despite this favorable dynamic, we are being highly disciplined and selective in our pursuit of opportunities. And we believe pricing for these assets could become more attractive in the near to medium term. To help fund these opportunities, we continue to pursue prudent asset recycling by disposing of smaller retail assets, where cap rates have proven stickier. This form of capital recycling will also help shape our portfolio as we dispose of retail properties and redeploy proceeds into the Industrial segment under new long-term sale leasebacks at current market terms with tenants who meet our capital now.

Finally, as we approach the end of 2022, I reflect on the goals we set 3 years ago at our Investor Day, including ABR, nonretail exposure and AFFO per share. As we sit here today, I want to highlight that we are ahead of our Investor Day ABR goal by $61 million. Our industrial exposure is over 20% and growing. And the midpoint of our AFFO per share guidance is $0.14 higher than our original 2022 target.

Looking back even further, since the spin-off of SMTA in 2018, we have increased our ABR by 82% to $661 million, growing our industrial rents by $108 million, increased our walls to 10.4 years and raised our public tenant exposure to 53%.

Over the same period, we have meaningfully improved our balance sheet, liquidity, internal processes and technology systems. And with this strong foundation, our portfolio and platform are well equipped to perform, take advantage of the opportunities we are seeing today, and increase shareholder value over time.

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

Thanks, Jackson. During the third quarter, our annualized base rent increased $13.8 million to $661 million, with $12.8 million driven by net acquisitions and $1 million from organic rent growth.

We received $1.2 million of rent from the 7 theaters released in 2020 and 2021, representing 87% of their stabilized rent. As of October, only 3 theaters remain under variable rent arrangements as the rest have fully reverted to base rent. Other operating income was elevated this quarter to $2 million, which included approximately $1.5 million in nonrecurring income, predominantly from a government taking for a highway expansion.

On the expense side, cash interest increased $3.3 million from last quarter with approximately $2.8 million, driven by a 145 basis point increase and the weighted average interest rate on our bank debt. During the quarter, we issued 1.1 million shares of common stock to settle existing outstanding forward contracts and issued an additional 2.2 million shares through our ATM, generating $141.9 million net proceeds at an effective price of $42.72 per share.

Additionally, we again raised our quarterly dividend to $0.663 per share, representing an annual growth rate of 3.9%, while maintaining our AFFO per share payout ratio of 75%. After locking in $800 million in term loans during the quarter and effectively fixing their payments through well-timed interest rate swaps, we had no floating rate debt outstanding at quarter end.

Subsequent to quarter end, we received commitments for a $500 million, 2.5-year delayed-draw term loan facility, which will allow funds to be drawn up to July 2, 2023, and will mature on June 16, 2025. This new facility provides us with significant debt capacity to pursue attractive acquisition opportunities, allows us to be patient when determining when to access the unsecured bond market and further demonstrates the strength of our banking relationships. We ended the quarter with $1.3 billion of liquidity, consisting of $1.2 billion in revolver capacity and $110 million of cash, which will further be enhanced by the new term loan facility that we expect to close in the coming weeks.

Turning to guidance. We are narrowing our AFFO per share range to $3.55 to $3.57, increasing our midpoint by $0.01, which represents growth of 9.5% from the prior year. We are maintaining our capital deployment target of approximately $1.5 billion and narrowing our disposition range to $250 million to $300 million. When we announced our 2022 guidance on January 10, inflation fears were much lower.

The U.S. 10-year treasury yield was 1.75%, 1-month SOFR was 0.05%, and our stock was trading at $48 per share. Despite these significant changes in the macro landscape, and our cost of capital since that time, our portfolio strength, capital allocation strategy and ability to timely source various forms of well-priced capital has allowed us to perform in line with the aggressive expectations we laid out in January and raised our quarterly dividend for the second consecutive year.

We remain well capitalized and positioned to take advantage of future opportunities.

With that, I will turn the call back over to the operator to open up for Q&A. Operator?

(Operator Instructions) First question comes from Anthony Paolone, JPMorgan.

Can you talk about just the ability to continue recycling capital to where you have been pretty accretively, just how deep that pool is to be able to do that? And how much growth do you think you could drive in the future by still buying with yields above -- the yields at which you're selling?

Anthony, I'll try to take a go at that. If you look at what we did this quarter, in terms of asset sales, they were all relatively smaller transactions. Six of those asset sales that we did in the quarter were 1031 exchange buyers that resulted in about 35% of the total sale volume in the quarter.

If you compare that to the second quarter, which was an equally large -- relatively large disposition quarter, I think only 3 of those transactions in the second -- 4 of those in the second quarter were 1031 buyers. So I think as we look out to try to think about our disposition plan, we think smaller is better, smaller granular assets are easier to finance right now because the other buyers, the non-1031 buyers were generally to high net worth individuals that probably paid all cash for these properties, and there were some small funds that we were able to engage with and sell property, too.

So what I would describe to you today is, we have a large number of properties on the market currently. We're a very price-sensitive seller. And I would describe all of these sales as generally noninvestment-grade sales. Like in the third quarter, none of these were IG-related tenants. And so that would be like QSRs, car washes, smaller assets that are more bite-sized, seem to have some attraction. So that's going to dictate the plan. It's really hard to project a target because I think you've heard some of the other commentary from our peers talk about declining 1031 depth out there.

