Modiv Industrial, Inc. Q3 FY2024 Earnings Call

Good day, and welcome to Modiv Industrial Inc. 3Q '24 Conference Call. All participants will be in listen-only mode. On today’s call, management will provide remarks, and then we will open up the call for your questions. Please note this event is being recorded. I would now like to turn the conference over to John Raney, Chief Operating Officer and General Counsel. Please go ahead, sir.

Thank you, operator, and thank you, everyone, for joining us for Modiv Industrial's third-quarter 2024 earnings call. We issued our earnings release before the market opened this morning, and it's available on our website at modiv.com. I'm here today with Aaron Halfacre, Chief Executive Officer; and Ray Pacini, Chief Financial Officer. On today's call, management will provide prepared remarks, and then we'll 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 the federal securities laws. Forward-looking statements are identified by words such as will, be, intend, believe, expect, anticipate, or other comparable words and phrases. Statements that are not historical facts such as statements about our expected acquisitions or dispositions and business plans 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 our reports on Form 10-K and 10-Q. With that I would like to turn the call over to Aaron. Aaron, the floor is yours.

Thanks, John. Hello, everyone. Thanks for joining us. Like some of you, I probably stayed up fairly late watching the results. No matter what someone's opinion is, I was hoping that it was decisive either way. One more uncertainty removed from the marketplace, so we have that. Of course, 10 years are up to where they were in June. It makes for an interesting time for REITs. Most REITs are selling off today. We are up a little bit, but I guess a broken clock is right twice a day. With that, why don't we get started? I'm just going to go right into Ray, have him give some prepared remarks, then I'll have a few comments and then we'll open up to questions. Ray?

Thank you, Aaron. Rental income for the third quarter was $11.6 million compared with $12.5 million in the prior year period. The decrease in rental income primarily reflects the disposition of two properties during the first quarter of 2024 and the sale of 14 properties in August 2023, partially offset by rental income from one industrial manufacturing property acquired on July 15, 2024. Third quarter adjusted funds from operations or AFFO was $3.7 million, which is comparable to the $3.7 million in the year-ago quarter. The decrease in rental income was partially offset by decreases in the adjustment for straight-line rents, primarily associated with the May 2024 increase in rent paid by the State of California's Office of Emergency Services to our Rancho Cordova property, along with decreases in property expenses and G&A. AFFO per share of $0.34 reflects a $0.01 increase over the prior year quarter AFFO of $0.33 per share, due to a decrease in fully diluted weighted average shares outstanding. Our repurchase of 780,000 operating partnership units and shares on August 1st, 2024, was partially offset by 157,000 shares sold in our ATM offering during September 2024. If our repurchase of the 780,000 shares from First City Investment Group on August 1 occurred at the beginning of the quarter, pro forma AFFO would have been $0.35 per fully diluted share. Interest expense for the quarter was $3.2 million greater than the comparable period of 2023 due to $2.4 million of unrealized non-cash net losses on swap valuations, which increased interest expense in the current period, while the prior year period had included $795,000 of unrealized gains on swap valuations, which decreased interest expense. Now turning to our portfolio. Following our eight-year lease extension with WSP USA for our San Diego property and a five-year lease extension with LabCorp for our San Carlos, California property, our 43 property portfolio has an attractive weighted average lease term of 13.8 years. Though the majority of our tenant credits are private, approximately 33% of our tenants or their parent companies have a credit rating from a formally recognized rating agency of BBB- or better. Annualized base rent for our 43 properties totals $40.2 million as of September 30th, 2024. With respect to our balance sheet and liquidity, as of September 30, 2024, total cash and cash equivalents were $6.8 million and we had $280 million of debt outstanding. Our debt consists of $31 million of mortgages on two properties and $250 million of outstanding borrowings on our $400 million credit facility. We do not have any outstanding debt maturities until January 2027. Based on interest rate swap agreements we entered into during 2022, 100% of our indebtedness as of September 30th, 2024, held a fixed interest rate with a weighted average interest rate of 4.52%, based on our leverage ratio of 48% at the quarter-end. We're actively evaluating the changing interest rate environment and intend to enter into new swap agreements on or before December 31st, 2024, to continue our full cash position, since we expect at least one, if not both, of the current swaps to be canceled on December 31st, 2024. As we reported in our earnings release, our Board of Directors declared a cash dividend per common share of $0.0975 for the months of January, February, and March 2025, representing an annualized dividend rate of $1.17 per share, which is an increase of $0.02 per share or 1.7% compared with our current annual dividend rate of $1.15 per share of common stock. I'll now turn the call back over to Aaron.

