Earnings Call Transcript
AGREE REALTY CORP (ADC)
Earnings Call Transcript - ADC Q2 2025
Operator, Operator
Good morning, and welcome to the Agree Realty Second Quarter 2025 Conference Call. This event is being recorded. I would now like to turn the conference over to Reuben Treatman, Senior Director of Corporate Finance. Please go ahead, Reuben.
Reuben Goldman Treatman, Senior Director of Corporate Finance
Thank you. Good morning, everyone, and thank you for joining us for Agree Realty's Second Quarter 2025 Earnings Call. Before turning the call over to Joey and Peter to discuss our results for the quarter, let me first run through our cautionary language. Please note that during this call, we will make certain statements that may be considered forward-looking under federal securities law, including statements related to our updated 2025 guidance. Our actual results may differ significantly from the matters discussed in any forward-looking statements for a number of reasons. Please see yesterday's earnings release and our SEC filings, including our latest annual report on Form 10-K for a discussion of various risks and uncertainties underlying our forward-looking statements. In addition, we discuss non-GAAP financial measures, including core funds from operations, or core FFO; adjusted funds from operations, or AFFO; and net debt to recurring EBITDA. Reconciliations of our historical non-GAAP financial measures to the most directly comparable GAAP measures can be found in our earnings release, website and SEC filings. I'll now turn the call over to Joey.
Joel N. Agree, CEO
Thanks, Reuben, and thank you all for joining us this morning. I am extremely pleased with our performance during the first half of the year, having invested over $725 million across our three external growth platforms, while further solidifying what we believe to be the preeminent retail portfolio in the country. The $725 million-plus invested year-to-date represents a more than twofold increase relative to the first half of last year. All three of our external growth platforms have broad and expansive pipelines, and we'll see acceleration in the third quarter. Hence, we are raising our full-year investment volume guidance once again to an updated range of $1.4 billion to $1.6 billion. The midpoint of this range represents a 58% increase over total investment volume for last year. Most exciting is not the defensive nature of our portfolio or balance sheet in a dynamic world. It is now our dominant market position, driven by a best-in-class team that executes on hundreds of transactions annually across our three growth platforms. This value proposition is unparalleled. And when combined with our internal asset management platform and deep retailer relationships has built a differentiated and unmatched company. It has been 15 years in the making since this vision was outlined in our one-page operating strategy, December of 2009 to be exact. And I'm delighted to say that it has been realized. I am confident that these factors will drive an increased earnings algorithm in the coming years without moving up the risk curve in any manner. We continue to expand our war chest during the quarter, now having raised over $1 billion of capital year-to-date with $1.3 billion of outstanding forward equity. With over $2.3 billion in total liquidity, no material debt maturities until 2028 and pro forma net debt to recurring EBITDA of just 3.1x at quarter end, our balance sheet remains best-in-class and is positioned to support our growth well into next year. To support this growth, we've continued to scale our team, enhance our systems and refine our processes, building a well-oiled machine and widening our competitive moat. We've added over 20 new team members year-to-date across the organization, increasing the scale of our horizontally integrated platform to support current activities as well as growth for years to come. We have driven industry-leading efficiencies with the deployment of additional systems, including AI and machine learning tools as well as enhanced integrations and streamlined workflows. Additionally, we have commenced the next iteration of Arc, which will come online next year. We've already started to reap these benefits in 2025 as we're raising our full-year AFFO per share guidance by $0.02 at the midpoint to a new range of $4.29 to $4.32. This represents over 4% growth at the midpoint and demonstrates our ability to provide consistent and reliable earnings growth without deviating from our investment strategy. Peter will provide further details on the guidance range and its key input shortly. We continue to see the biggest and best retailers take market share, which acts as a tailwind to all three of our external growth platforms. Even in today's uncertain macro environment, we are seeing the highest level of retailer demand for new brick-and-mortar locations since the great financial crisis. Nearly every retailer in our sandbox is focused on adding net new stores, underscoring the critical role that retail net lease assets play in an omnichannel retail world and as outlined in our previous commentary in white papers. Moving on to the second quarter in detail. We invested over $350 million in 110 properties across all three platforms. This includes $328 million of acquisition volume across 91 high-quality retail net lease assets. Notable acquisitions during the quarter included a sale-leaseback with a leading national auto parts retailer, a one-off Walmart Supercenter in Ohio, and a $75 million grocery-dominated portfolio, representing one of our largest non-sale-leaseback transactions since the inception of our acquisition platform in 2010. This unique opportunity was owned by an elderly woman and was sourced through 18 months of working in off-market opportunities. These differentiated examples underscore the strength of our platform and its ability to source differentiated opportunities in a substantial and highly fragmented space. The acquired properties had a weighted average cap rate of 7.1% and a weighted average lease term of 12.2 years. Over 53% of base rent acquired was derived from investment-grade retailers, and we continue to add to our ground lease portfolio during the quarter. We anticipate selling a few lower-yield noncore assets from the aforementioned $75 million grocery-dominated portfolio, which will include both acquisition cap rate and investment-grade percentage for the quarter post disposition. Although we only commenced one project in our development and DFP platforms during the quarter, don't be fooled, we continue to see increased activity and have a deep pipeline. We anticipate announcing several projects in the quarters ahead, while construction continued on 14 projects during the quarter with aggregate anticipated costs of over $90 million. We wrapped up 4 projects during the quarter, representing aggregate investment of over $13 million. These projects were with leading retail partners, including TJX, Burlington, 7-Eleven, Boot Barn, Starbucks, Gerber Collision, and Sunbelt Rentals. In total, we had 25 projects either completed or under construction during the first half of the year, representing $140 million of committed capital, including $98 million of costs incurred through June 30. We