Earnings Call Transcript - NNN Q1 2025

Operator, Operator

Greetings. Welcome to the NNN REIT Inc. First Quarter 2025 Earnings Call. Please note, this conference is being recorded. I will now turn the conference over to your host, Steve Horn, CEO. You may begin.

Steve Horn, CEO

Thanks, John. Good morning, and thank you for joining NNN REIT's First Quarter 2025 Earnings Call. With me today is Vin Chao, our Chief Financial Officer. I'd like to start with a high-level update on our bank and furniture and restaurant assets before we delve into the first quarter results. We're making excellent progress resolving these vacancies, and I'm confident that we will be in a solid position to have the vast majority resolved by year-end. On a post quarter update, in terms of our 35 furniture stores, 15 are resolved through leasing or sale and 15 have significant interest, and we anticipate nearly all being handled by the end of the third quarter. For the restaurant assets, we gained full possession this quarter following the conclusion of the eviction process. We've leased or sold 38 and have strong interest in the other 31. Looking ahead, as we fully put to bed the two tenant defaults from the fourth quarter of 2024, we anticipate a total impact of only $0.15 to $0.25 on our stabilized core FFO per share for the year. That's less than 1%. This minimal effect serves to highlight the lasting significance of robust real estate fundamentals throughout the duration of a 20-year lease. Let's go to the highlights of our first quarter financial performance. Our portfolio of 3,641 freestanding single-tenant properties continues its strong track record. Occupancy at the end of the quarter was 97.7, a slight dip from our long-term average of approximately 98 percent due to the finalization of the eviction process. We are encouraged by the significant interest in our available properties from numerous strong national and regional tenants, and I expect our occupancy rate to trend upwards as the year progresses. Notably, we experienced limited to no credit losses within the portfolio during the first quarter. Given the current macroeconomic backdrop, I'm confident in the portfolio's ability to deliver excellent performance over the long term. Our portfolio's stability through events like the GFC and the pandemic with minimal impact underscore its strengths. We prioritize relationships with sophisticated tenants and actively manage our assets to prepare for future uncertainties. While maintaining our disciplined underwriting approach, we successfully acquired 82 new properties during the quarter for approximately $232 million. These acquisitions featured an attractive initial cap rate of $7.4 million and a long-term lease duration of over 18 years. Significantly, all of our acquisitions this past quarter were sale leaseback transactions, a testament to the effectiveness of NNN's acquisition team and relationship-focused efforts. NNN takes pride in this relationship-driven business model, which facilitates consistent repeat business. Not only in the current environment, but every transaction we remain highly selective in our underwriting and we'll continue to prioritize sale leaseback transactions with our established tenant relationships and not operators or developers that are financial engineers. Regarding the current acquisition pricing market trends, we begin the year with the first quarter initial cash cap rate of 7.4%. This compression was in line with the February discussion. We anticipate some cap rate pressure in 2025 compared to the previous year. Now at the start of May, second quarter cap rates are mostly holding steady with the first quarter. However, we are seeing significant compression in the larger portfolio deals, causing us to forego those opportunities. In the first quarter, we executed strategic dispositions. We sold 10 properties and generated $16 million in proceeds and only one of those assets was vacant. These funds are earmarked for reinvestment in new acquisitions and this activity aligns with our full year disposition guidance. Continuing our history of sound financial management, Vin and the team have ensured a robust balance sheet. We finished the first quarter with nearly $1.1 billion availability on our $1.2 billion line of credit and $400 million debt maturity in the fourth quarter is manageable. This reinforces the effectiveness of our self-funding model. The strong financial footing provides the company with the necessary flexibility to execute our 2025 acquisition guidance of $500 million to $600 million. To summarize, our first quarter performance in occupancy, leasing and rent collection further validates our consistent long-term strategy. This involves acquiring well-located properties with strong regional national tenants at appropriate rents, supported by a strong and flexible balance sheet. With that, I'll turn the call over to Vin for more detail to review our quarterly numbers and updated guidance.

