Spirit Realty Capital Inc (SRC) 2020 Q4 法說會逐字稿

Greetings, and welcome to the Spirit Realty Capital Fourth Quarter 2020 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Pierre Revol, Senior Vice President of Corporate Finance and Investor Relations. Thank you, sir. Please go ahead.

Thank you, operator, and thank you, everyone, for joining us this morning for Spirit's Q4 2020 Earnings Call. Presenting today's call will be President and Chief Executive Officer, Jackson Hsieh; and Chief Financial Officer, Michael Hughes; Ken Heimlich, Chief Investment Officer, will be available for Q&A.

Before we get started, I would like to remind everyone that this presentation contains forward-looking statements. Although the company believes these forward-looking statements are based upon 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'd refer you to the safe harbor statement in today's earnings release, supplemental information and Q4 2020 investor presentation as well as our most recent filing 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. A reconciliation of non-GAAP financial measures to most directly comparable GAAP measures are included in today's release supplemental information and Q4 2020 investor presentation furnished to the SEC under Form 8-K.

Today's materials are available on the Investor Relations page of the company's website. For our prepared remarks, I'm now pleased to introduce Mr. Jackson Hsieh. Jackson?

Thanks, Pierre. Good morning, and welcome, everyone. It's hard to believe that just a little over a year ago, we held our Investor Day in New York. For those of you who attended or had the chance to watch the webcast, it was a turning point for Spirit. We had finally become a simplified triple net REIT with a competitive cost of capital, and we outlined our plans to take Spirit forward and create value for our shareholders. As I was preparing for this call, I reflected on several of the key objectives we talked about, what we have accomplished and what is still left to do. And for this earnings call, I will revisit many of those objectives in the context of our 2020 results. So let's start with our portfolio. At our Investor Day, we laid out our medium-term portfolio targets, one of which was to overweight our investments in large, sophisticated operators with a particular focus on public, noninvestment-grade credits where we find attractive yields and lease terms. We like these tenants because of their scale and operating sophistication, access to permanent capital, moderate leverage policies and governance and believe these types of credits anchoring a diversified portfolio will provide better risk-adjusted returns than a purely investment-grade focused strategy.

Our credit piece has held up well during 2020. And not only did we experience very [few] tenant defaults, we actually saw many credit improvements. In our most recent investor presentation, we added a slide called Credits on the Move, where we provided examples of credit improvements across 15 tenants.

As you'll see, several have received credit -- recent credit upgrades, including At Home, BJs, Tractor Supply and PetSmart. A few of our larger private tenants became public, like Albertsons, GPM investments and Academy Sports. And a few are being consolidated through M&A to form larger companies, including Bass Pro shops acquisition of Sportsman's Warehouse and Callaway's acquisition of Topgolf.

We're already seeing many of these credit improvements translating into cap rate compression and these operators, along with several more across Spirit's diverse portfolio, are good examples of how our rigorous credit analysis informs investment decisions that add value. Another Investor Day target was to further diversify our asset allocation by layering in a higher percentage of industrial assets. Given the nature of our industrial portfolio and the attractive acquisition opportunities in 2020, the strategy proved both timely and fortuitous.

During the fourth quarter and the full year, 56.5% and 57.7% of our acquisitions, respectively, were in the industrial asset category. And 14.9% of our portfolio is now comprised of this asset type compared to 9.5% 1 year ago. I should also note that we collected 100% of rents from our industrial tenants during the fourth quarter.

Overall, Spirit's portfolio was put through the ultimate stress test in 2020. And I believe it proved itself. As you saw in our release, during the year, we sold 18 income-producing properties for $76.7 million in proceeds and at a blended cash cap rate of 5.89%. We also sold 20 vacant properties for $27.7 million, producing a net gain of $1.3 million, further demonstrating the granularity, liquidity and institutional demand for our properties, even during periods of economic dislocation.

We also achieved 99.6% occupancy across 1,860 properties, ending the year with only 7 vacant assets. Our cash flow collections increased to 94% in the fourth quarter. And if you exclude movie theaters, the cash rent collection rate was 98%.

In addition, we have no bankruptcies across our top 20 tenants since the COVID pandemic began. In fact, you would have to go to our 39th tenant Studio Movie Grill to find a bankruptcy in Spirit's portfolio. Bottom line, our portfolio strategy is working. Our asset base is stable. And as we enter the new year, we see upside, as the vaccine rollout gains momentum. Some important growth-oriented goals we laid out at Investor Day were to: expand the acquisitions team; increased deal flow; and return to $600 million rents by 2022. We added key members to the acquisitions team in April and May and plan to add a couple more support personnel this year, expanding our bandwidth to source and process new business. We were one of the earlier institutional players to pivot back to growth in 2020. And as you can see in our most recent quarterly results, our acquisition pace has ramped up meaningfully.

For the quarter, we added 99 properties across 15 transactions at a cash yield of 6.7%, an economic yield of 7.45%. The weighted average lease term for our acquisitions was 15.2 years, which increased our total portfolio WALT to 10.1 years. You may remember, our original pre-COVID 2020 capital deployment guidance was $700 million to $900 million. And even with pausing in the second quarter, we deployed $878 million, near the top end of our pre-COVID guidance range. We also grew our annualized base rent to $510 million from $461 million last year, an increase of 10.6%.

Despite the impact of COVID-19, we stay right on plan to meet our growth targets. Another key goal was to further integrate our asset management and acquisition teams. At our Investor Day, we talked extensively about how our teams work together to close acquisitions. I've always believed their complete integration is critical, not only for transacting efficiently but for developing tenant relationships that ultimately result in new business.

To that end, we recently completed an important realignment within the organization that has formally folded acquisitions and asset management teams together. Ken Heimlich moved from the Head of Asset Management to Chief Investment Officer with both the acquisitions and asset management departments reporting to him. Daniel Rosenberg, who previously moved from Asset Management to Head Acquisitions in 2018, will now head the Asset Management function under Ken's direction.