And I think that is the case because the upper leg of these transactions are being affected by other nonretail real estate sales, but we still believe that we'll be able to find a way to accretively recycle. And obviously, that will in turn inform us what our acquisition appetite will be going into 2023.

Okay. And just a follow-up. If I look at your acquisitions in the quarter, the 6.9% yield, is there any lag to the market adjusting cap rates higher here?

And just trying to understand like if those were struck today, would there be any adjustment upwards? Just any comments on where cap rate adjustment is right now in your view?

Yes. I mean, I think if you were to look at -- there was definitely a lag effect in the third quarter. I can tell you our fourth quarter is already the low 7% cash cap range in terms of what we expect to close in the fourth quarter. And what we're seeing today, just we're seeing things in the mid- to high 7 to low 8 cap range for assets that a year ago were probably 150 basis points lower, just to give you some benchmarks.

So it's the same assets just wider, 150 wider, especially in that industrial area. On the retail side, Tony, we're seeing probably 50 to 75 basis point widening compared to a year ago. So yes, you'll start to see it impacted in our go-forward acquisition production. And so for us, dispositions, free cash flow are really pretty critical for how we're looking at next year's plan, obviously, given where our equity is trading right now, we're not interested in necessarily issuing at these current levels.

Next question will be from R.J. Milligan, Raymond James.

Just a question on leverage ended the quarter at 5.2x debt to EBITDA, Jackson, you mentioned that you're not interested in issuing equity at these levels. I'm just curious where you are comfortable taking leverage without tapping the equity markets?

I mean, we've talked about in the past -- well, first of all, our ratings are really important to us. So whatever we do, we're not going to put that at risk. We've talked in the past 5.2 to mid-5s as kind of a range of leverage that we target. I think we're obviously set up with these additional term loan facilities to go past that if we found the right opportunities, but to be honest with you, we'd only do that if we were confident that we could get the balance sheet back to a more normalized [5.2, 5.5] Range. Does that make sense?

Yes. Yes. That makes sense. And it seems like you guys are leaning a little bit more into Industrial, and you mentioned that the cap rates have probably expanded there 100 basis points. I'm just curious what the expectation is in terms of absolute levels of cap rates in industrial over the next several quarters?

I mean if you -- I guess I would say, like, you have to remember from my last -- from the last quarter, we talked about probably too much about high-yield indexes and term loans and spreads widening. Well, that's continuing to persist for a lot of issuers. And if you look at our sale leaseback percentage this quarter, it's about 60% -- close to 60% of our acquisition volume was a new sale leaseback oriented.

In the first quarter that was 45%. In the second quarter, it was 56%, and I can tell you in the fourth quarter, it's north of 80%. But what that means is, we are finding opportunities where companies really need the capital with good use of proceeds, and they're just evaluating a sale leaseback versus accessing high-yield bond or bank debt or term loan. And we're focused on mission-critical assets in that segment. So I think you're going to see that sale-leaseback percentage continue to be very, very high as we move into the fourth quarter and beyond because that's where we're finding the most attractive opportunities.

If you think about my comments earlier about the dispositions, we have a large number of properties that are existing leased assets on the market. We're not a forced seller. If we don't get the right price, we're just not going to sell it. And so what we can do is, kind of line up where we think we're getting fair value for the asset and transact.

And those that we're not getting fair value, will obviously not sell or pull those assets for the market. Well, that's what's happening in the market today. You have a large number of existing leased assets for sale, retail, industrial, office and most of those are probably not going to sell. I mean the volumes are way, way down, but there will be a small number of sale-leaseback transactions with companies that need to grow, need to go on with their business. And that's why we believe that we're one of a very few number of companies that can kind of solve that capital need right now. So a couple of our peers do it as well.

Next question will be from Brad Heffern of RBC Capital Markets.

Lost rent stayed relatively low this quarter at the 30 basis points. I guess has that changed at all in October or November? And are there any signs of any tenant stress?

Well, most of that lost rent was related to Regal. Maybe, Mike, if you want to talk about that.

Yes. I mean, definitely in the third quarter, I mean, that bump up in loss was really regal. They didn't pay September rent, they weren't acquired to. They did pay October and November, however. So I would expect that to -- I mean, related to Regal, that would obviously reverse itself.

Yes. And we -- all those leases are in effect. And obviously, we're talking to Regal along with many of our many other landlords at Regal properties right now.

Okay. Got it. I wasn't specifically asking about Regal. I was asking more broadly on just tenant stress in general.

We always look at -- we consistently evaluate our tenant base. Obviously, the fact that we're finding these opportunities for tenants that need capital, we're also very focused on our existing tenants in terms of where they sit, and how they're performing. I would say the benefit of our portfolio, and we've talked about this in the past, is it's very diverse from a tenancy revenue and industry and location standpoint across our 2,100 properties. But more importantly, like we have very large, sophisticated operators. They've got different access to capital, they generally do a really good job. So -- but obviously, we're very mindful and we're paying attention.

And then there was a decent size drop in investment-grade exposure quarter-over-quarter. It sounded like that was not due to disposition. So was that a downgrade? Or can you talk about what was driving that?

Ken, you can take that?