Thank you, Ray. This quarter, we dedicated significant time to a potential joint venture deal. Despite our efforts, which you saw in October didn't materialize in its current form, we continued to work hard and accomplish tasks, reflecting positively on our team. In a company of our size with limited assets, investment choices hinge largely on the quality of our team. Our patience in this unpredictable market since our listing, along with making tough but necessary decisions, showcases the caliber of our team, for which I am truly grateful. Notably, we achieved this without fresh capital, in a challenging interest rate environment with limited trading volume. Given the circumstances, we should consider ourselves fortunate to still be here. Reflecting on our listing, companies like Power REIT, which started at a $200 million market cap, now stand at about $3 million. Others, like SquareFoot and OPI, were larger than us at that time and faced tough choices that compromised their standing. However, we remain resilient; our portfolio has improved. Three years ago, we were over 50% office space, and now we are the only dedicated industrial manufacturing REIT. While Gladstone has made some acquisitions, our approach emphasizes patience and discipline rather than sensationalism. My candid communication style may be apparent in our press releases, but the essence of our work is simply about progress and being strategic with our decisions. As we look toward the remainder of this year, I am focused on two key initiatives. The first is the UPRE transaction, which we've been negotiating for months and are visiting the site. Provided there are no unforeseen environmental issues, we expect to finalize this. The second focus, which some may have overlooked, pertains to our swaps. To clarify, we entered into hedges for two term loans — one for $150 million and another for $100 million — to minimize interest expenses. We chose a swap contract with a put feature that should protect us against significant interest rate increases. I believe there's virtually no chance that the first swap for $150 million will revert to us, especially with current 10-year rates. The market is complex right now, but I'm confident the second swap will also either be canceled or returned to us, and we've planned accordingly with Chatham Financial, which provides us daily pricing on a variety of swap contracts. We’re tracking this carefully despite the rate volatility. Lastly, I want to emphasize our commitment to enhancing communication with investors. We focus heavily on retail investors and, as such, have the lowest institutional ownership among similarly sized REITs. This results in our stock trading a small fraction of the total shares issued, as many of our investors prioritize holding for dividends over daily market fluctuations. This dynamic makes attracting large institutional investors challenging, especially in the current market. Nevertheless, we appreciate the strength of retail investors and will work on improving our communication with them in the upcoming quarter and beyond. I welcome your questions and look forward to an engaging discussion. Operator, let's open the floor.

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. The first question is from Rob Stevenson from Janney Montgomery Scott. Please go ahead.

Good morning. Aaron, beyond the Jacksonville asset, now that you've moved beyond these two larger deals that you were looking at, how active is the pipeline today? And how are you guys feeling about that given your comments about rates and asset pricing, et cetera?

