Earnings Call Transcript
AGREE REALTY CORP (ADC)
Earnings Call Transcript - ADC Q4 2023
Operator, Operator
Good morning and welcome to the Agree Realty Fourth Quarter 2023 Conference Call. This event is being recorded today. I would now like to turn the conference over to Brian Hawthorne, Director of Corporate Finance. Please proceed.
Brian Hawthorne, Director of Corporate Finance
Thank you. Good morning, everyone, and thank you for joining us for Agree Realty's fourth quarter 2023 earnings call. Before turning the call over to Joey and Peter to discuss our 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 and 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 thank you all for joining us today. I'm happy to share that 2023 was a strong year for our company. Reflecting on the past year, we implemented several strategic initiatives that set us up for continued success. In preparation for potential fluctuations in capital markets, we pre-equitized our balance sheet in the fourth quarter of 2022 by raising $560 million in forward equity at a net price of just over $67.50. Although some viewed our approach as conservative at the time, we felt confident that while interest rates increased quickly, cap rates would be slow to rise in our large, illiquid, and fragmented market. We aimed to remain true to our core strategy of providing debt financing without expanding into new verticals or increasing our risk through credit or tenant concentrations. Instead, we continued to apply our disciplined and established approach by investing in the leading retailers in the country. These are the companies capable of investing in price, labor, and fulfillment while crafting a unique value proposition for customers. Although the performance of our stock has been disappointing, our resolve has not faltered. Management, along with our exceptional Board of Directors, demonstrated their confidence by making nearly $12 million in insider purchases during 2023. Net lease is a long-term business, and we believe in the importance of consistency, reliability, and quality of cash flows, which will ultimately drive outperformance. While we may not control economic volatility, we can focus on creating value rather than just short-term earnings growth. The era of abundant capital is behind us, prompting a significant shift in our capital allocation philosophy. We have seen the consequences of investing at minimal spreads; it results in little to no growth in AFFO per share. In this new economic landscape, our priority is on achieving substantial investment spreads and selecting the best risk-adjusted opportunities, rather than simply accumulating volume. We will not increase our base without ensuring meaningful AFFO per share growth, nor will we take on additional risk to create short-term growth opportunities. We are dedicated to allocating capital in a disciplined way to foster sustainable growth. On the last quarter's call, we discussed the scenario where we could achieve over 3% AFFO per share growth in 2024 based on conservative assumptions without external growth. With more than $235 million of forward equity raised by the year's end and expected free cash flow of around $100 million, we have a clear view beyond that scenario. We can invest about $500 million this year on a leverage-neutral basis, excluding any proceeds from asset sales and without needing additional equity capital. More importantly, we remain agile and ready to seize opportunities as they arise. With over $1 billion in total liquidity, including the forward equity raised last quarter, we have plenty of room to maneuver and full options available. Additionally, we have no significant debt maturities until 2028, and our pro forma net debt to EBITDA was just 4.3x at year-end. Our strong balance sheet, combined with a top-tier portfolio, and a historic investment-grade exposure of over 69%, ensures highly reliable cash flows in today's changing environment. The strength of our financial standing and our portfolio is reflected in the positive outlook from S&P regarding our BBB credit rating last week. We believe that our credit metrics reflect those of a higher-rated company, and the positive outlook represents progress in gaining recognition for how we operate our business and manage our financials. Moving on to our standard update, this past quarter we navigated significant market challenges and successfully invested nearly $200 million in 70 high-quality retail net lease properties across our three external growth platforms. This includes the acquisition of 50 properties for over $187 million. The properties purchased in the fourth quarter were leased to leading operators in areas such as home improvement, agricultural supplies, off-price retail, tire and auto services, and convenience stores. As illustrated by our activity in the fourth quarter, we were able to push cap rates higher, surpassing 7% for the first time since 2019. The acquired properties had a weighted average cap rate of 7.2%, which reflects a 30 basis point increase compared to the third quarter and an 80 basis point increase from the previous year. The weighted average lease term was 10.1 years, and approximately 71% of annualized base rent came from investment-grade retailers. We also acquired 7 ground leases in the quarter, accounting for about $30 million or 14.8% of our total acquisition volume. In 2023, we invested more than $1.3 billion in 319 retail net lease properties across 41 states. We continue to leverage all three external growth platforms to identify attractive risk-adjusted opportunities. For the full year, nearly 74% of the annualized base rents from acquisitions were sourced from investment-grade retailers, and ground leases constituted roughly 9% of the rents acquired. Notably, we increased our sale-leaseback activity in 2023, collaborating with prominent operators in the agricultural supply and convenience store sectors. Sale-leasebacks made up one-third of our acquisition activity in 2023, up from just over 10% the year prior, further highlighting our capacity to offer comprehensive real estate solutions for our retail partners. Moving