Yes. So what happened? The biggest driver of that change during the quarter was the downgrade of coals from investment grade. So there's -- but none of the dispositions, as Jackson mentioned were investment grade. That's not a target for us on the disposition side. It was largely driven by the downgrade of coals. And a little bit of it also was driven by the acquisitions that we're doing today tend to knock the investment grade. So you're adding more noninvestment grade and you had a downgrade of coals.

The next question will be from Josh Dennerlein of Bank of America.

I guess curious like on the dispositions, is it more about kind of optimizing the portfolio, like how you wanted to look? Or are the sales more about kind of optimizing capital raising, just curious how you kind of balance those objectives.

I would say it's first -- it's both really. But the optimizing of capital is probably in the current -- for us currently, either our current publicly traded cost of capital, it's paramount. Because we have a very diverse liquid granular portfolio. So we have lots of opportunities to try to harvest those opportunities and reinvest in things where we have a lot of conviction around right now.

But also, it gives us an opportunity to continue to shape this portfolio. We constantly are evaluating the different industries that we're in, and trying to find kind of that sweet spot balance of diversification. And I think for us, adding more industrial, we think, is a wise thing to do and we've consistently been doing that, and we'll try to do that going into 2023, obviously, in the fourth quarter as well. But the other thing it does, Josh, is, it's very informative to have a lot of properties on the market for sale.

We get to see the depth of the bidding universe, how different groups are coming in and out of the market. And that's just extremely valuable information for where I sit. When we think about is this the right time to be investing for us relative to maybe it might get better later. So there's just really -- as opposed to hearing it from brokers or other consultants anecdotally, like we know real time. I can tell you, like if you look at the buyer list and bidding list between the second quarter and third quarter is very, very different. The depth, the number, the type of buyer is very, very different. And we're seeing that in our current disposition pipeline that we have right now, it's very much happening in the moment. So we think it helps us. It informs us to be a better buyer.

And then I guess, if nothing really changes on your cost of capital, should we kind of assume that like your net acquisitions going forward are going kind of smaller than the past, just because you're going to be doing more sales. Is that a good way to think about it?

Yes. Look, it's -- I mean, it's -- I'm not excited about our cost of capital in terms of where our equity yield -- or AFFO yields right now. But that being said, we generate a decent amount of free cash flow. The portfolio is of a size right now where it's large -- it's not super large, not super small, but it's large and diverse. And I think what you can expect from us is we're going to be extremely opportunistic on how we think we need to fund ourselves. I think if you look back since -- I think, I've been with this company and this team, we've always been pretty thoughtful about how we raise capital to fund our business.

And sometimes it's through ATMs, sometimes it's through larger offerings, sometimes is through dispositions. And I think we'll continue to do that. And I hate to sort of forecast what happens if this happens or that happens. But I said we're not going to raise capital that's dilutive, number one. And we're going to continue to push really hard on dispositions, a core priority in the company. And if those things don't materialize, obviously, you have leverage as a kind of a toggle if you want to go that route. But I said also ratings are really important.

So we're going to be really thoughtful as we come out with our 2023 plan and end up, we're not going to be heroes or anything like that either. So we'll just be very measured, and try to find the best opportunity that matches up with what we believe are great opportunities to enhance this portfolio that we own.

Next question will be from Haendel St. Juste of Mizuho.

Wanted to go back to investment spreads for a second, but more on a look-forward basis. It looks like your cost of capital today is somewhere in the, call it, high 6s. Curious what type of spread do you think you can generate as you deploy incremental capital today? And then some thoughts or maybe can you discuss the pipeline, what the cap rates now look like?

Well, I'll do pipeline first. We're being extremely picky on things that we're looking at right now because the number of opportunities has continued to increase. And I think I'd characterize it the buyer base for the things that we're looking at is relatively small. It's a couple of our handful of our public peers, especially for some of these larger opportunities, largely being north of $20 million, and the private buyers that need mortgage debt, I mean, they're not really able to do it, I don't think, right now.

And so I guess the way we think about it is; look, we have free cash flow, we have disposition proceeds that all goes into the cost of capital mix. We know what our AFFO multiple of yield is. We were able to get stock sold last quarter in the low 40s. At these current levels cap rates would have to be extremely, extremely high for us to consider that, I think, and right now, I would say cap rates are still widening.

I'm just not sure how wide they'll ultimately go, but at some point, I think you kind of run into ceiling. But high 7s to low 8s is kind of a reasonable area where we think we might be able to get things done next year. Mid-7s to low 8 cap rates. For assets once again, that we're probably 150 basis points tighter a year ago. So it's not like we feel like we're buying low-quality opportunities. These are very, very good opportunities. There's just not as much capital out there.

Got it. Got it. That's helpful. Appreciate that. And then the question, I guess, stepping back, you've typically given forward your guidance during the third quarter earnings. It sounds like the decision this year is probably a function of the macro uncertainty and needing more clarity on your sources and cost of capital.

But I think many of us are trying to get a sense if it's reasonable to think of the third quarter, the $250 million-ish as a good run rate given the elevated cost of capital and debt pricing and the shift in the market. And so I'm curious if that's fair. And then what type of growth do you think you can generate without issuing incremental equity capital and still operating in your leverage targets?

Yes. I mean we even put the guidance out particularly because of some of the challenges in the macro environment right now, I wouldn't want to even try to guess right now. Like I said, we have a large number of properties on the market. I'm not going to say exactly how large, but when I say it's large, it's large.

