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STORE Capital Corporation is an internally managed net-lease real estate investment trust, or REIT, that is the leader in the acquisition, investment and management of Single Tenant Operational Real Estate, which is its target market and the inspiration for its name. STORE Capital is one of the largest and fastest growing net-lease REITs and owns a large, well-diversified portfolio that consists of investments in over 1,650 property locations, substantially all of which are profit centers, in 48 states.
Moira Conlon, 310-622-8220
Andrew : Alright, we'll keep nearing on time. I am Andrew Rosivach the REIT analyst for Goldman. It’s my pleasure to introduce Chris Volk and his team. Chris is the CEO of STORE. STORE focuses on single tenant profit center properties with a focus on retail. With that I'm going to hand over the discussion to Chris, and he can also introduce Mary and Cathy.
Chris : Good morning. For those of you listening on the webcast, I would like you to know that there are 20 intrepid people here listening to this with us, who braved the morning and the earth to get here.
For us, it's 5am, so I'm going to be lucky to remember my name. I've been up since 3:30.
STORE Capital is a leader in providing net lease solutions to middle market or larger companies. So for those of you who don't know us, that's what we do. And STORE is an acronym that stands for Single Tenant Operational Real Estate. Today, we have about 1,400 properties rented to 321 customers in 47 states. This is not the first rodeo for me or for members of the team here. This is the third public company that we've all been associated with that we have started and taken to fruition. STORE is a little bit different from the other companies in the sense that we're focusing exclusively on profit center real estate. It's like having a focus over the years and then just sharpening that focus over 30 years. Today we focus on assets were we can get unit level profit and loss statements from the assets. Today we have about 97% of our tenants and locations giving us unit level financials, which is really impressive.
I've been doing this personally for over 30 years. For people unfamiliar with the company, I would encourage you go to our website and look at the investor tab. Actually if you just look main tabs you can focus on what we do for our customers. A lot of value added, on the website you can find that, why our customers work with us at the time. Go to the investor tab to see the presentation. Download that.
With me, I have Cathy Long, who is our Chief Financial Officer. Cathy and I have been working together since the 80s. And then Mary Fedewa, who runs the acquisitions. Mary and I have been working together since around 2001, which is when we sold our first company to GE Capital, and she was in charge of integrating us and did such a good job that she's here today. We integrated her back. With that, Andrew if you have any questions, I'm happy to answer them.
Andrew : Yeah, I thought as an ice breaker we could get an update on the the state of tenant credit. You guys, as a neat feature, have a lot of detail on the underlying operations of your property, which really differentiates you from a lot of your peers. Up to what month do you have information and what are you seeing in terms of coverage trends, both in terms of your portfolio overall and perhaps what segments are doing better or worse.
Chris : Sure, well, we do our first quarter earnings numbers we'll be dealing through ... most of that stuff is going to be through year end at that time. When we disclose or talk about tenant credit so you get your December numbers by, let's say, April 15th, in that neighborhood.
The numbers tend to lag a quarter or let's say 60 days they lag, but we have a pretty good insight into how our customers are doing. I would say that the investment risk for STORE is partly a function of tenant credit, but not solely a function of tenant credit. Tenant credit is just one aspect of risk. So, there is this notion that tenant credit quality is equal to contract quality. So if I ask if people in the audience "Do you want a Home Depot store or Ashley's store?" A lot of people will raise their hand and say I want the Home Depot store. Because they gravitate to credit and they assume that credit is going to be equal to the contract risk, which it's not. There are a lot of other aspects that go into it. Including how much you pay for the Home Depot store, do you have a master lease, do you have unit level financial reporting, length of lease and those kinds of things.
We try and endeavor every single quarter to give a disclosure, not just about our tenant credit, which we do a histogram of tenant credit quality, but we also give a histogram of what we call a STORE Score, which is basically a tenant credit quality overlaid with store level profitability from the 97% of the stores that report to us. Because store level profitability is really key and it changes the probability of default. The more the stores can make, the less likely the lease is to default on you.
