Postal Realty Trust, Inc. Q4 FY2021 Earnings Call

Greetings, and welcome to Postal Realty Trust Fourth Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Jordan Cooperstein, Vice President of FP&A, Capital Markets. Please go ahead.

Thank you. Good afternoon, everyone and welcome to the Postal Realty Trust fourth quarter and yearend 2021 earnings conference call. On the call today we have Andrew Spodek, Chief Executive Officer; Jeremy Garber, President; Robert Klein, Chief Financial Officer; and Matt Brandwein, Chief Accounting Officer. Please note the use of forward-looking statements by the company on this conference call. Statements made on this call may include statements that are not historical facts and are considered forward-looking. These forward-looking statements are covered by the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks and factors that are beyond the company's control, including, without limitation, those contained in the company's latest 10-K and its other Securities and Exchange Commission filings. The company does not assume and specifically disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. Additionally, on this conference call, the company may refer to certain non-GAAP financial measures, such as funds from operations, adjusted funds from operations and adjusted EBITDA. You can find a tabular reconciliation of these non-GAAP financial measures to the most currently comparable GAAP measures in the company's earnings release and supplemental materials. With that, I will now turn over the call to Andrew Spodek, Chief Executive Officer of Postal Realty Trust.

Good afternoon, and thank you for joining us today. Postal Realty Trust produced a strong 2021, exceeding our acquisition target for the year. We acquired 239 properties for approximately $118 million at a weighted average cap rate of between 7% and 7.5%. Notably, more than three quarters of our acquisitions were sourced off market, demonstrating our access in the industry. We continue to execute on our postal property consolidation strategy and to grow our stable cash flows from our in-place rents. We see an enormous opportunity within this large, highly fragmented market. We are the leading owner of properties leased to the postal service and with only a 5% market share, we have a significant opportunity in front of us to make additional accretive investments. Furthermore, with increased financial capability on our balance sheet and deep-rooted knowledge of our market, we are well positioned to support the company's ongoing growth. Heading into 2022, similar to the broader real estate industry, we are continuing to see cap rate compression, but with our extensive network and robust pipeline, we are confident our acquisitions will exceed $100 million with current deal flow trending in the 6% to 8% cap rate range. Notwithstanding our experience and successful execution to date, it is important to invest in our platform to further expand our moat, extend our leading position, and continue to scale. This year, we are making investments in our technology and enterprise systems to allow us to even better utilize our proprietary and industry-leading data, enhance operational efficiency and support our ongoing growth. As part of our investment, we are excited to have closed on the acquisition of real estate asset counseling, commonly known as REAC, a highly regarded consulting firm in the postal real estate industry, founded by former senior postal service real estate executives. For almost 30 years, REAC has advised the postal ownership community by providing assistance with lease negotiations, due diligence, and property development along with many other services. REAC brings decades of experience, relationships and proprietary data under our umbrella, strengthens our competitive advantage within the industry, and adds additional insight and understanding to our sourcing and underwriting of acquisitions. We look forward to REAC contributing value to our consolidation strategy. We continue to receive interest from potential sellers who understand the value proposition in working with Postal Realty. As we have stated over the years, our financial capacity, proven track record and ability to offer multiple sources of consideration, such as operating partnership units, makes us the natural buyer of assets leased to the postal service. The postal service has proven to be an incredibly stable tenant across every economic cycle. It has created an irreplaceable logistics network that includes critical infrastructure to support the ever-growing e-commerce industry. In fact, this week, Congress passed legislation to overhaul the US postal services finances and delivery services, further ensuring its continued endurance. The key elements of this legislation include reforming health benefits, shifting much of the retiree benefits to Medicare and repealing the requirement that the postal service prepay future retirement health benefits, thereby helping to improve their finances in a meaningful way. We believe this legislation provides further validation of the importance of the postal service to this country's infrastructure and our business strategy of accretively aggregating the properties that support these important services for years to come. As we continue to acquire postal properties and retain our leading position within the postal real estate space, we continue to be a resource to the postal service in their current and future needs. As we move ahead, we have an experienced team, stable and secure cash flows, a proven ability to effectively own and operate properties, and a robust pipeline, all of which supports our confidence to create value for our stakeholders. I'll now turn the call over to Jeremy.