I like the current pipeline. Recently, I noticed comments from Buzz and Gladstone mentioning some opportunities, and we're seeing that as well. Over the summer, it was quite stagnant, but now I'm identifying a few more opportunities that appeal to me. In terms of pricing for these manufacturing assets, which are not flexible spaces or warehouses but true manufacturing facilities, the discussions have generally been in the high-7s to low-8s range. Brokers indicate that there aren't many buyers at the moment, which is understandable given the current environment. It's challenging to make decisions right now. However, I believe some of that stagnation might have cleared recently, and we'll see the outcome of this soon. Overall, I'm optimistic about the pipeline, but we are exercising discipline because I don't want to take on additional debt, which limits our options in terms of capital. Nonetheless, we mentioned in October a joint venture deal that is currently on hold, which involves potentially recycling some assets that are not strictly manufacturing—some are industrial or non-industrial. There are a few assets that could transition from low six-cap to eight-cap returns and generate significant AFFO growth while remaining stable. In summary, we are pleased with what we see in the pipeline, which shows early positive signs, but we don't know how inventory will evolve. Typically, what we're witnessing now will persist for the rest of the year due to the difficulty in closing new deals. We usually see a renewed surge around mid-January, but for now, we are finding things we like.

Is the $6 million for the Jacksonville OP unit asset the total purchase price, or is there an additional cash component that raises the price above $6 million from a modeling perspective?

Yes. No, it's all in. That's it. There's no cash.

Okay. And then I guess the other one for you is that you alluded to it a minute ago in terms of asset sales. How are you thinking about the Kia asset and sort of when the right time is for you to sell that asset given that it's probably one of if not your largest asset and going to wind up having significant capital coming in to be redeployed? Is sometime in '25 the right time to sell that asset? Is there certain benchmarks along the way that you're looking for to figure out when the right time is to recycle that asset?

Good question. First and foremost, we still have Costco looking solid to close around July or August. We've heard from our tenant in OES that they are going through their valuation process with hopes to exercise their purchase options. Those are two large assets that we need to address. Additionally, solar turbines, a tenant in San Diego, will be leaving in July, and we plan to put that on the market as an owner occupant. Until about three weeks ago, the solar turbines parcel was conjoined with the WSP parcel, and we have spent the last two years working to split them in the City of San Diego, which has now been completed. This separation is advantageous for us, as we have an eight-year lease on Woods that positions that asset well. We will explore options for that, and we can now pair off the solar turbines. I mention this because there's still some housecleaning to do; we aren't finished with those assets yet. In the meantime, Kia remains a very high-quality asset with a long lease term and attractive rent increases. I believe that as we enter a more stable rate environment, the cost of capital for potential buyers will improve, making it a large asset to purchase. Could this happen in '25? I don't have specific plans for that yet. The tax basis is very low, so we need to be mindful of the 10/31 exchange. However, I anticipate plenty of opportunities ahead. Ultimately, we aim to focus entirely on industrial assets, and that goal is approaching sooner rather than later.

Okay. That's helpful. And then Ray, from a numbers perspective, you bought back some OP units and possibly some stock during the quarter. What was the average price on the stuff that you bought back in the third quarter?

$14.80.

Okay. So that's what that $14.80 number was. Okay. I didn't know whether or not that was the number.

Yes. That was the owner of Kia, right? So that was their units. We bought them back. Those are the same units we issued to him in January 2022 at $25. So the 780,000 units, which were OP units hence talk, issued at $25, retired at $14.80, and then we turned around and prospectively with the OP unit transaction for the Jacksonville, Florida, we'll have reissued $600,000 of those $780 at a $2 per share premium.

Okay. That's helpful. And then last numbers one for me. The dividend increase is effective January, not for the already declared fourth-quarter dividends, right?

That is correct. Yes.

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

Just a couple for me this morning. Aaron, you've been pretty quiet, I think, on your current tenant performance, except for the ones that we know about Costco, KIA just talked about. Is there anything else going on in the portfolio that we should know about? Any known vacates other than I think you just talked about Solar Turbine? Can you just give us a little bit more color on kind of the day-to-day with your tenants?