We come up with a contract rating. If you look at our contract rating today, the average contract rating is around 75% of its investment grade or better. If you looked a year ago today it would have been 76%. We're kind of in line. If you look at the unit level coverages for March, the median coverages at the store level for March it was 212, a year ago in March of 2015, it was 195. It gives you an idea that it's basically the same. Today we have around 80% master leases. Master leases are when you have one lease governing multiple assets. A year ago in March of last year it was 73%. So we've actually gotten better from a contract perspective, and getting that investment to replace when cost is held constant at 82% year to year.
What we've seen, basically, overall is that the portfolio contract quality has remained fairly flat. I would say that tenant credit quality has been, by in large, relatively flat. We've seen some movements, if you look last quarter, there were some movements down in credit quality but in terms of default probability it weighted to probably a 10th of a percent. So it was nothing to write home about.
People have asked us questions about everything from Gander Mountain, which is a retailer. Most people get concerned about retailers today because you have Sports Authority that skipped 11 and went right to 7. So they have basically are liquidating, so people get nervous about retailers. You should know, first of all, that most of the assets that we invest in are service assets. 70% of what we do is service. You can't buy a sandwich over the internet and you can't get a work out over the internet. You can't drop your kids off virtually over the internet to a daycare facility. We focus very heavily on service in part for that reason.
The retail we do own tends to be mostly experiential retail, where we think the bricks and motor really do matter over the long term. That being said, we have two credits people like to ask us about. The largest credit we have in the portfolio is less than 2.5% of sales today or 2.5% revenues, but it's Gander Mountain sporting goods. It's widely rumored that Gander, and Gander's private which is why I can't really talk about how they did, but it's widely believed that they had an unprofitable year last year. I would say it's mostly due to weather issues, and management is pretty confident about where they are in 2016.
Certainly, if you look at Sportsman Warehouse, their numbers were up last year. Their numbers were up this year - they are a public company. The space itself is a relevant space. Beyond that I would tell you that we get, and are maybe the only landlord out there that actually has, unit level numbers on how our stores are doing. The stores are profitable and we feel good about that. So from a contract risk perspective we feel solid for the time being and are pretty confident on how they're doing.
The other one that people like to talk about is Conns, which is another public company. And Conns announced a sort of unexpected loss in the first quarter. Again, we have a total of seven locations, they are under one master lease. Those stores have a median coverage that's reasonably north of where our median coverage is overall. We feel pretty confident. Not only our stores doing well, but the company itself. Actually it fills the need.
We like the niche they're in better than some of the rent to own store because if you are dealing with sub-prime market, there is a benefit to people owning stuff that they buy as opposed to just renting it for a high price over a long period of time. We like it. We certainly like how our stores are performing, and we think the company has lots of liquidity. I thought I would just preempt those questions, if you were going to ask any of them.
That's a long way of saying we're happy with the credit quality of our contracts at this point. We are far and away the most diversified company in the net lease space and it's really by design. If you look at the top 10 customers today that we have, it's less than 16% of our revenues. If you look at the top 5, it's about 9% of our revenues. The level of diversity dwarfs any company that we ever ran previously. Again, this is part of sharpening your focus and vision in terms of what you are doing. It makes us sleep well at night.
Andrew : Maybe I'll slip in one more for Mary, maybe you could talk a little bit about the other piece of the equation, which is the deal flow. Where are you seeing the biggest opportunities, and on Chris's point of diversification, are you naturally going to be increasing your tenant and industry diversification going forward, given your pipeline?
Mary: Sure. To start with deal flow, it's terrific. We have an $8 billion pipeline that was up in the 1st quarter from $7.4 billion at the end of the year. I'll remind you that we are a pure play and profit center real estate, so we're looking for companies that are profitable and have single tenant boxes where they own their real estate today. It's a large market, we address it primarily directly. Over 75% of our business is knocking on doors, talking to CEOs and CFOs that own their real estate. Allowing us to create our contracts. Allowing us to create the pipeline that we have as well.
From that perspective, I would say we have a plethora of industries in the pipeline and it will continue to be very diversified as we go forward and very consistent is what we see.