anticipate development spend to be up at least 50% year-over-year as both platforms continue to ramp. Our asset management team continues to address upcoming lease maturities. We executed new leases, extensions, or options on approximately 950,000 square feet of gross leasable area during the quarter. This included a Walmart Supercenter in Ohio, a Best Buy in California, and 5 geographically diverse leases with The TJX Companies. In the first half of the year, we executed new leases, extensions, or options on 1.5 million square feet of GLA with recapture rates of approximately 104%. Notable examples in recent quarters include the re-leasing of our former Big Lots in Manassas, Virginia, and Cedar Park, Texas, with net effective recapture rates of almost 170% and 150%, respectively, as well as the re-leasing of our former Party City in Port Arthur, Texas, with a net effective recapture rate of 115%, demonstrating our emphasis on fungible boxes in dominant retail corridors. At quarter end, our best-in-class portfolio surpassed 2,500 properties spanning all 50 states. The portfolio includes 232 ground leases, comprising over 10% of annualized base rents. Our investment-grade exposure stood at 68%, and occupancy rebound post the re-tenancy of the former Big Lots by 40 basis points to 99.6%. Dispositions remain limited. However, our only At Home located in Provo, Utah, across from a new Target, is currently under contract to sell and nonrefundable at a 7% cap. We purchased the At Home as a pure real estate play in 2016 and have had interest in the site from multiple retailers and prospective purchasers. The disposition cap rate of 7% is nearly 50 basis points inside of where we acquired the asset, and we anticipate realizing an unlevered IRR of approximately 9% upon closing this quarter. Although At Home recently exercised a 5-year option and the lease is anticipated to be affirmed in bankruptcy, I'm confident that At Home will ultimately suffer the same fate as Party City, JOANN, and Rite Aid and ultimately liquidate. With that said, I'll hand the call over to Peter to discuss our financial results for the quarter.
Peter Coughenour, CFO
Thank you, Joey. Starting with the balance sheet. We had a very active quarter with over $800 million of debt and equity capital raised, bringing total capital markets activity year-to-date to over $1 billion. We raised approximately $415 million of forward equity in the quarter via our ATM program and a 5.2 million share overnight offering in April. In May, we completed a $400 million public bond offering comprised of 5.6% senior unsecured notes due in 2035. In connection with the offering, we terminated forward starting swap agreements of $325 million, receiving almost $14 million upon termination and reducing our all-in rate to 5.35%. During the quarter, we also settled close to 700,000 shares of forward equity for net proceeds of approximately $41 million. As of June 30, we had approximately 17.5 million shares remaining to be settled under existing forward sale agreements for anticipated net proceeds of $1.3 billion. At quarter end, total liquidity stood at $2.3 billion, including cash on hand, forward equity as well as $1 billion of availability on our revolving credit facility, which is net of amounts outstanding on our commercial paper program at quarter end. Pro forma for the settlement of all outstanding forward equity, our net debt to recurring EBITDA was approximately 3.1x, representing the lowest level since Q4 of 2022. Excluding the impact of unsettled forward equity, our net debt to recurring EBITDA was 5.2x. Our total debt to enterprise value was approximately 28%, and our fixed charge coverage ratio, which includes the preferred dividend, remains very healthy at 4.2x. Our only floating-rate exposure remains short-term borrowings, and we continue to have no material debt maturities until 2028. Our balance sheet is extremely well-positioned to fund our growth into next year as we've locked in an attractive cost of capital, which helps provide visibility into the acceleration in our multiyear earnings algorithm, as Joey mentioned. Core FFO per share was $1.05 for the second quarter, which represents a 1.3% increase compared to the second quarter of last year. AFFO per share was $1.06 for the quarter, representing a 1.7% year-over-year increase. As Joey highlighted, we have updated our full year 2025 earnings outlook to reflect the strong first half to the year. We raised both the lower and upper end of our full year AFFO per share guidance by $0.02 to a new range of $4.29 to $4.32, which implies year-over-year growth of over 4% at the midpoint. The increase in our earnings guidance is largely driven by higher investment activity as evidenced by our increased investment guidance as well as a lower assumption for treasury stock method dilution. As a reminder, if ADC stock trades above the net price of our outstanding forward equity offerings, the dilutive impact of unsettled shares must be included in our share count in accordance with the treasury stock method. Our stock is trading at lower levels than in late April, and if it continues to trade near current levels, we anticipate that treasury stock method dilution will have an impact of roughly $0.01 on full year 2025 AFFO per share. That said, the impact could be higher if our stock moves materially above current levels, as was evident in last quarter's guidance or if we were to issue additional forward equity. Our guidance has been updated to include an assumption of 25 basis points of credit loss at the high end of our AFFO per share range and 50 basis points of credit loss at the low end of the range. I want to reiterate that our definition of credit loss is fully loaded. It encompasses not only credit events, but downtime due to a tenant vacating at lease maturity unrelated to credit issues, and other partial or nonpayments for any and all reasons. It also includes any operating and tax expense that ADC is responsible for paying while a space is vacant in addition to lost rental revenue. We believe this is an important distinction versus narrower definitions of credit loss used by some of our peers as we're looking to provide a more comprehensive picture of not only credit events, but overall economic loss for modeling purposes. Our growing and well-covered dividend continues to be supported by our consistent and reliable earnings growth. During the second quarter, we declared monthly cash dividends of $0.256 per common share for April, May and June. The monthly dividend equates to an annualized dividend of over $3.07 per share and represents a 2.4% year-over-year increase. Our dividend is very well-covered with a payout ratio of 72% of AFFO per share for the second quarter. We anticipate approximately $120 million in free cash flow after the dividend this year, up over 15% from last year. This provides us with another source of cost-efficient capital to fund our growth while maintaining a growing and well-covered dividend. Subsequent to quarter end, we announced a monthly cash dividend of $0.256 per common share for July. The monthly dividend also equates to an annualized dividend of over $3.07 per share and represents a 2.4% year-over-year increase. With that, I'd like to turn the call back over to Joey.