to our Development and DFP platforms, we achieved a record year with 37 projects either completed or underway, representing about $150 million in committed capital. We are seeing heightened activity across both platforms as we assist our retail partners in executing their store expansion plans and enable struggling merchant developers to secure funding for their projects. We initiated 4 new development and DFP projects during the fourth quarter, at a total anticipated cost of around $13 million. The new projects include a Burlington and HomeGoods in Arizona, and two Starbucks in Illinois. Construction progressed on 12 projects during the quarter, with anticipated total costs of approximately $51 million. Lastly, we completed construction on 4 projects during the quarter at a total cost of about $16 million. We disposed of 5 properties in 2023 for total gross proceeds of roughly $10 million, including 3 properties sold during the fourth quarter. The weighted average cap rate for disposals in 2023 was 6.1%. I expect more opportunistic dispositions in 2024 as we aim to sell assets at attractive cap rates and strategically redeploy that capital. On the leasing front, we secured new leases, extensions, or options on 425,000 square feet of gross leasable area during the fourth quarter, including a T.J. Maxx in New Lenox, Illinois and a Walmart Supercenter in Hazard, Kentucky. For the entire year of 2023, we executed new leases, extensions, or options on approximately 1.9 million square feet of gross leasable area. We are well positioned for 2024 as only 28 leases, or 110 basis points of annualized base rents, are set to mature. At year-end, our premier portfolio encompassed 2,135 properties across 49 states, including 224 ground leases representing 11.7% of total annualized base rents. Occupancy slightly increased to 99.8%, and our investment-grade exposure reached an all-time high of over 69%. Lastly, I am pleased to welcome a new member to our Board of Directors. LingLong, who was Rocket's first software engineer over 25 years ago, now serves as a Chief Leadership Adviser for Rocket Central, overseeing executive leadership development for the Rocket companies. Previously, she held the position of Chief Information Officer of Rocket Mortgage, one of the nation’s largest mortgage lenders, for a decade. LingLong brings over 25 years of technology and leadership experience, and we are excited to have her expertise on our esteemed Board of Directors. I will now pass the call to Peter, and we can begin the question-and-answer session.
Peter Coughenour, CFO
Thank you, Joey. Starting with earnings; core FFO per share was $0.99 for the fourth quarter and $3.93 per share for the full year 2023, representing 3.4% and 1.6% year-over-year increases, respectively. AFFO per share was $1 for the fourth quarter and $3.95 for the full year, representing 5.2% and 3.1% 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 approximately $0.05 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 $0.247 per share for October, November, and December. On an annualized basis, the monthly dividends represent a 2.9% year-over-year increase. For the full year, the company declared dividends of approximately $2.92 per share, a 4.1% increase year-over-year and almost a 12% increase on a 2-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. Subsequent to year-end, we declared a monthly cash dividend of $0.247 per share for January and February 2024. The monthly dividends reflect an annualized dividend amount of over $2.96 per share or a 2.9% increase over the annualized dividend amount of $2.88 per share from the first quarter of 2023. General and administrative expenses decreased quarter-over-quarter to 5.7% of revenue, adjusted for the noncash amortization of above and below market lease intangibles. For the year, G&A expense totaled $34.8 million or 6.1% of adjusted revenue. With our continued investments in systems, including ongoing enhancements to our proprietary ARC database, we anticipate that G&A expense will continue to scale as a percentage of adjusted revenue in 2024. We recorded $709,000 of income tax expense during the fourth quarter. This brings the total for the year to $2.9 million, near the midpoint of our guidance. Turning to our capital markets activities. We raised over $370 million of gross equity proceeds during the year via the forward component of our ATM program. With more than $235 million of forward equity raised late in the fourth quarter, we anticipate putting in place a new ATM program in the coming weeks in the normal course. We also demonstrated our ability to access attractive bank debt with a market-leading $350 million 5.5-year term loan at a fixed rate of 4.52% inclusive of prior hedging activity. The term loan received strong support from our key banking relationships, and the 5.5-year term allowed us to extend the maturity into 2029. As Joey mentioned, our debt maturity schedule remains in an excellent position with no material maturities until 2028. Our capital markets activity further fortified our balance sheet and positioned us for continued growth in 2024. We ended the year with over $1 billion of total liquidity, including more than $235 million of outstanding forward equity, $773 million of availability on the revolver, and approximately $15 million of cash on hand. In addition, our revolving credit facility and term loan have accordion options, allowing us to request additional lender commitments of $750 million and $150 million, respectively. In addition to our strong liquidity position, free cash flow after the dividend is now approaching $100 million on an annualized basis. As of December 31, pro forma for the settlement of our outstanding forward equity, net debt to recurring EBITDA was approximately 4.3x. Excluding the impact of unsettled forward equity, our net debt to recurring EBITDA was 4.7x. Our total debt to enterprise value was approximately 27%, while our fixed charge coverage ratio, which includes principal amortization in the preferred dividend, is in a very healthy position at 5x. With that, I'd like to turn the call back over to Joey.