These changes bring Danny's extensive tenant relationship building experience gained through his multiple roles, back to the asset management team. And he will -- Spirit had the initiative to develop business from existing tenants, bringing up Ken's time to focus more on new tenant underwriting and the deal pipeline. From a tenant relationship building standpoint, we have continued to make headway. The circumstances we face in 2020 allowed us to deepen relationships meaningfully with tenants, which resulted in new acquisitions with Life Time, At Home and BJs, to name a few.

In fact, you can see from our recent disclosure, Life Time is now our #1 tenant. In 2018, we purchased 5 Life Time locations from Blackstone. And since that time, we've cultivated a deep direct relationship with Life Time. Those efforts allowed us to add 2 more properties under a new direct sale-leaseback during the fourth quarter. We believe Life Time is a best-in-class health and fitness operator, and the resort-like health clubs are well-located and have a variety of offerings that make them an attractive destination for their customers, while providing stiff barriers to entry for their competitors. This transaction is an example of the type of relationship business we are expanding upon.

A couple of other important goals that I will briefly touch on from our Investor Day. We're improving our credit rating and enhancing our scalability with technology tools. I will let Mike discuss our credit profile and progress in detail during his remarks, but I will just say that our balance sheet is stronger now than before the COVID-19 pandemic. As for the technology, that's something we have continued to refine and invest in every day. We have integrated power apps to our BI tools, which are used for every acquisition, and predictive analytics are becoming more developed and widely adopted across the company. Our accounting, legal and operational systems are excellent, as demonstrated by our ability to release earnings sooner and provide sector-leading disclosures while executing 238 deferral agreements and hitting the high end of our pre-COVID acquisition guidance, all possible because of the continued efficiencies gained from our technology tools.

So we have continued to move the ball forward, and we accomplished a lot in 2020. But what's left? For us, not surprisingly, it's simply the recovery of movie theaters, which represents 5.1% of our annualized base rent. While the industry remains challenged, it is worth noting that the liquidity and survivability of our operators has improved and may improve even further. Most of our regional operators have access to main street lending program, which provided 5-year unsecured financing, and we believe all of our regional operators are eligible for $10 million in grants under Saver Our Stage relief plan approved by Congress in December. Outside of the regional operators, our national operators have all raised substantial amounts of capital significantly improving our liquidity position.

Regarding our 2 operators that filed in 2020, Goodrich and Studio Movie Grill, there are some positive developments there as well. As we previously disclosed, the 4 former Goodrich locations are now under a master lease and are being converted to a strong regional concept, imagine.

The tenant plans are to invest approximately $10 million into the renovation to those 4 theaters starting in the next few months. Our Studio Movie Grill site in Georgia is being assumed in the bankruptcy, and we are in LOI negotiations with a new operator for the 3 former Studio Movie Grill sites in California. While we only recognized 34.5% of movie theater rental revenues during the fourth quarter, by the end of 2021, we may have all of our operators within the Movie Theater segment paying rent.

Regardless, I don't believe theaters are at 0 for Spirit, they will come back, it's just a question of when and how much. In the meantime, we are moving forward and growing the FFO and the theaters will just have to catch up to us. When I first started thinking about where we are today versus where we were a year ago and the impact that COVID had on our progress, I initially focused on our 2020 AFFO per share of $2.95, which is ironically the same pro forma number we guided to for 2019 at our Investor Day.

So for a moment, I thought, wow, we just lost the year of progress. But when I walked through the rest of our goals and objectives, I realized that we didn't actually lose a year. Yes, our earnings took a hit, which I believe is just transient. But we achieved every other goal and benchmark that we set out to do and more. Today, at Spirit, we have a proven portfolio with strong tenants and tested underwriting, a fully integrated asset management and acquisitions platform that is producing results, deeper relationships with our tenant base, enhanced tools to support our underwriting, forecasting and monitoring, a pristine balance sheet and the opportunity to substantially accelerate earnings growth over and above our expectations, depending upon the shape of the movie theater industry's recovery.

Finally, I believe our team is best-in-class, and I hope we have demonstrated that over the past 3 years. Spirit is much stronger and a better positioned company than just a year ago, and our team, portfolio and platform are in a great position to create the value we outlined at our Investor Day. I'll just end by saying, if you attended or listened to our Investor Day in 2019 and you like the Spirit story and the value creation opportunity, then you should really like it now. With that, I'll turn it over to Mike. Mike?

Thanks, Jackson. We compounded the growth that began last quarter by more than doubling our capital deployment volume during the fourth quarter, which increased annualized base rent by $29 million, slightly offset by accretive dispositions for a net increase of $26.3 million. Fourth quarter rental income, which included base cash rent of $117.9 million, increased $15.5 million to $128.4 million. The increase was driven by acquisitions completed in both the third and fourth quarters and recoveries of prior period cash rents of $600,000 in the fourth quarter compared to write-offs of prior period cash rents of $2.9 million in the third quarter. Net recoveries this quarter versus prior quarter losses reflect the better cash collections trajectory we're continuing to experience.

Other income was very small this quarter, contributing only $68,000 to earnings. As I mentioned last quarter, our 2 remaining mortgage loan receivables totaling $29 million were repaid in full, greatly simplifying our income streams. Going forward, other income will primarily be generated by our one remaining direct financing lease, interest income on invested cash and any lease termination fees. Property cost leakage, defined as unreimbursed property costs as a percentage of base rent, improved to 1.9% in the fourth quarter compared to 2.7% in the third quarter and 4.1% in the second quarter. We target 2% as our long-term average run rate.