Joel N. Agree, CEO
Thanks, Peter. Operator, at this time, let's open it up for questions.
Operator, Operator
Your first question comes from the line of Linda Tsai from Jefferies.
Linda Tsai, Analyst
Can you give us some color about your ATM activity in 2Q and overall timing given your overnight equity offering in late April?
Joel N. Agree, CEO
You're breaking up a little bit, but I think you asked about the ATM activity during the quarter, correct?
Linda Tsai, Analyst
Yes, your overnight equity offering in late April.
Joel N. Agree, CEO
Got it. Yes. The ATM activity during the quarter all predated the overnight offering in April. During the overnight offering at the post-commencement of launch, I promised investors that we would be inactive in the capital markets and we were fully funded, and we held that promise.
Linda Tsai, Analyst
And then I think you said acquisition cap rates would expand going forward. What's the magnitude? And any highlights on the tenants you're targeting?
Joel N. Agree, CEO
We are not targeting any new tenants and will focus on our current areas of operation. I expect that acquisitions in the third quarter will be similar to those in the first quarter, but with a greater volume as we have just begun sourcing for the fourth quarter.
Linda Tsai, Analyst
Just one last one. Just given all the macro headline volatility, how are you thinking about retailer and consumer health right now? Do you have a view of whether it's improved or deteriorated year-to-date?
Joel N. Agree, CEO
Well, I think consumer health has undoubtedly deteriorated, at least consumer sentiment. We've seen those numbers swing. I think this morning's jobs report most likely affirms that conclusion. Ultimately, this enters to the benefit of our portfolio, which is focused on core durable goods and necessity-based retailers that are the biggest in the country. And that has been our focus, will continue to be our focus. We will stay away from experiential. We'll stay away from discretionary and we're going to buy things, as you see this quarter, whether it's auto parts, groceries, or tire and auto service that continue to be required by consumers to live their daily lives, from the biggest and best operators that can offer the lowest price. And we're seeing that throughout retailer earnings reports, right? The biggest and best operators here are going to continue to gain market share. And simultaneously, we're going to continue to gain market share.
Linda Tsai, Analyst
Do you think retailer health is improving though overall?
Joel N. Agree, CEO
We'll see how the health of retailers is. Smaller retailers are likely to struggle. The recent bill and the actions in Washington will ultimately have an impact, and tariffs will make things difficult for smaller retailers. Those retailers that face tariff increases on the goods they sell or on the components of those goods will have to either reduce their profit margins or raise prices, which may drive them out of the market. On the other hand, larger retailers with stronger balance sheets will have more options to manage the increase in costs due to tariffs, whether by passing those costs onto consumers, absorbing the costs, or having better negotiating power with their suppliers. This situation is a reality. The bill and tariffs negatively affect smaller businesses but benefit larger retailers like Walmart and Kroger and other major operators in the country.
Operator, Operator
Your next question comes from the line of Ki Bin Kim with Truist Securities.
Ki Bin Kim, Analyst
So looking out at the investment landscape, Joey, can you just talk about some of the opportunities that you see, maybe in particular, the DFP business for developments? And maybe you could just touch on volume, quality and pricing, things like that.
Joel N. Agree, CEO
So the opportunities I mentioned earlier make this the most excited I've been since COVID. It's the result of 15 years of vision. In the net lease sector, there’s often a focus solely on acquisition volumes. Our acquisition volume will be strong, and our third quarter pipeline is significant. Regarding development in our DFP business, we plan to initiate at least $100 million in projects before the year ends, involving over 10 geographically diversified projects with some of the largest retailers in the country. Additionally, we have a substantial shadow pipeline. This vision was established 15 years ago, prior to launching the acquisition platform when we were still a micro-cap, aiming to be a real estate company in the net lease market rather than just a simple spread investor. Anyone can engage in that to varying degrees of success, but I’m not interested in being part of that group. My background is in real estate, and this company embodies that. What you will observe is the scaling of all three external growth platforms as they progress, and the culmination of that vision is to establish ourselves as a full-service real estate company for the largest retailers in the country.
Ki Bin Kim, Analyst
And can you remind us what is the type of margin or spread that you're earning on the development versus an equivalent acquisition yield?