If we were able to execute at those levels, that would help us kind of drive a certain type of acquisition activity next year. If we're not able to achieve it, it's probably going to go down for next year, the volumes. But it's hard to kind of to answer that right now, so that's why we didn't want to put it out there until we get a little more information through the close of this year and early. I think we'll be better informed to give the market an idea about next year's earnings and growth and acquisition volume.

I appreciate that. I understand. And then just one last one if I could. Just curious if you could kind of update your view on potential M&A, how that maybe has evolved or may be impacted by the change in the cost of capital, the contraction on the spreads. It seems that the spread investing equation here has changed pretty meaningfully, and likely weighs on the growth and likely limit the upside for the stock. So just curious on the latest thinking for M&A here.

Yes. I mean I think one of the companies that was taken private, obviously, I think it was a unique situation. I'm talking about store, right? And I think that for me, the positive sign for that is you had a global sovereign wealth fund that has sort of embraced this net lease asset class. That's wonderful. I think that's wonderful for all of -- for us and for all of our peers. That company had just very unique ABS facilities, like we've had in the past, that I think enable them to kind of be able to generate the kind of cash on cash yields that, that investor required. I mean, for us, we're not necessarily set up that way. All of our debt unsecured, you can see how our bonds trade. But more importantly, I think it's hard to predict like M&A in the future, I think, look, the environment is not great right now for -- the macro environment is a little bit distasteful.

And so usually that doesn't result in a lot of M&A unless it's maybe stock for stock, but also very difficult right now. So I would say, like for what we're focused on, things that we can control, we want to make this portfolio and company better, constantly improve it.

We believe that this shift into a higher percentage of industrial assets, new sale leasebacks, long-term leases, higher annual rent bumps, the rent bumps are exceeding 2% now. We think that's going to position this company better in the future, whether we get the equity multiple or maybe we can attract sovereign wealth funds to do things with us. Sure, that would be great. But -- we just want to make the company better. And that's what we're really trying to do right now. And we think what we're doing is doing that -- that's in our control. But to answer your question, I don't think there's going to be widespread M&A right now. The environment is just too uncertain for (inaudible) very companies right now.

Next, our question will be from Michael Goldsmith of UBS.

Can you remind us just how much prior (inaudible) this year, how much you have remaining for the fourth quarter and what you expect leading into next year?

You talked about deferred rent? Michael?

Yes, correct.

I think we have about $9 million left to collect, and I believe we'll collect hopefully 60% by the end of next year. I have to look back, and I think we collected about that this year. And all of our deferred rent has been repaid for the obligations of the tenants on time. So it's been moving along. I think that when we struck all referral agreements that balance was well into the 20s initially coming out of COVID. So it's come down materially. We've even had total tenants prepay early, so it continues to drop.

And then just on the portfolio shifting from at least the acquisition or investment is shifting to industrial from retail, but there's a big pickup in the home furnishing space. And that's one that we may be facing a little bit more challenge in this current environment, given there was a lot of -- there was a lot of home buy, furniture purchasing and home furnishing purchases through the pandemic. So just trying to get a better understanding of what you're seeing in this category, and why the focus on it in the third quarter.

Yes, Mike. So the 2 home furnish -- we bought a La-Z-Boy, small pool, yes. Yes, La-Z-Boy -- (inaudible) furniture location. I mean like I said, those were existing leases. They were not sale-leasebacks. They made sense given at the time when we were looking at them on a relative basis. But if you think about what we're doing now is just really shifting more to that sale leaseback opportunity that I talked about. You'll see that shift in the fourth quarter, and it's going to be predominantly industrial in that fourth quarter. So I would say some of that -- some of the assets that were acquired were probably earlier in the year committed that we're rolling in. But my comments on how we're moving forward is going to be primarily industrial, long-term lease, sale leaseback, new sale leasebacks.

We'll just go back to your question on (inaudible), just to make sure I'm clear. All the deferred rent we've been collecting, that was all recognized in earnings last year. So none of that's affecting our earnings, just to be clear. That's all -- that was recognized last year in the second quarter. And so the rent that we have collected and continue to collect does not actually impact our earnings.

Got it. So you won't be facing -- it sound like you have to lap that next year.

Correct. That's right. None of that rent we collected this year was recognized in earnings for this year, it was all recognized last year, all in one quarter.

Are there any -- as we look ahead, I know you're not providing guidance, but are there any onetime items from '20 from this year that you will have to lap for any potential benefit?

Yes, I mean talking about like the other income, that line got a little chunky this quarter. So that tends to be more nonrecurring.

Good luck in fourth quarter.

Next questions comes Ki Bin (inaudible) of Truist.

So when you talk to your tenants, what's your best sense for them, the cost of a lease versus alternative funding sources? And is that spread -- has it gotten wider from I guess, more favorable or unfavorable as it pertains to direct lease?

Yes. For a lot of -- some of the companies that we've been targeting, especially the noninvestment-grade tenants, a lot of these companies are sitting on (inaudible) 400, 450 kinds of credit facilities. And like their secondary bonds might be trading at 11%, double digit. And if you kind of -- I talked about this last quarter, but the high-yield issuance, new issuance volumes are way, way down. Part of that is that the new issue premium is so high right now for a new add-on bond just because the secondary bond levels are trading so wide.