This improvement was driven by the continued stabilization in our tenant's operations and balance sheets, enabling them to pay current on their lessee obligations, such as property taxes. Core G&A remained low this quarter at $12 million, and we reported $48.4 million for 2020 or $4 million less in 2019. We do expect that G&A will moderately increase in 2021 due to a normalization of travel, office expenses, performance compensation and additional ESG initiatives.

Finally, while modest, I do want to point out that our income tax expense was a positive $133,000 this quarter, versus a normal run rate expense of around $150,000 due to a onetime tax liability true-up related to the termination of our external management agreement with SMTA.

Now I'll turn to everyone's favorite topic, rent collections. As Jackson mentioned, we collected 94% of our base rent during the fourth quarter or 98% excluding theaters. And that collections rate was very steady over all 3 months of the quarter. We've also seen an uptick in January, with cash rent collections currently standing at 95%, but we believe that percentage may go higher. Please note that our collections metric does not include any recoveries from prior quarters or any repayments of deferred rent.

Regarding movie theaters, we recognized in earnings $2.3 million of movie theater rents during the fourth quarter out of a base of $6.6 million or 35% of movie theater ABR. Of that $2.3 million, we collected 44% in the fourth quarter, a slight increase from the 40% collection rate we reported during the third quarter. We have not placed any additional movie theater tenants on cash recognition.

For the year, we deferred $31.9 million in rent, of which $5.6 million was deemed not probable of collection, or said another way, was not recognized in our earnings. We also abated $6.3 million of rent. During 2020, we received $6.1 million in deferral repayments and ended the year with a deferred rent receivable balance of $20.2 million. Our deferred rent balance is primarily comprised of 4 industries: 20% movie theaters; 18% health and fitness; 18% casual dining; and 16% entertainment.

During 2021, we expect preferred rent repayments of approximately $12.9 million and expect to incur additional rent deferrals, primarily through percentage rent agreements with certain movie theater tenants. While the actual amount of those deferrals will depend on each tenant's 2021 revenues, the maximum amount of those deferrals as currently structured, would equate to $9.2 million. We've also currently agreed to abate $1 million rent during 2021.

Given the stability in our tenant base and rent collections, with the remaining area of recovery primarily confined to movie theaters, we are returning to our pre-COVID operating metrics to report on tenant health. As such, you will see in this morning's reporting materials, the inclusion of lost rent, which is a percentage of contractual rent that we deem not probable of collection.

For the fourth quarter, our lost rent was 3.4% or 1% excluding movie theaters. The delta between our fourth quarter cash rent collections of 94% and base rent is the 3.4% of lost rent, 2% of recognized rent deferrals and 0.6% of rent abatements.

Now turning to the balance sheet. During the quarter, we entered forward contracts to issue 6.4 million shares at a weighted average price of $36.85 per share. Also during the quarter, we settled 8.9 million shares under forward contracts, resulting in net proceeds of $310.9 million. As of year-end, we got unsettled forward contracts for 4.1 million shares of common stock. We ended the year with corporate liquidity of $1 billion, leaving us in a great position to start 2021. Our credit metrics also improved from the third to the fourth quarter. Leverage declined from 5.6x to 5.3x or 5x pro forma for the unsettled forward equity. Our fixed charge coverage ratio rose from 4.2 to 4.4x, and our unencumbered asset ratio improved from 2.6 to 2.8x.

As a result of our conservative balance sheet and stabilized operations, we received 2 outlook changes from the rating agencies, including an outlook upgrade from negative to neutral from Fitch and an upgrade from neutral to positive from Moody's. We are very pleased with both outcomes. Regarding our upcoming maturities, we paid off our 2020 term loan in January and anticipate paying off the convertible notes when they mature in mid-May. After the convertible notes maturity and excluding our revolving credit facility, we will have no unsecured debt maturities until the second half of 2026.

Now turning to guidance for 2021, we forecast net capital deployment, which includes acquisitions and revenue-producing capital expenditures net of dispositions of $700 million to $900 million. We forecast AFFO per share of $3 to $3.10, implying a year-over-year growth rate of 2% to 5%. I also want to note that we are maintaining a higher lost rent reserve in our forecast this year, which we believe is prudent to have further clarity around the economic recovery, COVID vaccine rollout and government stimulus.

And finally, I just want to reiterate what Jack said earlier, that Spirit is in a better position now than we were a year ago. And while our earnings growth was stunted last year, I believe we will recover very quickly and ultimately provide shareholders with the value creation that we originally laid out at our Investor Day. So with that, I will turn the call back to the operator to open up for Q&A. Operator?

(Operator Instructions) Our first question is coming from Haendel St. Juste of Mizuho.

First, I guess, is on rent collection and deferrals. How much of the 3.4% of lost rent is reserved against? And did you move any tenants the cash basis in the fourth quarter or January?

Mike, do you want to go ahead?

Yes. So all of 3.4% of loss rent is reserved against. And we didn't have any material changes in terms of tenants moving to a cash base in the fourth quarter. But I can't think of any that actually moved in the fourth quarter.

Okay. And the $1 million of abatements that you mentioned in 2021, can you give us a little bit of color on maybe what (inaudible) coming from? And is that $1 million included at both the upper and lower end of your guidance range this year?

Yes. The $1 million is in all the ranges, is in the upper and lower, and those are set. That's going to be permanent in the theater industry, and those are just abatements that we exchanged for lease enhancements.

Got it. Got it. And then on moving theater (inaudible) in 5% of rents here. I'm curious if we should read into your comments that you would be more willing to transact in this sector and perhaps engage with some of the larger national operators, and how should we think about that 5% of exposure there? And I guess as part of that AMC, having recently done some recapitalization. Just curious on your level of comfort with not only the sector, but larger national operators like AMC?

