Broadstone Net Lease, Inc. (NYSE:BNL) Q1 2024 Earnings Call Transcript May 2, 2024
Broadstone Net Lease, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Hello everyone and welcome to the Broadstone Net Lease’s First Quarter 2024 Earnings Conference Call. My name is Bailey and I will be your operator today. Please note that today’s call is being recorded. I will now turn the call over to Brent Maedl, Director of Corporate Finance and Investor Relations at Broadstone. Please go ahead.
Brent Maedl: Thank you operator and thank you everyone for joining us today for Broadstone Net Lease’s first quarter 2024 earnings call. On today’s call you will hear prepared remarks from CEO, John Moragne; President and COO, Ryan Albano; and CFO, Kevin Fennell. All three will be available for the Q&A portion of this call. As a reminder, the following discussion and answers to your questions contain forward-looking statements, which are subject to risks and uncertainties that can cause actual results to differ materially due to a variety of factors. We caution you not to place undue reliance on these forward-looking statements and refer you to our SEC filings including our Form 10-K for the year ended December 31st, 2023 for a more detailed discussion of the risk factors that may cause such differences. Any forward-looking statements provided during this conference call are only made as of the date of this call. And with that I’ll turn the call over to John.
John Moragne: Thank you, Brent. Good morning everyone. As we discussed during our call last quarter, the largest variable in establishing guidance this year was the timing of our healthcare dispositions and the subsequent redeployment of proceeds generated from the portfolio sales. With our team’s ability to execute in scale on both fronts early in the year, I am pleased to announce that we are increasing our per-share AFFO guidance and establishing a range of $1.41 to $1.43. Before opening the line for questions, we’d like to provide context for this update and our perspectives on the overall operating environment. As we have been emphasizing since February of last year, the macroeconomic backdrop and interest-rate environment has had a considerable impact on commercial real estate markets and in particular, the net lease transaction market.
While the net effect has resulted in historically significant declines in transaction levels, this environment has also presented opportunities to think creatively and differently, while continuing to lean heavily on our existing relationships, disciplined underwriting, and operational expertise. Our actions over the last 18 to 24 months have provided us the flexibility to continue making decisions we want to make in this environment, not decisions we were forced to make. With the capital, talent, and experience we have at BNL, we are primed to drive long-term value creation and earnings growth. I am extremely proud of what our team has accomplished so far this year, including the sale of 37 clinically-oriented healthcare assets in connection with our healthcare portfolio simplification strategy, generating gross proceeds of $251.7 million.
The closing of these 37 assets along with an additional disposition completed after quarter end, accounts for approximately 50% of the assets we have identified as part of our healthcare simplification strategy and we remain in various stages of marketing and negotiation on an additional 20% of our clinical assets that we anticipate concluding later in 2024. The remainder will likely take additional time to achieve optimal disposition outcomes. As part of this effort, we continue to work through a final resolution for Green Valley Medical Center. Completed dispositions have successfully reduced our health care exposure to approximately 13% of our ABR as of March 31st. Our near-term goal is to reduce our health care exposure below 10% of our ABR, at which point, it will naturally become a less emphasized portion of our portfolio similar to office.
Turning to our investment activity, first quarter transaction market represented the lowest single-tenant net lease transaction volume in at least 15 years, highlighting the continued misalignment between buyers and sellers with a recently reignited rate environment further exacerbating the disconnect. We still believe a higher degree of selectivity is required as we navigate this environment and we are focused on sourcing off-market investments and unique capital allocation opportunities where we can partner with developers and tenants seeking capital solutions as the constraints on traditional commercial real estate lending process. Despite the challenging environment, our team was able to invest $202 million year to date with an additional $122 million of investments currently under control.
We navigated the transaction environment by leveraging existing relationships, sourcing nearly $150 million of our year-to-date investments through direct off-market deals that closed shortly after quarter end, including an 84.5 million investment in retail assets, located in one of the most highly trafficked trade areas in St. Louis. This unique opportunity stems from an existing relationship that resulted from our ongoing UNFI build to suit. It includes a $32.5 million investment in seven individual triple-net outparcel assets, leased to strong national and regional concepts, including Bass Pro Shops, Chick-fil-A, LongHorn Steakhouse, and Burger King to name a few. The remaining $52 million is transitional capital with portions designed to convert to a long-term ground lease subject to tenant consents.