Vin Chao, CFO

Thank you, Steve. Let me start by letting you know that, during this call, we will make certain statements that may be considered forward-looking statements under federal securities laws. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to these forward-looking statements to reflect changes after the statements are made. Factors and risks that could cause actual results to differ from expectations are disclosed in greater detail in the company's filings with the SEC and in this morning's press release. With that out of the way, before I get into the quarterly review, I wanted to start with some broader commentary and initial observations. Although, today's elevated level of uncertainty has created volatility in the capital markets, our fortress balance sheet combined with our deeply-experienced team and battle-tested portfolio is well positioned for long-term success in almost any environment. We know this because we've been there. In addition to weathering the GFC and COVID-19 that Steve mentioned, we are also the only public net lease REIT to have experienced Black Monday, the bursting of the dot-com bubble, and the attacks on September 11th, all while delivering 35 years of consecutive dividend growth. While our long and successful track record gives me comfort that we can manage today's economic environment, it's the strength of the NNN platform and its people that give me the confidence that we will continue to create shareholder value in the years ahead and through economic cycles. The depth of talent, the strength of the processes and systems, and the experience of the team are true differentiators within the REIT universe. I'm not sure if everyone knows this, but the average associate has been with NNN for over 10 years and the senior leadership team has been here for over 20. This deep institutional knowledge is a key competitive advantage, particularly in times like these. NNN truly is a well-oiled machine. With that, I'll get off my soapbox and get into the quarter. This morning, we reported core FFO of $0.86 per share and AFFO of $0.87 per share for the first quarter of 2025, each up 3.6% over the prior year period, while annualized base rent was up over 5% year-over-year. Results were slightly ahead of our internal plan, driven primarily by lower-than-planned bad debt and net real estate expenses. Our NOI margin was 95.9% for the quarter, while G&A as a percentage of total revenues was 5.6% and 5.9% as a percentage of NOI. Free cash flow after dividend was about $55 million in the quarter. This quarter benefited from $8.2 million of lease termination fees or about $0.04 per share. This fee was expected and largely driven by one lease that was dark but paying for some time. We were able to negotiate a deal to recapture the present value of the remaining rent and are now looking to sell the property. Turning to operating results. Overall leasing activity for the quarter was strong with 25 renewals and eight new leases completed in the quarter for a blended rent recapture rate of 98%, reflecting the high quality of the portfolio. Occupancy remained high at 97.7% despite the fall off from Badcock and Frisch's and has never dipped below 96.4% over the past 20 years, reflecting the stability of the portfolio and its cash flows. As Steve mentioned, we are making good progress on addressing our vacancies and have now released or sold almost 50% of our former Badcock and Frisch's stores in only about two quarters and we have good visibility or good activity on the vast majority of the remaining stores, a testament to the strength in the underlying real estate. Although these two tenants have created some near-term noise, the reality is that our experienced operations teams are well-equipped to effectively handle these situations as they have over the last 40 plus years. As Steve noted, when all is said and done, we expect less than a 1% impact to annual FFO per share. Importantly, we expect to achieve this outcome with minimal tenant capital expenditures. From a watch list perspective, things have not changed much since last quarter. No new tenants were added and our primary concern remains at home, which we have been flagging for some time. As a reminder, we have 11 at-home stores that account for about 1% of annual base rent. In-place rents are low at just over $6.50 per square foot and our stores are well-established with an average tenure of about 12 years. Turning to the balance sheet. Our BBB-plus balance sheet remains in great shape and it keeps me sleeping well at night despite what's going on in the world. We ended the first quarter with a sector-leading 11.6 years of term remaining on our debt maturities and just 2.5% of our total debt tied to floating rates. This gives us strong visibility. Liquidity stood at $1.1 billion net debt-to-EBITDA was 5.5x and 100% of our assets are unencumbered giving us great flexibility to execute our business plans. On April 15th, we announced the $0.58 quarterly dividend per share, which equates to an attractive 5.4% annualized dividend yield at a conservative 66% AFFO payout ratio. Lastly, I'd like to provide some color on our outlook for the balance of the year. As we discussed last quarter, we signed leases on former Frisch's locations that will add the greater of $2.8 million annually or 7% of sales when rent commences on May 1st. Also, as discussed last quarter, we embedded a credit loss reserve of 60 basis points into the 2025 outlook. Given that we've had no notable credit losses year-to-date and in light of our outlook for the balance of the year, we feel comfortable with the 60 basis points for the full year. Finally, we have a $400 million 4% bond maturing in November. For perspective, we believe current pricing on a new 10-year issuance would be about 5.6%. We also have capacity on our revolver, which is priced SOFR plus 87.5 basis points and had an effective rate of 5.2% in the first quarter. As always, we will be opportunistic and look for ways to capitalize on the current market volatility as we manage our financing needs. Also, while we do not provide guidance on termination fees, given their inherently unpredictable timing, as you are updating your models, please keep in mind that the $8.2 million booked in the first quarter was unusually high and not reflective of the normalized run rate. All that said, given our strong start to the year, our internally funded investment plan and with over 40% of our acquisition volume already completed, we are comfortable maintaining our 2025 outlook for core FFO per share of $3.33 to $3.38 and AFFO per share of $3.39 to $3.44. Details regarding the underlying assumptions supporting our guidance also remain unchanged and can be found on Page 3 of this morning's press release. Lastly, you may have noticed some changes to the earnings release presentation. We take pride in the transparency of our disclosures and are committed to providing investors and analysts with the information they need to efficiently and effectively underwrite the long-term value of our company. We hope you find the changes we made helpful in your analysis, and I'm always available to discuss ideas on how we can improve our reporting. Before I turn the call back to the operator for Q&A, I want to thank the executive team and the Board of Directors for entrusting me as only the second CFO in NNN's history. There's a long tradition of success here that I, along with the rest of the team, will work tirelessly to continue. I also want to thank the entire organization for their warm welcome to the company and for their help in making this seamless transition. With that, John, please open up the lines for questions.