Yes. Maybe I'll take that. Haendel, it's Jackson. So yes, I'd say more than likely, our theater exposure will not increase in the short term. We're still trying to make sure we work with our diverse portfolio of operators. I did see the AMC reference. I can't really comment on it. Obviously, if it went through, it would be great. But the other anecdotal information that we saw last weekend was in China on the opening weekend of Chinese New Year, they did tremendous amount of business out there. It was $775 million of revenue. So it's -- the theaters are doing well in China. And obviously, they're handling the pandemic quite admirably in terms of containment.

In China, they're still booking seats online and things like that. So people are going to the theaters, and they're not really seeing any new big content. It's all to be more local-driven content. So as my comment said, people are going to go to the theaters. And with the stimulus that's been put through main street lending, and hopefully, our Save Our Stage grants -- and those grants, by the way, those $10 million grants are just grants. They don't have to be repaid. We think that's going to give both our regional and nationals the time. Obviously, the national operators don't get that $10 million grant. But we think they're going to get the time to be able to get that content that's on shelf to come out. So I'd say to answer your question, I don't see any new net investment in theaters for us in the short term, but we'll evaluate it as time goes on.

Our next question is coming from Vikram Malhotra of Morgan Stanley.

Just maybe, Jackson, you talked a lot about sort of the goals that you had set out for the year. And as you look back, you've achieved most of them. I'm just wondering, given sort of the push in acquisitions, the hiring, as you look into the next year or 2 and given the hiring you've done on the acquisitions team, what areas are you sort of focused on that were maybe similar to what you were doing pre COVID? And then can you talk a little bit about where you're making changes in terms of either property types, geographies and just maybe even if there's any changes in the approach?

Sure. Well, first on the -- let me just spend a minute on -- what -- on how we're doing the business as it relates to the current team. That realignment that we talked about with Ken, in practice, that started to happen in the middle of last year, as we restarted our investment or investment process, again, after the second quarter, I brought Ken into the acquisition pipeline meetings as well as Travis. And so they were integrally involved in just even the formation of what we're going to pursue. As you remember, a lot of our acquisitions people were also working on rent deferral. So Danny was running one of the asset management teams. And it just became really clear as we continued on that process that this was like a natural move to have Danny do what he does best, which is asset management and build those client relationships with our existing tenant base and Ken's leadership on the investment side to make that final shift, as we talked about moving him into the Chief Investment Officer role.

So I want to make sure people understand that we've been doing this already for a good half year this past year. So it just was a natural adjunct. In terms of investment approach, you've heard us talk a lot about our sweet spot being public tenants in the single B, BB area. We put that slide, if you get a chance to look at it later, I think it's Slide 8 in our investor deck, it talks about those top 20 public tenants in the Spirit portfolio.

But the other interesting stat is if you looked at our publicly owned tenants and looked at it compared to 2017 in the second quarter, and if you remember, that was about 37%. Shopko, surprisingly, was our #1 tenant back then. Today, we're at 51% in terms of public ownership. And we love that because that's permanent capital, that's tenants that delever. So as we think about our investment approach, we're looking at not only good real estate, good credit, but we're looking at tenants that can benefit from positive uplift, so to speak. And that's why we really love that page on Page 9 that talks about these credits on the move. And if you look at that page, that's 19% of our contractual rent, if you look at that. And just read the little comments and see what's happened. It's quite good, to be honest with you, and that's what we -- and it wasn't luck, it was very deliberate and intentional on our part. So we think that, that continued work on focusing on the heat map, focusing on real estate rankings, focusing on credit, being really deliberate about our asset allocation is going to pay off. And then I think finally, and this is a long-winded answer. But if you just look at our investment in the fourth quarter, our average investment size is about $4 million, right? We did 99 properties, if you do the math. But the range of asset that we acquired was $1 million to average -- up to north of $30 million in terms of size. So there was a lot of diversification within the portfolio. If you look at the average deal size, transaction size for the year, it's kind of right around $30 million, so -- if you look at the math. So we're going to continue to try and build diversity, be very focused on these industries, very deliberate. And just sort of do the business, I don't think we have to do very much organizationally this year, just add a couple more I'll call it, junior level support into that team to support Ken and would be in good shape.

Okay. Great. And then just to get your sense of sort of the earnings power of Spirit in a post-COVID world, you mentioned the balance sheet is in a better position versus pre COVID. So can you touch upon -- sort of where would you like sort of leverage to be on a 12, 18-month period? And then if we think about a target for, say, cash flow growth, (inaudible) target, but the ability to grow AFFO from here on, on a multiyear period, do you think there's a change in that range in terms of what Spirit can achieve?

Well, I'm going to let -- I'm going to -- before I pass it over to Mike to answer some of this, one thing I would just say is the portfolio is very stable. And I don't know if we could have said that 4 years ago, it was more challenging. We have a very, very stable tenant and portfolio base. So you have to have that as a starting point. And then we also have the benefit of the portfolio is improving, right? Like credits are improving. So that's a really good thing. Then it's simply just acquiring and acquiring with -- acquiring assets where there's "no surprises". And one thing that we did in 2020, we had no -- we had one deferral request in -- from the acquisitions that we did in 2020. And that deferral request was ultimately retracted by the tenant. So they're all current on their obligations.

And if you keep doing that and you sort of are deliberate about what you do and you finance it appropriately, yes, you can really -- this is a really powerful earnings machine. And Mike will go into the nuance of the movie theaters, which I've told you that they will come back and we expect them to really help us, as we move on through the course of the year. I don't know, Mike, if you want to add on to some...