The $52 million covers the online portion of the retail center that is currently more than 95% leased. This was a unique opportunity in which we were able to step in as a holistic capital provider for the entire center and acquire seven triple net retail assets with a strong real estate fundamentals and tenants at above market cap rates. The other significant direct transaction we closed after quarter end was a $65 million single-tenant industrial campus in California occupied by leading candy manufacturer. While we would normally wait until Q2 earnings to provide additional details on transactions closing in the quarter, we wanted to provide investors a sense of what we are working on in this environment, particularly given the proximity of these investments closing to Q1.
We look forward to discussing these and other Q2 investments in more detail during second quarter earnings. As we execute on our healthcare portfolio simplification strategy, our overall portfolio composition is increasingly weighted to industrial and defensive retail and restaurant tenants and it continued to perform well in the first quarter, as evidenced by 99.9% rent collections excluding Green Valley and 99.2% occupancy as of March 31st 2024. While our overall operating results remain strong, we are seeing incremental pockets of credit risk as the broader impact from the duration of higher interest rates appears to be having an effect. We remain vigilant in our tenant monitoring efforts and maintain great in our portfolio due to its highly diversified construction, which limits the impact of any potential individual credit event and our proven ability to manage through any such situation that may arise.
In this higher for longer environment where financial conditions are less conducive to the type of interest rate fueled growth that the net lease sector had grown accustomed to in the post GFC world, net lease rates will need to focus on operational expertise and finding creative ways to generate deal flow and accretive growth. In a historically low transaction environment like this, we could choose to run up the risk spectrum in exchange for yield. But I don’t believe that would be prudent due to potential credit risk and our view of the continuing risk reward and balance on higher cap rate deals. Now is the time to be creative and opportunistic, while maintaining underwriting discipline, to position B&L as an alternative capital provider, to take advantage of the commercial real estate lending pullback and to double down on the things that have made B&L successful over the last 16 years.
Solid portfolio and balance sheet fundamentals operational expertise and a growth focused mindset. With our industrial focused but diversified investment strategy, I believe B&L presents investors with a differentiated approach to net lease investing in growth. The increased role we can play in development and build-to-suit transactions adds a compelling additional building block to our growth strategy. We view these types of opportunities as part of our core building blocks to sustainable long-term growth which include best-in-class fixed rent escalations, investments in our existing tenants and assets, traditional external growth and development funding opportunities. While the combination of these building blocks will vary based on market conditions they provide a compelling path to near and medium-term value creation and earnings growth.
With that, I’ll turn the call over to Ryan who will provide additional details on our transaction efforts, our building blocks for growth and portfolio updates.
Ryan Albano: Thanks, John, and thank you all for joining us today. As John mentioned, during the first quarter we were able to execute on a key piece of our healthcare portfolio simplification strategy through the completion of a portfolio sale comprised of 37 assets for $251.7 million at a cap rate of 7.9%. These dispositions reduced our medium term lease maturities and improved our overall portfolio WALT to 10.6 years. Additionally, the incremental proceeds from this sale add to our existing dry powder, placing us in a position of strength as we actively pursue high-quality investment opportunities. As we step through this disposition effort and begin focusing on the remaining properties identified, we anticipate various transaction time lines that comfortably extend into 2025, given the need to address some combination of shorter lease duration space utilization rates and elevated credit risks.
As John and I have communicated in the past, we are intently focused on the tactical execution of our healthcare property sales and maximizing value for our shareholders. Alongside our disposition efforts, we once again demonstrated our high degree of selectivity during the first quarter for funding revenue generating capital expenditures of $3 million and incremental UNFI development fundings of $36.9 million. In total, we have funded approximately $130.7 million towards the UNFI build-to-suit development through March 31st. And the project remains on track for delivery and rent commencement no later than October of this year. Now turning our attention to new investment activity. While our standards remain very high for allocating capital to new investments, our sourcing efforts have yielded several positive outcomes as John highlighted in his comments.
We favor opportunities that support growth for stable and healthy companies for situations, where we can provide solutions to transactions that are disrupted by the current market environment. This has resulted in our evaluation of more opportunities for build-to-suit transactions, forward commitments of completed developments and other directly sourced opportunities in addition to selective regular way marketed transactions. These transaction formats allow us to access high-quality opportunities today through a differentiated sourcing model and create embedded AFFO growth for future periods, which when coupled with our in-place portfolio rent escalations, produce a compelling run rate growth profile before even considering contributions from external growth opportunities.
While facing historically difficult transaction environment, our pipeline remains robust given an influx of these types of opportunities. Our focus on achieving appropriate risk-adjusted returns and creating long-term value for our business and its shareholders is resolute and the balance of real estate fundamentals and underlying credit support against prevailing market pricing on investments remains front and center. In an environment, where the traditional net-lease growth model and transaction environment is constrained, we feel confident in our ability to drive meaningful near and medium-term growth through our capacity to leverage opportunities arising from our other core building blocks, investments in our existing assets and development funding opportunities, in addition to our best-in-class fixed rent escalations.