Andrew : So I've got 15 more, but I want to stop to see if anyone in the audience has ... Sir, I think you use the mic.
Audience 1: Hi, 2 unrelated questions. The first one is on cap rates. I imagine that you've got different perceptions of credit qualities of the properties you're looking at. Can you just give me a range of the cap rates?
Then the second question is, with all this unit level reporting, what do you do if you see a negative trend? Either in an individual property or a group properties?
Chris : Mary, why don't you talk about cap rates first.
Mary: I would say what is interesting about cap rates, and Chris can go into this in a lot more detail as well, but there is this misnomer in the marketplace that a lower cap rate equals lower risk. It's not really true. It's not a perfect market that way. The way it is somewhat of a perfect market is the more service and the more value you can add to the customer, the higher cap rate you can charge. That's pretty clear.
If you have a Home Depot that you're bidding in the marketplace, you can really add no value to Home Depot on that. How you can add value is by paying the highest price to whomever owns it today, even it is Home Depot to Home Depot. It's a low cap rate, low value to the customer. If you have a customer where you can actually add value you can give a very flexible long term lease, or you can offer the opportunity to substitute assets if they need to, operational flexibility where you can actually provide a tax advantage solution, then you can ask for the cap rate and you can get more cap.
Our cap rates this year we are guiding to 7.75%, and I'd say that that's a pretty good number for us, and we see cap rates above and below that.
Chris : I would say, just to give people an idea of this market place. Just to put this in perspective. If you think about every REIT that operates in the net lease space, combine all these companies, perhaps us included, do maybe 10% of the market. So 90% are buying this from the marketplace.
I remind myself every day to make me feel less important. Most of the business is done by people who have no access to deal flow, they don't have a sales force. They don't write their own contracts. They actually have no access to deal flow, they are buying transactions where the contracts are already written or where the assets have been aggregated in some way to make them easy to bid on.
And that's the vast majority. Substantially all of the business gets done in the net lease investing space is done that way. What we have tried to do is break that mold. Mary has 6 direct relationship managers reporting to her. Those 6 people generate 75% of the business that we do. About 90% of the transactions that we do are done on our own lease form. We are actually creating the lease contract. Which means about 10% of our transactions were done where we had a lease form that was presented to us by somebody else.
This is a big deal because if you have no access to deal flow, you are therefore at people's mercy in terms what what cap rate you buy things at. And not only that, you are also in the business of making only one decision because since the lease contract is already presented to you, then the question is what do you want to pay for the lease contract. You don't get to choose what you pay for the real estate. The real estate is a derived number based on what you are paying for the contract.
It's a single point of choice. Whereas, if you can actually write the contract, you can decide what's the building worth, what do I want to pay for it. And then, your second choice is what should the lease rate be on the contract that I'd like to write. Which is why, if you look at our portfolio, and why we believe it's important for you to understand, that we're in these investments at about 82% of replacement cost.
Now, we have some assets that were in north of 100% of replacement cost and there are reasons for that. But we disclose this to you, which is fairly unique to STORE. A lot of where our cap rates are done is the function of whether people have access to deal flow or not. If you have access to deal flow, then you can achieve a larger contract rate. And it has nothing to do with risk. It has very much to do with access to transaction flow.
If you don't' have access to transaction flow, then you have to accept whatever is there in the auction marketplace. You're not adding any value to anybody. The tenant doesn't even care if you live or die. The tenant isn't actually involved in the transaction one way or the other. A lot of this stuff is there, it's already been predone.
If you buy a Home Depot store from a developer, Home Depot isn't actually in the loop. You don't even need to know the CFO of Home Depot. We're in the business of knowing the CFOs and the CEOs of the companies that we do business with. We're there to try to make them better off, and all these people, all of them, have a choice whether they own or rent their real estate.
While you're average CEO or CFO might start with the notion that the cap rate that we charge and the proceeds that we give are the end all and be all, the real truth of it is that they are not the end all and be all. The world is full of people that have nice cap rates and nice proceeds. But they find when they go to their landlord and they say "Gee, I have a really nice property, I'd like to expand it," they find that most landlords, the vast majority, cant' do that. They cannot expand the property. "Gee, I'd like to close down a property, relocate it," most landlords have no desire to work with them. And frankly, they finance their assets in ways that don't permit this.