I'll add on a couple of things. Let me start with the balance sheet. I mean, as Jack said in the portfolio, we have a very stable base, I think our acquisition strategy is going to produce a lot of growth. I think that's the key. I mean, if you look at us today, we can produce AFFO growth. And our cost of capital is not as good as a lot of our peers, but we still produce that growth with our acquisition strategy, we get good yields. So our balance sheet will continue to improve. I mean, you saw the ratings actions in the last couple of quarters. I believe that with Moody's, we were only 1 of 2 people in their universe that they rate, that they took a positive ratings action on a lot -- since COVID hit. So it's pretty impressive. But we're going to continue to improve. And our cost of capital is going to continue to improve. So I think that's a different. I think we can produce AFFO growth today with our existing strategy comparable with all of our peers. But as our equity multiple catches up, which I think it will, as people see that growth. And our cost of debt continues to improve with continued ratings improvement, continued size, build of the company, that's -- our spreads are going to continue to compress on our bond side. You've seen that materially over the last couple of years. All that's going to continue to widen the investment spreads we can get, which will accelerate our growth.

And when I think about our balance sheet, and I think about this every time we issue (inaudible), it's cheaper and cheaper, and I look forward. We saw some legacy pieces of paper in our capital stack. We have these converts coming due on May 15. And when I started as CFO about 3 years ago, those seemed pretty cheap. Today, 3.5% (inaudible) seems really expensive for us. And I think forward, we have CMBS debt still on the books at over 5.5%. We have preferred that we issued at 6% cum-callable next year in 2022. And so I start thinking about it with our -- even our current cost of debt, we could -- those are very accretive refinancing opportunities that we have today because our cost of capital has improved so much, and that will continue to improve more. So I think that's a big thing that Spirit has that our acquisition model works to grow AFFO and our cost of capital continue to get better.

And then on theaters, as Jackson mentioned, look, we've taken a very conservative approach on our theater revenue recognition, I think more conservative than some. And that really leaves you a lot of upside. When you look at our Q4 numbers and you know that 70% of our theater revenue is not in there. And knowing the diversification of our theater tenant base, it was very diversified, lot of regional operators that are getting a lot of government stimulus and are actually in pretty good shape. There's a lot of upside as those earnings return. We're not kind of thinking on those today. And so I think when you just take all that into account, I think it's a very good multiyear growth trajectory for Spirit that could really surprise people.

One last thing I'll add. You talked about years to come, and I think that ultimately -- and Vikram, you know in my former career, before I came to Spirit, I was on the banking side. So it was all about trying to solve clients -- really trying to work with clients' objectives and try to help them. What we do here at Spirit -- and as we kind of continue to align our organization with our tenants, our tenants are our partners, right? We want to really help them grow, that conversation is happening now. We're doing repeat business with existing tenants. It's a very powerful advantage for us, not just from a predictability standpoint, as you kind of map out the future in terms of our acquisition pipeline, but how we can shift the allocation of the portfolio.

And [NNN] does it as well as anyone. And so we are trying to aspire to do it that way. And I believe we have the right people in place, processes in place. We're still not there yet. I think we're really gaining a lot of momentum. But that's when we really pull that piece of the puzzle together, you're going to see some tremendous earnings acquisition power of the platform.

Our next question is coming from Harsh Hemnani from Green Street Advisors.

Just talk about the industrial deals this quarter, about half of the deals here that were industrial. And so I'm just trying to understand your appetite for the property type going forward, given all the capital saving [it] right now. So what kind of cap rates you're seeing? And are you still looking to acquire it going forward?

Yes. I would say, yes, the answer is yes, Harsh. We still -- we do have an appetite for industrial. We will do more. We're not going to -- we don't have a particular target in mind. Part of this -- of what we're doing is trying to find the best risk-adjusted returns for our capital, right? So it's going to fluctuate. I mean it was obviously high this year, this past year and high -- particularly high in the fourth quarter. But what I would tell you is it's going to continue to moderate going forward. We still like a lot of the industry -- we still like what we do with the -- in terms of the other industries that we invested in like gyms. You saw us do health and fitness. We're absolutely excited about what we did with Life Time and we did another property on the high volume, low-cost operator side.

So yes, we're -- I wouldn't say there's any new shift in what we do, but industrial has been -- we talked about it for a while, and we've continued to increase our investment activity, and that's going to be an important part of what we do. I think the piece of the puzzle that's a little bit different and nuanced for us is the type of industrial properties that we're buying, they tend to be long-dated direct sale leasebacks with fixed escalations. We're not buying multi-tenant industrial. We're not buying industrial value add. That's not really -- that's not in our wheelhouse, where we think we can add value is really understanding kind of the credit profile and upside of a particular tenant. And hopefully getting in at a very good basis with a long-term lease. And we've already seen that in some of our industrial acquisitions where we've seen real credit upgrades, and that's a big positive for us. So I'd say that our industrial is a very narrow defined lane right now. We're not competing, I would say, with the broader-based -- some of the broader-based value-add and core industrial buyers right now.

And then on the health and fitness side, you talked about the lifestyle deal a little bit. And obviously, we haven't seen a lot of public market capital flowing towards the health and fitness [probably] type. I was just wondering, how is the bidding process there? Was there a lot of competition? And what kind of cap rates you're seeing on that property tax, you can share that?

Yes, I'm not going to -- because -- what I can tell you on that particular transaction that we talked about it being a direct -- Life Time was a direct deal, there was no broker, right? So they had a desire to do something by year-end. We had similar desire. We know these properties well. We know that credit well. What's great about what they do, all of their facilities are open today in the United States. They have a very, very unique business model, it's almost like country club like. And in terms of their data, the data that they have on who's coming into their gyms, who got COVID, if they did, they're -- it's very impressive data, and it's not -- there is -- they're very, very safe. And what we like about them is they've been able to adjust their business model to be very profitable, even with some of the space constraints that were put upon them by different municipalities. And I don't know like you, I can tell you about me personally, I really want to go back to the gym. I'm tired of riding telethon at home. It's really kind of getting a little bit of annoying.

So I believe that people will vote with their feet when they can. And not all operators are going to do well. We really like Life Time. We -- like I said, we made an investment in the fourth quarter on a high-volume, low cost operator, which is equally going to be super successful, we believe. So yes -- no, we still are very favorable in that industry because we believe that the COVID vaccines are going to eventually get us back to some of -- normalcy.