And I think that's just a function of -- there's a whole -- we have a longer discussion on why spreads are so wide right now. Obviously, a lot of global cross currents in the U.K. There's just a lot of things right now that are creating extremely wide spreads. For us, as a sale-leaseback alternative, if we can lock in at 8.25%, numerically, it's lower, right, than what they can issue at bank debt right now, even new bonds. But where the tenants kind of push back on us, it makes sense.

If they issue a bond or term loan at those higher rates, they can always prepay that debt. There's either prepayment or yield maintenance or defeasance, they can actually prepay it. The minute they enter into a sale-leaseback on a mission clinical asset with us, it's a 20-year obligation. You can't get out of it. And that has certain inflexibility sometimes for them.

So when they look at doing a sale leaseback versus just issuing corporate debt, it just has to be probably a little bit lower, just given some of this elevated spreads and where absolute corporate rates are right now.

And so that's why I've said that like we're not going to do 10% sale leasebacks right now. I don't see right now in the current environment. But we are seeing that 150 basis point widening. And I think it's just a function of supply and demand of capital that's willing to do it, i.e., us and some of our peers. And these companies they need to move on. Some of them are growing, some of them are expanding. Some of them are doing mergers and they need the financing.

So we're kind of trying to thread that sweet spot, really good credits that we believe good industries, really good real date, great leases, at what we believe our wide pricing from a historical standpoint. And we think that in the future, spreads will normalize from where they are today eventually. So that's kind of the lens that we're looking at.

Okay. And when you look at your 2023 lease expirations, you have about 3.2% rolling, any early thoughts on how lease negotiations are progressing and broadly what we should expect in terms of retention rates or spreads?

Yes. This is Ken. The lease expiration is -- to be frank with you, it's just the basic walking and tackling that we're doing every day. We're not only addressing '23, we're addressing '24, '25, and in some cases '26.

But we're very happy with the way the progress that we're making. You can see in that in the lease expiration schedule, it's interesting if you look at the leases that are expiring in the '33 and beyond, and that thereafter line item, we've managed to move that up for several quarters in a row. So we're very happy with the progress we're making.

So I guess let me ask you a different way. Any reason to expect the retention rates to be any different from what we've seen from you guys for the past like the year or so?

We don't see anything materially different. .

Next question will be from Wes Golladay of Baird.

When I take a look at the sale leaseback activity that you're doing, are you seeing better value at a particular price point? And how has competition changed throughout the year?

I think, what's the way I would answer it, there's a lot of sale-leaseback opportunities that won't get done. They don't make sense. They don't make sense for us. I don't think it makes sense for anyone. So that's one sort of bucket. What I would tell you is that larger dollar-size deals are there are just less people that can actually do those right now. And that's an area that we're looking at very carefully right now. So I think it's -- I would just say like there's a lot of companies that need capital and they are obviously kind of like, oh, I'll do a sale leaseback.

And I just don't think a lot of them are going to get done. So I don't think -- it's hard for me to overgeneralize an answer to your question, all I can tell you from our lens, we're seeing lots of interesting stuff at very wide pricing relative to what we saw a year ago. We don't have to be mindful that we don't have infinite sources of capital right now that are accretive. So we're trying to be very measured and methodical as we move forward from here.

Got it. And then when you look at your cost of capital, it's all kinds of (inaudible) at your cost of equity. But it looks like the -- it's adjusted for the 150 basis points change you've seen at cap rates, but is it the debt side that you're more concerned about on the cost of capital at the moment that will keep you from you dialing up more volume at this point? .

Mike, you can...

Yes. No, actually, we're much more comfortable on the debt side. We have -- we did the $800 million term loan that we fixed. We have today our $1.2 million line is completely undrawn. We had $100 million of cash on the balance sheet. And then we have this new $500 million term loan coming in. And if you think about just our liquidity from a debt capacity standpoint with this new term loan.

I mean that will carry us all the way through next year, probably into '24 without having to access any of the debt markets. So from a debt standpoint, I feel pretty set. I think it's more of the equity side that we're focused on.

Okay. Got that. And then revenue-producing CapEx, there's a lot of stuff that goes into that. That picked up this year. You mentioned about funding a lot of the acquisitions with dispositions and free cash flow. So just curious how you see the revenue-producing CapEx trending next year.

I think that's something that I think will continue to be a part of our investment structure. It's generally related to existing tenants. And we think that it's important for existing tenants that we're prioritizing to kind of be constructive with them. Obviously, we have to adjust for the current pricing environment with them if we decide to do that. But I would say, like, we'll have a mix of revenue-producing capital as well as straight up acquisitions that are new sale leasebacks that are industrial next year. I just can't give you the percentage of the volume right now.

Next question will be from Greg McGinniss, Scotiabank.

Jackson, as we head into maybe more challenging economic environment, how are you evaluating these non-investment-grade industrial sale leaseback tenants to determine those with good uses for the capital that you're providing them versus those maybe looking for a cash out?

Yes. I would say we're not focusing at all on cash outs. It's the normal blocking tackle you would want us to be focused on, starts with what type of industry they're in, how are they positioned what does their balance sheet look like? How much floating rate debt exposure do they have? How much concentration do they have from their revenue sources? How reliant are they on FX changes? How are they -- it's just a variety of different things that you go through on Credit 101.

