Good day and welcome to the Modiv's Second Quarter 2022 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. On today's call, management will provide prepared remarks and then we will open up the call for your questions. Participants may also ask a question by emailing [email protected]. Please note this event is being recorded. I would now like to turn the conference over to Megan McGrath, Investor Relations for Modiv. Please go ahead, ma'am.

Thank you, Operator, and thank you all for joining us today to discuss Modiv's second quarter 2022 financial results. We issued our earnings release and investor supplements before market open this morning. These documents are available in the Investor Relations section of our website at modiv.com. I'm here today with Aaron Halfacre, Chief Executive Officer of Modiv; and Ray Pacini, Chief Financial Officer. On today's call, management will provide prepared remarks and then we will open up the call for your questions. Before we begin, I would like to remind you that today's comments will include forward-looking statements under federal securities law. Forward-looking statements are identified by words such as will, be, intends, believe, expect, anticipate, or other comparable words and phrases. Statements that are not historical facts, such as statements about our expected acquisitions or disposition are also forward-looking statements. Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements. Discussion of the factors that could cause our results to differ materially from these forward-looking statements are contained in our SEC filings, including a report on Form 10 Q. With that, I would now like to turn the call over to Aaron Halfacre, Modiv's Chief Executive Officer. Aaron, please go ahead.

Thank you, Megan. Hello, everyone, and thank you for joining our second quarter earnings call. Joining me today is Ray Pacini, our CFO, who will cover our financial results in detail following my opening remarks. Then I will close with a few more thoughts on the market before we open the line for Q&A. First, some highlights from the quarter. We grew our second quarter adjusted funds from operations by 18% to $3.6 million, while our total revenues grew by 14% to $10.4 million, driven by growth in our portfolio. We maintained a lean and disciplined cost structure and remain laser-focused on our goal of transforming and growing our portfolio while driving attractive long-term shareholder returns. We approached the second quarter with patience and discipline. On last quarter's earnings call we mentioned the disruption in the real estate transaction markets, characterized by delays and deal cancellations as buyers and sellers adjusted to the extreme volatility in interest rates and inflation. From a yield perspective, it's been a slow summer, with both buyers and sellers pausing in the marketplace to find an equilibrium. Since we are not encumbered by specific acquisition targets or liquidity concerns requiring us to buy or sell properties, we were patient, remained committed to our investment discipline, and paused our transaction activity until we found opportunities in the latter part of the quarter. Early in the second quarter, we completed one acquisition, Lindsay Precast, for $56 million at an 8.5% weighted average cap rate, which we outlined for you on last quarter's call. We also completed the disposition of one office property during the quarter, EMCOR, for $6.5 million at a 7.8% cap rate. Following the close of the quarter when we felt the market had achieved a more balanced posture, we completed two additional acquisitions in the industrial manufacturing space and have signed an agreement for another office property disposition, our property in Williams Sonoma, which we expect to close later this month. Year-to-date, we have made great progress executing on our long-term strategy to exit non-core office properties and shift into industrial and select retail assets. The Modiv team has completed $162 million in acquisitions at an 8.2% blended weighted average cap rate and has completed four office dispositions for total proceeds of $47 million, excluding the anticipated Williams Sonoma disposition. I am proud of the progress we continue to make on the strategic repositioning of our portfolio. Even during these volatile times, we continue to punch above our weight and remain heads down on execution. We remain focused on diversifying our assets, increasing our walls, growing our portfolio, and generating long-term earnings power for our shareholders. We have made significant headway on these goals in a short amount of time, and we know that these results will over time resonate with the investment community and eventually be reflected in our share price. I want to take a moment to discuss our three most recent acquisitions: Lindsay Precast, Producto, and Valtir, and how they are a great representation of the type of property Modiv is focused on. All three of these companies are involved in industrial manufacturing. Lindsay, as previously mentioned on our last call, is an industry-leading precast concrete manufacturer and steel fabricator. Producto, with its two locations in Upstate New York, is a precision manufacturer for the medical, semiconductor, aerospace, and defense markets. And Valtir, with locations in Ohio, South Carolina, Texas, and Utah, manufactures commercial highway products, such as guardrails and barriers. When we evaluate opportunities in the industrial manufacturing space, we focus on mission-critical properties where value is being created onsite. We look for manufacturing products where demand is consistent and relatively defensive in nature, such as infrastructure and components. Another key factor is that the property location is vital to the manufacturing business and is a positive economic contributor to the local community, all contributing to the sticky nature of the property and the long-term value of the real estate. We believe there is, and will continue to be, a trend toward reshoring of manufacturing in the U.S., especially following the supply disruptions witnessed from the global pandemic and recent armed conflicts. Additionally, we believe this subsector of industrial assets is far more resilient to speculative overbuilding, thereby metering the supply that comes online. As a result, we believe it is reasonable to expect to see continued opportunities in industrial manufacturing that are valuable and accretive. Finally, some thoughts on the market as we continue to navigate uncertain economic times. While we do not have a crystal ball into the economy, we are more convicted than ever in our decision to continue to transform our portfolio with a focus on longer leases and sustainable long-term industries that can perform throughout economic cycles. We believe that the market will continue to seek clarity from the Fed as we make our way through the summer and into the fall. We anticipate that the overall deal volume is likely to pick back up in September, allowing cap rates and funding rates to level off as volatility recedes. We're continually evaluating a robust pipeline of small and large acquisition opportunities that we believe will create meaningful long-term value for our shareholders. In fact, though we are reaffirming our 2022 AFFO guidance for the year, we do believe we will exceed the $50 million acquisition target we announced last quarter, potentially by as much as $25 million of late fourth quarter acquisitions. In summary, in the second quarter Modiv continued to execute on our strategy during a meaningfully volatile period of time in the markets. Our patience and strong work ethic have allowed us to deliver on our long-term strategic plan while also driving adjusted funds from operation growth for our shareholders. I have the utmost confidence in our experienced management team, who have successfully navigated multiple economic cycles in the past and continue to find attractive opportunities that meet our strategic goals. I will now turn the call over to Ray Pacini for his remarks.

