Q2 2024 Earnings Summary
- Robust Acquisition Pipeline and Growth Prospects: EPRT achieved its highest acquisition volume quarter to date in Q2 2024, with $334 million invested, and expects continued strong acquisition activity, supported by a full pipeline and significant liquidity.
- Favorable Market Conditions for Investment Strategy: The tight capital markets provide EPRT with opportunities to invest at attractive returns, as middle market tenants have limited capital alternatives, enabling EPRT to transact and put capital to work effectively.
- Resilient Portfolio Performance and Strong Tenant Relationships: EPRT's portfolio is in great shape, with tenants operating strongly, and industries up from a coverage perspective, demonstrating the resilience of their business model and strength of tenant relationships.
- Increased competition and downward pressure on cap rates are expected as interest rates decline, potentially impacting initial yields and profitability. Management noted that as "competition normalizes and interest rates start coming down, we would expect to see some pressure on our initial cap rates off of these historically high levels."
- Slight decline in unit-level rent coverage ratios, with an increase in tenants with coverage under 1x, which may signal potential risks to portfolio performance. The weighted average unit-level rent coverage ratio decreased to 3.7x, and exposure to under 1x coverage increased slightly.
- Persistent bid-ask spread in the market is weighing on dispositions, potentially affecting the company's ability to sell assets and manage the portfolio. Management mentioned a "persistently wide bid-ask spread", with a 25 to 75 basis points difference between their selling price expectations and market bids.
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Acquisition Outlook and Pipeline
Q: What is your acquisition outlook and pipeline for the next 6-12 months?
A: Our investment pipeline remains solid and ahead of last year, with potential investments between $200 million to $250 million. Despite seasonal slowdowns in Q3, we are confident the pipeline supports an active quarter. We continue to focus on sale-leaseback transactions, which make up 80-90% of our portfolio. -
Impact of Rate Cuts and Competition
Q: How will expected rate cuts and increased competition affect your business?
A: As rates decline, we expect competition to normalize, leading to downward pressure on cap rates, lease terms, and rent bumps. Competitors are already returning to the market, and we anticipate this impact in Q4 and early next year. Nevertheless, we are prepared to add value and continue transacting as competition increases. -
Investment Spread and Cost of Capital
Q: How are investment spreads compared to your cost of capital currently?
A: We price deals based on market dynamics, not our cost of capital. Our investment spreads have ranged from 150 to over 300 basis points. Currently, spreads are in the 200 basis points range, which is healthy for continued investment. We've benefited from stock price movements and favorable bond issuance spreads, improving our net investment spread by approximately 50 basis points. -
Leverage Capacity and Liquidity
Q: How much can you invest before hitting your leverage targets?
A: We have between $700 million to $1 billion in dry powder within our targeted leverage range, providing ample capacity to execute our growth plans. Our low leverage and strong balance sheet position us well for future investments. -
Tenant Health and Rent Coverage
Q: Can you discuss the decline in unit-level rent coverage?
A: Our weighted average unit-level rent coverage decreased slightly to 3.7x this quarter. The increase in properties with coverage under 1x is largely due to development sites coming online that are not yet stabilized. We actively manage our portfolio, selling assets if we identify permanent impairment. Overall, the portfolio is performing well, and these minor changes do not affect our strong position. -
Competitive Landscape
Q: How quickly will competitors return if rates decline further?
A: Competitors, especially public peers, will return quickly as they gain visibility into their cost of capital. We've already observed some competitors re-entering the market. Private competitors may lag due to dependence on bond markets, but overall, we expect competition to increase promptly as rates decline. -
Equity Issuance and Liquidity Strategy
Q: Would you consider issuing equity now to lock in current share prices?
A: While we have ample liquidity and are fully funded for the year, we remain opportunistic on equity issuance. With our shares trading above $30, issuing equity is compelling. We're mindful of extending our equity runway and will consider issuance if we see strong pipeline visibility. However, we currently have sufficient capacity and can be opportunistic. -
Bid-Ask Spread Impact on Dispositions
Q: How has the bid-ask spread affected your dispositions?
A: The bid-ask spread remains wide, between 25 to 75 basis points, impacting our ability to sell well-leased assets. In Q2, we sold higher-risk assets at a 7.3% cash yield. The spread has not changed in Q3. -
Red Robin Investment and Tenant Watchlist
Q: Any updates on tenants like Red Robin on your watchlist?
A: Our portfolio is in great shape, and our Red Robin assets are performing well. While there may be concerns about the company's equity story, our restaurant assets continue to operate effectively. Our perspective on Red Robin has not changed this quarter. -
Unit-Level Rent Coverage Decline
Q: What is causing the decrease in unit-level rent coverage under 1x?
A: The increase in properties under 1x coverage is mainly due to development sites not yet stabilized. Some operators face situational challenges, but there is nothing systemic across our industries. We monitor these assets closely and consider dispositions if necessary.