Essential Properties Realty Trust - Q4 2023

Transcript

Operator (participant)

Welcome to the Essential Properties Realty Trust's fourth quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. This conference call is being recorded, and a replay of the call will be available two hours after the completion of the call for the next two weeks. The dial-in details for the replay can be found in yesterday's press release. Additionally, there will be an audio webcast available on Essential Properties' website at www.essentialproperties.com, an archive of which will be available for 90 days. On the call this morning are Pete Mavoides, EPRT's President and Chief Executive Officer; Mark Patten, EPRT's Chief Financial Officer; and Rob Salisbury, EPRT's Senior Vice President and Head of Capital Markets.

It is now my pleasure to turn the call over to Rob Salisbury.

Mark Patten (EVP, CFO and Treasurer)

Thank you, Operator. Good morning, everyone, and thank you for joining us today for Essential Properties' fourth quarter 2023 earnings conference call. During this conference call, we will make certain statements that may be considered forward-looking statements under federal securities law. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to those forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings press release. With that, I'll turn the call over to Pete.

Pete Mavoides (President and CEO)

Thank you, Rob, and thank you to everyone joining us today for your interest in Essential Properties. We finished 2023 with a strong $315 million of investments in the fourth quarter and just over $1 billion invested for the full year. This translated to AFFO per share growth of 8% in 2023, which we are proud of given the industry backdrop of heightened volatility in the capital markets and wider bid-ask spreads in the transaction markets, serving as a testament to the resilience of our differentiated investment strategy and variable portfolio. As the fourth quarter results indicate, our portfolio continues to perform at a high level, with unit-level rent coverage of 3.8 times, occupancy of 99.8%, and same-store rent growth of 1.5%.

The overall health of our portfolio is a result of our disciplined underwriting process, which focuses on growing operators in durable, service, and experience-based industries and owning granular and fungible properties that generate strong cash flow for these operators. By underwriting and focusing on all three risk factors associated with net leased real estate investing, corporate credit, unit-level performance and lease risk, and real estate basis, we're able to construct and own an exceptionally durable portfolio of properties. Regarding our strong and consistent year of investments, we remained active in support of our longstanding tenant relationships as they increasingly turned to us as a valued and reliably consistent capital provider to grow their businesses given the limited funding availability in the bank market and the continued dislocation in the credit markets and the diminished level of competition from other net lease investors.

With quarter-end pro forma leverage of 4.0x and liquidity of nearly $800 million, our balance sheet continues to be well capitalized for continued investment activity as we look to aggressively capitalize on these trends that are creating the opportunity to generate historically wide risk-adjusted returns. We are affirming our 2024 AFFO per share guidance of $1.71-$1.75, which implies year-over-year growth of 5% at the midpoint. Turning to the portfolio, we ended the quarter with investments in 1,873 properties that were 99.8% leased to 374 tenants operating in 16 industries. Our weighted average lease term stood at 14 years at year-end, which is consistent year-over-year, with only 4.7% of our ABR expiring through 2028. From a tenant health perspective, our weighted average unit-level rent coverage ratio was 3.8x this quarter, down slightly from last quarter, driven in large part by investment activity.

Our same-store rent growth in the fourth quarter was 1.5%, an improvement from 1.2% in the third quarter, driven primarily by positive leasing results and asset management activities, including at a gym operator that we discussed in our last earnings call. During the fourth quarter, we invested $315 million through 43 separate transactions at a weighted average cash yield of 7.9%, representing a continued increase in pricing power for sale leasebacks, as we noted on the last earnings call. Our investment activity in the quarter was broad-based across most of our industries, with no notable departures from our well-defined investment strategies. The weighted average lease term of our investments this quarter was 17.6 years, and the weighted average annual escalation was 1.9%, generating an average GAAP yield of 9.1%.

Our investments this quarter had a weighted average unit-level rent coverage of 3.3 times, and the average investment per property was $3.0 million. Consistent with a key tenet of our investment strategy, 97% of our quarterly investments were originated through direct sale-leaseback transactions, which are subject to RO lease form with ongoing financial reporting requirements. 72% contained Master Lease provisions, and 96% were generated from existing relationships. Looking ahead to the first quarter of 2024, we have closed $40.9 million of investments to date at a cash yield of slightly above 8, and our pipeline remains robust as an increasing number of middle-market companies are seeking sale-leaseback capital as a financing alternative as other sources of capital have become unavailable or uneconomic.