But I think for us, the key thing is how mission critical is this real estate that we're looking at. What is the rent relative to what we believe market? What would be the potential reuse for this facility? How critical is this industry, like if -- god forbid, there had to be a restructuring, what would that look like? Is it a 7 or 11? How valuable would these properties be? All of that kind of goes into our calculus before we kind of make a decision to move forward. But what I would tell you, what we're not doing is high rent, high-levered, overrented set leasebacks. That's not what we're talking about here. And I think if you look back, I kind of specifically referenced the sale of that Haggen property. If you kind of roll the tape, if you remember that situation was a $224 million acquisition back in the day.

Obviously, the company filed for bankruptcy. But we were able to obviously restructure leases with new operators. And obviously, that was done with kind of the prior regime here. But what we've been committed to do is continue to sell those. So if you sort of look at the tape, we sold all but one of those properties at this point, and generated sales proceeds of $249 million, as well as generated another $75 million in total rents and settlement fees since the acquisition of that portfolio. So it's been almost $100 million net gain over purchase price and 5% on the investment.

And I just go back to why was that good real estate generally locations that operators wanted to go into are very granular and liquid, like those 2 Smart & Finals that we sold. And so we've continued to take on that thesis on everything that we buy, everything that we bought (inaudible). So it's not just the lease, there's a lot of factors that go into these decisions that we make when we're sort of deploying capital.

Yes. I appreciate the color there. Mike, just a quick one. Are there any plans to swap the new term loan? And if you did, what might that all in rate look like?

Yes. That's something we're going to evaluate. So we have time before we would draw that down, we have until July. I mean if I look at today, I think that we'd be swapping into the mid-4s.

I think that's probably a little steep and the short end of the curve is a little elevated, and it's tuned after your term loans, so you're looking at the shorter end of the curve. I think if you look at how we did the last swap, we timed that pretty well. We did it actually well before we even closed that term loan because rates dipped and so we took advantage of that. And I think if you look at the same playbook here, we see the rates dive where we think there's an attractive price, will swap and we're going to have 6 months to do that.

And we also take the view that there's going to be a lot of doubt that can come out between now and July with the Fed, and that could affect the trajectory of rates in the curve. We could take the view that we want to stay floating. We have a conviction that rates are actually come down over the life of that term loan we use it and we have that commission, we'll leave it floating. So I think it's too early to tell, but we obviously prefer to be fixed where we can. We're going to evaluate that and try to be opportunistic with how we approach that.

Next, our question will be from John Massocca of Ladenburg Thalmann.

So maybe just digging into the kind of trial acquisition pipeline a little deeper. What's the bifurcation in there between maybe manufacturing and warehouse distribution assets? And has the cap rate and kind of cap rate expansion you've seen over the last 6 months differed between those 2 kind of specific tenant industries.

I'll let Ken...

John, so what I would say is there's not a bright line, but we tend to look at more of the light manufacturing opportunities. But I would submit that when you're looking at a light manufacturing facility or a pool of facilities in a transaction, they typically have a distribution component. It's very common to have that component within the facility. But as far as pure light manufacturing versus pure distribution, I would suggest it's going to be more on the light manufacturing side. And there might be a little more yield expectation for those types of assets. But it's not some huge divide.

Okay. And then maybe sticking with Ken, if you think about your Theater assets, is there any kind of read through, I guess, in terms of credit health from what's going on with Regal? Or is that kind of a very isolated situation you're fine?

Yes. We clearly view theaters as kind of in their own bucket. They've got their own industry. Here's what I will tell you. We tend to have a lot of regional theater operators within our theater bucket. They're doing phenomenal.

They're solid. They came out of COVID extremely well capitalized; I would submit that in some cases, better capitalized through the SVOG program than they've ever been. Regal's got its own path. We're going to deal with that. Interestingly, our -- not only our regional theater operators, but others that we haven't -- we don't deal with today, we do get inbounds on the Regal assets, about interest in them. So theaters are definitely different, but we're comfortable, especially with our regional operators.

Next question will be from Spenser Allaway of Green Street Advisors.

Maybe just sticking on the tenant health topic for a second. Just given the high inflationary environment, can you guys comment broadly on rent coverage in the portfolio and how that may have changed in the last 6 months?

It's actually a very stable, Spenser. I guess, I'll just tell you a way I think about it, 20% of our tenant base is investment grade. That has a certain kind of obviously risk profile as we go into this more uncertain macro environment, 53% are public, some are investment grades. Some are noninvestment grade. Some are just have no rating -- and then we've got a 29% PE bucket. Generally, you should expect more noninvestment-grade debt facilities in their capital structure on their portfolio of companies.

And then we've got sort of another 19% that individual operators, which by the way, some of those are really large, especially on the restaurant side, pretty good credits. So we don't have -- I sometimes see people look at us as, oh, you're a high-yield portfolio, it's not really true. I mean, statistically, it's not true. And it's also very diverse. So I think what we're trying to really ascertain as we go through working with our credit team, especially on a noninvestment-grade tenant base, where are those sources of revenue coming from? Are there things on the horizon that could change their prospects?

So obviously during COVID, a lot of tenants were impacted by transportation costs, just terms of logistical issues that are happening. Now some of that's burning off, right, to you read about what's happening with ports and the cost of moving goods, containers and freight coming down, but there's other issues. There's companies that have global FX exposure are being impacted.