Operator, Operator

Certainly. The first question comes from Daniel with Bank of America. Daniel, please proceed.

Unidentified Analyst, Analyst

Good morning. The 1Q acquisition pace was much higher than expected. Could you expand on that? Do you see less competition in the transaction markets?

Steve Horn, CEO

That's a good question. We operate in a highly competitive market, and it's been highly competitive for over twenty years. Just the names have come and gone. Now the result was all of our transactions except one were sale leaseback primarily through the relationships. But it was elevated just more timing. Going into the fourth quarter, we knew there were some M&A deals that we were looking to get done and they landed in the first quarter. However, it was within our guidance range for the full year. It was primarily the auto services sector where there's a fair amount of consolidation going on.

Unidentified Analyst, Analyst

Got it. And if I could just follow-up on that. Could you touch on the expected pace of acquisitions moving forward? And do you plan on expanding into the auto services?

Steve Horn, CEO

Yes, we do a bottom-up approach. We can only buy stuff that is for sale, and we look for consistent core FFO growth over time. We maintain guidance of $500 million to $600 million, but as Vin alluded to, we're kind of 40% there. Looking at the pipeline for the second quarter, I'm very comfortable that we'll hit that guidance range given where we stand today. However, given everything that's going on in the macro economy and the uncertainty, I don't think it's prudent to elevate acquisition volume since I don't have visibility to the third or fourth quarter yet. That being said, if everything kind of maintains status quo, I could see us making good acquisitions for the year.

Operator, Operator

The next question comes from Spenser Glimcher with Green Street.

Spenser Glimcher, Analyst

Given the recent economic volatility and ongoing uncertainty, can you just talk about existing tenant appetite for growth? And then maybe on the flip side, are there any tenants who had expressed interest to grow and maybe kind of hit the brakes on growth plans as of late?

Steve Horn, CEO

I think they're reevaluating their growth plans. Some deals that we had in the pipeline were canceled because of what's going on. They don't want to miss out on opportunities if things settle down. Our pipeline for Q2 is pretty solid, and we're just starting to look at opportunities for Q3. Our tenants are still looking to grow at the margin. I don't think you're going to see any heroic M&A deals in the near term. We've noticed that the pace has slowed down in the U.S.

Spenser Glimcher, Analyst

Okay. And then any changes to tenant rent coverage, just with ongoing tariffs and things related to consumer spending?

Vin Chao, CFO

Yes, as far as rent coverage and tariffs, I would just say that between service tenants and nondiscretionary tenants, that's about 85% of our annual base rent. So we feel relatively okay about tariff impacts, other than the impact on the overall economy, which we will filter through if things stay in place. Generally speaking, I would say rent coverage has remained stable.

Steve Horn, CEO

I'll add some real-time coverage, Spencer. Our team was at the car wash conference this past weekend and reported that car wash sales were very strong for the quarter. The CEOs I spoke with, whether from collision or the tire sector within auto services, mentioned that they have seen an uptick in their sales over the last two months. So that was all positive. To echo what Vin said, for the most part, I would expect our rent coverage to be quite stable throughout the portfolio.

Operator, Operator

The next question comes from John Kilichowski with Wells Fargo.

John Kilichowski, Analyst

I guess an extension of the tariff question. It sounds like the existing portfolio is still performing well. But maybe as we think about your strategy on underwriting going forward for new investments, have tariffs impacted that at all? Like are you looking at different sectors or is it same old?