Thank you, Aaron, and hello, everyone. I will now discuss our operating results for the second quarter and first half of 2022, provide an update on our portfolio, and cover our balance sheet and liquidity. As Aaron mentioned, second quarter AFFO increased 18% to $3.6 million or $0.35 per diluted share from AFFO of $3 million or $0.34 per diluted share in the second quarter of 2021. AFFO for the first half of 2022 increased 25% to $6.6 million or $0.64 per diluted share from AFFO $5.3 million or $0.59 per diluted share in the first half of 2021. The primary drivers of the increase are recent accretive acquisitions and the rent bumps of the portfolio. Total second quarter revenue increased 14% to $10.4 million from $9.1 million in the year ago quarter. Total revenue for the first half of the year increased 11% to $20 million from $18.1 million for the first half of 2021. These revenue increases largely reflect the rental income contribution from the property acquisitions made during the second half of 2021 and first half of this year, partially offset by the decrease in rental income from five dispositions during 2021 and four dispositions in February 2022. On the expense side, G&A costs were $1.6 million in the second quarter, down from $1.9 million in the second quarter of last year as the company continues to focus on maximizing efficiency in our operations and undertaking process improvements; G&A costs were $3.7 million for the first half of the year, down from $4.6 million for the first half of last year. These reductions in G&A also reflect the impact of our exit from the crowdfunding business. Property expenses were $2 million in the second quarter, an increase from $1.9 million in the prior year period and were $4.7 million for the first half of the year, up from $3.6 million for the first half of last year, reflecting higher property and other taxes due to growth in our portfolio. Property expenses for the first half of both 2022 and 2021 were 1% of average real estate assets during their respective periods. Most of these expenses are reimbursed by tenants, with at least 80% reimbursed each year. Fifty-three percent of the increase in property expenses for the first six months of 2022 compared to the same period of 2021 reflects the one-time write-off of $587,000 related to the canceled acquisition of 10 properties leased to Walgreens in the first quarter, given changes in market conditions and the failure of the mortgage servicer to approve our assumption of the related CMBS loan prior to the contract termination date of February 18, 2022. Now, turning to our portfolio. As Aaron stated in his remarks, we continue to focus on acquisitions primarily in the industrial manufacturing sector, while keeping an opportunistic eye on the retail sector as we continue to execute on our long-term strategic plan to reduce our office exposure. During the second quarter, we acquired an eight-property portfolio leased to Lindsay Precast for a total of $56.1 million at an initial cap rate of 6.65% and a weighted average cap rate of 8.52%. These properties are located in Colorado, Ohio, Florida, and North and South Carolina. As Aaron mentioned, following the close of the quarter, we completed two industrial manufacturing acquisitions in sale and leaseback transactions with productive holdings in Valtir, LLC, which was formerly known as Trinity Highway Products, for a total purchase price of $28.7 million and a blended weighted average cap rate of 9.55%. The productive acquisition comprised two properties in Upstate New York and the Valtir acquisition included properties located in South Carolina, Texas, Utah, and Ohio. The productive acquisition has a 20-year lease term, and annual lease escalations of 2%. The Valtir acquisition includes a 25-year lease term for the South Carolina and Ohio properties, with a 15-year lease term for the Texas and Utah properties, and annual rent escalations of 2.25%. Including these transactions, our year-to-date acquisition activity totals $162 million at a weighted average cap rate of 8.2%. We have a strong pipeline of potential acquisitions under review, and we will continue to patiently pursue accretive opportunities that make sense for our portfolio and our shareholders. Now, I'll provide some color on our portfolio management activities, which are also a key component of our ability to generate long-term returns for our shareholders. During the second quarter, we sold one office property for $6.5 million. We're also under contract to sell an additional office property, which we expect to close by the end of this month. When including the successful closure of our two pending sales, on a year-to-date basis, we'll have sold five office properties and one flex property as we execute on our plan to reduce non-core assets in our portfolio. The exit cap rate for the five office asset sales was 7.69%. Taking into account these recent acquisitions and the pending disposition, as of today's date, our portfolio consists of 48 properties located in 19 states. The portfolio is comprised of 26 industrial properties, which represent approximately 51% of the portfolio based on annual base rent, 13 retail properties representing approximately 90% of the portfolio, and nine office properties representing approximately 30% of the portfolio. We expect to continue to opportunistically sell office properties for the portfolio, but we'll remain patient and disciplined in this process. Now turning to our balance sheet and capital markets activities. As of June 30, 2022, we had total cash and cash equivalents of $11.7 million and $201.4 million of outstanding indebtedness consisting of $44.6 million in mortgages and $156.8 million outstanding under our credit facility, including $6.8 million on the revolver. The company's leverage ratio as of June 30 was 38% and 42% when including the recent acquisitions, but not including the pending property sale. In accordance with the terms of our KeyBank credit facility, we defined the leverage ratio as debt as a percentage of the aggregate fair value of our real estate properties, plus the company's cash and cash equivalents. We are targeting leverage of 40% or lower over the long-term, once we achieve a scale of roughly $1 billion or more in assets. However, we will consider higher leverage in the near term if we identify attractive acquisition opportunities in advance of completing dispositions or raising additional equity. As we reported during last quarter's call, in May we executed a five-year interest rate swap on our $150 million term loan, resulting in a fixed rate of 3.858% when our leverage ratio was less than or equal to 40%. Based on the current balance sheet, approximately 93% of the company's indebtedness now holds a fixed interest rate. As previously announced, our Board of Directors declared dividends for common shares of approximately $0.096 for the months of July, August, and September, representing an annualized dividend rate of $1.15 per share of common stock. Based on recent trading prices, this dividend equates to a greater than 7.4% annual dividend yield. As Aaron mentioned, we have reaffirmed our 2022 annual AFFO guidance in the range of $1.26 to $1.36 per diluted share. The upper end of this range assumes that we complete an additional $22 million of acquisitions between now and the end of the year.

