Essential Properties Realty Trust Q2 2024 Earnings Report

Essential Properties Realty Trust EPS Results

• Actual EPS: $0.29
• Consensus EPS: $0.42
• Beat/Miss: Missed by -$0.13
• One Year Ago EPS: $0.41

Essential Properties Realty Trust Revenue Results

• Actual Revenue: $109.30 million
• Expected Revenue: $102.99 million
• Beat/Miss: Beat by +$6.31 million
• YoY Revenue Growth: +26.40%

Essential Properties Realty Trust Announcement Details

• Quarter: Q2 2024
• Date: 7/24/2024
• Time: After Market Closes
• Conference Call Date: Thursday, July 25, 2024
• Conference Call Time: 10:00AM ET

Essential Properties Realty Trust (NYSE:EPRT) (NYSE: EPRT) is a self-administered real estate investment trust that acquires, owns and manages single-tenant commercial properties subject to long-term, triple-net leases. The company’s portfolio primarily consists of small-box retail and industrial assets, including convenience stores, automotive service centers, quick-service restaurants, fitness centers and other necessity-based businesses. Under a triple-net lease structure, tenants assume responsibility for property taxes, insurance and most maintenance expenses, providing Essential Properties with predictable, stable cash flows.

Since its founding in April 2016 and its initial public offering later that year, Essential Properties has pursued a growth strategy focused on partnering with creditworthy tenants operating in densely populated trade areas. The company seeks assets that align with its risk-adjusted return objectives and benefit from strong demographic trends. Through a combination of acquisitions and built-to-suit development projects, it has expanded its footprint across more than 30 states, enhancing diversification by tenant industry and geography. This disciplined approach to portfolio expansion enables Essential Properties to capitalize on market inefficiencies and forge long-standing tenant relationships.

Headquartered in West Palm Beach, Florida, Essential Properties operates an in-house platform covering acquisition sourcing, underwriting, asset management and property administration. The leadership team comprises seasoned real estate professionals with extensive experience in investment management, capital markets and property operations. By maintaining an integrated internal platform, Essential Properties seeks to streamline transaction execution, optimize asset performance and deliver long-term value to its shareholders through a resilient, net-lease model.

Essential Properties Realty Trust Q2 2024 Earnings Call Transcript

Key Takeaways

• Q2 Investment Activity: Invested $334 million across 35 transactions at an 8% weighted average cash yield, driving 5% AFFO per share growth year-over-year.
• Strong Portfolio Metrics: Ended Q2 with 2,009 properties 99.8% leased to 395 tenants across 16 industries, boasting a 14.1-year average lease term and 3.7x unit-level rent coverage.
• Healthy Balance Sheet: Maintained 3.8x pro forma leverage against $1.1 billion liquidity, and closed a $450 million term loan at a 4.99% fixed rate to support ongoing growth.
• 2024 Guidance Reiterated: AFFO per share guidance remains at $1.72–$1.75, reflecting prudent leverage posture and a near-term headwind to EPS from unsettled forward equity.
• Robust Pipeline Outlook: Despite a seasonally slower Q3, the pipeline is up year-over-year with no immediate sign of cap rate compression, positioning the company for continued deal flow.

Presentation

[Operator]

Ladies and gentlemen, welcome to Essential Properties Realty Trust second quarter 2024 earnings conference call. At this time, all participants are on a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. This conference is being recorded, and a replay of the call will be available two hours after the completion of the call for the next few weeks. The dial-in details for the replay can be found in yesterday's press release. Additionally, there will be an audio webcast available on Essential Properties website at www.essentialproperties.com, an archive of which will be available for ninety days.

[Operator]

On the call this morning are Pete Mavoides, President and Chief Executive Officer, Mark Patten, Chief Financial Officer, Robert Salisbury, Head of Capital Markets, Max Jenkins, Head of Investments, and AJ Peil, Head of Asset Management. It is now my pleasure to turn the call over to Robert Salisbury.

[Robert Salisbury, Head of Capital Markets at Essential Properties Realty Trust]

Thank you, operator. Good morning, everyone, and thank you for joining us today for Essential Properties' second quarter 2024 earnings conference call. During this conference call, we will make certain statements that may be considered forward-looking statements under federal securities law. 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 those forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings press release. With that, I'll turn the call over to Pete.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thank you, Rob, and thank you to everyone joining us today for your interest in Essential Properties. On our first quarter earnings call, we discussed how our business is well suited for the current market environment, which has been characterized by tight lending standards and volatile capital markets. Our position as a reliable and consistent long-term capital provider to our middle-market relationships is highly valued. Against this backdrop, our second quarter results continued to showcase the strengths of our business model with a well-capitalized balance sheet and a value proposition of providing growth capital in our targeted industries. This quarter's results were driven by a healthy portfolio and $334 million of investments, resulting in AFFO per share growth of 5%. In the second quarter, 82% of our investments were generated from existing relationships, underscoring the value we provide to our middle-market tenant base.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