While we have capitalized on the dislocation in private credit markets generating heightened pricing power with favorable lease terms, we are cognizant of the potential for easing in the monetary policy over the course of 2024, which could alleviate financial conditions bringing with it a lower cap rate environment. Should our pricing power diminish later this year, we would hope to benefit from a commensurate reduction in our cost-of-debt capital such that our net investment spread is maintained. As a value-added capital provider, we're able to dynamically price our sale-leaseback transactions, which over time has afforded us the ability to generate investment returns in excess of market pricing. That being said, our current pipeline today suggests that our investment cap rates should be stable in the near term.

From a tenant concentration perspective, our largest tenant represents 3.8% of ABR at quarter-end, and our top 10 tenants now account for only 18.1% of ABR. Tenant diversity is an important risk mitigation tool and a differentiator for us, and it is a direct benefit of our focus on unrated tenants and middle-market operators, which offers an expansive opportunity set. In terms of dispositions, we sold 9 properties this quarter for $30.6 million in net proceeds at a 6.6% weighted average cash yield with a weighted average unit-level coverage ratio of 3.5 times. As we have mentioned in the past, owning fungible and liquid properties is an important aspect of our investment discipline as it allows us to proactively manage industry, tenant, and unit-level risks within the portfolio.

Going forward, we expect our disposition activity over the near term to remain relatively in line with our trailing eight-quarter average, driven by opportunistic asset sales and ongoing portfolio management activity. With that, I'd like to turn the call over to Mark Patten, our CFO. Mark?

Mark Patten (EVP, CFO and Treasurer)

Thanks, Pete, and good morning, everyone. As Pete noted, we had a great fourth quarter, which was punctuated by a strong level of $315 million of investments at a 7.9% cash cap rate. Among the headlines from the quarter was our AFFO per share, which reached $0.42. That's an increase of 8% versus Q4 of 2022. On a nominal basis, our AFFO totaled $67 million for the quarter. That's up $11.1 million over the same period in 2022, an increase of nearly 20%. This AFFO performance was in line with our expectations when we updated our guidance last quarter. For the full year ended December 31, 2023, our AFFO per share totaled $1.65 per share, which is an increase of 8% over 2022. On a nominal basis, our full year 2023 AFFO increased by 21% over 2022, totaling $253.4 million.

Total G&A was $7.3 million in Q4 of 2023 versus $6.5 million for the same period in 2022, with the majority of the increase relating to an increase in compensation expense. Our recurring cash G&A as a percentage of total revenue was 5.2% for the quarter and 5.9% for the full year of 2023, which compares favorably to the 5.8% and 7% respectively for the quarter and full year of 2022. We continue to expect that on an annual basis, our cash G&A as a percentage of total revenue will decline in 2024 as our platform generates operating leverage over a scaling asset base. Turning to our balance sheet, I'll highlight the following. With our $315 million of investments in Q4 of 2023, our income-producing gross assets reached $4.9 billion at year-end.

From a capital markets perspective, in the fourth quarter, we completed the sale of approximately $47.9 million of stock, all on a forward basis on our ATM program. Additionally, during the quarter, we settled $190.6 million of the forward equity we raised in September. At year-end, our balance of unsettled forward equity totaled $130.6 million. Our pro forma net debt to annualized adjusted EBITRE, adjusted for unsettled forward equity, was 4.0x at year-end. We are committed to maintaining a conservative balance sheet with best-in-class leverage and liquidity. At year-end, our total liquidity stood at nearly $800 million. Our conservative leverage, robust balance sheet, and significant liquidity positions the company well to fund our growth plans for 2024 based on the pipeline we see today.

Finally, the strong performance to end the year in 2023, our conservatively capitalized balance sheet, and the investment pipeline we're seeing all support our previously issued 2024 AFFO per share guidance range of $1.71-$1.75, which implies a 5% growth rate at the midpoint. It's also important to note that with the ATM equity issuance achieved this quarter, we do not require additional external equity capital to achieve our 2024 guidance. With that, I'll turn the call back over to Pete.