Thank you, Ray. Before we turn to Q&A, I would like to share some thoughts on Modiv's share price. The summer months have not been overly kind to net lease stocks overall, but particularly unkind for a thinly traded small-cap rate with an still too large allocation to the office sector. Modiv's current trading prices remain well below fair value should you measure it on either NAV or the multiple Research Analyst price targets. Heck, we even trade below book value. Despite these rather depressed prices, the management team and Board of Directors do not feel panic. We understand that at some point our story will resonate with a broader institutional investor base, and our share price will regain normalcy. That said, being patient is not the same as being idle, and Modiv continues to take deliberate action to deliver results that will resonate with institutional investors. In less than 10 months, since September 30, 2021, we have increased our wealth from under six years to over 11 years. We reduced our office exposure from 50% to only 30% of the portfolio and increased our annual base rental revenue by $7 million to $36 million. These are impressive statistics, and we believe we will be able to deliver even more results in the near future. The quality, resilience, and long-term earnings power of our portfolio continues to improve. As a longtime participant in the REIT markets, I know all too well the perils of the small-cap conundrum Modiv is currently presented with. Some small-cap REITs are really the management teams that run them, stay small-cap REITs forever, finding that their skills could only bring them public, but were not sufficient to bring them to scale. Other small-cap management teams, in an emotional or egoistic desire to be bigger, chase scale with poor capital allocations that either destroy their balance sheet or parental lock them into a dilution spiral. REIT history has shown us that small-cap REITs can emerge as attractive scalable enterprises. Agri, Essential and NETSTREIT are just a few examples of this. For us here at Modiv, we are ardent students of the marketplace, both past and present, and we combine our acumen with patience, knowing full well that at the right time we will be able to advance beyond the small-cap conundrum into a realm of greater and greater investor following. We continue to look at all opportunities big or small, knowing that the right opportunity will present itself and we have the expertise to capitalize upon it. With that, I'd like to thank everyone for joining us today, and will now turn the call over to the operator for questions.