Joey Agree, CEO
Thank you, Peter. To summarize, we are very well positioned to execute in 2024 to drive sustainable earnings and a growing and well-covered dividend. At this time, operator, let's open it up for questions.
Operator, Operator
Our first question will come from Spencer Allaway of Green Street Advisors.
Spencer Allaway, Analyst
Given that you guys have capital locked in and as you mentioned, you have a very strong liquidity position. Why not provide some formal acquisition guidance at this time?
Joey Agree, CEO
So I think, first of all, we're in an extremely volatile macroeconomic environment, including interest rate volatility here that's going on. And so I think our number one focus is not going to be aggregating volume today at de minimis spreads, as we talked about in the prepared remarks. We're 100% focused, and the team is disciplined here, focusing on deploying capital at 100-plus basis point spreads into our sandbox of the country's leading retailers. And frankly, with 70 days of visibility in the net lease space, that's our average duration from letter of intent to close, I can't tell you what's going to happen in 71 days, let alone later in the summer or fall.
Spencer Allaway, Analyst
Okay. And then as you think about the three different kind of investment verticals that you play in, can you just talk about where you're seeing the best spreads today?
Joey Agree, CEO
The best spreads are found in development, as we do not take speculative risks when acquiring land or expecting buildings without having a tenant secured and all necessary permits in place. The greatest returns will be within the development spectrum, where duration is correlated with risk. We are seeking significant spreads when developing to match the potential of acquiring similar assets. On the other end, our focus for acquisitions is to deploy capital at least 100 basis points above our cost of capital. As we've mentioned previously, we perceive our cost of capital as a forward AFFO yield with a 75-25 split tied to 10-year unsecured pricing, and we are taking a conservative approach by not factoring in unburdened free cash flow. Our objective remains to invest that capital 100 basis points above our perceived cost.
Spencer Allaway, Analyst
Thank you for the color, Joey.
Operator, Operator
Next question comes from Smedes Rose of Citigroup.
Smedes Rose, Analyst
I understand that you're reluctant to provide a full-year outlook, especially regarding acquisition activity. However, could you share what you’ve observed so far this year, particularly how cap rates have changed from the fourth quarter, where you secured rates at 7.2%? A bit of insight into your near-term observations would be appreciated.
Joey Agree, CEO
Sure. Cap rates are currently very varied due to the fluctuations in the underlying markets and interest rates. The fourth quarter was quite volatile. We witnessed the global base rate increase by 25% from 4% to 5% in just 70 days and then decrease by 28% over the following 21 days. It's uncertain what will happen next or what the Federal Reserve will say. However, I believe a rate hike is more likely this year than a cut in March. Consequently, cap rates are unpredictable as sellers' expectations regarding the economy and interest rates differ greatly. To build on my previous comment, a 100 basis point spread affecting our cost of capital will likely lead to a significant increase in our cap rates in the first quarter, approximately 30 to 40 basis points, still aiming for that increase compared to the fourth quarter, without sacrificing credit quality. This will involve aggregating unique opportunities, short-term blend and extend prospects, top-performing stores guided by our retail partners, and asymmetric opportunities. However, the market's transactional volume is currently a fraction of historical levels, and sellers' expectations are highly variable. Unfortunately, when the 10-year rate was at 4% early in the fourth quarter, we were nearing a new normal. Since then, the volatility has created uncertainty and fluctuating hope among borrowers.
Smedes Rose, Analyst
Okay. I wanted to ask about the G&A expense and how it will likely increase as a percentage of revenue. Do you have an idea of what percentage we should expect this to rise to throughout 2024?
Joey Agree, CEO
So embedded in our guidance, what Peter had any color embedded in our base case of over 3% AFFO growth, which clearly is off the table right now given the forward equity that we've raised and the color I've given on the pipeline, the percentage of G&A of revenue will go down. The absolute number we anticipate going up because auditors, professional services, and everything else continues to go up in this world. Peter, anything I'm missing?
