Greetings and welcome to the NETSTREIT Corp. Second Quarter 2024 Earnings Call. At this time, all participants are in the listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Amy An. Thank you. You may begin.

Thank you for joining us for NETSTREIT's second quarter 2024 earnings conference call. In addition to the press release distributed yesterday after market close, we posted a supplemental package and an updated investor presentation. Both can be found in the Investor Relations section of the company's website at www.netstreit.com. On today's call, management's remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. For more information about these risk factors, we encourage you to review our Form 10-K for the year ended December 31, 2023, and our other SEC filings. All forward-looking statements are made as of the date hereof, and NETSTREIT assumes no obligation to update any forward-looking statements in the future. In addition, certain financial information presented on this call includes non-GAAP financial measures. Please refer to our earnings release and supplemental package for definitions of our non-GAAP measures, reconciliations to the most comparable GAAP measure, and an explanation of why we believe such non-GAAP financial measures are useful to investors. Today's conference call is hosted by NETSTREIT's Chief Executive Officer, Mark Manheimer, and Chief Financial Officer, Dan Donlan. They will make some prepared remarks and then we will open the call for your questions. Now I'll turn the call over to Mark.

Thank you, Amy, and thank you all for joining us this morning on our second quarter 2024 earnings call. We had a steady second quarter, completing over $116 million of gross investment activity at a blended cash yield of 7.5%. A larger portion of our acquisitions this quarter were sale-leaseback transactions, as we have seen more attractive risk-adjusted returns from our opportunity set in that area. Due to the difference in sourcing channels this quarter, our acquisitions had an attractive rent growth profile with longer lease terms at 16.7 years average remaining lease term. We have a new Top 10 tenant this quarter after two property additions with Life Time Fitness, a premier health club provider whose operations have proven resilient in the current economic climate due to the chain's focus on the more affluent customer. This direct sale-leaseback was part of a larger package which allowed us to select the two best assets from the group at highly attractive price points. One of the assets is a former United States Tennis Association location in the northern suburbs of Atlanta, which has been expanded and upgraded by Life Time over the past few years. The other asset is another infill location in Austin, Texas, which consistently performs as one of the top five most profitable locations in the Life Time chain. While we have seen a number of sale-leaseback opportunities with Life Time over the past few years, this was the first opportunity that gave us access to some of their most attractive real estate at accretive cap rates on an appropriate basis. We may selectively add to this tenant concentration if we can continue to acquire top-performing assets at favorable pricing with a reasonable basis. On the development front, we commenced rent on six projects totaling $12 million. Our current development pipeline consists of 12 projects with a total estimated cost of $39.6 million, which includes estimated remaining funding of $12 million. Moving on to dispositions. We continue to execute on strategic asset sales to recycle capital into investments with longer leases and better rent escalations and decreasing our exposure to certain tenants. We completed six dispositions in the quarter for total proceeds of $13 million at a blended cash yield of 6.8%. At quarter end, our portfolio consisted of 649 investments with an ABR of $148 million. Our 90 tenants operate in 26 industries across 45 states with 83% of our portfolio leased to investment-grade or investment-grade profile tenants. Our weighted average lease term remaining on the portfolio is 9.5 years, with less than 4% of leases expiring through 2026. As we look to further improve the diversity of our portfolio, we will continue to explore all acquisition sourcing channels where we can get the best risk-adjusted returns, including sale-leaseback opportunities that give us access to well-located real estate where the tenant generates significant cash flows at a very high rent coverage. While having a large number of publicly traded companies in our portfolio has created headline noise for us most recently, we believe the economic impact to our cash flow generation should be negligible over the long term. As a reminder, we do not only rely on the corporate credit of our tenants but also the unit level performance of our assets and the quality of our real estate collateral. The two most topical tenants in the news have been Walgreens and Big Lots. As it relates to Walgreens, we have just one lease expiring before 2029 and it is a high-performing asset with minimal renewal risk. As mentioned in the past, we maintain an ongoing and constructive dialogue with Walgreens which allows us to proactively asset manage our stores in real time. That said, we continue to believe we own some of the better-performing stores, which should limit our downside risk. With regard to Big Lots, they recently announced the closure of more than 10% of their stores. We have one location on that list and based on our assessment of the market, we are confident in our ability to re-tenant the location with potential upside in rent. The remainder of our Big Lots stores generate better than average foot traffic with rents that we believe are at or below market with attractive real estate fundamentals. As we look out to the remaining half of the year, we are focused on further enhancing our portfolio's diversification with tenants that have strong management teams and operate in defensive industries. Before I hand the call over to Dan, I want to discuss the fraud incident that occurred during the quarter. The company was the victim of a criminal scheme involving a business email compromise of an employee that led to two fraudulent transfers totaling $3.3 million to a third party impersonating one of our development partners. The result was a $2.8 million loss net of insurance recoveries. When we learned of the issue, we took immediate action, including blocking access to the compromised account and launching a review with the assistance of third-party experts. Our investigation has determined this isolated event poses no further threat to the company or its partners, and we believe we have taken the appropriate steps to prevent this from occurring again. With that, I'll hand the call to Dan to go over our second quarter financials and then open up the call for your questions.