And in terms of cap rates, I would just say they were wider than a year ago, stayed the obvious, from an investment standpoint. So we also thought that, that was kind of an interesting time for us to make those investments. And we believe there will be cap rate compression in that segment as time goes on this year.

Our next question is coming from Ki Bin Kim of Truist.

In terms of your 2021 guidance, the $2.3 million of movie theaters that you are currently booking, recognizing revenue, what is implicit in [2021] guidance?

Mike?

Yes. We won't be digging too much in the details, Kim, but I can tell you, it assumes a modest -- a very modest recovery in the back half of the year. And so said another way, it would -- that recovery trajectory will have some impact on the low and the high end, but it will not make or break our guidance. As normal in a normal year, our guidance is going to really hinge on our acquisition volume timing and cap rate.

Okay. And in terms of acquisitions and dispositions, can you just provide a little more details in terms of like cap rates on your acquisitions and disposition? And for acquisitions, what type of assets you're targeting?

Well -- Kim, this is Jackson. I mean I think for us, I think it's going to look a lot like what it looked like in the fourth quarter. We usually talk about trying to target somewhere between a high 6 and 7 going-in cap rate. And that's going-in cap rate, not economic cap rate, right? Because most of our deals have very elongated lease terms with escalations, so the yield is much higher, but economic yield.

But I would say, if you look at our heat map, we're just going to continue to do what we do. I think one of the things that's interesting about Spirit, if you look at our top 5 tenants from a percentage of total ABR or contractual rent, I mean, they're right on top of each other. There's very little spread in terms of like 2% to 3% -- 2.5% to 3% of ABR in that top 5 tenancy. And if you go down the top 10, sort of similar. I think there's like 100 basis points of difference between the tenth tenant and the largest tenant, Life Time Fitness. So what I would tell you is our top tenancy is going to move, just given as we deploy and move and we're not going to tell you exactly what they are right now, but we will in time. But it's -- the industries are -- if you look at our heat map, we're pretty disciplined. It's all pretty transparent there.

So look, we look forward to doing more car washes. I think you'll see us do -- continue to do industrial, light manufacturing, you'll see us hopefully do more casual dining. QSRs are challenging because of the pricing, but we think there's going to be some interesting casual dining opportunities. We love health and fitness. We love the sporting goods area. We love warehouse. Our warehouse clubs At Home, love those guys, right? We've continued to do more At Homes. It's such a good story. And so a lot of the things that we had acquired have been real beneficiaries of COVID. And as we come out of COVID, we'll shift some of that allocation into more, what I'll call real estate that relies on high-touch aggregation of people right now. So you'll see us make that shift as the year goes on.

Our next question is coming from Wes Golladay of Baird.

I guess, a question on the capital allocation. Is it a fair assumption to say that you're willing to move up the risk curve for a certain segment of which you're going to allocate this year? Or I guess, do you view as maybe not as higher risk based on the quality of the real estate. And I'm looking specifically at the Life Time Fitness, I see it's been under pressure from the rating agencies, but maybe you could talk about the quality of the real estate.

Sure. I mean, to us, like Life Time, it's such a unique business model. It's -- if you look at the size of those facilities, they will be -- they will do what they do because there's demand for those facilities, right? And the way we think about it is credits can change, obviously, given different exogenous events that occur outside. And so even if there were a deterioration on the credit, I'm not saying specifically Life Time, but just to use them as a hypothetical example, that facility is going to still be what it is today. The credit may change, the credit may recalibrate, restructure and if it did, it would still be what it is. Because once again, there's demand for those facilities. And to me, what we really focus on is what is the demand for this particular unit type? Does it have the ability to go through different economic cycles, i.e., 20 years at a minimum, right? And we believe that like facilities like that, have the consumer demand backdrop to kind of propel them for the next 2 decades.

So if you have that, you're going to get through it, whether a credit changes or not because things do happen in an economic -- as you go through different economic cycles. So that's an important part of the discussion that we look at when we make an investment like that. So it's not just good real estate, right? Obviously, real state is really important. So that's also a consideration. But when you look at the long-term demand, consumer demand, that's really what it really comes down to. And the barriers to entry for those types of facilities, and it's really difficult to replicate that. So we think that -- we're very confident about their abilities. And yes, there may be shorter-term credit downgrades and things like that. But long term, we think the viability of that unit, the operator, that location, because of all that consumer demand coming on the top line will support it.

Yes. Maybe...

And in terms of other risk, we don't consider ourselves risk taker. I mean we're buying very long dated, steady assets. And if you look at our portfolio -- I mean, look, we used to get a lot of comments on quality of the portfolio. It is not a risky portfolio, what we have today. And we're not going out on the risk curve. That's not -- that's why when we focus on that 7 or high 6 going-in cap rate, we think we're taking adequate risk-adjusted -- making risk-adjusted benefit -- investments based on our cost of capital. We start to go for a higher yield. Obviously, there's (inaudible) better return, but the higher the far rates start to come into play. And obviously, we're not in that low 6 area, which is (inaudible) investment grade. So we think we -- our sweet spot, we think we understand it. We know what -- we've got history behind it, and we're going to sort of stay in that lane.

Got it. I guess maybe another way to frame the question, looking at your Slide 9, you obviously had a lot of credit improvements. And there are some -- maybe some tenants that are -- when the rating agencies look at them, maybe a little bit higher credit, but maybe you see improvement. And to be fair to the Life Time looks like even the rating agency say that credit is likely to improve over the next few years. So do you see opportunity to invest in stuff that you see will make it to Slide 9 over the next, call it, year or 2?

