ABOUT THE EPISODE
Recently we interviewed Mark Manheimer, the CEO of Netstreit (NTST), a net lease REIT that listed shares in August 2020. In this 23 minute interview we discussed a variety of topics including growth, balance sheet, and dividend safety.
We also upgraded NTST to a Strong Buy and added shares to the Durable Income and Cash is King portfolios.
Thanks and Enjoy!
Hello everyone. This is Brad Thomas with The Ground Up and I'm back again with another CEO interview. And of course today, one of the topics I'm really happy to talk about is Net Lease REITs, which is one of my favorite property sectors in the REIT space. And I'm joined today to discuss that with Mark Manheimer. Mark is the CEO of Netstreit REIT, ticker symbol N-T-S-T. Mark, it's good to see you today.
Yeah, likewise. Excited to get rolling here.
Great. Well August 2020 Netstreit became a publicly traded company. Of course, you were a private company before that and took this legacy portfolio to the public market. So not quite a year, but certainly you've got a little bit of experience now in the public space and lets...
If we could Mark, before we get into the company, would you mind just... I'd love to hear from you about the Net Lease market today, just an overview of what are you seeing out there in terms of the supply and demand opportunities that you're seeing in the marketplace?
Yes, sure. So, the Net Lease market I think, what is oftentimes missed about the market when people talk about it is A, how large it is and then I think I heard another CEO recently mention that in the US it's about $4 trillion. I think they're going a little bit more international by saying its $8 trillion, right now in Europe. So just a massive opportunity set and then...
So massive supply. And then the demand has certainly kicked up from 1031 buyers, signing for individuals, small family offices, institutional capital has poured in as well as the number of public REIT's. And so for us, managing through that, we've got a very well-defined acquisition criteria in what we're trying to do with our portfolio in a niche that I think is an area where maybe it doesn't have quite as much competition, which I think we can certainly get into in a lot more detail, which I think is a bit of our competitive advantage.
Great. And again, I think you were one of three companies that listed recently in the Net Lease sector. So certainly a lot of new demand in terms of the REIT space and you're based out in Texas, but your company has a pretty broad geographic footprint. So can you talk a little bit about your existing portfolio, where those properties are located and what is your I guess, key differentiation with your other Net Lease REIT's in terms of the types of properties that you're aquiring?
Absolutely. So, we're in 38 States, like you mentioned. We're geographically diverse across the country and continuing to build on that diversity as we increase the size of the portfolio. 203 properties at year end, that's a little bit over $700 million in gross asset value, 10 and a half years of weighted average lease term.
So, pretty long-term there also. Looking at the lease expiration schedule, we have less than 1% of our leases expiring before 2025. So, very focused right now on the acquisition side of the table. 70% of our income comes from investment grade tenants. Another 8% comes from what we define as investment grade profile. And that's tenants with more than a billion dollars in revenues and less than two times leverage.
And typically that's going to be a hobby lobby or an aisle user or a tenant that just doesn't have a need for a credit rating, typically with no debt or very little debt. So there's not much reason for them to go out and get a rating, but we think we're taking a very similar risk profile and getting a little bit more yield there. So we're trying to expand that on the margin.
Very focused on what we define as defensive industries and retail that is well positioned for a post e-commerce world. And really, there's really three sub-sectors in the defensive industries that's going to be more than half of our... Half of our portfolio comes from necessity. So that's going to be grocery, pharmacy, home improvement.
Another sector that we're seeing more and more growth is really that deep discount sector. Your TJ Maxx Ross in Burlington and those types of tenants that have really been thriving pre- pandemic. And then once things start to reopen, that's really where consumers have rushed back the most and then service. So that's going to be restaurants, convenience stores, where there needs to be a physical location to get to the customer is really in the last few miles of distribution. You think about restaurants.
I think most people thought of that as you need that, go to the restaurant to get it. That's not really the case anymore. So, that really, when we think about the real estate side of the equation, which is just as important as the credit side for us, we want fungible real estate so that in the event that we take an asset back, we can replace the rent through another tenant.
It's very fungible where a lot of different uses come into play. Restaurants, we need to have a drive through otherwise we're not going to buy it. There needs to be enough parking to be able to handle Uber Eats and the changing consumer demand. And so I think that's really our differentiating factor, the quality of our real estate and the quality of our tenancy, I think, is best in class.
Objectively, credit wise, I think the numbers speak for themselves. But even when we were putting the strategy together and deploying capital, going back to 2019 as a public company or a private company, we were very focused on what works in retail and having tenants that have great access to capital and are using that capital to adapt to the change. Survival of the fittest. Who can adapt, that's not necessarily who's strongest today.
And so those tenants have really thrived and we did have a lot of pushback from some institutional investors. Back in 2019, it was very much a risk on environment. Everybody was saying, "We'll go buy Topgolf and movie theaters. You get more yield doing that. The expansion is going to last forever." And we just said, "Hey, look retail is going to continue to evolve. And the ones that are going to evolve with it are going to be around in 10, 20, 30 years. And the ones that are cash strapped and pulling the cash out of the business and not focusing on what's around the corner, I think are going to struggle." And you've certainly seen some bankruptcy. Retail is a four letter word in some people's minds.