Thank you. At this time, we will be conducting a question and answer session. Our first question comes from the line of Gaurav Mehta with EF Hutton. Please go ahead.

Thank you. Good morning. I wanted to go back to your prepared remarks on the transaction market where you talked about some slowdown in Q2 and then achieving balance after Q2. I was wondering if you could maybe provide some color on how much the cap rates moved before the interest rate hike cycle and what your expectations are going forward?

Hey, Gaurav, this is Aaron. Absolutely. One way to look at this is to consider all the activity we've gone through with our investment committee, where we've submitted letters of intent and evaluated cap rates for deals we've pursued and others we've decided to pass on. To give context, I'll reference the fourth quarter of last year as a baseline. During that time, we were involved in over $100 billion of deals, and we observed cap rates in the mid to high fives for many of those transactions. As we transitioned into the first quarter, we were understandably busy with the IPO, including the off-market KIA transaction and Kalera. Overall, we experienced somewhat lower volume since supply began to slow down in February and March. We observed cap rates mostly holding steady, ranging from the low sixes to 6.25. Primarily, we focused on industrial manufacturing in our acquisitions. In the second quarter, we noticed many deals returning that we chose not to pursue due to unfavorable cap rates. We saw several deals that had been previously tied up fall apart, like the Valtir transaction. We liked the asset but found the pricing unattractive, and since the sponsor had different priorities, we were given another opportunity. We made sure to communicate the cap rates we were targeting, and we managed to close a productive deal involving a sponsor acquiring properties and businesses simultaneously. However, the timing of their closing didn’t align well with market rates. This particular deal was initially marketed at a tighter cap rate, but few buyers were prepared to move within a reasonable timeframe. That said, we encountered numerous opportunities with cap rates in the sevens. While not all of these deals warranted that rate, we did see a significant increase in cap rates overall. Recently, I've been involved with a variety of assets, and although I can't disclose the specifics of our current letters of intent, I can share that we have observed some deals returning to the market with clearing prices back in the low sixes. While this is surprising to me as a first impression, I understand that rates have slightly improved, making financing more accessible. People seem to be regaining their confidence, chasing deals again after a brief period of panic. From late July to August, there’s been a noticeable increase in aggressive bidding similar to what we witnessed in the fourth quarter and first quarter. It’s an intriguing dynamic that I find doesn’t completely align from my perspective; it feels a bit counterintuitive. Furthermore, we've seen an influx of new deals, with six more entering the pipeline just in the last week after a quiet July. It seems we’re still navigating the market. I haven’t had the chance to fully compare notes with other net lease peers on their acquisition status, but I know some are bidding for the same assets, both among our peers and among private investors. Currently, the feeling from the cap rates seems slightly tighter than they were a month ago, even though they remain wide compared to the first quarter, which appears reasonable given recent rate movements. However, the pricing seems competitive, and the vibe leans more toward desperation than opportunity.

Okay. That's great color. Thank you. And maybe I have one more question on Valtir 1. The cap rate on that acquisition is over 9%. Can you provide some color on that specific property, why the cap rate is higher on that property?

On which one? I'm sorry.

Valtir 1.

Valtir 1 has a 15-year term and includes assets located in Texas and Utah. We evaluated the entire portfolio, and after a thorough assessment with our Chief Investment Officer, we determined that the facilities in these locations were somewhat less vital and in worse condition. However, the land is positioned for development and is situated in promising industrial areas. We proposed a shorter lease structure and adjusted pricing accordingly, which the owners accepted as they were eager to finalize the deal. Our approach is methodical, focusing on the overall benefit for both sides. We felt comfortable offering shorter-term leases since they provide us with some flexibility; the tenants can extend if they choose. If my assessment holds true, these assets are slightly less critical to them, but given their location and potential land value, we believe they will be much more valuable for us in 15 years. This strategy enables us to balance risk while capitalizing on an opportunity.

Thank you. Our next question comes from Bryan Maher with B. Riley Securities. Please go ahead.

Good morning, Aaron and Ray.

Hi.

Was hoping to drill down a little bit more on the kind of manufacturing industrial properties versus industrial warehouse, which just seems like everybody wants to bid on. And given that some of those assets that you're buying are different layouts, et cetera, that are just not a big metal box. What kind of a premium on a cap rate basis do you expect to get in general for those types of assets over just buying big box warehouses, like so many REITs are doing?