Thank you, Andrew. We are pleased that in 2021, we produced a 63% increase in revenues year over year. This reflects strong collections from our existing portfolio, along with contributions from accretive acquisitions during the past year. We once again collected 100% of our rents and have effectively managed our lease expirations. For each of the next three years, leases representing 7% to 12% of our total rent on an annual basis remain up for renewal. During the fourth quarter until March 7, 2022, we have not received any notices of termination by the postal service. During 2021, we had a 99% weighted average lease retention rate consistent with our historical weighted average, which shows how important these buildings are to both the postal service and the communities they serve. This high rate continues to validate our due diligence process in identifying locations that we believe are important to the postal service. 2021 acquisitions added 1.8 million net leaseable interior square feet to our portfolio, inclusive of 204,000 square feet from 148 last-mile properties, 452,000 square feet from 87 flex properties, and 1.2 million square feet from four industrial properties. Subsequent to year end and through March 7, we acquired an additional 38 properties for approximately $12 million excluding closing costs. The company has another 13 properties totaling approximately $14 million under definitive contracts. I'll now turn the call over to Rob to discuss our financial results, balance sheet, and outlook for 2022.

Thank you, Jeremy, and thank you everyone for joining us on today's call. Postal Realty Trust is well positioned to continue executing on our growth plan and is supported by the steps we took to further strengthen our capital structure. In the fourth quarter, we delivered funds from operations or FFO of $0.24 per diluted share and adjusted funds from operations or AFO of $0.25 per diluted share. For the full year 2021, FFO was $0.95 per diluted share and AFO was $1.05 per diluted share, 12% and 5% increases respectively from the prior year. We have a straightforward and conservative balance sheet. As of December 31, 2021, we had nearly $6 million of cash and approximately $96 million of gross debt with a weighted average interest rate of 2.41%. This is comprised of approximately $83 million of fixed rate debt and $13 million of floating rate debt outstanding on our revolving credit facility. Since our IPO, we have consistently remained at or below our targeted 40% net debt to enterprise value and seven times net debt to annualized adjusted EBITDA, and we expect to continue to do so in 2022. At year end, those metrics were 16.7% and 3.3 times respectively. During the fourth quarter, we successfully completed a follow-on equity offering where we issued approximately 4.9 million shares and raised $83 million of gross proceeds. With only $28 million drawn as of March 7, under our revolver, our upsized credit facilities completed during 2021, provide us with the necessary flexibility and financial capacity to support our growth strategy. In the fourth quarter, we completed the acquisition of a property in Downtown Milwaukee. The revenue from this property, like our San Mateo property, is reflected in our fee and other line item as they are financing leases containing purchase options that we have assumed have a high likelihood of being exercised during the course of the lease. We have provided additional disclosure on these financing leases in our upcoming 10-K filing. The acquisition of REAC was executed for a total consideration of $1.6 million consisting of $225,000 in cash and $1.4 million in operating partnership units. We expect the immediate bottom line impact to be minimal when factoring in potential revenue, cost savings, and additional expenses associated with the acquisition. As Andrew discussed, it is important to continue to invest in our platform to further expand our moat and continue to scale our business. This includes investments in our technology, enterprise systems, and incremental hires. To achieve accelerated future growth, we anticipate our cash G&A in 2022 to increase by approximately $2 million to $2.5 million. These investments will be governed by the growth in our portfolio as we continue to focus on progression in the ratio of cash G&A, as a percentage of revenues. Also, given some of the dynamics affecting supply chains and delivery of goods, our recurring capital expenditures in Q4 were larger than prior quarters in 2021, primarily due to roofing supplies ordered earlier in the year and subsequent work being performed once those materials were available. We recently announced that our board of directors raised our quarterly dividend to $0.2275, which annualizes to $0.91 per diluted share. This represents the 10th consecutive quarter of dividend growth and a 4.6% increase from the fourth quarter 2020 dividend. As we look ahead, our company remains very well positioned even within an inflationary environment. We have a credit tenant, a high historical lease retention rate, the ability to mark rents to market and a strong balance sheet with limited floating rate debt, all contributing to stable cash flows. This concludes our prepared remarks. Operator, we'd like to open the call for questions.

Thank you. Our next question comes from Jon Petersen with Jeffries. Please state your question.

Great, thanks. First question was just on the acquisition guidance. I think you noted 6% to 8% cap rates that went back a year ago. I think going into 2021, you were guiding to 7% to 9%. Not really surprised to see the compression. We're seeing that across real estate in general, but just, I don't know, any thoughts about competitiveness for this space and trends in cap rates that we should be thinking about.

Hey Jon. Thanks for the question. I think as you're pointing out, I don't think this is a post office specific issue that people are seeing. This is really across all different types of real estate. And the compression that we're seeing today is in the 6% to 8% range. I can't really give you guidance on the rest of the year, but that's how we're seeing things. I think I've been seeing what most people in the real estate business have been seeing, which is this compression has been going on for months, and it's just kind of gotten a little more compressed more recently.