Yes. We have resolved the situation with Kalera, which has been vacant since the bankruptcy proceedings concluded last summer. We've had several discussions with various strategic parties, including vertical growers and others interested in the property for its water source. We're preparing to formally take that property to market, likely in the fourth quarter or January. It’s the only underperforming asset we have, and any proceeds will be beneficial given that the capital isn’t generating any returns at the moment. Solar Turbines has been a long-term tenant, and they recently exercised an option for a two-year extension, but they will be leaving soon. We're actually pleased with this, as the potential pricing for an owner-occupant is significantly higher than what we would have received as a tenant. Overall, I believe our portfolio is solid and appealing to individual investors. My own net worth is deeply tied to this company, and I understand that many investors feel the same way. We’re committed to building a strong portfolio. While our average lease term is around 13.8 years, this includes the upcoming vacancy from Solar. We’ve also secured a five-year lease extension with Labcorp ahead of schedule, and most of our leases are absolute triple net. There are a few legacy double net leases that I plan to address in time, but the majority of our properties feature 20-plus year leases with reliable manufacturers that have consistent operations over decades. This portfolio is quite stable, and we monitor our assets closely, especially considering the concentration risk associated with having 43 properties. While I’d prefer to scale up significantly, we are ensuring to manage this portfolio diligently.

And just one more for me. Thanks for those comments. Given the election outcome, regardless of what you think of each candidate, is that changing your view on your acquisitions? I mean, I guess we should expect increased onshoring of manufacturing. But how does that tweak how you're thinking about acquisitions of industrial manufacturing going forward? And that's all for me.

Yes. I believe I previously discussed the reasons behind our focus on industrial manufacturing. There is significant support for this sector nationally. It has been consistent under both political campaigns, and I anticipate it will remain robust for some time. If we consider potential tariff introductions, the products we manufacture are already produced and sold domestically, which adds to their value. While there is a possibility of increased orders, we will continue to uphold our operational leases, so any fluctuations in manufacturing output won't drastically impact us. Our support for American workers is vital, and I genuinely believe in their capabilities. A Trump administration may lead to increased onshoring or nearshoring, but it takes time for manufacturing to ramp up. As noted in a podcast with Elon Musk, manufacturing requires time to establish. This is why we prioritize durable manufacturing that is already established rather than trends that may fluctuate significantly. I appreciate manufacturing because it focuses on creating tangible products rather than consumer spending. Many of these products are not commonly found on popular retail platforms or in discount stores, and their straightforwardness is appealing. The current environment is favorable for this approach. Our distinct position, lacking institutional following, means we trade differently from the general market and serve as a natural diversifier. For those interested in REIT sectors, we provide one of the best avenues for investing in American manufacturing without the noise of commodity pricing. As long as management continues to maintain a strong balance sheet, we remain confident. Real estate trends and interest rates are also part of our consideration. If you're optimistic about real estate, adding our offering could complement your portfolio since it's not aligned with traditional trading patterns and supports durable investments. There's potential upside too; for instance, our last appraisal indicated a value of $23 a share. Despite hitting a new 52-week high recently, which demonstrated that the market appreciates our prudent decision-making, there’s a need for transparency and solid investment principles. I'm optimistic about manufacturing but require more funds to expand our asset base. Our ability to raise more capital depends on investor interest, as we won't resort to borrowing. The absence of a large float means our stock can experience more volatility based on individual trades. We're concentrating on attracting capital from retail investors, as a larger market cap will ultimately draw institutional investors' interest. Until then, our focus remains on those who appreciate what we offer in the manufacturing sector.

Thanks, Aaron. Up 4%.

The next question is from Gaurav Mehta with Alliance Global Partners. Please go ahead.

I wanted to go back to your comments about your expiring swaps. Do you expect the new hedges that you're looking at to have similar terms and similar rates as your expiring swaps?