With quarter end pro forma leverage of 3.8 times and liquidity of over $1.1 billion, our balance sheet positions us well to continue to grow our portfolio by investing in our core industries at attractive spreads. The business is performing well, with solid tenant credit trends and strong investment volumes. However, these positives are offset in the short term by the earnings per share headwinds of the conservative posture on leverage we elected to take, given the capital markets volatility discussed above. Mark will review this in more detail, but we believe our balance sheet capacity and competitive cost of capital will allow us to continue to drive strong earnings growth in 2025 and beyond. For 2024, we have reiterated our AFFO per share guidance range of $1.72 to $1.75.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

As our second quarter results indicate, our portfolio continues to operate at a strong level. We ended the quarter with investments in 2,009 properties that were 99.8% leased to 395 tenants operating in 16 industries. Our weighted average lease terms stood at 14.1 years at quarter end, which is up year over year, with only 4.1% of annual base rent expiring through 2028. From a tenant health perspective, our weighted average unit-level rent coverage ratio was 3.7 times this quarter, down slightly from last quarter. Same-store rent growth in the second quarter was 1.4%, down slightly from last quarter as the portfolio absorbed a small headwind from the five properties that we own that were impacted by the Red Lobster bankruptcy.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Two of these properties were rejected as part of the Chapter 11 process, while the remainder are occupied and leased. During the second quarter, we invested $334 million through 35 separate transactions at a weighted average cap rate of 8%, relatively consistent with our last quarter and up 60 basis points from a year ago. Our investment activity in the quarter was broad-based across most of our top industries, with no notable departures from our investment strategy. This quarter, our investments had a weighted average initial lease term of 17.8 years and a weighted average annual rent escalation of 1.9%, generating an average cap rate of 9.1%. Our investments this quarter had a weighted average unit level rent coverage of 3.0 times, and the average investment per property was $3.4 million.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

The vast majority of the investments this quarter were originated through direct sale-leasebacks, which are subject to our lease form with ongoing financial reporting requirements. Additionally, 76% contained master lease provisions. Looking ahead to the third quarter, our investment pipeline remains solid and up year-over-year, in the context of what is typically a seasonally slower period in the calendar. As we have discussed in the past, we expect that the recently rejuvenated expectation of Fed easing could result in modest cap rate compression later in the year. However, we have not seen this in our current pipeline, which currently suggests a cap rate similar to the second quarter. From a tenant concentration perspective, our largest tenant represents 4.7% of ABR at quarter end, and our top 10 tenants now account for only 18.6% of ABR.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Tenant diversity is an important risk mitigation tool and a differentiator for us, and it is a direct benefit of our focus on middle market operators, which offers an expansive opportunity set. Dispositions were below our trailing eight-quarter average in 2Q, reflecting a persistently wide bid-ask spread in the market. We sold six properties this quarter for $4.8 million in net proceeds. This represents an average of approximately $800,000 per property, highlighting the importance of owning fungible, liquid properties, which allows us to proactively manage portfolio risks. The dispositions this quarter were executed at a 7.3% weighted average cash yield, with a weighted average unit-level rent coverage ratio of 0.5 times.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Over the near term, we expect our disposition activity to remain relatively in line with our trailing eight-quarter average, driven by opportunistic asset sales and ongoing portfolio management activity. With that, I'd like to turn the call over to Mark Patten, our CFO, who will take you through the financials and the balance sheet for the second quarter. Mark?

[Mark Patten, CFO at Essential Properties Realty Trust]

Thanks, Pete, and good morning, everyone. As Pete noted, we had a solid second quarter, which was highlighted by a strong level of investments at an 8% cash cap rate. Among the headlines from the quarter was our AFFO per share of $0.43, which is an increase of 5% versus Q2 2023. On a nominal basis, our AFFO totaled $77.1 million for the quarter. That's up $15.2 million over the same period in 2023, an increase of 25%. This AFFO performance was in line with our expectations, underlying the updated guidance range we provided last quarter, as stronger than anticipated investment volume was partially offset by later timing of closing those investments within the quarter. Additionally, of note, we recognized $1.5 million of other income this quarter related to cash proceeds we received from a legal settlement.

[Mark Patten, CFO at Essential Properties Realty Trust]

Because this settlement represents the recoupment of our legal and other expenses that negatively impacted AFFO in prior periods, we included these proceeds within AFFO this quarter. Resolution of this matter and commensurate recognition of other income was anticipated in our updated guidance range. Total G&A in Q2 2024 was $8.7 million versus $7.6 million for the same period in 2023, with the majority of the increase relating to increased compensation expense as we continue to invest in our team. Our recurring cash G&A, as a percentage of total revenue, was 5.6% for the quarter, which compares favorably to the 6.1% in the same period a year ago. Our total G&A and recurring cash G&A were also in line with our expectations for the quarter.

[Mark Patten, CFO at Essential Properties Realty Trust]

We continue to expect that on an annual basis, our cash G&A, as a percentage of total revenue, will decline as our platform generates operating leverage over a scaling asset base to enable us to manage a larger portfolio and invest at higher levels. We declared a cash dividend of $0.29 in the second quarter, which represents an AFFO payout ratio of 67%. Our retained free cash flow after dividends continues to build, reaching $26.9 million in the second quarter, equating to over $100 million per annum. We continue to view our retained free cash flow as an attractive source of capital to support our investment program. Turning to our balance sheet. With our $334 million in Q2 2024 investments, our income-producing gross assets reached $5.5 billion at quarter end.