Okay. Any new entrants in the market, anybody you guys are seeing, I guess, bid against you guys on these properties that you don't normally see?

No, the competition is pretty much the same. I think that sellers are just asking for higher prices and they're getting it, and they're seeing that assets are trading at lower cap rates whether it's a bank or a pharmacy or a post office or anything else. I think again, we're just seeing what everybody else is seeing. It's a fragmented market and we're out there buying. As I stated, the vast majority of our deal flow comes off market and so we have a very deep network, and we're confident we'll be continuing to purchase these properties in the 6% to 8% cap rate ranges just where we're seeing things today.

Okay, and then, I guess my last question, on this new legislation that passed through Congress, it seems unanimously good for the post office in terms of I think just having a little bit more financial flexibility, I would imagine that leads to kind of more investment in their supply chain. And I guess I'm trying to take it to the next level and think about how that impacts you guys. Like, do you anticipate more maybe expansion or kind of like redevelopment projects that might kind of lift some upside for you guys or is there a risk that, maybe part of additional growth means like more relocations to kind of larger spaces, maybe if we could just think through some of the potential impacts directly for postal reality.

Hi, John, this is Jeremy. I think the first part of your question, we were really excited to see this was 15 years in the making. And if you went through the Joy's tenure plan, this was really the cornerstone. This allows them to move forward with plans to invest in infrastructure on a strong footing. We think that we're going to see the benefits of the USPS investment in their network. Whether it impacts choices of locations or existing locations is, I think, as Andrew has talked about many times when we do see exits from buildings, it's really driven by the existing space, either being too small or too large. I don't think that any of this investment infrastructure is really going to change the need for existing buildings. I think that our network of buildings is going to continue to be valuable and increase in value. As you read some of the opportunities, whether it's offering different government services in the buildings, different licensing, fishing, drivers, social security, there's just a lot more that they'll be able to explore now that they've moved this sort of overhang of finances out of the way for now.

Got it. All right. That's great. Thank you guys.

Our next question comes from Ki Bin Kim with Truist. Please state your question.

Thanks. Good evening. Can you talk a little bit more about the acquisition you made of REAC, and if, looking at the website, it looks like it's basically a consulting company of three people. Does this acquisition also contribute to the higher G&A that you alluded to this earlier in the call?

Sure. I appreciate the question. So this company that we acquired has been really a resource to the postal ownership community for decades. I've leaned on them at particular times. Their network within the ownership community is tremendous. The network within the postal service is tremendous as well. They've provided all types of consulting and advisory work to very different types and sizes of projects. And we're very excited to have them on board. I really think that they just help bolster and secure all the institutional knowledge that we have and adding all the institutional knowledge that they have and all the data that they have acquired over these years, being in this space is just going to be more valuable from an underwriting, sourcing, and management and leasing perspective. So we are really very, very excited about it. The three people that you see on the site are the principles. They have other people that work for them. Their stable is a little more involved than those three principals, but the brand itself and the integrity and the recognition that they have within the spaces is terrific and we're happy to have them.

And the G&A increase, how much of the $2 million to $2.5 million increase is tied to the personnel that's coming on board versus your indirect hire?

Thank you, Bin, it's Rob. Thanks for that question as well. They are part of that increase as well as our investments in technology enterprise systems and some other incremental hires. And I think the important thing to note about the REAC acquisition is that while they will be a contributor to some of the expense line item, they also will be a contributor to the other side of the ledger on the revenue side and we expect the bottom line impact to be quite minimal in the near term with those two items.

So I guess one last question on this topic, does this acquisition come with any kind of revenue streams, or is it more lead generation type of upside?

We actually are acquiring an enterprise that is active, that has active engagement recurring client revenue. So, from day one they will continue to be engaged with clients.

Our next question comes from Michael Gorman with BTIG. Please go ahead.

Yeah, thanks. I just wanted to follow up on that one. So engage with clients. Can you just give us a sense for how you're thinking about it? Is this, it sounds like it's an external resource, but will this go towards the kind of external management business that's within postal or, and I guess, what's your sense for the future of that consulting business now that it sits within theoretically another landlord within the space and just, I'm just trying to triangulate kind of what the strategic angle is here.

