Earnings Call Transcript - ADC Q4 2022

Operator, Operator

Good morning, everyone, and welcome to the Agree Realty Fourth Quarter and Full Year 2022 Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. We do ask you please limit yourselves to two questions during the call. And please note today's conference is being recorded. At this time, I would like to turn the conference call over to Brian Hawthorne, Director of Corporate Finance. Please go ahead, Brian.

Brian Hawthorne, Director of Corporate Finance

Thank you. Good morning, everyone, and thank you for joining us for Agree Realty's fourth quarter and full year 2022 earnings call. Before turning the call over to Joey and Peter to discuss our record results for the quarter, let me first run through the cautionary language. Please note that during this call, we will make certain statements that may be considered forward-looking under Federal Securities Law. 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 these 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.

Joey Agree, CEO

Thank you, Brian. Good morning and everyone thank you for joining us today. I'm pleased to report that 2022 was another record year for our company. Notable milestones over the past 12 months included record investment activity over $1.7 billion, surpassing our record high by 20%. The addition of over 440 high-quality net lease properties to our growing portfolio, the commencement of a record 28 development and Partner Capital Solutions projects for total committed capital of nearly $110 million, the receiving of an upgraded investment grade credit rating of Baa1 from Moody's Investors Service and positioning our balance sheet to execute in 2023 without the need for additional capital, while raising approximately $1.7 billion including $1.3 billion of equity. We closed 2022 with approximately $1.5 billion of liquidity at year-end, including more than $550 million of outstanding forward equity available at our election. Including our forward equity, pro forma net debt to recurring EBITDA was approximately 3.1 times at 12/31. As demonstrated by our fourth quarter acquisition activity, cap rates crept higher, but bid-ask spreads remain as sellers are slow to adjust to current market dynamics. As always, we remain disciplined to our investment strategy and refrain from going up the risk curve via credit or residual risk to create the appearance of a quickly expanding cap rate environment. Similarly, we will not chase cap rates down to levels that fail to create sufficient spreads to drive appropriate returns for our shareholders. Our focus remains on the best retailers in the country with strong balance sheets to allow them to withstand the current macroeconomic environment regardless of the level of deterioration. Our team is doing a terrific job navigating this environment, leveraging our strong industry-wide relationships and track record while uncovering opportunities to add to our growing portfolio. Our pipeline includes both smaller one-off transactions and larger sale leasebacks with our leading retail partners. Given that pipeline, I am confident our team will be able to source north of $1 billion of acquisition activity at spreads that are appropriately accretive. During the fourth quarter, we invested approximately $421 million across 157 properties via our three external growth platforms. 131 of the properties originated through our acquisition platform, representing acquisition volume of approximately $405 million. The properties acquired during the quarter are leased to best-in-class operators in the auto parts, tire and auto service, home improvement, dollar store, off-price retail, convenience store and farm and rural supply sectors, among others. The acquired properties had a weighted average cap rate of 6.4% and a weighted average remaining lease term of 10.6 years. Over 73% of the acquired rents are derived from investment grade retail tenants. For the full year 2022, nearly 70% of the annualized base rent acquired was derived from leading investment grade retailers, while ground leases represented more than 5% of rents acquired. Moving on to our development and PCS platforms. We again had a record year with 31 projects, either completed or under construction, representing over $118 million of committed capital. This includes 28 projects commenced during the year with the total anticipated costs of $110 million. During the fourth quarter, we commenced six new development and PCS projects with total anticipated costs of approximately $37 million. We completed the development of two projects while construction continued on another 18 projects. We continued to call noncore assets from our portfolio with seven properties sold during the prior year for gross proceeds of over $45 million. These dispositions were completed at a weighted average cap rate of 6.5%. On the leasing front, we executed new leases, extensions or options on approximately 850,000 square feet of gross leasable area in 2022, including 198,000 square feet during the fourth quarter. Notable new leases, extensions or options included a Chase Bank ground lease in Stockbridge, Georgia, where we had our first opportunity to recapture a ground lease due to the tenant’s lack of options. We eventually executed a new 15-year lease with Chase and were able to increase the rent by approximately 160%. The NOI lift we were able to generate is emblematic of the embedded value in our ground lease portfolio. Moving into this year, we are in a very strong position with 1.3% of annualized base rents maturing. Subsequent to year-end, we have executed a number of lease extensions, bringing this number down to only 1% for the remainder of the year. At year-end, our portfolio encompassed 1,839 properties across all 48 continental United States, including 206 ground leases representing 12.4% of total annualized base rents. Occupancy remained a very healthy 99.7%. Again, our investment grade exposure stood at nearly 68%. And all of our top 10 tenants carry an investment grade credit rating. Our best-in-class portfolio is very well positioned to withstand the current macroeconomic environment. With that, I'll hand the call over to Peter and then we can open up for any questions.