I believe there's a substantial premium to be had, though I can’t specify an exact figure since we generally don’t focus on distribution assets. The cap rates are significantly tighter for high-quality assets. You're right; there is immense interest in distribution properties, and many players excel in this area with numerous quality assets available. However, I have a couple of somewhat skeptical perspectives. Firstly, I think Prologis will outperform everyone else. However, Prologis can't meet the needs of every client. Secondly, our cost of capital isn't favorable; we can't invest in distribution assets with a cap rate of 5.50% just because we’re fond of them. The opportunities we might pursue, our guidance suggests a 6.25% cap rate, which we have actually surpassed. If we could purchase at 6.25% or even 6% while tolerating some aspects, we'd often be looking at older, outdated properties. Just because they have a long-term triple net lease doesn’t mean they should justify such a tight cap rate; it just doesn’t add up to me. I recall a story years ago about a developer I met in Pennsylvania who built a concrete tilt-up warehouse off a turnpike, signed a 10-year lease with a tenant, then moved them to another location a few years later after obtaining a tax abatement for a new project nearby. If you can easily relocate tenants without affecting their operations, it's hard to see how we have leverage in lease negotiations. While there is overall high demand for eCommerce and distribution, if that demand falters, our negotiating power diminishes, similar to the challenges faced in the office sector. In contrast, industrial manufacturing presents a different scenario since buildings typically have been in place for over 20 years or more. The private equity sale-leaseback model often dominates this sector, leading us to overlook many manufacturing assets. For instance, I wouldn't want to invest in a facility producing dog food when I’m uncertain about the demand for it. Instead, I'm interested in assets that are truly relevant to the broader economy. For example, I visited a facility called Producto, with one asset in Jamestown and another in Endicott. At the Endicott location, they manufacture borescope lens housings for drones using aluminum tubes. Due to supply chain disruptions, they now need to find alternative sources for these materials, which may increase costs significantly. Another example is from a visit to Lindsay Precast in South Carolina, where they encounter issues with aggregates for concrete because their typical supplies are impacted by geopolitical factors. Both these companies have seen their pricing power increase due to their ability to adapt to supply chain challenges, making them resilient businesses, although they might not be glamorous. They are essential to our economy, yet often overlooked. For instance, Alex P. recently offloaded their industrial manufacturing assets at a 7.2% cap rate, illustrating the current market trends favoring distribution properties. While this trend is popular right now, we cannot participate competitively. I appreciate these assets due to their blue-collar nature and recognize their potential; though they might not capture attention at first glance, they require thorough credit evaluation to uncover their true value, especially those with undervalued cap rates.

That's really helpful. My second question is about retail. It seems you haven't discussed much lately about buying retail, despite having a decent stake in Dollar General and recently acquiring Raising Cane's. What are your thoughts on that active segment for the next year, particularly over the next two to four quarters?

We completed a significant deal with Kia this year, which represented a substantial amount of retail and provided a cost advantage since we issued OP units at a lower rate and secured a cap rate that was more favorable than our peers. However, from an allocation perspective, this was a considerable portion of retail for us. We haven't focused much on smaller retail assets, even though they are available. The cap rates in that area are tight. I take an opportunistic view on retail; for instance, we purchased Raising Cane's last July, knowing it had six years remaining and that Raising Cane's was interested in the assets. It was the final asset in the insurance company's portfolio, and we acquired it at a rate about 100 basis points more favorable than the market, which makes me optimistic. I view Kia similarly. I'm generally open to exploring various sectors if we believe we can generate returns for our investors, which reflects our hedge fund and active asset management approach. However, many competitors are acquiring considerable amounts of retail with better capital costs. This raises the question of how I can add value by pursuing similar assets to those bought by NETSTREIT, Essential, Internet, Owl, or PINE. While I appreciate what we currently own, I'm also aware that I could sell for a premium if necessary. We're being selective because we haven't encountered any particularly compelling retail opportunities that align with our strategy at this time. This isn't meant to undermine retail; it simply doesn't seem to fit our current approach, but we remain open to opportunities as they arise.

Thank you, ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Aaron Halfacre for closing remarks.

Thank you, Operator. Thank you, everyone for joining us today. It was a pretty straightforward quarter. We matched fund basically. We sold some office we bought, and we bought some industrial. I think that's a steady rate quarter. Hope to do it again for you in future quarters. And I appreciate your attendance. Thanks so much.

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