Pete Mavoides (President and CEO)

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

Operator (participant)

You will now be conducting a question-and-answer session. If you would like to ask a question, please press *1 on your telephone keypad. The question tone will indicate that your line is in the question queue. Press *2 if you would like to remove your question from the queue. Using speaker equipment, it may be necessary to pick up your handset before pressing the * keys. Please hold while we pull for questions. The question comes from Connor Siversky with Wells Fargo. Please press question.

Connor Siversky (Director and Equity Research Analyst)

Good morning out there, and thank you for the time. Quick question on the liquidity profile, understanding that a chunk of that $800 million in liquidity is really predicated on the revolver. I'm curious, with the robust pipeline you mentioned, how comfortable would you be letting leverage run towards the end of this year? And then what is the desired funding mix for each incremental acquisition between free cash flow, capacity on the forward, and the revolver?

Rob Salisbury (SVP, Capital Markets)

Mark, why don't you tackle that one?

Mark Patten (EVP, CFO and Treasurer)

You got it. All right, a couple of things. In terms of just kind of funding mix, generally speaking, we had been largely probably 60/40 in terms of equity and debt, but now with almost $100 million of free cash flow, that's probably more like 60 equity, 30 debt, and 10 is kind of your free cash flow. So that's kind of how we think about looking at liquidity. In terms of running leverage up, I guess what I'd say is we've said pretty consistently that if we were to choose a range that we thought was reasonable in terms of leverage, it would be 4.5x-5.5x. So if you think about that and we're sitting at 4x right now, we've got a fair amount of runway to go before we ever even kind of step into that range.

Pete Mavoides (President and CEO)

Next question, operator.

Operator (participant)

Our next question is from.

Mark Patten (EVP, CFO and Treasurer)

Hold on, operator. Connor, were you good?

Connor Siversky (Director and Equity Research Analyst)

Yeah, no, I'm good. I think the line cut out for a second, but I'll leave it there for now. Thank you.

Mark Patten (EVP, CFO and Treasurer)

That was.

Operator (participant)

Your line did just cut out at the very end there.

Mark Patten (EVP, CFO and Treasurer)

Sorry, I just kidded. All right, next question, please, operator.

Operator (participant)

Okay, our next question comes from Josh Dennerlein with Bank of America. Please proceed with your question.

Farrell Granath (Equity Research Associate)

Hi, good morning. This is Farrell Granath on behalf of Josh. My first question, I wanted to ask if you can go into a little bit more detail on the unit-level rent coverage and the slight downtick or how that was attributed to recent acquisitions?

Mark Patten (EVP, CFO and Treasurer)

Yeah, I mean, listen, we provide pretty granular detail and our supplemental on the unit-level rent coverage. Clearly, the headline number decreasing from down 20 basis points, some of that is attributable to the acquisitions in the fourth quarter as well as the acquisitions in the third quarter, both of which were at 3.3 times. There's always some ebbs and flows with different operators and different reporting periods and the like. Overall, the portfolio is in a great spot, and we're not seeing any concerns that give us pause.

Farrell Granath (Equity Research Associate)

Great. I guess on the flip side of that, the increase in your same-store rent growth, is this being driven off of either different lease terms, higher escalators, or what type of driver that's going into that?

Mark Patten (EVP, CFO and Treasurer)

Yeah, I mean, that's just going to be the rent escalations built into our contracts. Generally, they range from anywhere between 1.25% on up to 2%. On average, it's 1.7%, I believe. There's different compounding periods. And clearly, at 1.5%, that represents a pretty solid flow-through of those escalations for us. And that's going to kind of ebb and flow as we've disclosed.

Farrell Granath (Equity Research Associate)

Okay, great. Thank you so much.

Mark Patten (EVP, CFO and Treasurer)

Thank you.

Operator (participant)

Our next question comes from Smedes Rose with Citi. Please proceed with your question.

Smedes Rose (Equity Research Analyst)

Hi, thank you. I just wanted to ask you a little bit. You talked about some of the more traditional sources of capital, either not available or just becoming too expensive. But are you seeing other kind of competitors come to the market, or do you have sort of a relative advantage at this point as you look for new acquisition opportunities in this environment?