Joel N. Agree, CEO
Sure. All subject to duration and scope of the project. And so we benchmark those yields against where we can buy a like-kind asset at pricing today, not where comps are, but where we could purchase it. If we're going to take an existing building and retrofit it for a tenant and they're going to commence paying rent in 120 days from rent commencement, that could be 50 basis points wide of where we'll acquire such an asset. If it's an 18-month entitlement process and there's significant obstacles and hurdles that we're going to overcome to true organic development, that can be as wide as 150 basis points. So again, duration and scope, internal allocation of time and overhead are critical there. So we're doing all different types of projects. You will see in the second half of this year, round-up projects, retrofit projects. Many of them are $10 million plus, and we are very close to commencement or have commenced post-June 30.
Operator, Operator
Your next question comes from the line of Smedes Rose with Citi.
Smedes Rose, Analyst
On the development platform, I'm curious about what you believe could be the upper limit for investment in that area. Additionally, I think part of the reason your stock trades at a premium multiple is due to the expectation of growing AFFO by at least 4% or more each year, driven by external acquisition opportunities and your capital cost spread. Are you indicating that you plan to shift more towards this development platform over time because you believe the spreads are more favorable and it will allow for faster growth in AFFO? Or is this development emphasis growing alongside your acquisition activity of around $1.5 billion? I'm trying to understand the...
Joel N. Agree, CEO
Yes, let's break this down. First, these are not capital allocation decisions. We have a strong balance sheet with $2.3 billion in liquidity and $1.3 billion in forward equity for a reason. We will pursue every deal that aligns with our investment guidance and internal standards across all three platforms. Our Q3 acquisition pipeline is significant, and we're just starting to build Q4. Although there are no major sale-leasebacks, our pipeline grows daily, and we've had a good start this week. We believe we can achieve better returns and yields through development and our DFP program, but that won't stop us from investing in acquisitions. We are targeting the same tenants and collaborating with our retail partners in similar areas. If you examine our earnings algorithm and our five-year historical AFFO growth trend, you’ll see it’s a good reference point. Many might not be aware that our 2024 investment volume was the lowest since 2019, slightly over $900 million, due to capital market conditions and our stock being in the 50s for the first half of last year. This impacts this year's earnings, which are currently at a midpoint of over 4%. We made a conscious choice last year to remain disciplined, starting with a do-nothing scenario and avoiding investments within a 75 basis point margin. We aimed to invest in real estate or credit that met our historic underwriting standards. Additionally, we had to pause leasing efforts due to Big Lots vacancies after the failure of their first exit from Chapter 11, which caused a 40 basis point decrease in occupancy during the first half of the year. However, we have now rebounded to a 99.6% occupancy rate as of June 30 due to our re-leasing efforts. This is a down year for AFFO growth, but all three platforms will contribute to future growth. Development projects will take longer to impact, but this isn't about capital allocation decisions or detracting from acquisitions. It's about realizing a future where all three platforms are performing effectively.
Smedes Rose, Analyst
Okay. I would leave it there, but thanks for the incremental color.
Joel N. Agree, CEO
Smedes, did I miss anything there? That was a multipart question, I know.
Smedes Rose, Analyst
No, I think it's good. I mean I guess just on the development platform, do you see sort of an upper limit of how much you kind of invested there at what time, is that $1 billion, $500 million?
Joel N. Agree, CEO
What we laid out about six months ago was our three-year goal of investing $250 million annually. We have clearly made significant progress toward that objective. I want to mention that we are in discussions with new retailers that may lead to geographic territories being assigned to us. Therefore, I can't specify an upper limit. Whenever I provide a figure regarding the size of our operations or what we can achieve, we typically reach that target. Hence, I prefer not to disclose a specific number. My aim when we started the acquisition platform was to build a $1 billion diversified net lease company, so I don't want to put that figure out there either. We have made substantial investments, and I am open to further investments in personnel, processes, and systems to help facilitate our expansion. Importantly, this is not speculative development; we are not betting on land or vacant spaces. These projects are either turnkey or ground leases with guaranteed maximum price bids in place before we proceed, and the returns are effectively fixed. That defines our business, which is fundamentally non-speculative and provides a margin of safety compared to acquiring a similar asset.
Operator, Operator
Your next question comes from the line of Michael Goldsmith with UBS.
Michael Goldsmith, Analyst
I want to follow up on the developments in DFP regarding the earnings algorithm. Is it accurate to say that incorporating DFP developments with traditional acquisitions enhances consistency in both magnitude and stability of the earnings algorithm? I'm trying to clarify the point about the diversification within the three-pronged approach.
Joel N. Agree, CEO
I would think of it quite simply. We have one business that everyone focuses on net lease, one line of business, external growth, acquisitions. And that's what everyone wants to focus on in net lease acquisition volume. Our acquisition volume will be very strong. At the same time, we have been working for years now to build and scale development and then our development funding platform. These are just additive, that's all they are. They are additive, both qualitative and quantitative. And they ultimately build out a holistic relationship with retailers, that we are a critical real estate partner, that we are working along multiple different fronts with them, and we are a differentiated real estate company. That has never been done in the net lease space. Again, the 'spread investors,' anyone can do it. We have no interest in being part of that. Our goal when we created our one-page operating strategy in 2009, over 15 years ago, was to be a differentiated real estate company in the net lease space. I am more than proud to say that this team has now achieved that goal, and we are going to see in the coming months the fruition of the results of all those efforts.