[Mark Patten, CFO at Essential Properties Realty Trust]

The scale of our income-producing assets continues to build, and we expect to approach $6 billion by year-end. The significant diversity and increasing scale of our asset base continues to be a favorable underpinning of the reliability and durability of our cash flows and provides an increasing level of risk mitigation. On the capital markets side, it was a productive second quarter. Through our ATM program, we completed the sale of approximately $137 million of stock, all on a forward basis. With no settlements during the quarter, our balance of unsettled forward equity totaled $319 million at quarter end.

[Mark Patten, CFO at Essential Properties Realty Trust]

One element of our second quarter results that's also worth highlighting is our current share price, being materially above the weighted average price of our unsettled forwards, which was $24.75 at quarter end. Under the Treasury Stock Method, we account for the potential dilution from these forward shares in our diluted share count. For the second quarter, our diluted share count of 177.6 million shares included an adjustment for 904,000 shares from our unsettled forward equity related to this Treasury Stock calculation. At a high level, we view the impact of the accounting treatment for this unsettled forward equity as a matter of timing, as these shares will ultimately be settled to fund the business, notably as investments are closed later this year.

[Mark Patten, CFO at Essential Properties Realty Trust]

Therefore, while this calculation creates a near-term headwind to our current earnings per share metrics, it should have little to no impact to our AFFO per share in 2025 and beyond. Our pro forma net debt to annualized adjusted EBITDAre, as adjusted for unsettled forward equity, was 3.8 times at quarter end. We remain committed to maintaining a well-capitalized balance sheet with low leverage and significant liquidity to continue to fuel our external growth. With the recent backdrop of capital market volatility, we have maintained a pro forma leverage profile substantially below our historical average of the mid-4 times range. We believe our conservative approach has been prudent, particularly in light of elevated prevailing debt costs. With the prospect for central bank easing later this year, our leverage metrics may drift higher to more normalized levels.

[Mark Patten, CFO at Essential Properties Realty Trust]

Subsequent to quarter end, we closed on a $450 million term loan with a delayed draw feature. We are very appreciative of the continued support of our core banking relationships, and we were pleased to have four new banks join our bank group as part of executing this transaction. We drew $320 million at closing, a portion of which was used to fully repay the outstanding balance on our revolving credit facility. Assuming we exercise the extension options available to us, the term loan would mature in January 2030. We expect to draw the remaining $130 million over the coming months as a source of funding for our investment pipeline.

[Mark Patten, CFO at Essential Properties Realty Trust]

Consistent with our capital goals to efficiently match funding our assets, we swapped the initial $320 million draw for the fully extended term of the debt commitment at a weighted average fixed rate of 4.99%. At quarter end, our liquidity stood at over $1.1 billion, pro forma for our net unsettled forward equity and our 2030 term loan. With our equity and debt capital needs met for the year, our strong balance sheet and conservative leverage positions the company well to execute on our growth plans for 2024 and into 2025. Lastly, as we noted in the earnings press release, we have reiterated our 2024 AFFO per share guidance range of $1.72 to $1.75, which implies an over 5% growth rate at the midpoint.

[Mark Patten, CFO at Essential Properties Realty Trust]

With that, I'll turn the call back over to Pete.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thanks, Mark. In summary, we are very pleased with our second quarter results and remain optimistic about the prospects for the business. Operator, please open the call for questions.

[Operator]

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants who use the speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question comes from Haendel St. Juste with Mizuho. Please proceed with your question.

[Haendel Juste, Managing Director at Mizuho]

Yes, good morning, guys. Thanks for taking the question. The first question, I guess, is on the guide. I'm curious, why not raise it even a little bit at this point? It seems like everything is firing on all cylinders, strong volumes, a larger pipeline, as you noted, and improved cost of capital. So maybe you can talk to or even quantify some of the potential headwinds that are built in here, and maybe give some color on the Treasury Stock Method accounting dilution that is embedded in the guide, and any factors that perhaps we're not aware of that might be keeping you from raising the guide. Thanks.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, I would say, you know, Haendel, you're certainly right. Things are, you know, firing on all cylinders. The pipeline continues to build, and we continue to deploy capital. You know, clearly, as we said in the statements, you know, our capital position is really the majority of the headwind that we're seeing in our earnings. And, you know, given that, you know, it really, it just doesn't give us the visibility to drive the guidance up. But Mark, if you want to provide some color on that, you can.

[Mark Patten, CFO at Essential Properties Realty Trust]

Yeah, Haendel, basically, you know, not to get too granular about it, but if you think about the Treasury Stock Method, what you're really doing is you're assuming the execution of the settlement, which comes in at $24.75 a share. And the treasury stock is, you go out and buy as many shares as you can with those proceeds, that at $30, means you're gonna get fewer shares brought back into treasury, so you've got a net dilutive amount of shares from the issuance. And that's really... We tried to kind of quantify it, but if you think about the headwind, it's probably, it's probably $0.015.

[Haendel Juste, Managing Director at Mizuho]

Got it. Got it. That's helpful.

[Mark Patten, CFO at Essential Properties Realty Trust]

That's, by the way, Haendel, that's for the, that's for the full year.

[Haendel Juste, Managing Director at Mizuho]

Full year?