Yes, we are engineering it to maintain the same all-in rate or achieve a better one. One important point is that I won't be including any cancellation features. I recall a case study from my time at business school about airlines and their decisions to hedge fuel costs, which had varying results. In the REIT environment, hedging is essential. It’s reasonable to assume that our maturity rates will trend downward from this point forward, and I believe rates are likely to decrease. However, I understand that uncertainty is not favorable for individual investors, and while I generally dislike debt, I recognize it is often necessary in the REIT space. I remember when Public Storage had both preferred and common stock, which was a great time. Although I'm not a fan of debt, I understand its necessity, and we plan to hedge it effectively at the same or lower rates. Unlike before, we will not include any put features, and we will hedge to the exact maturity date of our debt. This approach is crucial because our funds from operations can fluctuate, leading to non-cash interest expenses that create volatility. This inconsistency is something I find undesirable. Moving forward, we will focus on acquiring hedges that align perfectly with maturity dates to minimize FFO volatility.

Thank you. The next question is from the line of Barry Oxford with Colliers. Please go ahead.

Thanks for the explanation on the hedge, Aaron. Looking at your cost of capital and the arrows in your quiver, where does the stock price sort of come in? You're up 15% year-to-date. Again, you're up nearly 4% right now, $17.40 $17.50. At what point do you say, hey, I'd be willing to do a decent-sized chunk, whatever number that is, in order to grow my asset base versus sales, which is just kind of a disposition that is just kind of running in place?

That's a great question, and it's something I've been thinking about for two years. I’ve gone through quite a process during this time. It hasn’t been easy. Although some may not support any overhead, I believe we’ve managed well. With a team of 11, we’ve maximized our resources and worked hard to achieve our goals with minimal funding. There’s a song that resonates with our situation, expressing that while we may not have much, we don’t need more either. We've accomplished a lot with the limited capital we raised, which amounts to about $3.9 million since going public, totaling around $6 million in common shares over three years. Yet, we recently reached a new high for the year and have seen our shares perform well today. I’m not looking to increase debt; I prefer equity. We did have discussions with a bank regarding a joint venture and considered raising $10 million to $15 million. I felt that amount could help address some challenges. Typically, the process involves seeking institutional investors to support the fundraising, which is difficult for us since we lack institutional backing. We’ve operated like a large real estate investment trust, but the market favors bigger players and easier capital access. The system is tailored for larger REITs that can secure funding from institutions which then aim for quick returns. If we were to attempt a $10 million or $15 million raise, it represents nearly 10% of our market cap, making it challenging to unwind that position given our trading volume. There are days when we see very little trading activity at the start of the day, making it impractical for investors to sell without significant discounts. Additional costs associated with underwriting and legal fees compound the challenges. This approach wouldn’t benefit us and wouldn’t enhance the value for our investors. Historically, we listed our shares without a substantial raise to provide investors with choice, valuing individual freedom. Our legacy investors were crowd-funded, and we’ve witnessed issues faced by other REITs that had to restrict investor access, which we wanted to avoid. We chose to list to prevent a situation of self-liquidation. Had we approached it differently, we might have executed a larger re-IPO, but that would mean selling a substantial portion of the company at a loss to individual investors. I believe we can be patient and continue to grow. For instance, if we raise $4 million quarterly through our ATM program, we could see a 10% increase in our market cap without diluting shares significantly. Previous appraisals suggested a liquidation value around $22, and even $20 reflects potential value. Raising funds at lower valuations would primarily benefit insiders and banks without benefiting investors or strengthening our portfolio. Therefore, we are committed to engaging with retail investors and will focus on raising funds that benefit them, whether large or small amounts. Ultimately, our future depends on making incremental growth, possibly leading us to a $200 million market cap, and eventually attracting institutional investors as we meet their criteria. I prefer doing that through retail dollars first. There's immense potential for growth over time. If we can raise capital in a way that doesn’t harm our existing shareholders, I’m all for it. Otherwise, we will continue to work diligently and navigate through this period as best we can.

That all sounds reasonable, Aaron. Appreciate the color. Thanks.

Looks like we have one more question.

The next question comes from Steve Chick with Sebis Garden Capital LLP. Please go ahead.