Peter Coughenour, CFO

Thank you, Joey. I'll start by recapping our balance sheet and capital markets activities during the year. As Joey mentioned, we were highly active in the capital markets, raising approximately $1.7 billion to further bolster our balance sheet and position us for continued growth. Notable activities include $1.3 billion of gross equity proceeds raised through two overnight offerings and our at-the-market equity program, and a $300 million public bond offering of 4.8% senior unsecured notes due 2032 with an effective all-in rate of 3.76%, inclusive of prior hedging activity. Our capital markets activities during 2022 provided us with approximately $1.5 billion of liquidity at year-end, including $557 million of outstanding forward equity, $900 million of availability on the revolver and $29 million of cash on hand. Our existing liquidity plus free cash flow after the dividend of approximately $85 million and any disposition proceeds enable us to opportunistically execute our growth strategy in 2023 without the need for additional capital. As of December 31st, pro forma for the settlement of the $557 million of outstanding forward equity, our net debt to recurring EBITDA was approximately 3.1 times. Excluding the impact of unsettled forward equity, our net debt to recurring EBITDA was 4.4 times. At year-end, our weighted average debt maturity stood at approximately eight years. With limited variable rate debt and no material debt maturities until 2028, we remain well positioned to withstand interest rate headwinds and capital markets volatility. Total debt to enterprise value at year end stood at 23%. While our fixed charge coverage ratio, which includes principal amortization and the preferred dividend remained at a healthy level of 5 times. Moving to earnings, core FFO was $0.96 per share for the fourth quarter and $3.87 per share for full year 2022, representing 3.5% and 8.1% year-over-year increases, respectively. AFFO per share was $0.95 for the fourth quarter and $3.83 for the full year, representing 3.9% and 9.2% year-over-year increases, respectively. As a reminder, treasury stock is included in our diluted share count prior to settlement, if ADC stock trades above the deal price of our outstanding forward equity offerings. The aggregate dilutive impact related to these offerings was less than half a penny in the fourth quarter and roughly $0.02 for the full year. Our consistent and reliable earnings growth continues to support a growing and well-covered dividend. During the fourth quarter, we declared monthly cash dividends of $0.24 per common share for each of October, November and December. On an annualized basis, the monthly dividends represent a 5.7% increase over the annualized dividend from the fourth quarter of 2021. For the full year, the Company declared dividends of just over $2.80 per share, a 7.7% increase year-over-year and a 16% increase on a two-year stack basis. Our payout ratios for the fourth quarter and full year remained at or below the low end of our targeted range of 75% to 85% of AFFO per share. After year-end, we announced a monthly dividend of $0.24 per share for each of January and February. The monthly dividend reflects an annualized dividend amount of $2.88 per share, or 5.7% increase over the annualized dividend amount of approximately $2.72 per share from the first quarter of 2022. General and administrative expenses in 2022 totaled $30.1 million. G&A expenses were 7% of total revenue or 6.5%, excluding the non-cash amortization of above and below market lease intangibles. We achieved 50 basis points of G&A leverage during 2022. Given our investments in systems, including our recently implemented ERP system and further improvements to our proprietary ARC database, we anticipate achieving similar G&A leverage this year. Lastly, total income tax expense for 2022 was approximately $2.9 million, including $723,000 of expense during the fourth quarter. With that, I'd like to turn the call back over to Joey.

Joey Agree, CEO

Thank you, Peter. At this time, operator, we'll open it up for questions.

Operator, Operator

Ladies and gentlemen, at this time, we will begin that question-and-answer session. Our first question today comes from Nick Joseph from Citi.

Nick Joseph, Analyst

Thanks. Joey, I was just hoping to get some more color on current cap rate trends, maybe specific to what you're seeing on the merchant builder side and the impact it's having on any recent deals?