[Mark Patten, CFO at Essential Properties Realty Trust]

Yes.

[Haendel Juste, Managing Director at Mizuho]

Got it. Got it. Also, I guess, you guys noted, I think, in the release that this was maybe the highest, I think, it's the highest acquisitions volume quarter to date. So maybe you could discuss some of the dynamics you're seeing in the market. Are you seeing more sellers willing to engage, or is it your better cost of capital? And then maybe, is this a runway that we can expect to stay at going forward near term? Thanks.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

...Yeah, I would, you know, continue to guide you to our 8-quarter average as a good indicator of the run rate. As we have said in the last couple of quarters, it's a good market for us to invest, really, given the lack of capital alternatives that many of the middle market tenants we work with are facing or the cost of relative financing options. And, we're working very hard to transact and put capital to work. But, you know, the way we go to market, you know, doing $10 million deals into $2 million to $3 million assets, it's, you know, there's only so much we can put through the system. And, we're fortunate this quarter to have some bigger transactions.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

You know, as we said on the call, our pipeline remains full, and we continue to work hard, which you know may suggest a you know robust third quarter here, but it's kind of too early to really tell. But we feel good about the investment market. We continue to have a relatively strong competitive advantage, and we're working hard to put capital to work.

[Haendel Juste, Managing Director at Mizuho]

Thank you, guys. Appreciate the time and the color.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thanks, Haendel.

[Operator]

Our next question is from Greg McGinniss with Scotiabank. Please proceed with your question.

[Greg McGinniss, Analyst at Scotiabank]

Hey, good morning. Just another one on the acquisition guidance. I appreciate, you know, looking at the trailing eight quarters, which following Q2, went up $30 million to around $275 million. Just wanna make sure that's kind of where you're thinking from a target standpoint, and then how much you have under LOI PSA today, because I think, you know, close to date is not, not too much, but sounds like you're confident that, you're gonna get a significant amount more done this quarter. So any color would be appreciated.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, obviously, you know, third quarter is always tough. You work hard to get your second quarter deals closed at the end of June, and then people kind of go away on vacation, and, you know, it's hard to get people on the other end of the phone engaged and working. And then they come back in September, eager to put deals to bed. So it's one of the harder quarters to forecast. One of the reasons why it starts off seasonally slow. As we said in the call, our pipeline currently is ahead of where it was last year, you know, roughly, you know, in the, I would say somewhere between $2 and $250 range.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

You know, there's always some variability into, you know, what closes in a quarter, depending upon timing, and we don't always control the timing of the transactions, as we're supporting, you know, M&A transactions often. So it's early in the quarter. We got a lot of work left to do. We think the pipeline supports, you know, an active quarter, and, you know, we'll see where it shakes out.

[Greg McGinniss, Analyst at Scotiabank]

Thanks. And could you also give some details around some of the large, maybe larger portfolio transactions that you were able to get done this quarter? And then also, you know, are looking to acquire more equipment shares. I know that you're kind of targeting 5% as a cap, so maybe there's a little bit more space there. Just curious if you'd go over that for that company.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah. You know, when we say larger portfolio deals, you know, it's just bigger, you know, $30 million, $50 million, $60 million sale leasebacks within our targeted industries. So it's not a bigger portfolio of, you know, kind of existing lease assets. And so it's just bigger operators with more assets to sell, and we did a sizable car wash sale-leaseback in the quarter, as well as a sizable childcare sale-leaseback in the quarter, and sizable, you know, I would say greater than $50 million. In terms of EquipmentShare, you know, we continue to have tenant diversity discipline around, you know, not wanting to have a tenant above 5%. That company continues to grow and continues to present us opportunities.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

We feel very comfortable with them as our largest tenant, but we're unlikely to run them above that 5% number.

[Greg McGinniss, Analyst at Scotiabank]

Okay, thank you very much.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thank you, Greg.

[Operator]

Our next question comes from Eric Borden with BMO Capital Markets. Please proceed with your question.

[Eric Borden, Analyst at BMO Capital Markets]

Hey, guys. Good morning. Appreciate the color around being fully funded for the year and, you know, plenty of liquidity. But just given where your shares are today, you know, would you be willing to issue forward equity here in order just to lock in that price and, you know, kind of set yourself up for 2025? Or are you just potentially trying to mitigate any future treasury stock dilution?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, you know, we, and I'll let Mark and Rob take a stab at that. But, you know, certainly, you know, we had an active quarter in, in the, second quarter in terms of the ATM. And we've been very aggressive in, in terms of, you know, putting, getting our capital, raised and, and behind us and allowing us to execute. You know, if, if we were willing to issue shares at, you know, $24.75, you know, certainly, you know, north of $30 is, is pretty compelling. But there is some seller's remorse when you look back and, you know, I, I, I clearly think, you know, as we get closer to $25 and we get, 2025 guidance out there, you know, you know, there's upsides to our shares.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

So, we will continue to be opportunistic on the equity side. We will continue to stay in a good capital position. But Mark, Rob, you add to that?