Absolutely. Absolutely. If you were sitting in our investment process, that's a huge part of what we talk about. I look over to Dave Wegman, I look at Travis, Ken. We're making real estate decisions, but the credit is huge. And it's not just the current credit, what would the credit be? And obviously, we have the hindsight of COVID. So without getting specific, I can tell you that the things that we invested in 2020, if those tenants had closed for business, you should assume that we were able to get structured protection for us in the event those facilities had to be closed, and so there was no rent disruption for us.

Got it. And then can you talk about what is the embedded bad debt reserve in guidance for this year and then maybe what it was for the fourth quarter 2020?

So historically, we talked about this back at our Investor Day, we typically have a 1% lost rent reserve built into our forecasting. We took -- we've taken that up in our guidance for 2021, excluding theaters. That's a whole another animal. So ex theaters, we've taken it up over 50 basis points that we're running. It's embedded in our guidance at the midpoint, right? So you can flex that up or down, low or high.

And then you have theaters, again, we just -- we assume -- I mean, you know what we did in the fourth quarter, we recognized it's pretty stable. And then we have a moderate recovery in the back half of the year. So that's the best way to kind of -- to model that out and think about with our portfolio stabilizing. So a little higher reserve and very modest recovery on theaters built in there.

Our next question is coming from Brent Dilts with UBS.

This is Upal in place for Brent. Most of my questions have been answered already, but I was wondering if you could provide any detailed metrics, (inaudible) around the industrial assets you've acquired in the fourth quarter? Anything around yields, cap rates, location and the types of the underlying tenants?

I mean I would say that a good number of them were public tenants. A good number of them -- the thing that's interesting about our industrial acquisitions, without getting into super detail on the names of the tenants, the facilities could be smaller mission-critical facilities, i.e., $4 million size to $30 million size facilities, but they all sort of have a common theme to them. We really believe in the fundamental underlying credit behind them. We believe in the long-term prospects of the industry that they -- in (inaudible). We think that the facilities that they operate in that we've acquired are pretty mission-critical for them. We think that the basis per square foot makes sense as it relates to -- we had to release that facility. And we generally think that of all of the buildings that we're buying, they are straight up industrial buildings, sheds, right? So that's -- but the other fundamental attribute is that they generally all have long-term leases. I mean, we are not buying things to re-lease value add. These are really critical facilities for good tenants. And all they want to do is just pay us rent and run -- do what they do. And we support -- those are the kinds -- that's how I would describe the layout in that portfolio.

Our next question is coming from Linda Tsai of Jefferies.

Any thoughts on growing the dividend in 2021? Should it mirror low to mid-single-digit AFFO growth you outlined?

Mike is smiling right now. So I'm going to let him take this question.

Yes, Linda, we actually talked about this back before COVID hit. Actually, I think it was our Q4 '19 earnings call in February last year. And our goal is to get to a 75% AFFO per share payout ratio (inaudible) dividend. So I think is that achievable in '21? It's obviously -- that's not what our guidance states. But again, there is upside in theaters, some of the things that could drive us there. But yes, it's not that far away. I mean, certainly, when I think back to where we were at Investor Day and the forecast we were talking about then and kind of the time line to hitting that 75% payout ratio and growing the dividend, it feels like we're kind of at that point again. So I think it's definitely near-term whether it's '21 or not, I'd say not impossible, but we'll see.

And then in terms of the 1.5% rent escalators, does this vary across industry type in terms of retail distribution or manufacturing?

Ken, do you want to take that, Ken? I'll add you?

Yes, I couldn't hear the question.

Oh, the 1.5% rent escalators variation across retail distribution or manufacturing.

Well, what I would say is all the acquisitions that we're looking at now tend to have, obviously, rent bumps escalators in them. Industrial, you're going to lean in more to the upside on that in the 2%, maybe even a little more. So the industrial escalations tend to be a little higher than the other -- the retail type of escalators. But that's an important feature in what we look for in all of our acquisitions. Does that answer your question?

Yes. And then just the last one on ESG initiatives. What's the focus as it relates to ESG? And what are some key benchmarks you're working towards?

Well, I think when you -- when our proxy comes out, you'll see some commentary on some of the rating improvement. I'll focus on [us] for a minute. We did a lot of things during COVID actually, which was really -- I'm proud of. We had a company-wide diversity symposium. We had an outside consultant come in. We invited our Board to participate. And really, the purpose of it was to talk about implicit bias. It was a great day. We were able to do it on Zoom. And like I said, it was moderated and participatory by the whole company. We, since then, created a diversity initiative committee and they are moving forward with some initiatives this year for the company, diversity. And then for -- on the women's side, we have done -- we've created -- we've really made a big effort to try to instill gender diversity as well as ratio diversity within the company. So we have an initiative there as well.

On the [E side], it's a little bit harder for us just given the nature of what we do. We're not developers. We are capital providers, and sometimes we are doing takeout financing, and we're looking at different ways where we can advance the E side of what we do. But I can tell you on the social side, we are very, very active and committed as a senior leadership team, and that goes down throughout the organization.

So (inaudible) during COVID we tried to find ways to -- interesting ways to bring the company together, have more fun, do things together. And I think that's really helped build our community just within our company.

Maybe just as a follow-up, when you underwrite acquisitions, do you look at the resiliency of the buildings you're buying?

Absolutely. Well, Ken, why don't you take that, Ken?

Yes. No, no. (inaudible) will be absolutely. We've talked about it before. We feel like we have a very nuanced property ranking model that every single acquisition we do. That's one of the first steps when we're -- in the early stages when we're still exploring the opportunity is we have the asset management team put every potential property through our property ranking model and a big piece of that model is specifically that, is the building and the real estate that the building sits on. So yes, it's absolutely an ingredient in our acquisitions and underwriting.

And one last thing, Linda, 50% -- our organization is almost 50% split gender, just so you know.

Our next question is coming from Joshua Dennerlein of Bank of America.

Ken, congrats on the new role as COO. Just I'm kind of curious to hear your early thoughts on how this new structure will help sort of see accelerated acquisition growth in the coming years? And maybe also how you think you'll spend most of your time under this new structure?