Mark Patten (EVP, CFO and Treasurer)

Yeah, thanks, Smedes. And I think that's a great question. I appreciate you asking it. We have a relative advantage to alternative sources of capital currently, like the bank market and the high-yield market and leveraged loans and private credit. A lot of those traditional sources of capital have been priced inside of sale leaseback capital. In the current environment, we're able to compete pretty competitively with those sources. And then secondarily, the traditional sale leaseback market participants are somewhat limited, particularly from the private buyers who are more reliant on debt financing and accessing the ABS market. A lot of those guys are a little more conservative in the current environment. So both from an alternative capital perspective and from a competitor perspective, we're finding a nice opportunity to put capital to work.

Smedes Rose (Equity Research Analyst)

Okay, and then just you mentioned you have a lot of room to draw on the revolver. But if you were going to just issue kind of 10-year unsecured debt today, can you just give us a sense of where you think it would price?

Mark Patten (EVP, CFO and Treasurer)

Yeah, I think the best mark would be our current bonds, which are out there trading. They're kind of in the mid-sixes. I would think that hopefully a new issuance at the yield curve could price inside of that, so-called low to mid-six.

Smedes Rose (Equity Research Analyst)

All right, thank you. Appreciate it.

Mark Patten (EVP, CFO and Treasurer)

Thank you.

Operator (participant)

Our next question comes from Eric Borden with BMO Capital Markets. Please proceed with your question.

Eric Borden (Analyst)

Hey, good morning out there. Just understand the majority of the acquisitions completed in the fourth quarter was heavily driven by existing relationships. But looking ahead and given the limited access to the bank markets for some of your potential tenants, are you seeing an uptick in new potential partners in the pipeline?

Mark Patten (EVP, CFO and Treasurer)

That's a great question. I generally tell people we like to see an 80/20 or 75/25 percent mix where we're 75% existing relationships, 25% new relationships because it's important for us to continually source new relationships because eventually some relationships outgrow us. Clearly, in the fourth quarter at 96%, it's more skewed towards existing relationships. In the current environment, we try to maintain our most profitable relationships and service the relationships that generate the best risk-adjusted returns and take care of the good clients and the reliable clients. And that's kind of what we're doing. I think in a more normalized environment, we would ebb back down to that 75/25 or 80/20. But clearly, partnering with long-term relationships is bringing value to us, and we're bringing value to them. And it's a dynamic market that we're happy to have those relationships.

Eric Borden (Analyst)

Okay, that's helpful. And then maybe on the disposition front, just given the potential for lower yields in the back half of the year, is there potential for that quantum of total dispositions to rise above your four-quarter trailing average, just given the benefits there?

Mark Patten (EVP, CFO and Treasurer)

Yeah, I think the expectation should be it's going to be more towards our eight-quarter average. Clearly, the current market for dispositions is a bit challenged. We have a very granular and fungible portfolio, but the lack of financing out there is making it a little more difficult to sell assets than in a normalized environment. We'll focus on kind of managing individual tenant and industry exposures and getting out of any risky assets that we see. I would expect it to be closer to the eight-quarter average. Really, we don't see the need to lean into dispositions to generate lucrative capital, given where we are from a balance sheet perspective.

Eric Borden (Analyst)

That sounds great. I'll leave it there. Thanks, guys.

Mark Patten (EVP, CFO and Treasurer)

Great. Thank you very much.

Operator (participant)

Next question comes from Nate Crossett with BNP Paribas Asset Management. Please proceed with your question.

Nate Crossett (Equity Research Analyst)

Mate is clarifying a little bit. Sounds like the needs for this year. We can just dive in if you can do it, and.

Mark Patten (EVP, CFO and Treasurer)

Nate, I got to tell you, I don't know. You came through broken up. I didn't catch that question. I don't know if you're on a handset or not?

Rob Salisbury (SVP, Capital Markets)

He might come back in. Why don't we just.

Operator (participant)

Next question then.

Rob Salisbury (SVP, Capital Markets)

Yeah, please.

Operator (participant)

Comes from Greg McGinnis from Scotiabank. Please proceed with your question.

Elmer Chang (Equity Research Analyst)

Hi, good morning. This is Elmer Chang on with Greg. Just on tenants, is there more conservatism on bad debt expense or credit losses baked into 2024 guidance versus the, say, 25-40 basis points you've experienced historically, given uncertainty with the consumer? And then how much of that is tied to experiential operators feeling demand pressures from consumers either returning to work or still feeling the effects of inflation?