Joey Agree, CEO

Yes, good morning, Nick. During the fourth quarter, we executed several transactions with merchant builders for Dollar General, O'Reilly, and Dollar Tree Family, taking advantage of situations where they needed to clear inventory. We're still in discussions with various retailers who have traditionally utilized their merchant builder platform for new stores, as that aspect of the business is currently paused. As we approach the end of 2023 and look into 2024 for new openings, retailers who relied on merchant builders are seeking new solutions, and we believe we can play a role in that. Regarding cap rates, the situation is quite complex. I would categorize them as trifurcated rather than bifurcated. If you're willing to accept more risk, there are plenty of options available, including assets with higher yields backed by private equity or lower-tier operators. In the investment grade space, there are numerous opportunities, and we could potentially acquire over $2 billion in 2023 if desired. Our focus remains on finding the right opportunities that can enhance AFFO per share while ensuring the quality of our portfolio meets our standards. Factors affecting cap rates include pricing and credit considerations. They have certainly increased from the lows we saw in 2021 and 2022. It's important to remember that this business operates similarly to bonds, which drives a demand for bond-like assets. Over the past year, we're seeing significant increases in debt financing costs, both short and long term, without a corresponding rise in cap rates. Consequently, we've observed both private and public investors in the net lease market taking on more risk to increase their yields, but we will not compromise long-term value creation for short-term gains. We will remain disciplined and observe how this situation unfolds.

Nick Joseph, Analyst

And then just maybe on the current pipeline, you talked about at least $1 billion of acquisitions, maybe less specificity than the normal given the environment. How are you thinking about the timing of those? Maybe you can talk about the current pipeline and then is the opportunity more in the back half of the year to exceed that $1 billion if deals start to materialize?

Joey Agree, CEO

I appreciate hearing that the opportunity is expected to be more concentrated in the latter half of the year. However, I can't predict what will happen in that timeframe, including tomorrow. Our current pipeline for the first quarter includes significant sale-leaseback transactions with industry leaders, as well as some individual deals. We are just beginning to build our pipeline for the second quarter, and we're about one-fifth of the way through that process. To be honest, we currently have no deals lined up for the third and fourth quarters; not one at this point. I can't say whether we will experience a smooth transition or a sudden downturn in the economy. Therefore, I believe it is best for us to stay flexible with our balance sheet and not require any equity right now, while also being disciplined in capital deployment as the year progresses. Different perspectives exist on this matter.

Operator, Operator

Our next question comes from Rob Stevenson from Janney.

Rob Stevenson, Analyst

Joey, can you talk about your future pipeline of development and partner capital projects? How aggressive are you being with new projects today, and do you see the current dollar volume of that pipeline growing, stable, or shrinking over the course of '23 as projects go in and come out?

Joey Agree, CEO

Yes, Rob, my previous answer regarding acquisitions applies here as well. We're not pursuing lower yields due to a potential rise in cap rates this year. When entering any development or PCS transaction, there is a duration involved. Some transactions take 6 months, while others can take 12 to 18 months. Therefore, it's essential to ensure appropriate compensation for the return on costs. We announced several projects in the fourth quarter and have more in our pipeline that are still unannounced. The key takeaway is that we are obtaining the right premium for the duration of risk involved. This risk isn't related to credit or residual concerns but specifically to duration. If we can acquire something with a comparable credit profile from our retail partners, and it's close to where we could develop or enter into a PCS transaction, we would prefer to have visibility into that 70-day closing period, or as much visibility as possible.

Rob Stevenson, Analyst

And then, talking to your core tenants, where's retailer expansion demand today versus where it's been over the last few years? And how does that sort of match up with your understanding of merchant developers ability to get capital to start new projects to fund that sort of development?