Moving to our in-place portfolio. As we highlighted last quarter, we remain cautious on and continue to pay extra attention to industries that are sensitive to discretionary consumer spending including some tenants that have been included in the recent headlines. The room place, a home furnishings operator occupying one asset and accounting for 0.2% of ABR remains in Chapter 11 bankruptcy, during which time, we continue receiving rents. At the end of the bankruptcy proceedings, which we anticipate occurring later this summer, the tenant will vacate the property. In the meantime, our team is focused on determining the optimal next step for this asset. Red Lobster, representing 1.6% of ABR has notably been in recent headlines. Our 18 master leased assets maintain relatively healthy site-level performance and we continue to monitor the situation as it unfolds.
We are comfortable with our exposure, which we have reduced over the last several years, remain cautiously optimistic about Red Lobster’s future and know the quality of the underlying real estate, represents a compelling value proposition to both Red Lobster and other potential users. Lastly, we only have three vacant properties as of March 31, including one that went vacant during the quarter upon the conclusion of our tenant’s lease term. This property received significant interest and we have executed an LOI with a new tenant and are in the process of negotiating a lease anticipating the tenant taking possession in late Q3 or early Q4. Beyond these properties, there is one additional tenant Shutterfly, that will be vacating its space when their lease expires on June 30.
We have already executed an LOI and are in the process of negotiating a lease with a new tenant for this location. Our new tenant is currently targeting lease commencement during the fourth quarter resulting in minimal downtime at the property. In summary, the broader market environment for new investments is certainly challenging and higher interest rates and sustained uncertainty are increasingly adding risk to the macroeconomic equation. Despite the difficult backdrop, we continue to demonstrate a differentiated ability to allocate capital to investments that enhance the value of our highly diversified portfolio and execute on assets and portfolio management objectives that drive strong operating performance. With that, I’ll turn the call over to Kevin to provide an update on our financial results for the quarter.
Kevin Fennell: Thank you, Ryan. During the quarter, we generated AFFO of $71 million or $0.36 per share, an increase of 5.9% in per-share results year-over-year. Results were largely driven by lower interest and G&A expenses. Bad debt in the quarter excluding Green Valley was 15 basis points, driven by a small gap in rent from the in-place. We incurred $7.8 million of cash G&A during the quarter, which tracks in line to slightly better than guidance. We once again, ended the quarter in a strong and flexible financial position, despite not engaging in any capital markets activity. From a leverage perspective, we ended the quarter in a position of strength at 4.8 times net debt, down slightly from five times at the end of 2023, driven largely by disposition proceeds from progress, on our healthcare portfolio simplification strategy.
We are retaining mostly fixed rate debt capital structure, with 30 million existing swaps rolling into fourth quarter and we routinely evaluate alternatives as we approach incremental floating rate exposure into 2025. At our quarterly meeting, our Board of Directors approved a $0.29 dividend per common share and OP unit. This is a 1.8% increase from last quarter, and a 3.6% increase over the dividend declared in the first quarter of 2023. This quarter’s increase marks our seventh consecutive semi-annual dividend increase, since our IPO and is payable to holders as of June 28th 2024, on or before July 15th. Our dividend remains well covered and represents a highly attractive yield in this market environment. Finally, as John previously mentioned, we are raising our per share guidance from $1.41 to a range of $1.41 to $1.43, as our team’s ability to execute on both our healthcare portfolio simplification strategy and growth objectives, provides additional clarity on estimated per-share results for 2024.
Our revised per-share guidance reflects the following key assumptions, which remain unchanged. Investment volume between $350 million and $700 million, disposition volume between $300 million and $500 million, with ongoing healthcare sales accounting for the substantial majority. And finally, cash G&A between $32 million and $34 million. With that, we will now open the call for questions.
Operator: Thank you. [Operator Instructions] Our first question today comes from the line of Michael Gorman from BTIG. Please go ahead. Your line is now open.
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Q&A Session
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Q – Michael Gorman: Yes, thanks. Good morning. I was wondering, if you could spend a little bit of time as you’re talking about how you think about the investment environment right now. And John, you talked about being, I’m a little bit more innovative and focusing on your skill set. And Ryan, you talked about some of the opportunities you’re seeing. Can you talk about, how you’re thinking about stratifying the opportunities and the returns required as you think about additional build-to-suits or kind of innovative transactions like the retail center that closed after the quarter ended?