Now, the opportunity cost to a company to have one of those two things happen, for just 5% of the portfolio even, not a big number, is staggeringly high. And so, in the face of that we charge a 7 cap or an 8 cap or a 9 cap almost is irrelevant. What we're going to do is try to earn higher lease rates because we're providing a service to people and because we're adding more value than what we cost.
That's very important to do. The other thing that's very important is to have an alignment of interest. So Mary's direct origination staff is incented, they actually realize more personal income if they get higher lease rates and higher lease escalators. That's a novel idea. Our average lease escalator is 1.7%. It doesn't sound like much but, in that lease space it's about the highest there is. We're big believers in trying to have internal growth and also margins for error. I'm not interested in buying assets that you can buy and cap rates you can get.
The people in this room all have a lot of money and you can all go onto Loopnet and you can all find a ton of pieces of real estate. While there is some value for us to be able to aggregate those assets for you, I don't think that's enough. We have to be able to buy things that you can't buy, at cap rates you can't get and contracts you can't get. With alignments of interest that you won't find. This is very important.
By doing that, we have just huge margins for error in terms of what can happen. For example, I guess the second point of the question which is what happens when we see something trending down? Well, if we can book something at a lease rate that's 100 basis points above the market, from an option marketplace, then we also have lots of options. We can sell a property if we want to, and our chances of getting our money back are pretty high.
But if we buy something at an auction price that's the highest price that anybody would pay at the time, much more difficult. So, we will sell 1-2% of our portfolio a year. This year we announced that we expect to sell something like $60-80 million worth of the real estate. We should do this, but not just to try to book some gains from time to time. But because we're trying to be proactive. Your always pushing on the risk curve all the time. The risk curve is not a static thing.
We have contracts and we're looking at assets. If we think that the residual value of those assets might be impaired, that's one good reason to sell. Now, we'll sell for other reasons too. We'll sell for diversity reasons. As I mentioned earlier, the portfolio diversity is by design. There are indeed a number of transactions we've done where we've sold down pieces of those transactions in order to get more diversity. We'll sell off transactions because we have opportunistic people calling us up, saying "Gee, I'd like to buy the property on this corner." Sometimes we do that, not often.
If we have transactions where we don't have a long term strategic relationship with the customer, we tend to be more prone to wanting to sell. If we have one or two assets with somebody, but we're not going to get any more assets and there is not a long term relationship, we might do that. We've had transactions where companies get picked up by larger companies that are investment grade companies or close to investment grade type companies. We have a definite pick up and credit profile and it's very unlikely we're going to do business with those companies as a landlord going forward because they are going to look to having much more lease rates in the future. Then in that case we may book some gains as well.
Booking gains is important, and you should know this because in the business that we're in this is not all a function of whether we take back a property from a tenant that can't pay us. That happens all the time and we've been doing this for 30 plus years. This happens all the time. When you do that investors often times focus on your ability to manage the property. What's your recovery? How do you feel good about this?
I would say the recoveries range. We've had recoveries as low as 30% and as high as 100 and plus percent. The average is probably 70 or something like that. The flip side is that we can also manage risk by portfolio management. Portfolio management is selling off assets and booking a profit. If we can book a profit it's like a negative default. It's a contra-default.
In 2014, for example, we booked something like $4 million in gains and we had no vacancies. 2015 we booked very nominal income. We had some vacancies. We had a 90% recovery on the vacancies we had. This year you'll probably see us selling more assets at a gain and being more proactive on that. Part of that is because we've been in existence for 5 years, we're passing the time where we can hold properties for tax purposes and sell them. But these are all things that we should do to manage risk and to create a huge margin of safety for investors.
That's probably a little long, but there you go.
Andrew : Any other questions from the field?