And so I think for us as we try to really understand what that concentration of revenue looks like, and how it could be impacted. And obviously, as I said earlier, on balance sheet, where these companies are with floating rate debt. Where are they with maturities? How is your lender base looking at them because I do think it's going to be different at the time. COVID put a lot of pressure on lenders, but there was a lot of forbearance. I think this time, I'm not sure. It depends on how long and deep economic kind of environment that we're going into persists. But I can tell you that we spend a tremendous amount of time looking at it with the team.

Okay. That's really helpful color. And then just one more. With new acquisitions being heavily industrial focused, can you just give us a sense maybe directionally of how coverage for that particular property type compares to the portfolio average?

So what's interesting about industrial, there's -- there are a fair amount of them where the unit level coverage is not applicable obviously, but we're going to look at corporate coverage. And we certainly, that's an ingredient when we do the underwriting. But I would say as you -- as we evolve into heavier industrial, there's going to be a lot of occasions where unit levels are not a factor.

But we look at other things. In industrial, the rent on the facility tends to be a very minor line item in the expenses. There are things that we're looking at rather than unit level coverage that make more sense for the asset, but we certainly aren't going to be looking at opportunities that are "dilutive" to the coverage, at least at the corporate level.

Okay. Yes. Sorry, I sort of carry out of that with you, so talking about corporate.

Next question will be from Linda Tsai of Jefferies.

When you do sale leasebacks, how much discretion do you have in terms of deciding which assets go into the deal? And what do those conversations look like?

I can tell you a year ago, they were really hard. There was a lot of people. It was more of a seller's market. So it was a kind of take it or leave it or take it this way or that way. Terms were really tough from a buyer standpoint, like tenant had a lot of leverage. I would describe it to you as completely flipped. The money has a better ability to determine what is what -- like what goes in, what goes out and what the terms are, and what the rates are, it really flips just because in my earlier comment, there are a lot of sale leasebacks that are in the market or being -- trying to be sought after that will not get funded. And so I think it's a great time right now, not just for pricing, but for sort of terms that were to get assignment language.

Back in the day, you used to have covenants on sale leasebacks. I'm not sure we're there yet, but it used to be like financial covenants on some of these things. If you looked a long time ago, before all these companies were as public and as active. But right now, the sale-leaseback is really solving an important part of a corporate capital structure right now for companies that want to grow. Obviously, companies that want to take out equity are trying to do that as well, but I would suspect -- hopefully, most people are pursuing those kinds of opportunities.

And then in terms of the types of assets you're disposing to recycle capital out of your asset mix, you have retail, industrial office, which assets are you seeing reach fair value the fastest to the point where you're willing to sell?

Yes. Look, I mean, I think if you look in the second quarter, Linda, like we got a lot of traction on, for instance, like a (inaudible) building, we've got really great pricing. We sold some of our industrial assets because, once again, it's very, very attractive pricing. And also, we wanted to -- believe it or not, to have kind of proof of concept. We've been buying a lot of industrial property since this team got here. And I think we've been successful at it. And we're trying to demonstrate an ability to show people we can buy things that make sense, and see compression in yields on the sale. If you looked at this quarter, it was all small assets, Taco Bells, little restaurants, a couple of grocery stores. I think as you look at the pipeline going forward, it's probably looking more like that, smaller bite-size opportunities, not really larger assets.

But that could really change. As we go into the new calendar year, you sort of never know how (inaudible) work, you have spreads tightened and there's obviously a lot of appetite. It's just that where people are trying to discover pricing. So we can pivot our disposition plan to do larger retail assets, a larger department store opportunities or retail opportunities.

And if we were not successful there, we consider selling industrial as well. But right now, I would answer your question, it's a lot of small, granular restaurants, car washes, things that we believe $3 million to $5 million size deals that we think can clear right now.

Next question will be from Chris Lucas, Capital One.

Actually, Jackson, just following up on that granular portfolio, how much of your aggregate portfolio do you think is comprised of sort of those more liquid, better valued smaller assets?

I would say, in terms of number of properties, we have 2,100 properties. I would say -- just going to guess. Definitely, the majority fall in that bucket of small and granular, drugstores, auto repair shops, Caliber Collision that sort of thing. We do have larger assets as well, right? Some of these industrial properties we're buying are bigger. They're probably not as liquid today, just given -- they need mortgage financing and probably don't appeal to that 1031 universe. But obviously, the large majority of the asset we have hit in that sort of $3 million to $6 million, $7 million size asset.

I mean, it's 2,100 properties, right? So -- yes. So there's no shortage. I think what we, Chris, focused on is what's -- when we sell a property, what's the tax impact to us? What's the lease duration? There's a certain type of asset that has a certain minimum wall on it that makes sense for the buyer base out there to get the pricing that we're focused on. So like this quarter, you might see more drug store sells for instance.

And then, Mike, I just wanted to -- just sort of a detail I wanted to iron out. So in the capital deployment activity spreadsheet that you have in the deck, it showing average annual escalators in the 1.5 to 1.9 sort of through the trailing 8 quarters. And then if I go forward, there's a forward sort of average rent increase number that you guys postulate as 2%. I guess, are the numbers comparable? Am I missing something been between the 2 slides?