Steve Horn, CEO

If you look across our portfolio, we have a very solid tariff-resistant portfolio. Since two-thirds to three-quarters of our deal flow comes from our tenant base, I still expect it to be representative of our current portfolio. The sale-leaseback model inherently allows the tenant to engage in some underwriting and they're signing 15- to 20-year leases. So they do a self-selection and they know their consumer better than any real estate executive. It's more on the discretionary side that we are kind of sidestepping deals right now that might be pro forma, but I think the auto services and convenience stores, if the opportunities come, we will still lean into those.

John Kilichowski, Analyst

Okay. And then maybe just jumping to the furniture and Badcock side. We appreciate the update. How has that impacted the non-reimbursable percentage of your OpEx outlook? It sounds like your credit expectations are still flat.

Steve Horn, CEO

Yes. If you look at our guidance for net real estate expenses, it's a little bit higher than we've historically reported, which is probably more in the $13 million range, we're looking at $15 million to $16 million for the year on guidance. That's reflective of some of the vacancies from the Badcock and furniture sectors. As we release those or sell them over the course of the year, that should improve, but that's all embedded in our outlook.

Operator, Operator

The next question is from Michael Goldsmith with UBS.

Michael Goldsmith, Analyst

Acquisition cap rates ticked down about 10 basis points in the quarter. So in terms of what you're seeing in the pipeline, are you expecting that trend to continue or maybe just kind of flatline from there? Just trying to get a sense of where we're headed from a cap rate perspective.

Steve Horn, CEO

I'm not seeing a material move up or down for the second quarter pricing. It's pretty much in line with the first quarter. Now as deals might slide into the third quarter, you might have 5 to 10 basis points either way. But the 740 is kind of where I'm looking at for the second quarter. Again, third quarter is too far out to speculate. But as we run out our models, we're not putting increases in cap rates because people are looking to deploy money in the first half of the year.

Michael Goldsmith, Analyst

I'm a bit envious that I couldn't attend the car wash conference this year. Regarding Mr. Carwash earnings, they mentioned a steady decline in competitive pressure with several new builds since the peak in 2023, and they also discussed market stabilization over the next few years. Do you view the carwash tenants you’ve partnered with as likely to succeed in the long run and therefore have limited risk from that standpoint?

Steve Horn, CEO

We're very comfortable with our car wash holdings. The reality is car wash real estate is really solid in demand. The vast majority of our car wash holdings are with Mr. Carwash, arguably the best operator in the business. We did those deals well before the market got overheated. Our average cost in Mr. Carwash is significantly lower than the deals that were done in the last few years. I think we're going to be net winners in the long run on our car wash holdings.

Michael Goldsmith, Analyst

Good luck in the second quarter.

Operator, Operator

Up next, we have Smedes Rose with Citi.

Unidentified Analyst, Analyst

This is Smedes Rose from Citi. I wanted to ask about the recent negative headlines and stock underperformance from some of your tenants that focus on discretionary spending, especially Game & Busters and Camping World. Do you have any overall concerns regarding these tenants? Additionally, are there specific factors about the locations you own that might reduce risk in this context?

Steve Horn, CEO

Camping World is one of our most valued partnerships. We've been working together for over 15 years, and we've been actively managing this relationship. During the peak of COVID, it was surprising to see Camping World thrive and become very profitable. Our coverage for those assets is more than eight times. The management team at Camping World has done a fantastic job renegotiating leases and maintaining strong assets, and I am very pleased with the property level coverage. The same applies to Dave & Buster's; our exposure primarily stems from Main Event over a decade ago, and we feel confident moving forward.

Vin Chao, CFO

Steve said it pretty well. The coverage on Dave & Buster's is healthy here. On Camping World, they reported yesterday, and although their stock didn't do so well, from our perspective as landlords, there are some positives in the quarter, and I think their news businesses are a bright spot for them. Given the uncertainty, Camping World is not catering to the highest-end side of the market, which we think is relatively better.

Operator, Operator

Up next is Linda Tsai with Jefferies.

Linda Tsai, Analyst

Did less-than-expected bad debt contribute to 1Q? And then of your 50 basis points embedded reserves, how much of that is known versus unknown?