Thank you, Mark. Looking at our second quarter earnings, we reported a net loss of $2.3 million, or $0.03 per diluted share. Core FFO for the second quarter was $23.4 million, or $0.31 per diluted share, and AFFO was $23.8 million, or $0.32 per diluted share, which was over a 6% increase versus last year. Turning to the expense front. Total recurring G&A declined 8% year-over-year to $4.6 million while recurring cash G&A declined 13% year-over-year to $3.3 million. In addition, with our total recurring G&A representing 12% of total revenues in the quarter versus 16% of total revenues in the prior year quarter, our G&A continues to steadily rationalize relative to our revenue base. Turning to the balance sheet. Our total adjusted net debt, which includes the impact of all forward equity as of quarter end, was $464 million. Our weighted average debt maturity is 3.6 years and our weighted average interest rate is 4.43%. Including extension options which can be exercised at our discretion, we have no debt maturing until January 2027. During the quarter, we sold 1.6 million shares, all on a forward basis from our ATM program, for a net equity value of $29 million. At quarter end, liquidity was $569 million, which consisted of $14 million of cash on hand, $302 million available on a revolving credit facility, and $254 million of unsettled forward equity. Turning to leverage. Our adjusted net debt to annualized adjusted EBITDAre was 3.4 times at quarter end, which remains well below our targeted leverage range of 4.5 times to 5.5 times. Moving on to guidance. We are maintaining our 2024 AFFO per share guidance of $1.25 to $1.28. We also continue to expect cash G&A to range between $13.5 million and $14.5 million, which is exclusive of transaction costs and one-time severance payments. Lastly, on July 23, the Board declared a quarterly cash dividend of $0.21 per share, which represents a 2.4% increase from the prior quarter. The dividend will be payable on September 13 through shareholders of record as of September 3. Based on the dividend amount, our AFFO payout ratio for the second quarter was 66%. With that, we will now open the line for questions.

The first question is from Wes Golladay with Baird. Please go ahead with your question.

Hey, good morning, guys. Can you talk about what categories are in the acquisition pipeline and the held-for-sale assets?

Sure. We are considering a diverse range of transactions. This includes some sale-leasebacks and we are also wrapping up several developments. We still have a few dollar stores to close, along with quick-service restaurants and typical tractor and supply deals you've seen in the past.

Okay. And then when you go back to the Big Lots comment, you mentioned a potential upside in rent. I know you have a low rent overall for the Big Lots. Can you talk about where the rent is for the asset that was, I guess, closed? And are you looking for term income and any CapEx needed?

The rent for that location is $5.29 per square foot, which is quite low and makes the real estate attractive. The store has not closed yet, but it is on a list of 149 stores that are set to close, which means they will likely begin going-out-of-business sales soon. This process will take some time. If they file for bankruptcy and we take back the property, there are still seven years remaining on the lease. If they were to reject the lease, we would receive a lease termination payment, and we would seek to find a new tenant for the property. We have already been discussing opportunities with potential tenants as well as a broker familiar with the area, and there is interest in that location.

Okay. And then Stop & Shop has been in the news. How do you feel about your exposure there? And are there any other tenants on your watch list?

Yeah, sure. So yeah, Stop & Shop, we've got two locations, which is a little bit less than 2% of revenues. I think they announced 32 closures that they're going to be going through. None of ours are affected by that, and we don't really see any risk to our locations. We have one in Beekman, New York that is currently getting extended and they're taking their five-year option, and then one in Somers, New York as well, that's one of their top-performing assets that has some term on it. So I really don't see any risk associated with that tenant. And then of course, Big Lots, we certainly are paying attention to what's going on with them.