So the consulting and advisory business will be part and parcel of the management business that we provide as well, right? And so we're going to be offering services or continuing to offer the services that they do today, whether that's for lease negotiations or for development of postal properties, or anything else that they currently offer. All of that will create revenue in the TRS, but it will also help us as an incubator to future deal flow. It will also help us with their lease relationships with the postal service. It would also help us with their relationship with the ownership community right, and so all of this is just helping to solidify us and our position as the leading owner within the space and as a resource and partner to the postal service.

Okay, great. And then last one, I think maybe in conjunction with that, Andrew, I know you've talked a lot about this in the past, in terms of the lease structure that you have that negotiated with the post office. Is that something that extends or that you could extend through the management business as well as a potential source of inducement or lead generation?

It probably could. We haven't actually offered management services to owners. It's something that when we created this public company, we gave ourselves the ability to do so. It is something that I believe at some point we will do. But we haven't, we haven't offered that service yet.

Thank you. Our next question comes from Ed Groshan with Height Capital Markets. Please state your question.

Good afternoon, gentlemen. And thank you for taking my question. So just following up on the tail end of that with the management services, I guess that just leads me to the 200 to 250 plus properties. You have a guidance of a $100 million. So I guess the base assumption is that they're still not in the guidance. But can you just give us an update on those please?

Yeah, this is Jeremy. The guidance for acquisitions this year does not reference or include any part of a ROFO as we've shared in the past. As soon as we hear from the representatives of the ROFO, we will share that with our investors and analysts, but as of the moment we don't have anything to report.

Okay. When the S1 was released and after going public, it seemed like there were expectations for acquisitions to occur frequently or soon. Is that still the case, or is it now just pending and will happen at some point?

I think at the time of the IPO, we did share that the ROFO existed because of an intention for the REIT to have an opportunity at some point to acquire these assets. We don't control the offer. So we're in a position of waiting to hear from the representatives in terms of timing. We also shared at the time of the offering, that there was a clear seasoning period that needed to exist before the representatives could even prepare to present us with a ROFO. And while that seasoning period has come to an end, I don't really have any further color on when I can anticipate being presented with opportunities on the ROFO.

Okay, Fantastic. Much appreciated. And then Rob, you talked about the Milwaukee acquisition and being in the fee income line and with a potential for, I guess, an option for acquisition in the future. Can you just, well, I guess, what are some of the triggers for those two properties that are in that line item that would result in them being acquired?

Both properties have an option for the USPS to purchase them at a fixed price. For Milwaukee, we are considering their acquisition at the lowest price, which would be at the end of the term in 2040. However, they do have some interim options available as well. As for the fee and other income line item, it won't significantly affect Q4 due to the timing of the Milwaukee asset purchase, but it will become increasingly important in that line item in the future.

So this is an option for the postal service to buy back property.

Correct.

Can you give me a sense in the postal system? Is that like a, is it a small part of the post offices that, or postal properties out there, or is, is that something that is more prevalent than what we've seen?

So it actually was fairly common. Back when they rolled out the network of postal properties in the 60s and 70s, they gave themselves purchase options in many leases. As time has gone on, and as these leases have rolled, a lot of them have renewed, and the postal service has not executed on those purchase options. But in this particular case, we believe that there, there is a likelihood of them purchasing it. And therefore we wanted to err on the side of caution and, and as a finance lease.

Okay. I'm just, I'm just wondering, I just said it, it cause now there's two properties like that. I was just wondering when, when…

You, I don't, yeah, this is not a target. This is not a target of our business. We're not out there looking to buy financing leases. This was a very good opportunity for us. This is a great property with very good income that is accretive to us. Even if they do exercise their purchase option, if they don't exercise their purchase option, then it's even more accretive. For us, it was, it was a very good opportunity that we had to take advantage of. And that's why we bought it. This is not something that we plan on adding to the portfolio very often, nor do I think it's a property like this is, is very common.

Yeah. And, and just for your reference, of the 1,004 properties that we own, there's only two financing leases in our portfolio.

Right, right. That, that's why I'm just really my question. And Andrew, you answered it right back in the 60s and 70s. It was a common practice just trying to get a sense of how prevalent it is. So, Andrew, you talked about, you have the option to do the asset management company. There's these properties out there where the post office has the option to buy them back? I would estimate given their financial difficulties over many decades that maybe they could use an asset manager that can run them more efficiently. Is that an opportunity there?

It may be an opportunity if they'd like to ask and manage some of their properties. I'm sure they'll give me a call.

Okay. Excellent. Thank you for taking my questions. Have a good evening.

On behalf of myself and the entire team, I wanted to thank you all for taking the time for joining us for this call. We look forward to connecting with all of you over the coming months.

And thank you. That concludes today's conference. I will now disconnect. Have a great day.