Joey Agree, CEO

It is a great question. It is extremely topical. We are having literally weekly conversations with our retail partners, the biggest retailers in the world. The vast majority of them aren't afraid of the overall macro environment because they know they would benefit from the trade down effect. Large format C stores, we have two entering Metro Detroit, both Sheetz and Kum & Go we've had the rare various levels of discussion with, the dollar stores, obviously, trade down effect, deep discount grocery or discount groceries, all the ones that continue to grow throughout this country, Dollar General, the Dollar General Market format, Dollar General with popshelf, Five Below and now Five Beyond, the auto parts operators. Obviously with cars on the road eclipsing 12 years and still not able to get a car, because the chips shortage, the auto parts operators AutoZone, O'Reilly, Napa want to continue to grow. The tire and service operators in this country, the National Tire and Batteries, Bridgestone, Firestone, Goodyear want to continue to grow. The challenge for these retailers is that they historically don't have a self-development platform and/or don't have the stomach to keep them on their balance sheet and then offload them via sale leaseback or permanently keep them on the balance sheet as the merchant builder business is that. And so, our conversations with these retailers revolve around which three of our external growth capabilities, acquisition, development and Partner Capital Solutions could potentially be a solution for them. And so, these are conversations that are ongoing. And they're producing some interesting dialogue. We'll see if any of them strike. By the way, you can add to that with Sam's Club for the first time in, what, 12 years, announced 30 net new stores. And so, you see that these discount-oriented retailer or these value-oriented retailers want to grow regardless of the storm clouds on the horizon. But frankly, the ability to grow is their challenge.

Operator, Operator

Our next question comes from RJ Milligan from Raymond James.

RJ Milligan, Analyst

Joey, your comments that there's plenty to buy, if you were willing to sort of hit the pricing expectations, but obviously being a little bit more prudent here. I'm just curious, what do you think has to happen for sellers to adjust those pricing expectations?

Joey Agree, CEO

It's a great question. I think first of all, we see the sentiment swings and shifts daily with new data and the Fed speakers rambling on like Tony Romo during a football game. Nobody knows that this is going to be a soft landing, a hard landing, this economy is going to flow up there like the Chinese spy balloon for a while, we have no certainty to this market, still hopeful, inclusive of real estate sellers, that the Fed is going to cut rates at the end of this year. Maybe that got washed away yesterday. And so, I think the current status quo results in a bid-ask spread. Now, we have more data this morning with consumer sentiment or consumer spending. And so, the challenge here is that nobody has visibility into how this economy is going to evolve here. And hence unless you are in middle market or a private equity sponsored retail or who needs capital today via sale leaseback where banks have pulled back and lenders have pulled back on LTVs, rates are obviously extremely elevated, you can find a lender or last resort in terms of sale leaseback who will be there as a secured creditor with your real estate to help you with your growth. Now, the challenge on the third-party market specifically is that there's still too much hope out there. And until that clears up, I think we're still going to have a bid-ask spread. Now, what we're doing is scouring the market through all of our contacts, all of our different distribution groups, all of our different stakeholders and partners out there and looking for the capitulation. And we're finding it. The question is, how much will we find as the economy evolves? And that I just don't have any idea because I don't know how the economy's going to evolve?

RJ Milligan, Analyst

That makes sense. And I guess a question for Peter. I'm just curious what you're seeing on the debt market side? Obviously, the market’s opened up a little bit for the REITs here. And I'm just curious, what are you hearing in terms of banks’ appetite for debt and what pricing might look like to that?

Peter Coughenour, CFO

Yes. I think first, RJ, in terms of the unsecured market, I think we could probably price 10-year unsecured debt today in the mid-5s. This is down from call it the 6s we discussed on last quarter's call, but frankly, still isn't overly attractive today, given we view our cost of equity to be in a similar range. In terms of the bank debt market and the term loan market, assuming we enter into swaps to fix the rate, I think we could probably price a five-year term loan today in the high-4s. And I view a five-year term loan to be more attractive today than a 10-year bond given the current pricing. All that being said, the good news is we have, as Joey mentioned, $1.5 billion of liquidity, more than $550 million of outstanding forward equity. And so, we don't need the capital today, either debt capital or equity capital. And we can continue to monitor our options and be opportunistic in terms of any future capital raises.

Operator, Operator

Our next question comes from Ki Bin Kim from Truist.

Ki Bin Kim, Analyst

So within the IG realm that you guys invest in, I'm just curious how the triple net financing option compares to your tenants’ alternative financing options and how that spread may have migrated over the past few months?

Joey Agree, CEO

First of all, Ki Bin, it's great to hear an operator say your name correctly on an earnings call. Apologies for the last one. So, when you say the financing options, are you talking about a seller's potential financing options relative to sale?

Ki Bin Kim, Analyst

No, I mean, for financing. I mean, they can tap the unsecured bond market; they can with a bank market. For your IG tenants, I'm just curious how triple net financing compares to those type of traditional debt financing options?