Michael Goldsmith, Analyst
As a follow-up, you've mentioned before the significance of scale in the grocery sector. Last quarter, you completed a sale-leaseback of an ACME property supported by Albertsons, and now you're acquiring more Albertsons through this portfolio deal. Does this indicate that you believe Albertsons aligns with the scale and stability in grocery that you're pursuing?
Joel N. Agree, CEO
Just one correction, this was our first material transaction; we did not do a sale-leaseback. We've never done a sale-leaseback with Albertsons. This was our first transaction related to Albertsons leases. It involved a third-party elderly woman in her 80s from California, whose family had a history in multifamily development and then transitioned into net lease assets. The $75 million diversified portfolio included, I believe, 5 Albertsons.
Peter Coughenour, CFO
Correct.
Joel N. Agree, CEO
Albertsons currently represents less than 1% of our total rents and total annual base rent. They are rated BB+ and are the third-largest grocery chain in the U.S., operating nearly 2,300 stores. While our competitors are focusing on smaller regional and local grocery operators with around $1 billion in revenue, which faces challenges due to current consumer sentiment, we are taking a different approach. We are creating what we believe to be the premier grocery portfolio in the nation, with Albertsons as a smaller component of it. The stores we acquired averaged about $740 in sales per square foot with a rent-to-sales ratio below 2%, showing strong performance. They have a weighted average lease term of roughly 14 years and pay an average rent of less than $14 per square foot. The portfolio is geographically diverse, covering Texas, Illinois, and Colorado. This strategy aligns with our white paper on investing in the largest grocery chains, which operate in a 2% margin environment and possess the necessary scale and balance sheets to compete on pricing. We believe that smaller operators with only $1 billion in revenue will experience significant struggles. For instance, generating $1 billion in revenue at a 2% margin results in $20 million in EBITDA. Engaging in sale-leasebacks will quickly lead to deteriorating lease-adjusted leverage and cash flows. Additionally, as mentioned in my earlier remarks, the downturn of investment grade ratings and yields during the quarter due to sourcing this off-market portfolio will be offset by the sale of Dutch Bros Coffee shops at 5% cap rates and non-core assets like corporate Jiffy Lubes that we plan to sell. Ultimately, our quarterly returns and investment grade ratings will align more closely with historical levels.
Operator, Operator
Your next question comes from the line of Jana Galan with Bank of America.
Jana Galan, Analyst
Maybe a question for Peter. On the bad debt in the guidance of 25 to 50 bps, is there anything identified? Or does that just give you some room on the potential that the 0.4 of expirations doesn't renew?
Peter Coughenour, CFO
Thanks for the question, Jana. In the first half of the year, our credit loss, which I addressed in my prepared remarks, encompasses a fully loaded credit loss. This includes not only credit events and lost rental revenue but also any operational expenses or costs associated with assets that are vacant for any reason related to credit or otherwise. We experienced credit loss that was relatively aligned with the lower end of the 25 to 50 basis point range, leaning more towards the 25 basis points. Looking ahead to the second half of the year, given the known credit issues in our portfolio, we expect to operate closer to that 25 basis points or to experience credit loss near that figure. The upper limit of 50 basis points takes into account potential unknown credit events or a buffer of roughly 20 to 25 basis points.
Joel N. Agree, CEO
As Peter mentioned in the prepared remarks, our definition of credit loss is comprehensive. It includes any situation where a tenant fails to pay rent, along with all unreimbursed expenses incurred by Agree Realty, and the necessary maintenance of the building during periods of vacancy. When a building is vacant, it requires heating and cooling to prevent mold and frozen pipes, along with fire suppression and ongoing maintenance to prepare it for re-leasing. This definition encompasses all related costs. Furthermore, net lease companies have been innovative in how they define credit loss. Credit loss specifically arises from a credit event and is calculated on a pro forma basis for the lease-up. However, we will focus on the actual economic impact, which equates to 25 basis points of our total revenues for the year, reflecting both outflows and the absence of inflows. This approach represents genuine economic underwriting in real estate, avoiding the need for investors to sift through ambiguous language and complex presentations.
Operator, Operator
Your next question comes from the line of John Kilichowski with Wells Fargo.
Sheryl Kaul, Analyst
This is Sheryl on for John. Could you provide us an update on your watch list? And what is baked in your guide in terms of going-in yields?
Joel N. Agree, CEO
Our watch list is minimal. At Home was notably on our watch list. As mentioned earlier, I fully expect them to go into bankruptcy similar to what we've seen before, with Chapter 11 where unsecured creditors receive nothing. They come out like Party City, JOANN, and Rite Aid, without an active business. Unsecured creditors who end up with equity and face losses then proceed to liquidate the company. This is under contract for a flat rate of 7. We could have managed that and redeveloped it, but we found better uses for our time considering the aggressive offer we accepted. Apart from that, our watch list is not significant at this moment. We are keeping an eye on a couple of movie theaters in our portfolio, and that's really all there is. We reduced that to 25 basis points, which included Big Lots this year during the first half.
Peter Coughenour, CFO
Yes. I think the watch list, to Joey's point, historically, the two biggest components there were At Home and Big Lots. And with those now resolved, the remaining credit issues in the portfolio are fairly de minimis one-offs, and there's nothing on the horizon of any material size that we see as imminent, and the portfolio continues to perform very well.
Sheryl Kaul, Analyst
That's helpful. And then one quick one on Big Lots. Can you remind us how many assets were sold or re-leased? And what was the final outcome?