Okay, thanks. I'll hop back in the queue.

Thanks, Wes.

Thank you. The next question is from Smedes Rose with Citi. Please proceed with your question.

Hi. Thank you. I wanted to ask about the overall acquisition activity. We were surprised that the pace slowed down compared to our expectations. In the first quarter, you mentioned that activity might be in line or ahead, so I'm curious about what dynamics you observed during the quarter that led to this slowdown. Can you provide an update on what you've seen or your pipeline for the third quarter?

The pace of activity has remained relatively consistent, although it may have slightly slowed down regarding margins. We have been very selective about the assets we are willing to add to our portfolio and have been careful with the capital we raised back in January. I anticipate that our pace this year will be similar to that of last year as we look ahead over the next 60 to 90 days.

Okay. And then could you just maybe talk a little bit more about the Life Time assets? I mean obviously, brought the overall investment grade profile of your investments down. Would you expect over time that that's going to move back into the low to mid-80% of your total investment activity or...

Yeah. I mean I think we're maybe a little bit less dogmatic about whether something is investment grade or not investment grade or investment grade profile. We're kind of looking at not only the corporate credit, what industry that tenant's in, what headwinds or tailwinds that might be affecting that individual tenant or that industry, how profitable the locations are. And then, of course, in the event that we ever have to take a property back, like you're seeing with Big Lots, that we're going to be able to backfill that location and replace the rent. So it's kind of a lot of different factors that kind of go into what we're looking at buying. Right now, we're seeing more on the sale-leaseback side, which is going to be typically some investment grade profile, some sub-investment grade occasionally, an investment grade tenant. There's kind of a large transaction out in the market right now that's with an investment grade tenant. And so I think it really had more to do with our sourcing channels, where we were getting the best risk-adjusted returns last year, which was we did a lot of blend-and-extends two years ago. And then last year, we're doing more on the development side. Those just happened to be more with investment grade tenants. And so from the time of our IPO, we came out and said we'll use it as a guidepost for investors, saying we'll be between 60% and 70% actual investment grade, which we've kind of kept to that. We kind of creeped over 70% there for a little while. But I think we're likely to stay somewhere around that range.

Okay. Thank you. Appreciate it.

Thank you. The next question is from Haendel St. Juste with Mizuho. Please proceed with your question.

Hi, good morning. This is Ravi Vaidya on the line for Haendel. What's the bad debt reserve that's currently embedded in your guide right now? And why not raise the guide at this point, given that it seems that you're above pace from an acquisition standpoint versus last year?

Hey, Ravi, good question. On the credit loss, as we started the year, we said at the low end of guidance, we were modeling 100 basis points, and at the high end of guidance, we were modeling basically nothing. As we've gotten through six months, we're now modeling 50 basis points at the low end and essentially nothing at the high end. As far as the decision not to raise guidance, with five months left in the year, we were comfortable leaving the midpoint at $1.265, namely because with almost 15 million shares unsettled through our forward sale agreements, the dilution associated with those depending upon our stock price can have a meaningful impact on the share count and therefore our earnings per share. So we just wanted to see a couple more months of trading, as well as a couple more months of activity before revisiting our guidance in October.

Got it. That's helpful. Just one more here. Would you say that your acquisition strategy has shifted? Is there now more of a focus on experiential real estate rather than in the dollar stores and pharmacies that currently make up a large part of the portfolio?

No, I wouldn't say that our strategy has really shifted at all. In fact, we've explored several Life Time Fitness sale-leasebacks over the past three to four years. One traded at a 5.9 cap and another in the 6s. We felt that the pricing was a bit aggressive, and the assets didn’t perform as well as those we acquired. This was a unique opportunity to grow with a tenant we believe is very strong and has high-quality real estate. The Austin location consistently generates top five cash flows across their entire chain. The Atlanta asset is somewhat unique as it’s located in the Peachtree Corner suburb just north of Atlanta, which we acquired for about $800,000 per acre. It’s zoned for potential residential conversion, so even if we ever took that asset back, we would make money on it. This transaction has unique characteristics, but we always evaluate the quality of the real estate, unit level performance, and corporate credit, which we felt fit very well within our portfolio. We were simply priced out on the last several transactions with Life Time in the past.

Got it. That's helpful. Thank you.

Thank you. The next question comes from Greg McGinniss with Scotiabank. Please go ahead.