Joey Agree, CEO

We believe the term loan market is a potential opportunity for us. Peter mentioned the current state of the 10-year unsecured market. We will continue to borrow on an unsecured basis, as we find this to be the most effective way to obtain capital.

Peter Coughenour, CFO

Ki Bin, are you asking in terms of our retailers?

Ki Bin Kim, Analyst

Yes.

Joey Agree, CEO

Well, that's a very interesting bifurcation today. So some of the most transactions that we have in our pipeline today are with sophisticated retailers, S&P 500 companies that recognize where their relative cost of capital are, where they can issue 10-year paper and say you know what, a sale leaseback makes sense and that's similar to what I referenced prior. Now, when we compare just to take a step back, IG versus non-IG, first, let's reframe this as high-quality retailers versus other retailers. Because I continue to remind people I love Chick-fil-A, I love Hobby, I love Publix, I love Aldi. These are not investment grade retailers; they're privately held, closely-held companies that don't have a rating. The high-quality retailers have options. They low-quality private equity sponsored retail or has very limited options today. One of those options and the largest option is a sale leaseback on their real estate. And so, we will not be the lender of last resort, or one of the largest creditors to a carwash startup and urgent care. Now, there are four car washes literally expanding in Metro Detroit as we speak that are all private equity sponsored with REIT capital behind them. They own none of their real estate. I can't figure out where all these new cars that need to be washed are from and how many monthly memberships are required by Metro Detroiters. So I think, in reality, we're back to the pre-COVID days here. We're back to the days where the high-quality retailers are going to thrive. They have the liquidity, the balance sheets. The low-quality retailers are now faced with a stressed economic environment. They need whatever capital they can to shore up their balance sheet or frankly, offload their real estate.

Ki Bin Kim, Analyst

And in terms of your balance sheet strategy, your leverage is at 4.4 times. How should we think about this as the year progresses? I'm curious if you would let the leverage kind of drift up here or keep it this way?

Joey Agree, CEO

Our leverage is definitely going to drift up. We ended pro forma for the settlement of the $552 million in equity at 12/31 at effectively 3.1 times leverage. Leverage is going to drift up to the 4 to 5 times targeted leverage range. We are not interested in the equity markets. We're not coming back to the equity markets via regular way or the ATM anytime soon. We have the capital and the flexibility to execute on our strategy for this upcoming year. And we're going to obviously drift leverage higher here to what we think is appropriate, that 4 to 5 times.

Operator, Operator

And our next question comes from Tayo Okusanya from Credit Suisse.

Tayo Okusanya, Analyst

I wanted to follow up on RJ's question. Joey, part of your response mentioned that no one knows where the economy is headed and that no one has a method to predict it. I'm curious about how you see the agency performing in different economic scenarios. Would you fare better if the economy continues to improve, or if it declines and you see distressed opportunities, would that be your opportunity to act? I’d like to know your perspective on how ADC would perform in each situation.

Joey Agree, CEO

I appreciate the question. The situation with current economic data is quite complex. We are in a unique position with a defensive portfolio and balance sheet, which allows us to be proactive. Regardless of whether the economic environment worsens, this portfolio is set to perform well. Conversely, if we experience a soft landing and the economy improves, we have the necessary capital and liquidity to act effectively. We are strategically prepared for various scenarios, and it's not the right time to take excessive risks or to hold back completely. We will remain disciplined and cautious, but if significant changes occur, we will adapt quickly, just as we did during COVID and when we initiated our acquisition platform. In both scenarios, we anticipate growth in AFFO and our dividends, with a focus on our portfolio and balance sheet.

Tayo Okusanya, Analyst

That's helpful. Peter, could you explain how you view credit and credit provisioning, particularly in terms of the impact on 2023 compared to 2022? I'm aware that you don't provide guidance, but please walk us through your perspective. Although you operate in a largely investment-grade space and haven't experienced significant credit issues, I'm curious about your thoughts on this matter.

Peter Coughenour, CFO

Sure. I guess just to recap 2022 first. We recorded about $400,000 of bad debt expense in 2022. That's call it roughly 10 basis points of revenue. And that's slightly below our longer term average, which is probably closer to call it 20 or 25 basis points of revenue. But as you mentioned, we specifically identify tenants or instances of bad debt. And so, predicting bad debt on a go forward basis can be difficult. With the current macroeconomic environment, where it is, I think that obviously presents some challenges for retailers. But we certainly feel with our portfolio and 68% of rents coming from investment grade tenants that it's very well positioned to withstand the current environment, and wouldn't really anticipate any significant deviation from what we've seen historically.