Yes. So the forward number is basically at a point in time number of now over the next 12 months, kind of point to point, how much do we expect our rent to escalate organically? And I talked about this before, but one thing that is alerting that number a little bit is those movie theaters relet. They have some pretty big escalations as they stepped up from the base rents, they're put in to their final -- finalized base rent, right? We had -- there's some runway built in as those things ramped up with the new operators. That's going to be done by the end of this year. And I'd say pro forma -- if you pro forma those out of that number, you're probably closer to our historical average of about 1.7%.

So that is adding a little bit of extra growth this year. So as we flip into next year, I expect our -- that number to come down a little bit probably around that 1.7% range. That being said, as we think further out, if we continue to buy more industrial and sell more of the granular assets, which tend to have lower escalators than the industrial that we're putting in, which tend to be more of the 2% to 3% escalators then you'll see that number kind of creep up over the longer term. But I think in the near term, you will see that kind of come down a little bit as those movie theaters kind of stabilized.

Okay. And then just one more for you, Mike. Just on Regal. Can you just remind us sort of how you accounted for their deferred rent? And is there anything that you guys will need to write off based on the filing? Or were you were on a cash basis? Or can you just kind of give us a quick history there?

Yes, they were not on a cash basis, they are today, obviously. We only had $135,000 of cash rent that was deferred and recognized in revenue, which we reserved for in the third quarter. So that is now fully reserved. Obviously, the September rent, they didn't pay is also fully reserved because again, they are on a cash basis. So that's all been reserved for in the third quarter. So there's nothing else, no other impact with Regal other than where we get to with their leases, if that changes.

(Operator Instructions) Next question will be from Ronald Kamdem, Morgan Stanley.

Just a couple of quick ones for me. Just going back to the acquisitions. Obviously, the cap rates moving up this quarter. As you're sort of thinking about sort of next year, right, there's a trade-off between volumes and cap rates. So is the thinking that should we be expecting sort of more cap rate -- higher cap rate deals given sort of the cost of capital? Or would you be willing to sort of step back on the acquisition volumes? Just trying how are you guys thinking about that?

We're thinking about both of those alternatives to the honest with you. We haven't committed just to sell-to-sell and buy-to-buy. I mean, I think what we're doing is taking a very measured steps. As I said, we have a lot of properties on the market currently. That's going to inform us not just on proceeds, but cap rate, we have another tranche that we're prepared to move forward on. And we don't have to sell these once again, right? It's only -- if we get what we believe is kind of the right price of what's being offered. And I think we're equally being measured on the investments that we're committing to or evaluating. So we really -- we're trying to -- we are not getting ahead of ourselves one way or the other.

We're not going to oversell without a pipeline and we're not going to build a big pipeline, and try to sell down. We're moving very much in lockstep, which is why I keep referencing a large number of properties in the market. And if the market improves, where we think we can sell kind of larger, either pools or assets, we'll obviously pursue that. That's why we don't want to probably -- we don't want to give guidance because it's really hard to tell.

We're looking at all sorts of different alternative scenarios here. And so we'll be in a better position to do that in the early part of next year after getting a lot of feedback from the assets that we have in the market. And also what we're seeing, as I said, on the cap rate side for acquisitions. But we think we're being as smart as we can about giving us maximum optionality because we could easily just sit and do nothing. Obviously, we're not going to sit and do doing, but we just sit and just collect rent.

But what we want to take -- what we want to do right now is taking advantage to try to improve this portfolio as we move into 2023, given all the things I described to you on the on the investment opportunity with sale leasebacks with industrial companies. So that's kind of the plan right now.

Great. And then my last one was just taking a step back, just trying to get a sense of where your head that, just strategically with sort of the cost of capital environment today, right? That markets are very high and the equity is still down.

You guys got a forward done this year, which looked really smart and so forth. As you're sort of thinking out over the next 2 to 3 years, what other sort of tools, options do you -- can you sort of draw on in these periods when cost of capital is maybe not there? Is the JV capital? Is it trying to time more? Just trying to get your sense strategically how you sort of operate when the cost of capital is not there?

I think for me, it starts with execution, operations, doing what we're supposed to do, monitor credit, stay close to our tenants, collect rent. Our performance, if you look across loss rent, property cost leakage, very low default rates, getting through COVID, in my opinion, it's been very really strong.

And we're going to have another opportunity, I believe, during this very uncertain time to be able to prove out the same level of execution. So that's really first priority for this organization that we're focused on. If you kind of are able to do that, I believe, well, like the markets kind of come, they ebb and flow, high-yield indexes are really out of favor right now. In my experience, that's not forever, and not permanent. And I believe you'll start to see a rotation at some point where high-yield indexes really start to compress, maybe faster than investment grade indexes.

And my suspicion is that's when we're going to probably outperform as the macro environment starts to loosen up, and we'll be in a great position to move forward based on that. I don't think we're going to try to do things that would be distracted right now from what I just described. Just primary blocking and tackling execution day-to-day for our 300-plus tenants across this 2100 portfolio company because we spent all this effort in the last 3 years building this fortress balance sheet. I want to take advantage of that at the right time, and I think we'll get that opportunity sometime in the next couple of years.

That concludes our question-and-answer session. I'll turn the conference back over to Mr. Jackson Hsieh for closing remarks.

Okay. Thank you, operator. I appreciate all of your interest in participating in this call this morning, and we really look forward to seeing many of you out at Nareit in San Francisco next week. Thank you.

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