Peter Coughenour, CFO
No, that's correct. I think in recent years, we've seen scale in G&A as a percent of adjusted revenue of approximately 40 or 50 basis points on an annual basis on average. It's difficult at this point to predict how much scale we'll see in 2024, but we do anticipate that G&A as a percentage of revenue will continue to come down.
Operator, Operator
Next question comes from Ki Bin Kim of Truist.
Ki Bin Kim, Analyst
So first question, I noticed you guys have about 10 big lots. So a question is about your guidance. And I think you embedded about 50 basis points credit loss reserves. So curious how much of that accounts for the known or highly likely move-out versus the unknown and a big loss, what is that as a percent of ABR please?
Joey Agree, CEO
Our current watch list includes our exposure to big lots and any at-home investments, which are real estate opportunities for us. For instance, we have a property in Provo, Utah, located next to a mall that is being renovated to include a new large-format Target. We are keeping an eye on big lots, but it's a small part of our overall portfolio, represented in the approximately 1% watch list linked to at-home. To illustrate, we had one big lot that didn't renew, but we are currently in a lease negotiation with a national auto parts retailer, which is a valued partner, for a 5% increase on a new 15-year lease. We feel confident about our real estate holdings and the watch list totals about 1%, much of which we aim to retain.
Ki Bin Kim, Analyst
Okay. And the big loss ABR percentage?
Peter Coughenour, CFO
Yes. Ki Bin, it's sub-50 basis points today in terms of our overall exposure to Big Lots. And I'd also note, on average, to Joey's point, in terms of being comfortable with the basis, they're paying just over $6 per square foot on average.
Ki Bin Kim, Analyst
Okay. And I appreciate your comments about being more disciplined on capital deployment if the pricing doesn't make a whole lot of sense. Since your last equity raise, obviously, your stock price has drifted slightly lower. So if you had to raise a new round of equity today and if you still want to hold on to the 100 basis point spread target, it would imply that you would probably have to buy something closer to an 8% GAAP cap rate. I'm not sure if there's enough desirable product at those prices, so if you can provide some commentary? And if that is the case, like would you just be comfortable slowing down the acquisition pace again?
Joey Agree, CEO
We began the year by establishing a baseline. Last year, we set a base case without any investment volume, projecting over 3% growth in AFFO with conservative assumptions. We will only consider investments below that 100 basis point spread if a unique and compelling opportunity arises. Regarding where our stock price and cap rates stand, I don’t expect significant expansion this year unless we see greater economic volatility than what we currently experience. This is a large and fragmented market, and our aim remains focused and disciplined in deploying capital at a materially accretive spread. The business is straightforward. If capital is deployed within the forward AFFO yield, it won’t yield positive results. We base our cost of capital on 25% 10-year unsecured bonds. If capital is invested within the forward AFFO yield, it won’t work and will not contribute to shareholder growth on an AFFO per share basis. Therefore, we will avoid accumulating assets just to increase our denominator without enhancing value and growth for our shareholders. The relationship between cap rates and volume is exponential, not linear. I’ve noted before that 75 basis points indicates caution. We have seen both anecdotal and empirical evidence showing that large volumes do not lead to annualized growth in the following year. A range of 75 to 100 basis points suggests selective investment opportunities. Once you exceed 100 basis points while considering your true cost of capital, excluding unburdened free cash flow or short-term debt, you begin to see positive opportunities. At 150 basis points, you can accelerate investments, as we did in previous years. However, we are not currently in that favorable 150 basis point environment unless you are willing to take on significantly more risk, which contradicts our company's principles. We are uncertain about how much we will be able to aggregate this year, but we will not deploy capital just to expand our asset base.
Operator, Operator
Next question comes from Joshua Dennerlein of Bank of America.
Unidentified Analyst, Analyst
This is Joshua Dennerlein from Bank of America. I know you made a few comments regarding your development pipeline. I am curious, given that there was about a 23% increase over 2022 and 2023, can we expect a similar increase going into 2024 for the total development amount?
Joey Agree, CEO
We are continuously answering calls and responding to inquiries from merchant developers and retailers, given the current liquidity issues in the construction lending market and the challenges merchant builders face in developing new stores. The outcome for this year will depend on our ability to achieve acceptable returns. We won't increase that number merely to start new projects, take on long-term risks, and fail to ensure the appropriate returns on our invested capital. Therefore, it's hard to predict how things will unfold, as they can change frequently. We have announced several new projects and completions this quarter, and our pipeline is expanding, although the speed of that growth is uncertain. Retailers are eager to expand right now, which is crucial. With retailers in our portfolio, including Walmart, that recently announced new store openings for the first time since the financial crisis, there is a strong desire for growth. However, factors such as construction costs, capital availability, return on investment, and rental rates per square foot need to be balanced. Our goal is to navigate these variables and identify which projects make sense with our retail partners. Unfortunately, I do not have clear visibility on what that final number will be.