Thanks for the color on the swaps, by the way. I think that's really helpful. Looking back at the JV transaction that's been tabled, the Miami battleship, with these deals and the way you want to structure it, the sellers would be kind of post-money shareholders in the company. From the terms that you kind of roughly outlined when you made the announcement last month, it looked like the deal would be very accretive and bullish for the stock. So I guess I'm curious as to the balancing act that they're doing and what's kind of the obstacle for them to do a deal where both sides benefit potentially so materially?

What was known was the first half of the deal, which would have been beneficial. The shares would have been issued at an attractive price, and we would have used minimal cash without incurring any debt. It would have been a beneficial transaction. Assuming we could acquire the second half of that portfolio at the same cap rate, it would have continued to be beneficial throughout the process. It was a balancing act, and both parties were working in a fair manner. They would have made money on that trade, and so would we. A few factors played a role in the situation. For accounting reasons, the joint venture couldn't clearly define the second half. I misunderstood or was overly optimistic, thinking our agreement allowed us to acquire the remainder at the same cap rate, but that perspective wasn't accurate. I don’t believe they misled us; it was more a miscommunication, which can happen when you're juggling various tasks and dealing with attorney negotiations. It became clear only when some legal language emerged that suggested a different approach than we had anticipated. Many CEOs have faced similar situations. I think of Jeff Witherell at Plymouth, who cleaned up his balance sheet after the Madison transactions and then pursued another deal with Sixth Street, likely believing it would be beneficial for growth. However, as deadlines approached, challenges arose, and he made his decisions accordingly. Similarly, I've been in positions where the pressures of legal budgets, egos, reputations, and other factors were at play. I was uncertain if I could obtain the second part of the portfolio at the negotiated cap rate, especially given the changing environment. I recognized that it was reasonable for the other party to seek higher prices if they could sell those assets for more. But my intention was to integrate a solid industrial manufacturing portfolio into ours, leveraging strengths for growth without gambling with people's money. We considered raising funds to ensure certainty, but the conditions for raising were not beneficial at that time. My goal isn't to seek growth simply for its own sake; it needs to be strategic, and our portfolio remains solid. They may end up selling for a price higher than what was offered to us. They had an institutional fund that needed to close quickly, and I didn't want to rush and risk making poor decisions. Selling certain assets just to complete another deal could lead to unfavorable outcomes. Ultimately, we made a tough decision. The initial part of the deal would have appeared beneficial and might have yielded short-term gains, but I was concerned about potential long-term risks. I need to plan for the future, not just the next quarter. I focus on preserving and intelligently growing the portfolio. I'm not sure if that deal will return, but we have had discussions about two other joint ventures. There is a current challenge with numerous private equity portfolios. While the quality of these portfolios doesn't differ markedly from ours, they typically carry higher leverage. If they leveraged their portfolios significantly in the past, they will face pressures soon to manage those levels. Market conditions, such as interest rates, need to shift to allow clarity and capital flow again, but current debt maturities loom large. While I don't believe a real estate crisis will occur soon, there is considerable leverage that necessitates lower rates or additional equity investment. I’m not flush with capital, and unless the market can provide beneficial capital, I won't enter into risky deals. My goal is to avoid making decisions that could trap us in unfavorable situations, as I experienced with the previous portfolio management context. We are committed to being the leading manufacturing REIT, and our conversations with potential partners stem from the liquidity we provide. Unlike traditional funds that make collective decisions about liquidating assets, as a public company, individual shareholders can make their own financial decisions. That flexibility remains valuable, and we believe opportunities will continue to arise, but we are not going to rush into decisions now.

Thank you. Aaron, thank you for your comments. We appreciate your transparency throughout the call.

All right, everyone. Thanks so much until next time. I encourage those who are reading this later to send us your questions; do send us your critiques. I don't mind the tough questions. I will try to be as transparent as we can without breaking any rules. I hope you guys have a good holiday and get some rest. Be well.

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