[Mark Patten, CFO at Essential Properties Realty Trust]

Yeah, I think what I, I think what I'd say first is, you know, we've got ample liquidity to address sort of our, our opportunities. So if you think about it from the standpoint of the unsettled equity, we have free cash flow we're generating, and otherwise, the remainder of the term loan, you know, we've got, you know, $700 million of liquidity, easily to get us to, even there, you'd be still pretty low levered in terms of the bottom end of our- the range we've articulated. So in one respect, we don't have to do anything, as we've sort of said in the remarks. But then again, you know, we've been opportunistic on the ATM. I certainly wouldn't think we would move away from that approach.

[Mark Patten, CFO at Essential Properties Realty Trust]

And then, the other thing, you know, we've been pretty consistent that if we start seeing, you know, visibility into a strong pipeline, that tends to be a good indicator that we might have an opportunity there. And as Pete said, the price is in a good spot. So, but right now, you know, the good news is we don't have things, so we can be very opportunistic.

[Robert Salisbury, Head of Capital Markets at Essential Properties Realty Trust]

Yeah, and I'd just add, with $750 million to $1 billion of leverage capacity today, there's plenty of flexibility for us to execute on the current business plan. That being said, we're always mindful of extending our equity runway and being ahead of not having to do anything defensively. We're in a good offensive position.

[Eric Borden, Analyst at BMO Capital Markets]

That's helpful. Maybe just turning to the acquisition outlook, you know. How do you think the next 6-12 months plays out for you, you know, with rate cuts seemingly on the table? Do you think the mix will remain heavily weighted towards sale leasebacks, or do you foresee traditional acquisitions becoming a bigger part of the picture here?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, you know, our portfolio has, you know, been 80% to 90% constructed with sale leasebacks. We believe in you know, putting capital to work in the context of the sale leaseback, where your counterparty is the tenant and an operator, filling a capital need. It's just a higher value-added way to deploy capital. And, you know, that's that viewpoint's independent of the rate environment. You know, we prefer to structure our own leases and underwrite our own deals and not buy existing lease deals. So, you know, going forward, I think you should expect us to continue to be largely focused on executing sale leaseback transactions.

[Eric Borden, Analyst at BMO Capital Markets]

Thank you. I appreciate the time.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thank you.

[Operator]

Our next question is from Caitlin Burrows with Goldman Sachs. Please proceed with your question.

[Caitlin Burrows, Vice President and Senior Equity Research Analyst at Goldman Sachs]

Hi, good morning, everyone. Maybe just a follow-up to that last one, and I know previously you mentioned how it's a good market for EPRT, given the lack of alternatives for your customers. But, maybe asked another way, is like, how do you expect your business and opportunity could change as rates come down? Maybe what could get worse for EPRT, but what gets better?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, I think, you know, there's always a value add proposition to sale leaseback capital, regardless of the, the capital markets condition. It just happens to be better in the tighter capital markets. As rates come down, you know, we expect the competition to normalize, and, and we've seen some of that already with the prospects of, of rate cuts and, you know, competitors coming back to the market, the, the leverage buyers becoming more competitive, and, and more, and all that manifests itself in downward pressure on, on terms and cap rate, in terms being lease term and bumps and everything that goes along with that.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

You know, it's imperative for us to be reliable and be a value-added capital partner to relationships, to differentiate ourselves from other capital providers, and that's what we intend to do. You know, since bringing this company public, we've invested across a hypercompetitive market set and, you know, there's a little less competition today, but we're certainly prepared to add value and continue to transact when competition normalizes.

[Caitlin Burrows, Vice President and Senior Equity Research Analyst at Goldman Sachs]

Okay. And then on the unit-level rent coverage side, looked like that declined a little bit in the quarter, still 3.7 times, but the exposure to the under 1 times increased slightly, so did the 1 to basically 1.5 times. So could you talk about who's in that bucket and whether there's anything proactive you can or want to do about that?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah. I would start by saying, you know, coverage is one risk factor, and we tend to look at coverage and couple it with credit risk, because, you know, coverage alone isn't gonna result in a defaulted lease or rent initiative. And so, as we disclose, you know, our credit watch list every quarter, you know, which is the intersection of credit risk and coverage risk, you know, that is actually down quarter-over-quarter, about 10 basis points from 100 basis points to 90 basis points. You know, as we think about the under one bucket, what you see there is a lot of our development sites coming online, where the tenant has, you know, cash pay rent against sites that aren't fully stabilized or even open and operating.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

So that's gonna make that number a little artificially high. And, you know, if we see an asset that we think is permanently impaired, and there's a credit that we don't have confidence in being able to, you know, weather that impairment or fix the problem at the unit, you know, we'll look to sell it. And that's been an active part of our business plan and our business strategy, and we'll continue to do that. And so, you know, I think that, as we said in the call, the portfolio is in great shape. You know, these minor tweaks, you know, at the margin really doesn't change that macro perspective, that the portfolio is performing very well, and we're operating from a strong base.

[Caitlin Burrows, Vice President and Senior Equity Research Analyst at Goldman Sachs]

Thanks.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thank you.

[Operator]

Our next question is from Smedes Rose with Citi. Please proceed with your question.