Mark Patten (EVP, CFO and Treasurer)

Yeah, listen, we have conservative rent loss assumption and credit loss assumptions built into our guidance as we always do. We take a very close look at our portfolio and look at individual exposures to include the credits, the unit-level coverage, and our rent basis to try to anticipate where we might take any rent loss. And there's a wide range of assumptions baked into guidance around that. As we've said in the past, generally, when you see us raising guidance throughout the year, it tends to be partially driven by the fact that those credit losses aren't really coming to play. So the 40-50 basis points, we don't give specific guidance on the numbers in there. But certainly, the range of guidance has a range around that, I think is fair to say.

We really don't have specific concerns about the consumer and specifically as it relates to the service and experience-based industries that we're in. Our experiential tenants are doing great and continue to see good sales trends there and coverage improvements. Our credit loss assumptions are going to be much more specific to individual situations and investments. That's baked into guidance, and we feel good about the guidance that we've reiterated today.

Elmer Chang (Equity Research Analyst)

Okay, thank you. And then you mentioned those experiential consumers not being concerned about them. But within the portfolio of early childhood and casual dining operators, how would you characterize their ability to pass through higher costs to consumers now that it seems inflation has been easing a bit and given you've talked about these types of businesses not being able to raise rates in the past several quarters?

Mark Patten (EVP, CFO and Treasurer)

Yeah, listen, I think early childhood is going to be much different than casual dining. Our early childhood education providers have done a good job of passing through increases. It tends to be lumpy around semesters and new students, but we've seen increasing trends there. I think the casual dining sector, the price is a little more, A, competitive, B, less discretionary. And certainly, those guys are going to have less ability to drive through inflationary pressures. And we are seeing some margin compression there. But ultimately, in all those industries, those end up being equity owner risk and not landlord risks. And we don't see any outsized losses flowing through the portfolio in general and then in specific in either one of those industries.

Elmer Chang (Equity Research Analyst)

Okay, great. Thank you.

Mark Patten (EVP, CFO and Treasurer)

Thank you.

Operator (participant)

Our next question comes from Haendel St. Juste. Please proceed.

Haendel St. Juste (Equity Research Analyst)

Hey, good morning. Hope you can hear me. First question's on, I guess there's a new tenant in your top tenant list here, Tidal Wave Auto Spa. So maybe can you spend a moment talking about them, the opportunity to do more with them, and your overall exposure to kind of the car wash, car care vertical, which I think is about 15% here. And that's it. Thanks.

Mark Patten (EVP, CFO and Treasurer)

Yeah, so Tidal Wave is a tenant that we've been doing business with for a number of years and a number of a number of deals over the years. And they've kind of eventually moved into our top 10. It's about a 200+ unit chain. It's currently led by its founder. And the company was founded back in 1999. So a well-run company. It's been in business for a long time, and we're happy to have them in our top 10. Generally, we're, as we've said in the past, very comfortable with car washes, given the trends in the industry and the stability of the cash flows and the high margins and the solid rent coverage. And that's why you see it as one of our top industries.

The exposure kind of came back a little bit in the last quarter, but we continue to see good opportunities to invest in that space, and we like it. So we'll continue to do so.

Haendel St. Juste (Equity Research Analyst)

Then maybe I think you made a comment on your pipeline saying that cap rates in there suggest that cap rates should be stable near term. Can you spend a moment or two talking about the pipeline, what's in there, any new categories, and broadly your expectation for cap rates, given the choppiness in the capital market? Thanks.

Mark Patten (EVP, CFO and Treasurer)

Yeah, as we said on the prepared remarks, the pipeline's full. When you run in a business that's nearly 100% sale lease back and nearly 100% follow-on business, your forward pipeline is going to look a whole lot like your portfolio, and that's what it looks like. Really nothing new. We're investing across all our industries and largely with existing relationships. In terms of cap rates, as the commentary around the competitive landscape would suggest, they're remaining stable. Clearly, I think around an 8. As I said on the prepared remarks, we would expect once the market normalizes and competition comes back in a more normalized fashion, we would expect some downward pressure on cap rates. Clearly, if interest rates trend down, we would expect some downward pressure on cap rates. But we're just not seeing that as we sit here in the first quarter.