Unidentified Analyst, Analyst
Great. And I believe this is along the lines of what you were just mentioning that last quarter, you made some comments about partnering up with retailers to kind of assist with bringing stores to close. Is there any other further update on that?
Joey Agree, CEO
The team is currently engaged with two national retailers over the next couple of days. We are consistently in communication to address the challenges involved in developing new stores. However, we will ensure that this does not compromise the interests of our shareholders, and we will seek to achieve suitable profit margins. The discussions are ongoing and quite dynamic, especially given the unpredictable nature of the fourth quarter. We will persist in these conversations, and I believe our comprehensive value proposition is indeed unique to retailers, who value our wide range of capabilities, including our asset management services.
Operator, Operator
Next question comes from Rob Stevenson of Janney.
Robert Stevenson, Analyst
Can you talk about what the cash spread on leasing done in the fourth quarter and for '23 as a whole was? And have the size of the bumps or other lease terms change given the persistently higher inflation these days?
Joey Agree, CEO
On the first one, Peter, do you have a number handy? I mean it's fairly de minimis.
Peter Coughenour, CFO
Yes, Rob, I would just say first that we don't have a ton of actually re-leasing activity in our portfolio. The vast majority of leases up for expiration so the tenant exercise an option which typically has an embedded bump within that option. That said, the recapture rate for Q4 and for the full year was north of 100%.
Robert Stevenson, Analyst
Okay. And then what about the lease terms? Are you guys trying to push higher bumps, more frequent bumps, etc., given the higher inflation or trying to mitigate people to CPI? How are you guys thinking about that as you're starting new leases on any of these development deals or any of the other stuff?
Joey Agree, CEO
Yes. National retailers generally do not accept CPI-based rent increases. They prefer to know the rent moving forward so they can plan accordingly. Given the inflation rates of 8% and 9%, and even over 3%, everyone recognizes that we are in an inflationary environment. As a result, both the frequency and magnitude of these rent increases are something most tenants are willing to reconsider in their lease agreements.
Robert Stevenson, Analyst
Okay. And then can you talk about the difference between cap rates on ground leases in the fourth quarter for the year overall versus the fee simple acquisitions? Is that spread sort of stayed relatively consistent? Are you seeing better opportunities or less opportunities in ground leases today and going forward? How should we be thinking about that?
Joey Agree, CEO
Very, very consistent, if any, a de minimis spread between the ground leases and net leases; we're generally working with our retail partners there. I think you'll see more of the same in the first quarter. Some of them are shorter-term, some of them are targeted by retailers in partnership with us.
Operator, Operator
Next question comes from Haendel St. Juste of Mizuho.
Haendel St. Juste, Analyst
Joey, I think you mentioned earlier in the call that you're anticipating, let's see, opportunities dispositions this year. Curious what categories you want client to call potentially how much you like to call in potential range of cap rates or any pricing color expectations?
Joey Agree, CEO
Yes. From a category perspective, we are not particularly focused on reducing our exposure to Walmart. The opportunistic sales will typically occur in markets that are under pressure but still attract significant capital, which is currently chasing opportunities with relatively low yields. We plan to redeploy that capital at about 150 basis point spreads. This can be observed in the auto service sector, as well as in other areas such as farm and rural supply, and potentially car washes. These are sectors where we feel comfortable with our investment, though there are still opportunities, potentially driven by tax incentives, in regions that remain active.
Haendel St. Juste, Analyst
Got it. That's helpful. And then just going back to the messaging here. Clearly, you're guiding to a capital light deployment, earnings growth, minimum 3, probably looks like 4% now expecting interest rates to be higher for longer. So I guess I'm curious, kind of from your perspective, what's the investment case for investors buying the stock here today? 3% to 4% earnings growth isn't too shabby in this environment, I get it but still likely to lag a number of your peers, I think, are we basically in a wait-and-see mode to a degree here?