[Smedes Rose, Director at Citi]

Hi. I think I just wanted to follow up a little bit on the last question around your tenant base, because we're starting to see in other sectors, you know, some weakness, not just in low-end consumers, but kind of flowing through to higher, you know, higher-end consumers. I'm wondering if you're hearing any feedback along those lines, from your tenants in general?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

We aren't seeing, and you know, keep in mind that you know, we are passive landlords, and we collect data on a you know, one-quarter lag. And so, you know, I think you know, those sort of sentiments that you're hearing very real time, we wouldn't really see in our numbers for you know, 90 to 120 days. Generally, you know, across the board, our industries are up from a coverage perspective with few exceptions. And you know, the portfolio and our tenants are operating you know, pretty strongly, and I think that's you know, really tied to being in you know, largely service and experience-based industries that aren't subject to you know, discretionary spending.

[Smedes Rose, Director at Citi]

Okay. And then, sorry if you covered this, I got on the call a little bit late, but are you still sort of expecting probably a little bit of a downward drift in cap rates as we move through the year at this point, or has that changed at all?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

I think that's right, Smedes. As competition normalizes and interest rates start coming down, we would expect to see some pressure on our initial cap rates off of these, you know, historically high levels.

[Smedes Rose, Director at Citi]

Okay, thank you.

[Operator]

Our next question is from Ki Bin Kim with Truist Securities. Please proceed with your question.

[Ki Bin Kim, Analyst at Truist Securities]

Thanks. Good morning. Just a couple follow-ups. On the unit-level coverage, that decreased a little bit. Yeah, I appreciate the comments around some newly developed assets that might be a drag on that as they stabilize cash flow, but maybe you can help us just break that down a little bit further. The under 1 times coverage increased about 50 basis points in this quarter. Was that, like, how much of that was driven by development versus some, you know, tenant categories that might have seen some deterioration?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, I would say, you know, we're not gonna split it that finely, fifty basis points. What I would say is, you know, the guys going into that group in the non-development sector are really situational specific, you know, to those industries, like movies or, you know, just an operator having some challenges. But there's nothing systemic or thematic about that across our industries. It's just really operators that are struggling for whatever reason.

[Ki Bin Kim, Analyst at Truist Securities]

Okay. And, going back to the competitive landscape, which has been favorable for you guys, just curious, you know, given your long history in the sector, if rates start to decline further, you know, how quickly do competitors start to rise up in your sector?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, I, I think, you know, it's really, you know, when they have a cost of capital or visibility to a cost of capital, right? And I think, you know, you think about public peers, you know, their cost of capital prices on a, on a daily basis, and for the private guys, visibility is really a bond market that supports them. So the, the private guys will lag a little bit until you get some more stability into the bond market. But, you know, the public guys, you know, they'll, they'll get right back into it and start bidding. And, and we've already seen some of that. And so, you know, I think, you know, it, it, it'll, it'll be quick.

[Ki Bin Kim, Analyst at Truist Securities]

Okay. Thank you.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thank you, Ki Bin.

[Operator]

Our next question is from Cheryl Call with Wells Fargo. Please proceed with your question.

[John Kilichowski, Vice President and Equity Research Analyst at Wells Fargo]

This is John Kilichowski. So, kind of going to your, your portfolio breakout here, you, you mentioned last quarter there was a 15% soft cap for any industry, and you're kind of hitting that with car washes. How does that impact your ability to grow the pipeline moving forward, if you may be getting to a point, you know, where you can't really consider those deals as much?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, you know, we have a robust opportunity set, and it's incumbent upon our investment professionals to source, you know, adequate volume to support our investment needs. We continue to invest in car washes, and if we do $300 million, you know, in a quarter, that gives us, you know, $45 million incremental just to stay, you know, flat. And then, you know, you price those deals accordingly. And so, you know, our opportunity set is robust, and, you know, the cap on car washes isn't constraining that in any way.

[John Kilichowski, Vice President and Equity Research Analyst at Wells Fargo]

Got it. Just to follow up to the last question, on the unit-level coverage... Is there anything there that is more of like a same store metric so that we can sort of parse out what may be development that's kind of artificially driving those numbers lower?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Not really. I mean, that's, you know, and that's why we disclose our credit watch list. You know, I think our unit disclosure around unit level coverage is informative, but that's a leading indicator of risk. And you know, we disclose the same store sales number in our sub, which was, you know, up 1.4%. You know, that's a quarter-over-quarter number. We disclose our watch list and we disclose our recoveries, and we think those are adequate kind of data points. And that, you know, coverage, you know, is just one indicator, and that's going to ebb and flow over the quarters.

[John Kilichowski, Vice President and Equity Research Analyst at Wells Fargo]

Got it. Thank you.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thank you.

[Operator]

Our next question is from Michael Goldsmith with UBS. Please proceed with your question.

[Michael Goldsmith, Analyst at UBS]

Good morning. Thanks a lot for taking my question. You know, well, it's been touched on a couple of times on the call and the mixed data points on the consumer. Recognize you have low, low exposure to the low-end consumer, but just given the, you know, the uncertain backdrop, does that change how you think about different tenant categories or individual tenants? Would, would you lean into certain categories or shy away from others in, in the current macro backdrop?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Really hasn't. And, you know, we've been very focused as we've built this platform on service and experience-based industries that operate out of granular and fungible real estate properties. And we make 20-year investments and, you know, this investment thesis has been developed over 20 years. And so, you know, year-over-year, ebbs and flows really don't materially change our underlying long-dated investment thesis.