Haendel St. Juste (Equity Research Analyst)

Appreciate that. Maybe on the terms that you're getting, given the lack of alternatives that a lot of these tenants have, you've been able to get longer walls, better bumps. I'm curious if you're getting any pushback from any of those folks, and could we see those terms get even better near term? Thanks.

Mark Patten (EVP, CFO and Treasurer)

Yeah, listen, every transaction we negotiate is a negotiated transaction. We've negotiated deals with these people in the past. So there's a lease in place, and the terms of the prior transaction tend to bias the new transaction. Our investment team has done a great job of improving the overall terms. I look back in the first quarter of 2022, our average rent escalation was 1.4. And last quarter, it was 1.9. And the quarter before that, it was 2.0. And really, for the whole year, 2.0, 1.9, 2.0, 1.9. I would not set the expectation that that's going higher, but we continue to negotiate the best terms that we can from these relationships. And we'll see what the market bears.

I would point out on the prepared remarks, our weighted average lease term at 14 years is the same as it was a year ago, which would speak to the benefit of the long-duration leases that we added this past year, which is a good spot to be.

Haendel St. Juste (Equity Research Analyst)

Appreciate the caller.

Mark Patten (EVP, CFO and Treasurer)

Thanks, Handel.

Operator (participant)

Our next question comes from John Massoca with B. Riley Securities. Please proceed.

John Massocca (Equity Research Analyst)

Good morning.

Mark Patten (EVP, CFO and Treasurer)

Good morning, John.

John Massocca (Equity Research Analyst)

Hey, John. So basically, with the pipeline, do you have kind of a rough number or brackets around the gross size of that today? I know you kind of mentioned it's full, but just maybe number-wise, what you'd be thinking?

Mark Patten (EVP, CFO and Treasurer)

Yeah, typically, we point people to our 8-quarter average as a good indicator of what to expect. I don't know what that exact number is, but somewhere between 2.50 and 3.

John Massocca (Equity Research Analyst)

Okay, that's helpful. And then in terms of volumes, have you seen any maybe reluctance on the part of sale lease back partners to kind of come to market or close deals, just given some of the interest rate volatility? I mean, essentially, are your partners on the selling of the property side maybe holding out for better cap rates or lower costs of alternative financing?

Mark Patten (EVP, CFO and Treasurer)

Yeah, there's some of that. There's clearly overall transaction volume in the single-tenant lease market is down 40%. I think a lot of that are people not choosing not to transact in the current market environment. But the flip side of that is these operators are running their businesses, and they have the opportunity to grow their footprints by buying smaller competitors or opening new units. Rent is a small part of that overall investment decision for them. They're aggressively growing and choosing to use us as a capital partner to do that. So while there is muted volume across the board, we still see an ample opportunity set to transact.

John Massocca (Equity Research Analyst)

Okay. And then maybe in terms of the competitive environment for sale-leaseback particularly, I mean, how does that look today? I mean, setting aside kind of the bank financing market or any kind of other types of financing you compete with, I mean, how many competitors are there out there today, roughly? And how does that compare to this time last year or maybe even a couple of years ago?

Mark Patten (EVP, CFO and Treasurer)

Yeah, listen, I don't think it's materially different from where we were a year ago because it feels like the overall capital market environment is about the same, if not improved slightly. But two years ago, there was 6-10 kind of new private capital-backed buyers who were coming to the market trying to build funds and platforms. And by and large, a lot of those guys are kind of not currently investing at the levels that they would have hoped. And so that private buyer is greatly diminished. We also, on occasion, compete with 1031 buyers, people coming in with large exchanges who are looking to place tax-deferred capital. And there's not a lot of people who are generating gains from the sale of real estate assets. And that source of capital is largely dried up and not competing. There's plenty of public market participants.

You guys follow them and know kind of where they are and what their appetites are. And so we certainly see competition here and there. But overall, it's a diminished level of competition that we're benefiting from.

John Massocca (Equity Research Analyst)

Okay, that's helpful. That's it for me. Thank you very much.

Mark Patten (EVP, CFO and Treasurer)

Thanks, John. Appreciate it.

Operator (participant)

If you would like to ask a question, please press star 1 on your telephone keypad. The question comes from Ki Bin Kim with Truist Securities. Your question.