Thank you very much. I would say I'm going to be spending a lot more time working with our acquisitions team. As Jackson mentioned, Danny -- we're very fortunate. Danny can come over and really focus on a very important initiative for us, which is continuing to grow with our existing tenants. Through COVID, we -- one silver lining, if you will, was how close we got to our tenants. So we know exactly which tenants that we like, which ones we want to grow it, and we're doing that.

In the fourth quarter, over 40% of our acquisitions are with existing tenants. So that's just kind of a start. But I would say that a lot of my [time] will be spent on the acquisition side. We've made a lot of improvement to our processes. We'll continue to do that. And I think -- and we're laying the foundation of the targeted sources that we want to do business with, which is not just our existing tenants. There's other targeted sources that we feel like we've got the flywheel spinning, and we're in a position now we can put a lot of focused time on building those processes.

Yes, Josh, I would just add one more thing, Josh, on that front. The exciting thing, I can tell you without being specific is essentially when tenants get through COVID, the next thing they say is, you guys are really good to work with. I got this new idea. I'm thinking about doing this and when we can get in early in that conversation, this might be -- I want to acquire this other operator. How do I do that? What can you do for me? And if you go back to listen what we've said in the past in terms of some of our values, when we do what we say for a tenant, that goes a long way because I think that while people talk about cap rates going down and people buying, it's -- people want certainty, especially on the operator side. They want to know who's on the other end, if I get into trouble or I need capital or I see a fantastic opportunity, I think they're going to make different decisions about who their financing -- who their financing partners are going to be going forward. So I think that's the silver lining. Those conversations have accelerated a lot recently, and I think we'll only continue to accelerate as the year progresses with our tenants. So I'm excited about that.

Our next question is coming from Greg McGinniss of Scotiabank.

Jackson, lots on COVID so far. So probably just one question for me today. But -- Spirit had a busy fourth quarter, a productive year despite the pandemic. You're expanding the acquisitions team, and I'm not trying to take away from the strong 2021 guidance at all. But what prevents you from being more bullish on net investments? Or if we might consider the target to be -- I don't want to say conservative, but maybe the high end of the range is very reasonable if the transaction market doesn't shift much?

I think what would change it would be -- we're very disciplined about this allocation. We're very focused on industry allocation and concentration and diversification. So I'd say that's one thing that could change it. I think the second is, look, I've said this in the past, there have been some interesting portfolios that we looked at last year, one in particular where we weren't successful. We're always looking at -- we have the ability to kind of size up the big portfolios, given our technology tools quite efficiently.

So if we did a larger portfolio, that would obviously impact the current guidance that doesn't -- current guidance for next year. But this year doesn't assume any portfolio acquisitions. So that could kind of move the needle a bit.

So yes, look, we're open for business, and we're going to keep -- so -- but I think this is a reasonable range that we put out there, and we feel good about acquisition side [wise.]

Okay. And I guess I lied, actually, I do have a follow-up. What's a reasonable level of dispositions to assume within the net investment guidance? And do you anticipate harvesting more of those kind of lower cap rate assets that we've seen you sell over the last couple of quarters?

Well, I think, first and foremost, what we -- and I'm going to pass it to Ken. Like we -- remember that we talked about this proof of concept. So when we decided to structure our disposition program last year, 2020, it was in depths of COVID, right? So we wanted to have a proof of concept. This year, you might see some -- there's some pretty -- Ken, I'll take thunder from you, but there's some real cap rate compression in some parts of our portfolio right now that we're evaluating.

Yes. It's what -- the level of inbound, unsolicited inbound inquiries into our existing portfolio has been interesting. It's definitely elevated. But what -- a couple of things I would throw out is we like to look at our acquisition to disposition ratio at 6:1, 10:1, somewhere in that range. So I would say that dispositions are always going to be a smaller ingredient based -- just simply based on that ratio that we're kind of targeting. But we do believe dispositions are really important for portfolio shaping. So throughout the year, it's still early, we will identify both risk mitigation dispositions, and we'll identify opportunistic or offensive dispositions that make a lot of sense when we're getting some compelling inbound inquiries. But at the end of the day, what I would suggest is it's much more focused on acquisitions.

Our next question is coming from Chris Lucas of Capital One Securities.

Jackson, just one question for you. The high-yield market has been incredibly liquid, I guess, to say it. It certainly helped some of the liquidity for some of your tenants over the past several months. I guess my question is, does the aggressive yields and financing availability in the high-yield market act as a potential competitive source of funds for those companies relative to sale leasebacks? And is that a concern of yours at all?

It's certainly something that when we talk with those types of tenants is on their menu as they look at their most efficient way to finance their business. I guess the way I would describe it is, we can fit and we can be very complementary to the high-yield market, especially as some of these companies look at acquisitions, particularly in that business, where they're looking at sale-leasebacks, high yield, leveraged loans, that's not the main part of what we do. But for sure, like, look, lower leveraged lending spreads do affect our cap rates, that's for sure. But then I think there's still -- like I said, our sweet spot is $500 million in revenue, $500 million to $1 billion in terms of a company's revenue. So while spreads have tightened, they haven't really compressed dramatically in this area. But I would tell you like, we -- it's not as aggressive as it was, cap rate wise, for what we're looking at, as I would say, last year this time, but we watch it carefully. And we think it can be complementary at times for us as well.

At this time, I'd like to turn the floor back over to management for closing comments.

Okay. Well, like I want to just once again -- I'm very proud of our entire organization, the senior leadership team, the Board. We are in very, very good position to move forward this year. And I'm very excited about the company's prospects. So look forward to meeting many of you next week at the upcoming conference and look forward to your continued support. Thank you.

Ladies and gentlemen, thank you for your interest. You may now disconnect your lines and log off the webcast, and have a wonderful day.