Cathy, let me give you one. If you ever look at the net lease space, capital structures are all over map. You guys have chosen to be at 6-7 times debt-to-EBITDA, although you're probably lower than that now, pro-forma from your last offering. Maybe you can give a sense of why you came up with that number and why it's the sweet spot.
Cathy: Okay. When we're looking at leverage, one of our goals is to match fund these long term leases we have with long term debt for as long as is economically feasible. When we think about leverage, we think about going long, we think also about being judicious. I think that when we lever an asset, if we lever it on a secured basis, we tend to lever it every effectively, very efficiently. So we'll do a little higher leverage on a secured basis, and what that does is create a very large and growing unencumbered pool. On the one side you're leveraging very well on a secured basis, but then you have a huge unencumbered pool that you have.
The way we've created this, we have a complimentary debt structure where we can also issue senior unsecured debt. That then has this very large unencumbered pool creating all those cash flows to support that debt.
Our goal is to try to get the broadest access to debt capital as we can. We're tapping different debt markets, and not only the secured debt market that goes though say the ABS market, but also the unsecured market that is a very deep market as well. Doing 6 times leverage, we think, gives us sufficient cash flows to cover our debt very well. Also for the equity holders, we think that that amount of leverage is appropriate.
If we were a private company we would probably leverage higher, but for public companies, I think where we are is pretty appropriate.
Andrew : Cathy, you initially did a lot secured, now you've done more as an unsecured borrower. If you continue to do a blend of unsecured and equity rather than secured would that potentially make you want to run with lower leverage?
Cathy: I think we could run with lower leverage. We tend to be on the very low side of what our range is. I think part of it is going to depend on the market. The more the market rewards a company for being lower levered the more likely it is we’ll stay on the low side, I would guess.
Chris: If you were to look at the net lease space and some of the finest capitalized companies out there, we tend to look at that on a funded debt-to-EBITDA basis, we stay away from enterprise value, by the way. We will also look at debt to cost sometimes, when you're modeling the stuff out, you would look at debt to cost. Debt to cost we're kind of in the 45% range.
If you look at our very first public company Franchise Finance, we were triple B rated with around 50% debt to cost at the time. Certainly, debt to cost is certainly well with the range of being a strongly investment grade company. On a funded debt to EBITDA basis similarly, and if you were to look at leverage with other companies and you guys are equity holders, and we tend to try to run our company for equity holders of course. Preferred stock to me is just another form of debt, so when I think about funded to debt EBITDA, we're also including preferred stock into the mix.
If you throw in preferred stock into the mix and look at everybody out there, they're going to be in 6 times, maybe high 5s, from funded to debt EBITDA basis. This company has other things that work in its favor from a leverage perspective. The first way our G&A is roughly 80 basis points of assets, it's going to probably come down over time. I expect it to come down to 60ish basis points of assets or so, over time.
On a cash basis, you should know, it's closer to 50 basis points or somewhere in that neighborhood, if you are looking at it on an AFFO cash basis. We're fairly efficient today, but we have room to get better. If you look at our interest costs. Our interest costs have been really attractive, certainly on a relative basis, but I expect them to get tighter over time. We're triple B minus Fitch only company today. We don't expect to live our life being a triple B minus Fitch only company, so you will see us add other rating agencies to the mix.
If you're going to go down the road of being triple B or be an unsecured investment grade company, you want to be in the triple B-ish area or better. So expect us doing that and of course, that will cause our relative cost of capital to come in tighter as well. In the meantime, I will tell you, the spreads that we've realized, both in 2014 and year to date 2015 - and I'm talking about spreads relative to long term costs of debt, not using our line or short term - but have been amongst the best I've seen in 30 years in this business. We've been excited to borrow money at not much north of 4% on a long term basis. And to have lease rates that are approximating 8%. 400 basis points is a staggering spread.
From an EBITDA margin perspective, if you compare us on an EBITDA margin basis to anybody in the business, we're as good or better than virtually everybody. That's because despite the fact that we have slightly higher G&A costs, we have almost no property costs. It's triple net leases and vacancies have been very low to date, which, knock wood, we hope to keep them low.
Andrew : Well terrific. Thank you very much. Thanks everybody for coming out.