Joey Agree, CEO
So let's take a step back. We have a 5% plus and growing dividend that's covered at the low end of our target payout ratio of 75%. We have a 5-year CAGR of 6% AFFO growth while qualitatively improving the portfolio to now approaching 70% investment grade and 12% ground leases. It is the strongest retail portfolio, I think, without exception in the country, and most investors and analysts would agree. We have a balance sheet that is fortified with $1 billion of liquidity with no material debt maturities until 2028, no floating rate exposure except anything outstanding on the line of credit. So if you take your 3% to 4%, you can go ahead and take the high end, then take the 5% and growing dividend, you're at 9% total returns there alone, assuming no dividend growth which it will grow this year with an underlying fortress balance sheet and an underlying fortress portfolio. I think that is a very compelling case in today's environment to invest in ADC. And I think, as I said in our prepared remarks, insiders here, inclusive of myself, agree. What we have done and what we have built without diminishing the qualitative aspect of our portfolio, is, I think, is without peer. We haven't loaded up on pharmacies. We've ran from Walgreens exposure. We don't have double-digit pharmacy exposure and double-digit dollar store exposure. We're not just out there checking the IG box. We've been talking about Walgreens now for years, reducing our Walgreens exposure to an inconsequential number, watching CBS overtake Walgreens in the pharmacy space. I think we have a proven track record now of not only being correct in our retail predictions and about the concerns in an omnichannel world, but we also have the balance sheet management, the earnings growth profile to, frankly, to bank on. And so I think there's something to be said, especially in today's environment for stability and predictability.
Operator, Operator
Next question comes from Mitch Germain of JP Securities.
Mitch Germain, Analyst
I know it's early in the year but I'm just curious if you're seeing any changes to the buyer pool?
Joey Agree, CEO
Mitch, honestly no. This market is very fragmented and large to begin with, and when you add a higher interest rate environment and liquid credit conditions, the buyer pool becomes uncertain. It's very difficult. Sometimes I find myself asking an investment or disposition committee who is buying and who is selling, and the answers often feel like riddles. I must admit, there are no parallels to draw from this situation. The market is not fluid right now; it's hit or miss. It's about being disciplined and making decisive choices regarding what you want to achieve.
Operator, Operator
Next question comes from RJ Milligan of Raymond James.
Richard Milligan, Analyst
I just want to follow up. I think someone asked this. I'm not sure if you provided an answer regarding the year-to-date activity so far.
Joey Agree, CEO
No, we haven't provided any answer or any update on the year-to-date activity. Although I did mention that we anticipate cap rates jumping in Q1 by approximately 30 to 40 basis points on the acquisition side.
Richard Milligan, Analyst
Got it. And so I know there's a difference between capital previously raised, right, via the ATM last quarter versus trying to go out and raise new capital, equity capital today. So I'm just curious if you are seeing that or 7.5% average cap rate or that cap rate expansion, would the goal then be to deploy the Q4 ATM proceeds quickly, I guess, what is the outlook for cap rates? Is it going to deploy at a 7.5% today, given that that's a pretty high absolute cap rate? Or is it still more of a wait-and-see even with the previously raised proceeds?
Joey Agree, CEO
Yes. Just to clarify, that's not market. These are manufactured transactions where we work out there creating value. That is nowhere near market cap rates today on a like-kind product. We're not out there buying lossy brochures here that are highly marketed and then through the auction process. And so if we can achieve those types of cap rates, we'll look at that spread relative to our cost of capital, deploy that equity. But I think as we highlighted, we have $500 million in leverage-neutral buying power today, not inclusive of any disposition proceeds. And so as the year materializes, again, as the pipeline and the pipeline grows, we'll look at all capital options for us but we don't need to do anything today. I think that's pretty clear with $1 billion of liquidity and that $500 million in leverage neutral power.
Richard Milligan, Analyst
Just one follow-up. Joey, you've frequently mentioned the lack of visibility over the past 70 days. However, you have still managed to provide some guidance on acquisition volume despite this uncertainty. Given the volatile environment in capital markets, I’m curious about what you need to see in those markets or in the transaction market to feel confident enough to provide a growth outlook for external acquisitions.
Joey Agree, CEO
I believe we need to reach a level of normalcy and stability in the macroeconomic environment. Honestly, I haven't seen any economist accurately predict outcomes since we injected $6.5 trillion into the economy and reduced interest rates to zero. For me, as someone in real estate, to speculate on what may happen in the next 11 months would be premature. We’ve been able to provide historical guides because we had some visibility into possible disruptions, geopolitical events, or crashes, but the current market volatility and the lack of clarity create a confusing situation. If we gain the necessary clarity and stability, we will definitely share that information. Otherwise, making any predictions would simply be ahead of ourselves.