[Michael Goldsmith, Analyst at UBS]

Thanks for that. And as a follow-up, can you talk a little bit about the time horizon for GNA to, as a percentage, trend down? You've mentioned compensation expense as a factor, so any sort of notable developments to your platform or anything that you can see to provide us insight into how GNA percentage kind of goes down over time?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, it's been pretty linear as we've grown our assets. Our G&A as a percent of revenue has, you know, trended downward. And, you know, we think, you know, just looking at the comps in the industry can give you a pretty good picture of, you know, how to run a platform like this efficiently. And, you know, there's data points at $2 billion, $6 billion, $9 billion, and $50 billion to kind of give you a sense of what that trend might look like. You know, our ambition is to run as efficiently as possible and better than market, and as we look at our peers and the other competitors in the market. So, you know, it's gone down.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

I don't know the exact numbers, but I think when we came public, it was probably about 11, and today it's 6-7?

[Mark Patten, CFO at Essential Properties Realty Trust]

It's under six.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

It's, it's going to continue to go down. You know, there's, there's a very large competitor, as you can assume that's a floor.

[Michael Goldsmith, Analyst at UBS]

Thank you very much. Good luck in the back half.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Hey, thank you much.

[Mark Patten, CFO at Essential Properties Realty Trust]

Thank you.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Appreciate it.

[Operator]

Our next question comes from John Massocca with B. Riley Securities. Please proceed with your question.

[John Massocca, Senior Research Analyst at B. Riley Securities]

Good morning.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Hey, John.

[Mark Patten, CFO at Essential Properties Realty Trust]

Hey, John.

[John Massocca, Senior Research Analyst at B. Riley Securities]

I know you've already covered a lot of ground, just kind of two quick detail ones, from me. The Red Lobsters that were handed back, was that in the quarter, and is that kind of reflected in the vacancy metrics that were reported? And I guess what else was kind of in the property subject to lease termination, if it did include Red Lobster?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Well, the Red Lobsters were put into the vacant bucket and part of our 5 vacant assets during the quarter. Anything else, AJ?

[Mark Patten, CFO at Essential Properties Realty Trust]

In the vacant bucket, the 2 QSR properties between us for-

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah. So, just a couple of, you know, three other assets. So, hopefully, that answers your question, John. Was there something else on it?

[John Massocca, Senior Research Analyst at B. Riley Securities]

It makes sense. Nope, that was it. And I guess because you haven't historically had a ton of this in the portfolio, but what's the look towards repositioning those properties? Are you still kind of inclined to sell them, or is there any possibility of retenanting those assets?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, our process is basically to hire, you know, a qualified and experienced local broker to find the best economic outcome for lease or sale. We tend to be indifferent, and we just try to find what works best for the asset. And so, you know, generally, you know, selling to a developer who is then going to try to retenant is a less attractive outcome. And so, you know, we're really only selling assets after, you know, we've not been able to find a tenant to take them. We're working hard, you know, a dual track to, you know, find solutions for all 5 of those assets in our vacant bucket.

[John Massocca, Senior Research Analyst at B. Riley Securities]

Okay. And then, Mark, sorry if I missed this earlier in the call, but what's the plan for swapping out or not swapping out the kind of remaining draw on the new term loan? Are you going to look to swap that once it's drawn, or is there any potential thoughts leaving that floating, just given where the interest rate environment is today?

[Mark Patten, CFO at Essential Properties Realty Trust]

Yeah, I appreciate that. I think our primary intent is that we would swap it out when we drew it. Haven't really looked at taking it through, leaving it floating. Just don't think there's, despite your appropriate point, that there might be some reduction in rates, just our plan is to swap it when we-

[Elmer Chang, Equity Research Analyst at Scotiabank]

Okay. That's it for me. Thank you very much.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thanks.

[Operator]

As a reminder, if you'd like to ask a question, please press star one on your telephone keypad. One moment while we poll for questions. Our next question comes from Josh Dennerlein with Bank of America. Please proceed with your question.

[Josh Dennerlein, Equity Research Analyst at Bank of America]

I was curious, for the deals that you're pricing today, how do the spreads to the cost of capital compare to maybe what you're considering as normal? And how much has that changed, given kind of the rally that you've seen over the past month?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah. I would start by saying, we don't price deals based upon our cost of capital. We price deals based upon the market dynamic and our perception of the appropriate risk-adjusted returns for each individual investment. The spread to our cost of capital is kind of an output, not an input. We've seen that spread fluctuate from as low as 150 basis points to as high as 300 basis points or plus. You know, currently, you know, depending on where you peg our cost of capital, it's somewhere in the 200s and certainly adequate and healthy for us to continue to invest.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, we've certainly gotten the benefit from, A, the stock price movement, and then also a much more favorable spread on our current ten-year bond issuance. So yeah, to Pete's point, we've probably seen a 50 basis point kind of appreciation in our net investment spread.

[Josh Dennerlein, Equity Research Analyst at Bank of America]

Great. And also, just thinking about the acquisition kind of going forward, how much can you buy before hitting your leverage targets?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

As Rob said earlier, we have somewhere between $700 million-$1 billion in dry powder, depending on, you know, within our targeted range.