Hi. Good morning. What do you think has changed at Life Time or on the demand side for those assets that the boxes are now pricing at an attractive basis for you? And are there other non-IG operators that you're now looking to pursue? So it might see a historical bias towards investment grade or equivalent acquisitions start to shift?

Yeah. I mean I would say what has changed with Life Time is really just what has changed across the entire market. Obviously, interest rates have an impact there. But there's just such little competition out in the market versus where we were two, three years ago where there was private equity, there was a lot of 1031 buyers, some large family offices that could write really big checks. Most of those are completely sidelined. So you have a handful of public REITs that are still active, but I think that is really the demand side has kind of fallen off with not as many buyers on the competition side. So I think that's really what's driving the situation with Life Time. Yeah, I mean, I think we're always looking for new tenants or open to sale-leaseback opportunities. We're open to really every different channel that we acquire assets through. And right now, it does seem to be that the sale-leaseback channel is a little bit more attractive, where we're getting very high-quality real estate at a very low basis with high rent coverage, with tenants that are growing that we think have blue skies ahead of them. So certainly looking at a number of those types of opportunities. But then we're also looking at a lot of grocery store transactions and other investment grade type tenants that you've seen us acquire in the past.

Okay. And on those Life Times, are you getting P&Ls on those? And can you disclose the rent coverage?

We do get unit-level coverage. I'll just say that they are very high.

Okay. Thanks. And one more just on the balance sheet. So given the increasing expectations, we'll see, hopefully, that debt costs are coming down with rate cuts, how are you thinking about the $150 million accordion remaining on the term loan versus just issuing a new loan? And if you were to tap the accordion, do you plan on swapping that?

Yeah. Hey, Greg, we would look at doing both. It kind of just depends on where bank demand is. The five-year swap rate today is around 380 basis points. Our spread over that swap rate is about 125 basis points. So all in, you're looking at very low 5%. I don't think we're looking at doing anything though on that front until we get out to 2025. Our credit facility comes due in August of 2026, and typically, you start to look to recast that and look at the rest of your term loan debt at the same time. So that's probably an early 2025 event. So it's a little too early to say what we may or may not do. But our preference certainly is to continue to push out our debt maturities throughout the course of the next few years.

Okay, thank you.

Thank you. The next question comes from Upal Rana with KeyBanc Capital Markets. Please go ahead.

Great. Thanks for taking the question. I'm assuming you have largely completed 3Q investment pipeline and want to get your sense of where cap rates and volumes are trending so far. And, are you seeing the early indication of where cap rates could shake out for your 4Q pipeline?

Yeah, always difficult for us to project too far out, but yeah, I mean, I think third quarter likely to see cap rates. I think they've really flattened out. So you saw us post a similar cap rate second quarter as we did first quarter. We don't think they're necessarily going up here in the short term, but these things can certainly change pretty quickly.

Okay, got it. Thank you. And then could you provide some color on the current in-place rents on the 27 Walgreens that you have? And where do you think the market is for those properties?

Yeah. So we're about $21 a foot on average, and I think they're all a little bit different, but I think we're probably slightly above market.

Okay, got it. Thank you.

Thank you. The next question is from the line of Joshua Dennerlein with Bank of America. Please go ahead.

Hi, good morning. This is Farrell Granath on behalf of Josh. I just wanted to ask, I guess in terms of the spread that you're seeing between IG and non-IG, I was curious if you could comment on that and if you're seeing any shift at all in terms of cap rates and pricing?

That's a great question. Historically, the difference we've observed between non-investment grade and investment grade has typically been around 40 to 50 basis points, which is fairly tight. However, currently, we are noticing that this spread is slightly wider than what we experienced over the last four years, although there are many factors affecting cap rates beyond just the investment grade designation.

Great. And I guess also just kind of thinking bigger picture, given the consumer being under pressure, are you seeing this specifically impact the stores in your portfolio, and are you receiving financials for a certain percentage of your portfolio that you've been monitoring?

That's a great question. The main distress is seen with lower-income consumers, especially concerning discretionary spending. With inflation squeezing their budgets, many are cutting back on non-essential items. Big Lots caters primarily to mid-to-lower income shoppers, and since inflation began rising, their sales have significantly struggled. For Walgreens, consumers are evaluating their purchases more critically, often deciding not to buy many items they previously would, leading to a decrease in pricing power. This has caused Walgreens' margins to decline from a stable 23% to 18%, primarily due to the impact of inflation on lower-income consumers.

Okay, thank you so much.