Operator, Operator

Our next question comes from Josh Dennerlein from Bank of America.

Josh Dennerlein, Analyst

Joey, just kind of curious how you think about dispositions as a potential source of capital in today's environment?

Joey Agree, CEO

We didn't provide guidance on dispositions this year because, honestly, getting involved in dispensations without pre-screened, all-cash buyers is not a good use of our time. We've dealt with the complexities before. This portfolio is in nearly perfect condition, so if anyone is interested in purchasing a few AMCs, they should reach out. It's essentially in a very good position. I'm reluctant to spend time in the 1031 market, especially with our team of about 77 members being quite busy. There are numerous challenges in that area right now. Given the state of this portfolio, I don't believe we need to pursue any major dispositions this year.

Josh Dennerlein, Analyst

Okay. I appreciate that. And has the competitive landscape for acquisitions in your spaces, has it shifted at all? Are you seeing less competition or maybe are there certain asset classes that people are really gravitating towards?

Joey Agree, CEO

No. I appreciate the question. We've seen less competition. We see less competition for the assets that fit within the context of our portfolio. 1031 buyers continue to wane as transactions grind slower in the country overall. And so, we see less competition. If you talk to brokers, transactional volume is down 60% in the space right now, in the month of January, they’re effectively down 60% based on my most recent conversations. Where that will go, nobody knows. And so, there's less downloads of 1031 buyers. Obviously, you remove leverage out of the equation or leverage that frankly, doesn't do much for you and negative leverage almost into the equation, it will inhibit some buyers from entering the space. And so, we're seeing tons of opportunities. We just won't pay up for them. So, we're not going to take $1 and break it into four quarters at the end of the day. We're not a change machine. We want to earn money on our capital, just not cycle it. And so, less competition, we're counting capitulations and we hope that continues to accelerate.

Operator, Operator

Our next question comes from Haendel St. Juste from Mizuho.

Ravi Vaidya, Analyst

This is Ravi Vaidya on the line for Haendel St. Juste. Hope you guys are doing well. I just wanted to follow up here. Given that there's less competition for the assets that you're targeting, are you able to secure better terms, maybe better annual escalators?

Joey Agree, CEO

Historically, third-party acquisition has represented a small part of our activities. We are not engaged in negotiating leases with escalators. In the current environment, sale leaseback transactions and development have led retailers to be more open to increasing acquisitions and are more willing to accept the scheduled increases that occur every five years.

Ravi Vaidya, Analyst

Got it. That’s helpful. Just one more here. Are you expecting any impact of the portfolio from the Kroger-Albertsons merger?

Joey Agree, CEO

Absolutely not. Kroger is one of our largest partners, and we have full guarantees from them. There has been recent speculation about a divestiture of 250 stores, and we will see how that develops with the potential closing in 2024 as they have indicated. We are also waiting to see how that will unfold through the FTC. But to be clear, we do not have any Albertsons in our portfolio.

Operator, Operator

Our next question comes from Linda Tsai from Jefferies.

Linda Tsai, Analyst

Hi. Can you remind us, what percentage of your acquisitions have been from the 1031 market versus sale leasebacks historically?

Joey Agree, CEO

Peter, I'm going to try to throw that one to you. I don't have that number on hand. I'll tell you, approximately last year 7%. Does that sound right with sale leasebacks?

Peter Coughenour, CFO

Yes, sub-10%, I think in 2022.

Joey Agree, CEO

We expect that number to be elevated in Q1. I can't provide historical data. When referring to the 1031 market, it's important to remember that these are sellers. Consequently, there will be 1031 buyers competing with us. What they decide to do with the proceeds—whether they enter into a down leg, choose to establish a new purchase agreement, or simply pay capital gains tax—is not always clear to us.

Linda Tsai, Analyst

Got it. And then just earlier you were talking about the ground lease situation with the Chase Bank in Georgia. You noted a lack of options that resulted in a high recapture rate. Was that more of a one-off situation or something you think happens more in the current environment?