[Josh Dennerlein, Equity Research Analyst at Bank of America]

I guess, just quickly, I know we were talking a little bit about the watch list. If there's been any updates either on individual tenants or if you can also make any comments on, I think it was brought up on the last earnings call, Red Robin, only just because of some credit downgrades going across them?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, you know, I go back to the commentary. The portfolio's in great shape and performing well. You know, our Red Robin investment, you know, back to my earlier comment of making 20-year investments and, you know, certainly I don't think our perspective on Red Robin is gonna change in a quarter. You know, our assets continue to perform well. There may be some noise around the equity story of that company, but, you know, the restaurant assets that we own are doing fine.

[Josh Dennerlein, Equity Research Analyst at Bank of America]

Great. Thank you so much.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thank you.

[Operator]

Our next question comes from Spenser Allaway with Green Street Advisors. Please proceed with your question.

[Spenser Allaway, Analyst at Green Street]

Thank you. Maybe just one more on your opportunity set. Acquisitions continue to fall within your targeted industries, as you mentioned, but just curious if there's been anything you've looked at that would be an interesting new venture for EPRT?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yes. Sorry to disappoint you, Spenser, but no, you know, we're sticking to what we do. You know, we conduct sourcing activities in our verticals to identify high-quality operators that are growing and who value us, and you know, that's really where we spend our energy and where our opportunity set comes from. So, we're fortunate. We don't need to really expand the box, and we're continuing to kind of invest in our core, in our core industries with our core thesis.

[Spenser Allaway, Analyst at Green Street]

Okay. And then, Pete, you also mentioned the persistent bid-ask spread that weighed on dispositions in Q2. Can you just comment on how wide that spread was in the quarter? And has that changed at all thus far into three Q?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

It hasn't changed in three Q. And, you know, I would say it's probably anywhere between 25-75 basis points between where we would sell a well-leased performing asset and where the market would buy it. And if you think about our disposition, dispositions in the quarter, you know, at a 7.3 of really at-risk assets, I think you see that in the coverage, you know, of high quality, well-performing asset. I think, you know, our strike price would be in the low 6s. So, you know, I think that's kind of where the bid-ask would be.

[Spenser Allaway, Analyst at Green Street]

Thank you.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Thank you.

[Operator]

Our next question comes from Greg McGinnis with Scotiabank. Please proceed with your question.

[Elmer Chang, Equity Research Analyst at Scotiabank]

Hi, good morning again. This is Elmer Chang with Greg. We just had a couple of follow-up questions. So most of your top tenant industry exposures seem to be highly fragmented industries, whereby you can jump in on an investment in a consolidation event. What has M&A activity been like year to date in your top tenant industries, and how do you see that playing out in the rest of the year?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

... You know, M&A activity is generally down, and, you know, with, obviously, capital harder to come by. And so, you know, we're transacting at a higher level despite a depressed level of M&A activity, which is really an indicator of the challenges to get alternative financing. And so, we would think M&A would pick up as capital markets normalize, and rates start coming down and, you know, multiples come, you know, expand and, you know, more sellers are willing to sell. And that should create more opportunities for us that will be offset by, you know, a broader range of capital alternatives for people transacting.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

So on balance, we think it'll be neutral, but there should be more consolidation and M&A activity in the back half of the year.

[Elmer Chang, Equity Research Analyst at Scotiabank]

Got it. That makes sense. And then similar question to those asked earlier about expectations of a rate cut increasing. I think you just mentioned it as well, but do you see the competition starting to come back to the market? Do you see that impacting lease term and, and rent bumps in your, your current pipeline that is further along in negotiations or more so in your, your newer negotiations?

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Yeah, I would say the current pipeline is relatively consistent with what we experienced in the second quarter, and that, you know, we would expect the competition to impact cap rate and terms, you know, into probably the fourth quarter and first quarter of next year.

[Elmer Chang, Equity Research Analyst at Scotiabank]

Okay, great. Thank you.

[Operator]

We have reached the end of the question and answer session. I would now like to turn the call back over to Pete Mavoides for closing comments.

[Pete Mavoides, CEO at Essential Properties Realty Trust]

Great. Well, thank you all for your time today. We look forward to the rest of the summer and engaging with you all in September, as we're on the road with several investor conferences coming up, and so thank you for your support. Have a great day.

[Operator]

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

Participants

Executives

• Mark Patten, CFO
• Pete Mavoides, CEO
• Robert Salisbury, Head of Capital Markets

Analysts

• Caitlin Burrows, Vice President and Senior Equity Research Analyst at Goldman Sachs
• Elmer Chang, Equity Research Analyst at Scotiabank
• Eric Borden, Analyst at BMO Capital Markets
• Greg McGinniss, Analyst at Scotiabank
• Haendel Juste, Managing Director at Mizuho
• John Kilichowski, Vice President and Equity Research Analyst at Wells Fargo
• John Massocca, Senior Research Analyst at B. Riley Securities
• Josh Dennerlein, Equity Research Analyst at Bank of America
• Ki Bin Kim, Analyst at Truist Securities
• Michael Goldsmith, Analyst at UBS
• Smedes Rose, Director at Citi
• Spenser Allaway, Analyst at Green Street