Kyle McGrady (Equity Research Analyst)

Hey, good morning. You have Kyle on for Ki Bin. I think on the second quarter call, you guys mentioned approximately 90 basis points, maybe are on the watch list with more than half of that in beaters. So can you just provide an update on how that's trended recently?

Mark Patten (EVP, CFO and Treasurer)

Yeah, so our current watch list, which I'll remind you we defined as the intersection of credit risk as single B minus or below and coverage risk as 1.5 or below, it's currently 70 basis points. So 20 basis points inside of where it was in the second quarter. And it's still 50% theaters.

Kyle McGrady (Equity Research Analyst)

Gotcha. Thank you.

Mark Patten (EVP, CFO and Treasurer)

Thank you. Operator, we got any more questions?

Operator (participant)

Our next question comes from Jim Kammert with Evercore ISI.

Jim Kammert (Equity Research Analyst)

Good morning. Thank you.

Operator (participant)

What is your question?

Jim Kammert (Equity Research Analyst)

Sorry. Good morning. Thank you. Pete, you and your team have worked with these middle market credits for a long time, obviously. It seems like the business is pretty well set up with your unit and parent or entity financial reporting requirements. But what are some of the flashpoints that you monitor or set off as sort of warning signs in your mind that something's a problem might be afoot with a given credit? I mean, when coverage declines from an original 3.5 to 2.5, or you had to round them up and collect the rent 3 months in a row tardy, I'm curious, what are some of those markers historically have helped you monitor and proactively kind of engage with those tenants?

Mark Patten (EVP, CFO and Treasurer)

Yeah, listen, I think I wouldn't even call it an early warning sign, but late payers or guys who aren't paying timely are certainly top of the list. Guys who are late on their rent, I would say generally, that tends to be less than a handful of actors. And historically, it's the same guys that you're arm-wrestling with. But currently, that's not a material amount. But more importantly, it's monitoring the trends at the unit level because that's ultimately our collateral and our first form of payments is solid cash flow at the unit level. One of the reasons we provide such disclosure around where our rents are covered and how they're covered. But from our analysis, it's more just tracking trends.

Anything that's falling off or below sector averages, when you have the amount of data that we have for each of these given industries, average sales per site, margin per site, rent growth per site, sales growth, all of that, trying to see outliers as to performance at the unit and understand that. To the extent that something arises that's concerning, then you're taking a deeper dive into the corporate credit to understand if our asset fails as a source of rent payment, how solid is the corporate credit that's backing that lease and understanding the risk there. Then ultimately, making a sell decision on assets that you don't think have the durability that you want and expect in the portfolio.

Jim Kammert (Equity Research Analyst)

That seems logical. Just one follow-up to that, do you have substitution rights in your master leases and whatnot? I mean, you said you might, obviously, for ailing assets, maybe look to sell them. Do you have other protections where you could either add other collateral or maybe work with the retailer to put a performing asset in and take a low-performing asset out?

Mark Patten (EVP, CFO and Treasurer)

Yes, many of our leases do have substitution rights where the tenant would be incentivized to take and exit an underperforming asset and substitute it in. I would say, more importantly, it's really just having good relationships and working with these tenants because our interests are aligned in not keeping a site that doesn't work online and operating. So we may re-tenant the site, and the tenant makes us whole for the contract rent that was in the lease, the delta between that and the underlying sub-tenant rent. So there's a lot of ways to work through it. I would say one of the benefits of being as granular as we are at the asset level, it's pretty easy and painless to work through individual site-level issues.

Jim Kammert (Equity Research Analyst)

Great. Appreciate the update. Thank you.

Mark Patten (EVP, CFO and Treasurer)

Great. Thank you.

Operator (participant)

No further questions at this time. I would now like to turn the floor back over to Pete Mavoides for closing comments.

Mark Patten (EVP, CFO and Treasurer)

Great. Well, Nate, we're sorry we didn't get your question in. If you want to follow up with Mark or Rob afterwards, we'd gladly kind of answer any questions that you might have had. But generally, congrats to the team for an excellent quarter and an excellent year. We feel pretty proud about the results we posted last year. We're excited about this year. We're off to a great start. So thank you all for your participation today. We look forward to engaging with you all at the upcoming conferences. Have a great weekend. Thanks, guys.

Operator (participant)

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