Thank you. We have a follow-up question. Sorry, the next question comes from Ki Bin Kim with Truist Securities. Please go ahead.

Thank you. Good morning. On the Life Time assets, can you just talk about the average age of those assets?

Yeah, I mean, they're fairly new. The one in Atlanta is kind of getting redone, used to be the United States Tennis Association location. So that's gotten a pretty big makeover. So it's essentially a pretty new building. And then Austin is only a few years old.

Okay, great. And on your cost of capital, I mean, obviously, you guys have a great balance sheet and an excellent position, but your equity price isn't quite efficiently priced. How should we think about this going forward? I know you have some runway to continue to buy, but thereafter, how do you think about funding your next round of deals?

Yeah. Hey, Ki Bin. With our leverage at 3.4 times, we can execute on our plan for the rest of the year. And still in the year at or below the low end of our targeted range of 4.5 times to 5.5 times. So we do have plenty of runway as you know. But, right now, we can achieve spreads just slightly north of 100 basis points, which means we can probably grow earnings year-over-year, somewhere around 2% to 3%. I don't think we're in a rush to raise equity, but we're confident that, as we continue to execute our plan that, our cost of equity will start to improve, particularly relative to the peer group, given the embedded cash flows that we have and the strength of our portfolio. But for now, we're being very, very judicious with how we manage our equity capital.

Okay, thank you, guys.

Thanks, Ki Bin.

Thank you. The next question is a follow-up question from Wes Golladay with Baird. Please proceed with your question.

Thank you for the follow-up. Considering your Walgreens exposure accounts for 5.9% of ABR, how much do you think is at risk of becoming vacant, and what is the remaining term on those leases? Additionally, do you have an estimate of the net value at risk for those Walgreens?

It’s always challenging to predict their actions. They have stated that they're reviewing many of their properties and aiming to improve them. I believe conducting portfolio reviews is a wise move and may be somewhat overdue. However, we maintain ongoing discussions with Walgreens, and they have provided us with valuable insights regarding their store performance, cash flow, and long-term commitments. Many of our transactions with Walgreens involved blend-and-extend opportunities, where we purchased short-term leases and extended them prior to closing, indicating their long-term commitment to these locations. Their situation has gotten a bit more difficult, especially concerning their margins, which likely means that their list of stores to review has increased. With the new CEO in place, they're focusing on a broader range of issues, which seems reasonable. Nevertheless, we have an average lease term of nine years and locations that typically perform well. We also know that a location set to come up in 2028 is among the top performers in their chain and is not under consideration for closure. Overall, while it’s possible that we might take over one or two stores in the next six or seven years, it won’t significantly affect our earnings.

Okay, thanks for that. And then just one last one on the fraud issue. Is this the last we're going to hear of it? Is anything changing on the internal controls or is it just a one-time event? And when we get to the third quarter, everything will be just in the rear view?

Yeah, that's exactly correct. We immediately rectified the situation, reiterated the importance of following our existing processes and how not to deviate from the preset procedures. Secondly, we enhance our procure-to-pay procedures by adding certain redundancies to the process. And lastly, this was company-wide. We stressed the importance of remaining vigilant and skeptical potential fraud in the workplace. So we would 100% would tell you that we believe this is a one-time event and we've done everything we can to prevent it from occurring in the future, in our view.

Okay, thanks, everyone.

The next question comes from Greg McGinniss with Scotiabank. Please proceed with your question.

Hello, again. Given the two lifetimes at around $70 million, I guess, we were somewhat surprised by overall acquisition volume this quarter. Were there deals that fell through or pushed out? And what gives you the confidence transaction volume going forward will be in line with what we've seen historically absent these larger deals or are there other higher-ticket assets you're pursuing?

To clarify, it wasn't $70 million; it was actually less than that. It's quite typical for us to have quarters where we complete a number of smaller transactions, and we've also handled larger portfolios in the past, including sale-leasebacks with 7-Eleven that exceeded $70 million. We're currently assessing our opportunities and determining what we can finalize within the quarter. Our strategy is to divest less efficiently priced assets to achieve the best risk-adjusted returns possible. We maintain a constant understanding of our position throughout the quarter. Therefore, we're confident in our ability to sustain the same pace we've had over the last four years.

Okay, thank you.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mark Manheimer for closing comments.

Thanks, everybody, for joining us today. I hope you have a great rest of your summer, and we look forward to speaking again in the future.

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