Richard Milligan, Analyst
One additional is clearly, you guys have been pretty proactive in selling down your Walgreens exposure over time. I'm curious if there's any other categories that you're looking to sort of get ahead of the curve over the next year or two?
Joey Agree, CEO
We didn't notice significant changes from a category standpoint. However, we observed specific issues with Walgreens in the pharmacy sector, particularly their declining front-end operations and their ongoing push for mergers and acquisitions to increase store numbers, which seemed illogical to us. Their struggle to effectively repurpose the front end of the store, especially with their beauty and fragrance initiatives, was evident. Additionally, we were heavily invested in Walgreens, with about 45% exposure in both 2012 and 2013, alongside our hands-on experience managing around 40 to 50 locations across six states. This situation was quite apparent as we watched those stores decline. On the other hand, the retailers in our portfolio are generally thriving and healthy. We've intentionally avoided the casual dining segment and experiential businesses, and we'll maintain that stance. Looking at our current portfolio, the retailers are performing well; the larger ones are growing and strengthening, investing in pricing, labor, and distribution, and figuring out how to enhance EBITDA in this omnichannel environment.
Operator, Operator
The next question comes from Linda Tsai of Jefferies.
Linda Tsai, Analyst
Regarding what you referred to as manufactured cap rates in 1Q being up 40, 50 bps through the auction process. Any more color on how you drive that level of expansion and how easy or difficult it is to achieve this?
Joey Agree, CEO
Yes. To clarify, those cap rates represent the value we are creating by pursuing off-market opportunities and blend and extend situations. These are not highly marketed packages through national brokers. We are collaborating with our retail partners to identify long-term opportunities that align with their interests. Could you repeat the second part of that question?
Linda Tsai, Analyst
Just how easy or difficult it is to achieve this and its sustainability?
Joey Agree, CEO
Not easy. Nothing is simple in today's world. It takes determination, which is one of our core values. Greatness requires grit. We leverage our relationships, and our team has strong credibility with retailers. We're not participating in the wholesale buying process anymore due to current capital costs. However, I am completely confident that our team will continue to find opportunities across all three external growth platforms that yield returns greater than both the market and our internal expectations.
Linda Tsai, Analyst
And then if sale leaseback was 1/3 of the acquisition volume, what can it grow to in '24? And similarly, where can DFP grow to as a percentage of the volume?
Joey Agree, CEO
From a sales perspective, we typically engage with tenants that do not require capital, as we aim to avoid becoming a significant unsecured creditor to any private equity-sponsored retailer. Currently, retailers that we have sold leasebacks to are on hold; their CFOs and real estate departments are monitoring market volatility. They understand their options for issuing bonds in the unsecured market today and are waiting for conditions to stabilize. Therefore, I do not expect the current situation to lead to one-third of our dealings. However, it is entirely possible that stabilization later in the year could change that. Regarding DFP, the situation is constantly evolving. We have expanded our team and developed our systems in relation to ARC, making our processes more efficient. Ultimately, our focus is on pricing, which depends on the developers and retailers, the returns they are willing to accept, and the rents they can afford for those specific sites, ensuring alignment with our return profile.
Operator, Operator
The next question comes from Ronald Kamdem of Morgan Stanley.
Unidentified Analyst, Analyst
I just have two quick questions. The first is, can you talk a little bit on the competition environment today for the IG focused market? And you mentioned that transaction volume is kind of low, like this year. But if you compare on a year-over-year basis, is that like getting worse or it's actually better than last year?
Joey Agree, CEO
Competition in our particular market is quite unpredictable. There are occasional high-net-worth individuals involved. The competitive landscape resembles what it has been in the past, with a similar composition, but the level of competition has significantly decreased due to the slowdown in transactions. I often point out that our biggest competitors are actually the expectations of the sellers themselves. Could you please repeat the second part of your question?
Unidentified Analyst, Analyst
The second is the transaction volumes. You mentioned that the transaction volume this year is kind of low, but if you compare on a year-over-year basis, it's actually better than last year or actually worse than last year?
Joey Agree, CEO
Well, the transaction closed acquisitions?
Unidentified Analyst, Analyst
Of the pipelines and just overall?
Joey Agree, CEO
We're still in the early stages. We have some insight into the Q1 pipeline. We are just beginning to generate transaction volume for Q1, which will be lower compared to last year. However, our main goal is to significantly improve the cap rates on a year-over-year basis. As we look ahead, it will be important to see what kind of normalcy or stabilization we can achieve in the broader economy, which is challenging to predict.
Unidentified Analyst, Analyst
Yes, that sounds reasonable. Regarding dispositions, I believe you mentioned that you expect to dispose of more assets this year. Based on your target cap rates, can you elaborate on how the disposition cap rate is performing in the current overall environment?