Joel N. Agree, CEO
Yes, we have one or two remaining. One has been approved and we will disclose it next quarter, by a national retailer you are all familiar with. Cedar Park, Texas was re-leased to Aldi, as we mentioned in the prepared remarks, with a significant increase in net effective rent and a brand-new term. Manassas, Virginia was also re-leased with a notable rent increase on a net effective basis, which we disclosed in the prepared remarks. We are continuing to work through one or two others, but we expect to resolve those very quickly.
Operator, Operator
Your next question comes from the line of Brad Heffern with RBC Capital Markets.
Bradley Barrett Heffern, Analyst
Joey, in the prepared comments, you talked about the highest level of demand for brick-and-mortar locations since the GFC. Obviously, we're still in a pretty uncertain environment and you have the potential tariff headwinds for retailers. I'm curious why you think that demand is so strong?
Joel N. Agree, CEO
Brad, we haven't seen any retailer pull back, and it's not that they won't potentially do so due to the tariff noise, headwinds and the 85 different dates that have been handed out by the White House. We just haven't seen it, the biggest retailers in this country, and it's aligned with our thesis going back a decade in our white papers. There are two drivers here. One is the bigger operators are taking share. Two, the bigger operators now all realize, and you've probably heard me say it before, that the store is not a spoke, it's the hub, right? Free delivery and free returns same day don't work from an EBITDA perspective, not unless you've got AWS backing it up in cloud computing and advertising revenue and ancillary sources of revenue. But from a selling goods perspective, that doesn't work. And so retailers have all realized that. We have never seen Walmart, Home Depot, Target, Lowe's, all growing their store count. It's all public information out there plus, plus, plus since prior to the great financial crisis. Sam's Club, Costco, you can keep going, all of these retailers invested for, let's call it, a 7-year period in distribution and fulfillment and logistics. And then they realized these investments are great. They make us more efficient. But guess what, we still lose money. We need the customer to get their butt in the car and try to get them to pick up those goods from the store rather than delivering them to their house for free because they're accustomed to it now. And if we can get them to the store to pick up those goods or return those goods, which is an absolute disaster, right? I mean those get paletted and sold by the pound, returned goods. We've actually done it as an exercise here from Amazon. Those returned goods, return them in store and maybe repurchase something else. So we've had a number of retailers speak to the team here. We have more retailers, national retailers, heads of real estate departments coming in and speaking to the team here that we're partners with and articulating how those impact on the business. The other piece to it is, specifically in some sectors, let's use auto parts, auto parts, we have seen the rise of the hub store. We have a white paper on this, I believe as well, Peter, right, yes?
Peter Coughenour, CFO
Correct.
Joel N. Agree, CEO
The rise of the hub store is driven by the demand for commercial tire and auto service, collisions, and dealerships needing a part in 30 minutes. This is unachievable from a central distribution facility. Auto parts retailers recognize that standard stores of 7,000 square feet cannot stock enough SKUs. Consequently, they require hub stores of 20,000 square feet and mega hub stores of up to 50,000 square feet, which serve as storefronts with warehouses in the back to hold various SKUs to quickly get a car off the lift and deliver that part within 30 minutes. That’s the core of the business. We are also observing the growth of large-format convenience stores, in which we are actively involved. These convenience stores are gaining market share, not because there is an increase in fuel sales or vehicles on the road, but by taking business from fast food restaurants and the front ends of pharmacies. They are capturing share in convenience items, allowing customers to quickly grab essentials like milk and pay a premium rather than navigating a large store like Walmart, Kroger, or Albertsons. Their success is attributed to their service and offerings, especially food and beverages for off-premises consumption, primarily at breakfast and lunch. The main focus here is convenience, speed, and ultimately profitability.
Bradley Barrett Heffern, Analyst
Okay. Thank you for the detail there. Maybe one for Peter on the guidance. The implication is a decent-sized ramp in AFFO per share in the second half of the year. Is there anything lumpy on the expense side that maybe is driving some of that? Or is that purely just the ramp in acquisition volumes?
Peter Coughenour, CFO
No. I think that's largely driven by the ramp in acquisition volume. I also mentioned in my prepared remarks the treasury stock method dilution and our assumption for roughly $0.01 of impact there for full year 2025 versus $0.02 last quarter. But there's nothing lumpy from an expense perspective anticipated in the back half of the year.
Operator, Operator
Your next question comes from the line of Wes Golladay with Baird.
Wesley Keith Golladay, Analyst
I just want to go back to the comment of $100 million in starts and getting $200 million into the ground. Can you clarify if that was for development or development and funding? And then for these assets you're going to develop, would you plan on owning them afterward?
Joel N. Agree, CEO
We plan to evaluate all pieces of real estate for sale, but ultimately, we have no intention of selling. We are not pursuing these projects in a TRS or off-balance sheet structure. We expect to initiate over $100 million in projects between June 30 and the end of the year.
Wesley Keith Golladay, Analyst
Okay. And you did mention some...
Joel N. Agree, CEO
At minimum, at minimum.
Wesley Keith Golladay, Analyst
Yes, go ahead.
Joel N. Agree, CEO
Yes. Peter understands technology way more than I do. I drew it on a piece of paper originally. Peter has handled it from there, but I will mention we have now fully built out our IT team here, and we're thrilled with that team and the partners we're working with. Peter, you're way smarter here than I.