John Moragne: Yes. Thanks, Mike. As we were talking about in the script, and as I think everyone knows, this is the lowest sort of marketed transaction volumes we’ve seen at least 15 years. Conversions are a lot harder, right now. So you’re having to work a lot harder to find these deals. It’s not the same environment that net lease got to enjoy for 15 years post GFC. So we’re focused as we talked about during the call, on finding direct deals, leveraging our relationships. We’re very proud of 150 million that we were able to close so far year-to-date, as a result of direct relationships with Sansone our partner on UNFI as well as the partner on the retail center, as well as direct relationships on the industrial campus that we acquired in California.
Building from that and touching on the core building blocks that we think we provide from a differentiated growth strategy and in that lease is, the opportunity to do more build-to-suits, we’re seeing right now and evaluating opportunities in mid-market industrial, on straight way deals as well as some retail. But a lot of the good opportunities we’re seeing right now, are build-to-suit for commits. The disruption that we’ve seen in the last, call it 1.5 year and commercial real estate lending persists and will persist for some time. So being able to step in as a whole as a capital provider, as an alternative capital provider, we think is really attractive. The yields that we’re seeing right now are solidly in the sevens, no stuff. That isn’t something that really works for us.
As we — as I said during my remarks, there is an opportunity right now to run up the risk spectrum, if you’re looking for yield. But that’s not something that we’ve always been comfortable with, and we’re certainly not comfortable with it today. So, we’re solidly in the sevens and we think there’s great opportunities both in sort of regular way acquisitions, as well as the build-to-suit and adding to those core building blocks.
Q – Michael Gorman: That’s helpful, John. And I guess, maybe just kind of self-evident. But as you get closer to the rent commencement on the UNFI, I assume the appetite to take on new build-to-suit goes up. Can you give a sense for where that that appetite sits in terms of as a percentage of the total business to have a development pipeline underway?
John Moragne: Yeah there’s a strong appetite for it. And UniFi is progressing really, really nicely right now. We’re expecting to come online at the end of Q3 or the beginning of Q4. As we talked about before it has an absolute rent commencement date of October 15th at the latest, but we believe it’s going to come online earlier than that. And so as we are winding down, our remaining commitment there to fund that starts to open up the opportunity for us to look at additional build to suit. And when we look at our core building blocks having a laddered build to suit structure out into the future over the next 12 to 18 to 24 months we think is a really attractive growth for investors to look at as you roll from one year to the next already having a built in investment pipeline that you know is going to come online from those build to suits, we think should be provide a differentiated approach to growth that you don’t see in the same material way across our industry that we’re able to do with these larger industrial build-to-suits.
So that’s a key focus for us right now as a percentage, it’s pretty significant in terms of the pipeline. And not all of those worked out, but we’re actively pursuing a handful of them and are excited about a few of them coming online in that 2025 time line.
Michael Gorman: That’s great. And maybe just last one for me. I know it’s not directly comparable, but obviously a lot of headlines lately in the pharmacy space and with Walmart with its health clinics. And I’m just curious, you had good execution on the healthcare properties year-to-date, have you seen any change in the tone or the tenor of the discussions you’re having? And in the last month or so just in terms of how investors are thinking about the health care space and the healthcare real estate specifically?
John Moragne: Yeah, I think the tone, people I think are comfortable with the approach that we’re taking. We’re very pleased to have roughly 50% of our goal already out the door. The plan in the near-term is to get our overall healthcare allocation below 10%. At that point when you’re single-digit ABR, becomes naturally a less emphasized portion of the portfolio. And so that’s the goal that we have here. We’ve got a good line of sight to the next 20%, 25% and we anticipate that that would close in the second half of 2024, and in the last 25% will take a little bit more time. I think in healthcare you’re looking at a lot of haves and have not. There’s places that are really well structured. And so from an investor sentiment standpoint depending on where they’re looking at the healthcare sector, there can be a lot of comfort and excitement of our own.
And then there’s a lot of places that are really struggling. And so where we sit and I think executing on the strategic plan fits well in terms of getting rid of that complexity, getting rid of an asset class that is not core to our long-term growth strategy and we’re excited to continue executing on it over the course of the next year or two.
Michael Gorman: Great. Thanks for the time.
John Moragne: Thank you.
Operator: The next question today comes from the line of Caitlin Burrows from Goldman Sachs. Please go ahead. Your line is now open.
Caitlin Burrows: Hi, good morning. Just as a follow-up to that last one. So you mentioned how on about 50% of what you want to sell in the healthcare portfolio is now done and you’re in talks on another 20% to 25% and the rest TBD. So could you talk a little bit more about the differences between the properties that you expect will take longer versus those that you’ve already closed or are in talks on?