Joey Agree, CEO
Yes. We're looking for those opportunistic areas where we can sell an asset generally in the plus or minus in the 6 cap range and then redeploy it north of 100 basis points, minimally above that in assets that we don't think long term necessarily have the growth potential profile that within the portfolio.
Operator, Operator
Next question comes from Alex Hagan of Baird.
Alex Hagan, Analyst
First off, where are the current yields on the new development funding deals?
Joey Agree, CEO
When referring to new development funding deals, we are primarily focused on new approvals and projects that are just starting. Specifically, we are looking at the DFP transaction, which is about six months away from beginning rental income and is expected to yield approximately 50 to 75 basis points above the long-term cap rates for acquisitions. For projects that require permit approvals, the yield expectations are much wider due to the associated duration risk.
Alex Hagan, Analyst
Okay. You mentioned earlier that you believe the likelihood of a rate hike is now greater than that of a rate cut. I'm curious about what the most attractive source of debt is currently and whether the company plans to issue long-term debt to pay down the revolver in the near future.
Joey Agree, CEO
Yes. Just, I'll let Peter answer the second question. I said just to repeat, the change of rate hike is probably better than this year, probably better than the chance of a rate cut in March. We'll see more data, obviously, tomorrow. But I think that rate cut expectation that the market had for March is clearly off the table and we'll see if we get any more hot prints that come out. Peter, in terms of the debt market, I'll let you take that.
Peter Coughenour, CFO
Yes. We started the year with $1 billion in total liquidity, so there's no immediate need to access the debt markets. We don't have any significant debt maturities until 2028, allowing us to be strategic about when we enter the debt capital markets. We can access both unsecured markets and bank debt markets, where we have strong backing from our banking partners. Typically, we prefer longer-term fixed-rate unsecured financing that aligns with the lease duration of our portfolio. In line with this, as mentioned in the 10-K, we entered into $150 million of forward starting swaps during the fourth quarter. These swaps are designed for a future 10-year unsecured debt issuance, with an effective rate just below 4%. This gives us flexibility regarding the timing of using those swaps, which have a mandatory termination date in June 2025 but allow for a return to the market at a later date.
Operator, Operator
The next question comes from Eric Borden of BMO Capital Markets.
Eric Borden, Analyst
Just a quick one on the watch list. What's the mark-to-market on the assets in there today? I think you mentioned Big Lots expiring or taking back space in the mid-single digits. Just curious about the rest of the portfolio?
Joey Agree, CEO
The Big Lots expiration that I mentioned, which is now at least related to auto parts, has a mark-to-market of approximately indiscernible on a new 15-year lease regarding our outlook for the remainder of the overall portfolio.
Eric Borden, Analyst
What is the portion of the portfolio that is on the watch list or that you expect to take back?
Joey Agree, CEO
I want to emphasize that we are very confident in the rental rates we have secured. Currently, these rates are in the mid-single digits, and constructing a facility like that is a significant investment. We believe that if we were to take back any of these properties, we would have no issues adjusting their value to reflect the current market conditions. While market rates can vary widely, finding properties in the mid-single-digit range is nearly impossible today.
Operator, Operator
The next question comes from Connor Siversky of Wells Fargo.
Connor Siversky, Analyst
Just in your conversations with tenants, can you offer a temperature check on the willingness for some of these retail operations to continue to expand in this current macro backdrop?
Joey Agree, CEO
Yes, as I touched on earlier, the retailers that we talk to want to continue to expand and continue to expand aggressively. I don't remember a time when Home Depot, Walmart, and Lowe's before except it prior to the GFC, we're expanding the large-format C-stores, the auto parts operators, the off-price retailers, it's all the TJX concepts, Ross, Burlington, Five Below. These operators have the desire to continue to expand across all of their different flags. And again, the challenge today is construction costs and ultimately what they can pay on a per square foot rental rate. But there is voracious demand in the discount space; again, we're focused in the necessity-based arena here. It is a voracious demand to continue to expand and open stores. We're seeing that really across the board, whether it's all the way from O'Reilly and AutoZone to tractor supply to Walmart to ALDI, which is obviously making a large acquisition and opening net new stores. I think you see that across the area in terms of discount-oriented operators.
Operator, Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Joey Agree for any closing remarks.
Joey Agree, CEO
Well, thank you, operator, and thank you all for joining us this morning, and we look forward to seeing you at the upcoming conferences. We appreciate everybody's time.
Operator, Operator
The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.