Peter Coughenour, CFO
Sure. Specific to Arc, I think the primary goal of that project is to build Arc on effectively a new backbone or system that will allow for more self-service and more dynamic reporting that can be used across the organization and will drive efficiencies in that we can manipulate the data more and drive to the decisions that we're trying to make across the organization. I think in addition to Arc, Joey mentioned some of the industry-leading efficiencies that we've gained through the implementation of AI. We implemented AI for lease abstraction about 3 years ago now. And we've been using that tool to abstract hundreds of leases that we onboard each year with a high degree of accuracy. That has increased over time, the accuracy, and the tool has resulted in significant time savings for the team. More recently, we've launched an AI tool to complete what we call our lease underwriting checklist, which compares our initial underwriting to the lease and confirms that there are no significant issues. With that tool, it used to take an attorney roughly 4 hours to complete each one of those, and that's now a matter of seconds. So we've seen hundreds of hours of time savings there, 400-plus hours from that on an annual basis, hundreds of thousands of dollars of savings just from the implementation of that tool. And then looking forward, I think we'll look to combine AI and incorporate more of that into Arc from a decision-making process moving forward.
Joel N. Agree, CEO
So Wes, we ran a test. Our IT team here ran a test looking backwards into deals that were approved in Investment Committee, and this is far out, this component. But I think it should demonstrate the future of what AI is capable of. Our team ran a test of deals that were brought in to Investment Committee and what they would be approved. With the percentage of approval using AI, they were 90% accurate, and it was just a test. It was a game to see if they could replicate Investment Committee's approval. We're using AI today, as Peter mentioned, for functional tasks and driving efficiencies. I want to take legal costs and cut them in half. That's my goal here. We have a great team and a great external team, but we don't need lawyers extracting leases, summarizing leases. We can now do them in 15 seconds using artificial intelligence. That is generative AI learning. And so the new Arc, which will be unveiled next year, 3.0, and I look forward to unveiling it, will enable our full data warehouse and multiple tools to be layered on in the future.
Operator, Operator
Your next question comes from the line of Rich Hightower with Barclays.
Richard Allen Hightower, Analyst
Let's discuss the asset management aspect for a moment. Generally, when it comes to tenants with very high credit quality, there are some trade-offs. One of them is that you tend to have lower escalators, and another is shorter weighted average lease terms. As you renew leases, could you share any changes in the lease structure that might be noteworthy, particularly considering the current shortage of good retail space in the country?
Joel N. Agree, CEO
Well, the shortage of space due to construction costs in this country, we see, and I think the shopping center reporters have demonstrated this and we've demonstrated with our re-leasing efforts, is the second-generation space that is A, B space is in high demand. That said, C space, functional obsolescence is a challenge, single-purpose boxes will always be challenges. I'll take issue with the first statement. Investment because the portrayal that investment grade has shorter weighted average lease terms and/or less escalators, we have effectively net of credit loss, approximately 100 basis points of internal growth. When you look at the totality of those circumstances, I don't think that is frankly economically true. So anyone can sign a sale-leaseback if you're a private operator or a public operator for 30 years, 50 years. Remember, Nick Schorsch had Red Lobster sign 25-year sale-leasebacks. Anybody can sign...
Richard Allen Hightower, Analyst
Blast from the past.
Joel N. Agree, CEO
A blast from the past. But guess what, a lot of this stuff is coming back now into net lease. With a lot of the private credit and the private capital that's flowing in, you can sign a sale-leaseback on your house. You can have escalators. You can sign a sale-leaseback at anything, escalators, you can do it for 50 years. The piece of paper isn't worth what it's printed on though. I mean ultimately, this is real estate, and can the tenant ultimately afford the compounding impacts of those annual escalators that you're going to write into that lease. Sale-leasebacks with non-credit tenants are simply financial structures that are akin to a lender. That is all it is. It is not our business. And when we talk about sale-leasebacks being an alternative form of financing for these non-credit small, middle-market, private equity-sponsored operators or small private operators, it is not an alternative form of financing. There is no other place where you can pull out 100% of the proceeds from the building. If I am a private equity-sponsored car wash operator and I go to a conventional lender and I say I want a first mortgage, maybe they give me 50%, maybe they give me 60%. Then I go and I try to get mezz on that real estate. Maybe if I'm really lucky, I can ramp that to those two combined to 75%. Good luck on that. It can be expensive. Who's filling the last 25% in that primary method of financing this real estate? A hard money lender, a bookie? Nobody, right? And so what we see is alternative markets aren't alternative markets to finance these assets. And look what we've seen in spaces like the car wash space, the experiential space, they are primary assets that don't provide for risk-adjusted returns that are ultimately appropriate. If I'm going to finance a full capital stack for any of those types of uses, I want a 14 cap, and I want my money out in 6.5 years. And I wouldn't even do it there, I don't think. I'd rather just run the business myself and own the equity.
Richard Allen Hightower, Analyst
Helpful comments. It'd be fun to get you on another panel with your peers and kind of go at it from multiple directions.