Vin Chao, CFO

In the first quarter, we really didn't have much in the way of bad debt or credit loss. So if you think about it, 10 basis points of credit loss is about $0.05 per share. Our primary focus is still at home, and that's the one we've been most focused on. At this point in the year, we don't have any loss associated with it. If something were to happen, we're still comfortable with our 60 basis points. For perspective, if there is some kind of filing, that would probably take a couple of months to settle. We have a lot of interest in recovery from quality tenants, and we have flexibility in managing these properties, so we're optimistic.

Steve Horn, CEO

Yes, it's good.

Operator, Operator

Your final question comes from John Massocca with B. Riley Securities.

John Massocca, Analyst

So just on the lease termination income, apologies if I misheard something on that, but it seems like there's kind of this constant narrative; yes, it's a little unusual to have this much, but then there are a couple of quarters it's been pretty heavy in recent quarters, so what do you consider the new maybe run rate to assume for lease termination income? And maybe kind of what drove lease termination income in 1Q?

Vin Chao, CFO

In the first quarter, we had one tenant that drove the bulk of the $8.2 million booked for the quarter. It was a dark but paying tenant that had been dark for about five or six years. We negotiated a deal where we got the entire present value of the rent that was owed over the balance of the lease, and we're now looking to potentially sell that asset. The go-forward run rate for lease termination fees is tough to gauge since they are hard to predict. Historically, we've probably been long-term average of $2 million to $3 million a year, but it's been a lot higher than that.

Steve Horn, CEO

The elevated lease term in the last couple of years is a result of us really focusing in and creating a high quality of earnings for the future.

John Massocca, Analyst

But is there something maybe in terms of the tenant base or your portfolio that drives this or something that's occurred in the last two or three years? It seems like it wasn't really something that got called out on earnings calls five or more years ago as much as it has been in the last, call it, eight quarters.

Steve Horn, CEO

No, it's primarily been just one tenant working with us in reconfiguring their portfolio and their larger boxes, higher rent. That's why they've been elevated.

John Massocca, Analyst

Okay. On the furniture side or former furniture side, I know it's early days with the new tenant in the leased assets, but any outlook on their performance just given some of the rent there is contingent on that?

Steve Horn, CEO

Yes. Just like any new retail concept, there's that honeymoon period, and we are currently in that honeymoon phase. They are performing exceedingly well currently. However, I expect over time they'll lose some momentum, but I'm very optimistic.

John Massocca, Analyst

Fair. And then with the remaining kind of former restaurant properties, is the view that most of those will remain restaurants, or is it thought that whoever you sell them to or yourself is going to convert into something else? What kind of CapEx outlook is there?

Steve Horn, CEO

It's too early to talk about the CapEx side of things, but we are getting interest. If it's car washes or convenience stores and with large regional operators, we're seeing great credit. We're early in negotiations, and the terms will likely depend on how the negotiations unfold.

John Massocca, Analyst

But I guess maybe the way you kind of phrased it, it would be fair to assume those are some of the later assets to get dealt with in terms of both the former furniture and former Badcock?

Steve Horn, CEO

I think Badcock is going to definitely outpace the former furniture assets because we're likely to sell more of those and there are many redevelopment opportunities. By definition, redevelopment takes a longer period of time to go through the pruning process.

Operator, Operator

We have one additional question in the queue coming from Ronald Kamdem with Morgan Stanley.

Unidentified Analyst, Analyst

This is on for Ron. I'm just curious if there's any specific retail new concept like you're looking to reduce exposure in the next 12 to 18 months?

Vin Chao, CFO

One that we're looking to reduce exposure to is AMC. It's been on our watch list forever, not so much from a bottom-up performance perspective but more from a category perspective. Not the easiest to sell one of those. We have a dark paying list and sublease list. These are the ones that we're trying to proactively manage, but it's not specific to one concept.

Unidentified Analyst, Analyst

I see. Yes, that makes sense. Regarding the acquisition volume, like in the last 20 days or so, do you see any changes in the competition landscape compared to last year? Can you comment on that?

Steve Horn, CEO

I think the landscape is pretty similar. You probably have a little bit more of the private guys entering the market again as we move through the year. But again, we work in a highly competitive market; just the names change. I'm not seeing any more or less overall competition. There's plenty of opportunity for us to hit our numbers.

Operator, Operator

We have reached the end of the question-and-answer session. I will now turn the call over to Steve Horn, CEO, for our closing remarks.

Steve Horn, CEO

I appreciate you guys taking the time this morning and jumping on the call, and we look forward to seeing you at the upcoming conferences. Thanks.

Operator, Operator

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