Joey Agree, CEO

I appreciate the question. This was a very unique situation. It was the first time in the company's history that a ground lease expired with no options remaining. We had another tenant interested in the property, willing to pay over $170,000 a year, which represented more than a 60% increase. Chase then signed a new 15-year lease at that same increase with 10% bumps every five years. This shows the inherent value in our ground lease portfolio when a building reverts to us for free. Again, this was the first occurrence, and I look forward to future instances. When a building comes back to us for free and someone has to start paying rent on it, you can expect to see net operating income rise. It's important to remember that we have fee simple ownership of the land; this isn't a leasehold split, and the tenant financed the construction of that building. In this case, a previous tenant on a ground lease paid for the building before Chase took over the lease, which is why there were no options left. We were able to negotiate a very favorable outcome, having bought that ground lease with two years remaining and no options.

Linda Tsai, Analyst

Thanks for that. And then how do you feel about the overall retailer environment, Regal, Party City, Tuesday Morning, Bed Bath, they're not issues for you, but do you think this is a limited situation or indicative of more distressed forthcoming?

Joey Agree, CEO

I believe we are witnessing the beginning of a phase similar to the pre-COVID era. There won’t be any pauses like during COVID when companies attempted to halt operations and inject capital with low-cost debt. Recently, for instance, Tuesday Morning filed for bankruptcy, and more bankruptcies are likely to occur. We might see similar outcomes for various sectors, including home and office supply, pet supply, and sporting goods. Past cases like TOMS Capital and a major Burger King franchisee showcase previous asset disposals. In the Chicago area, we have seen bankruptcies in different spaces including car washes, childcare, urgent care, quick oil change services, and entertainment. Companies backed by private equity will face challenges with either fixed or variable rate short-term debts as their loan-to-values and rates increase significantly. These loans typically have a lifespan of no more than five years. Consequently, we can anticipate a decline in retail similar to what we observed before COVID as we adapt to an omnichannel marketplace where e-commerce has reached about 25% penetration, through methods like online shopping, delivery, and click-and-collect services. It's just a matter of time before this transition fully manifests. Therefore, I'm quite optimistic that we are entering a period reminiscent of the pre-COVID era aimed at rationalizing the retail landscape.

Operator, Operator

And our next question comes from Wes Golladay from Baird.

Wes Golladay, Analyst

Are you guys seeing a lot of opportunity for the multi-tenant PCS openings? Looking at the earnings release, you had a few, anything Brenham, Texas and then Onalaska, Wisconsin at almost like a shopping center at first glance. So, what is going on there?

Joey Agree, CEO

Yes. We are exploring several opportunities with multi-tenant developments, particularly with off-price retailers like TJX, Burlington, Ross, and Hobby Lobby. These retailers are looking to expand but are facing challenges with financing projects due to issues with their previous developers or merchant builders. We believe this sector presents a continued investment opportunity for us as we seek out new projects.

Wes Golladay, Analyst

Got it. A couple of quarters ago, there seemed to be a difference between what you wanted for these transactions and what the retailers thought the pricing should be. Has that difference decreased at all now that the debt markets have stabilized and you've mentioned your cost of debt has dropped by about 100 basis points in recent months?

Joey Agree, CEO

I think Peter referenced about 20 basis points over the last few months, 10 years specifically, right? I think everybody's looking at the relative cost of capital. I think from the merchant builders’ perspective, specifically, they're looking at not only the relative cost of capital, they're looking at their construction loans, the availability of construction loans, and the interest rate on the construction loans. The labor shortage we have in this country is leading to inflationary pressures. Construction costs in this country haven't gone down since 1904 year-over-year. And so, now you combine that with an exit cap rate that's unknown to put a shovel in the ground as a private developer and build a TGX combo store with a Burlington or a Ross, you got to be pretty bold. And so, we think those are the types of asymmetrical opportunities where we can step in with our divergent capabilities and create value and create the appropriate spread for shareholders, while not going up the risk curve into assets that we don't think are appropriate.

Operator, Operator

And ladies and gentlemen, with that and showing no additional questions, I'd like to turn the floor back over to the management team for any closing remarks.

Joey Agree, CEO

Thank you, operator, and thank you, everyone, for joining us today. And we look forward to seeing you in the coming weeks at the upcoming conferences. Thank you.

Operator, Operator

And ladies and gentlemen, with that we’ll conclude today's question-and-answer session as well as today's presentation. We thank you for joining. You may now disconnect your lines.