Joel N. Agree, CEO
I'm happy to do it. I believe it would be educational for investors. I think it's beneficial to compare and contrast in earnings calls and meetings rather than addressing issues in isolation; discussing these matters is healthy for investors. The isolated nature of events in our subsector, as well as general market trends, doesn't provide investors with a complete picture or transparency. When you factor in reporting discrepancies, footnotes, and pro forma, the situation becomes complicated. Our business model is straightforward. The second slide of our presentation highlights consistency; we've been following the same approach since I started this acquisition platform in 2010 and took over operations. We will continue this approach. If we're going to make nuanced arguments, let's do so on their merits. Let's debate the pros and cons, allowing investors to draw their own conclusions. However, I must emphasize that financing certain types of uses with such low returns is not appropriately risk-adjusted, and I'm willing to elaborate on this in any format.
Operator, Operator
Your next question comes from the line of Jim Kammert with Evercore ISI.
James Hall Kammert, Analyst
Joey, just revisiting one more time the ramp in development activity. Would you say you're more likely just supplanting developer relationships that the retailers had? Or more strategically, are you supplanting more of the in-house development capability at those retailers?
Joel N. Agree, CEO
That's an interesting question, Jim. We are definitely filling the gap left by developers who can no longer perform due to financial constraints and market fluctuations. We've also established new relationships. Some retailers do have internal capabilities, and we have not observed them abandoning those. In fact, retailers are working to enhance their internal capabilities to better execute their store growth plans. So it's not about replacing retailer self-development; it's about capturing market share.
James Hall Kammert, Analyst
That's interesting. Have you reached out to all your retailers to find out if they are on board with this? Or do you still have new tenants that you haven't approached yet to explain Agree's full capabilities? I'm considering how much potential this could have for your expansion.
Joel N. Agree, CEO
I would say we have a scorecard and a scoreboard. It is in Arc. I can tell you there are very few we haven't talked to. Timing and economics have to align. We have new relationships that will materialize in '27, along with our existing relationships. A lot of it depends on timing; we are ramping up and need assistance. You can be a critical partner for us. Our other partners are not succeeding; they are not fulfilling their commitments. With $2.3 billion in liquidity and the expertise of a private real estate developer, we uniquely offer a value proposition that no one else can match.
Operator, Operator
Your next question comes from the line of Upal Rana with KeyBanc Capital Markets.
Upal Dhananjay Rana, Analyst
Great. Just a quick one for me. With the development and DFP pipeline ramping, how are you thinking about construction costs today? And you mentioned building 50 basis points wider where you can acquire. So just wondering if construction costs continue to rise, could that potentially eat into your 50 basis points?
Joel N. Agree, CEO
No, I appreciate the question. We have conducted a thorough internal analysis of the effects of various types of tariffs, led by Jeff Konkle, our Head of Construction. Additionally, we are fortunate to have John Rakolta, the Chairman of Walbridge, one of the largest contractors in the country, on our Board. His team also analyzed the impact of tariffs in the construction sector. We estimate that tariffs affect project costs, specifically vertical costs, which make up about 25% to 35% of total project expenses. We believe the current tariff situation may add around 1.5% to overall costs. Typically, we include a contingency of 7% to 10% in our projects, so we are not overly worried about the current tariff environment. However, we will keep an eye on it, although not on a daily basis. It should not have a significant impact on our overall construction costs. There are various sourcing methods that may evolve; we will consider buying domestic products. Retailers may also specify different requirements for building components. While some components could be subject to tariffs, we can adjust our construction features and engineering designs to optimize efficiency and possibly reduce that 1.5% impact.
Operator, Operator
Your next question comes from the line of Omotayo Okusanya with Deutsche Bank.
Unidentified Analyst, Analyst
This is Sam on for Tayo. I hope I didn't miss this, but what gave you guys the confidence around increasing your investment outlook given the uncertainty presented by the macro backdrop as well as potential credit risk stemming from some tariffs?
Joel N. Agree, CEO
Outside of sourcing acquisitions for Q4 between now and, call it, the middle of October, we already know it's there.
Operator, Operator
Your next question comes from the line of Ronald Kamdem with Morgan Stanley.
Ronald Kamdem, Analyst
Two quick ones just on ramping on the developments. Maybe can you talk a little more about are the lease structures any different from the acquisitions in terms of duration, yield, contracts? Just curious there.
Joel N. Agree, CEO
Yes, Ron, generally, obviously, they're new leases. So these are 10-, 15-, 20-year leases, generally, the fresh-faced terms that are starting. Standard lease structures, nothing different, either ground leases or generally turnkey leases. The economics, again, will subject to project duration and scope will be 50 to 150 basis points wide of where we could acquire and do acquire the like-kind assets. Really no different there, except the methodology of sourcing, obviously, and then the duration and the return requirements internally here.
Ronald Kamdem, Analyst
Great. And then my second one, Genuine Parts Company added to the top tenant list. Just any color there on maybe the opportunity with them to continue to grow?
Joel N. Agree, CEO
Look, that's NAPA. Obviously, it's an investment-grade auto parts retailer. They have made it to the top tenant list. Know we're very fond of auto parts as we discussed and wrote in the white paper, fungible boxes, great business, cars and every day setting a new record on the road. I'm not sure if anyone can be able to afford a car after all these tariffs actually hit. We continue to like the space. We like NAPA, but no plans to materially increase exposure from here.
Operator, Operator
And that concludes our question-and-answer session. And I will now turn the conference back over to Joey for closing comments.
Joel N. Agree, CEO
I appreciate everybody's time today. Thank you for joining us. We look forward to seeing you in the near future, and good luck to the rest of earnings season. Thank you.
Operator, Operator
This concludes today's conference call. Thank you for your participation, and you may now disconnect.