And so we really focus on what's working and what we think is going to work long-term and having real estate that's fungible. So when you get something wrong, you're not getting burned and you can replace those rents. And having tenants that we think are going to survive long-term, so we don't have a lot of disruption in our rents. And of course we start deploying capital very early on and the pandemic hits then. Which was the first bit of disruption, which happened obviously very quickly. And I think we had a really good handle on what we had and how important our assets were to our tenants, the long-term sustainability of those business plans. And so we had all rent deferrals or abatements and restructures, which we got a lot of lease term in exchange for providing those to those tenants.
We had all that done and documented in the second quarter of 2020, where some of the REIT's are still fighting those fights and trying to chase down rent, which I think speaks to the portfolio quality, but then also speaks to our asset management department of really understanding what it is that we have and what's important to the tenant and being realistic.
If the government's shutting you down, maybe you shouldn't have to pay rent, but we want something in return on the back-end and we're able to really get that resolved very quickly. And we've been receiving 100% of rent. So every penny of rent for the past six months.
And I think we're the only Net Lease REIT in the retail sector, at least that has been receiving a hundred percent of rent, even most recently. So we've been doing that for six months and expect to really put COVID in the rear view mirror as best we could in the second quarter of 2020.
And we knew that things could change and maybe we'd have to reopen some of those negotiations if the pandemic continued. But we're getting more and more optimistic with vaccination that we were in the right place. And there are going to be more disruptions and retail is going to continue to evolve.
So while I think there's a big reopen trade, I agree, I think, certainly there are sectors, movie theaters, I think there will be... I think there's a place for movie theaters that might be rationalized. And some of the sectors that got hit really hard may come back a bit, but I think next time there's disruption, I think we're going to be really, really well positioned on a go-forward basis.
Well, I was going to ask about movie theaters in the portfolio, but I would assume at a hundred percent rent collection, I assume you don't have any theater exposure whatsoever?
Yeah, no, that's right. So we don't have any experience in that real estate at all, which we didn't anticipate the pandemic, but we did anticipate the fact that that real estate is much less fungible. So when we talk about fungibility of the real estate, we don't want to have gyms where we're refilling pools and I've played that game, working in other REIT's, movie theaters are very difficult to reposition.
They're very costly to reposition. So we really like your vanilla box that are really well situated for e-commerce and the changing demands of the consumer and also great traffic. Traffic down, egress, all the things that are... Visibility, all the things that we know that the other tenants that we want in our portfolio would be interested in those boxes. We want to make sure that we're not just saying, "Hope it works for these guys and if not, we've got a big loss." Really want to really think about the downside before acquiring assets.
Yeah. I think we both can speak from experience. I built a theater just right across the street from my office here and it's now an extra space storage. They tore it down, of course it is hard to repurpose. So I fully agree with that and I've built quite a few advanced auto parts stores, an O'Reilly Auto Parts, and those boxes are really easy to retrofit and they're fairly generic. And so I fully agree with you there. I want to talk Mark, if we could a little bit now about the growth of your company.
And I guess one of the great things about Netstreit is you're still relatively small. You've got a market cap of around 500 million or so roughly, so certainly can move the needle. So how are you going to move the needle in terms of your capitalization and where are you going to come up with all this money to grow, because obviously there's a lot of opportunity. We've just talked about supply and demand, you're a small company. So how are you going to put this money to work and where's it coming from?
Yeah, that's a great question and I think that's... One of the big advantages for us is we've got a newer portfolio that I think is fairly pristine. Obviously now we're collecting a hundred percent rent, it's in really good shape. But turning to the growth vehicles that we approach, there's a massive market, there's really only two other public REIT's that are focused on your investment grade and high quality tenancy from the corporate credit perspective, but they're much larger than us. So they're... Really need to put a lot of capital to work, to move the needle. And so to your point, we've set our acquisition goal for 2021 at $320 million.
If we hit that goal, especially at the cap rates that we've been able to achieve, that gives us the best growth in the entire Net Lease space. And so we're really excited about that. And we want to be really thoughtful about how we're deploying that capital. So $320 million a year, 80 million a quarter, significantly less than the appetite of what you see with some of the other peer set.
So, the way we think about that is it's a highly fragmented market and that allows us to be... Really build out a bell curve of our opportunity set. And in terms of how things are priced and some are much more inefficiently priced. Some are very aggressively priced on the other tail and then you've got what's market price in the middle of that bell curve.
And I think the other larger REIT's are really taking out the bigger chunk of the middle of that bell curve as they should in order to be able to acquire enough. But for us, we can be highly selective and really chop off that left side of the tail and achieve higher cap rates.
And that's typically going to be us getting more creative in how we get into an opportunity. We put a few case studies in our presentation, on our website, at netsreit.com, that shows... A good example, there is a shopping center, REIT selling a shopping center. They had a Walmart and a Sam's Club in it. We send in our LOI for the Sam's Club and the Walmart and they call back to say, "Thanks guys, but we really want to sell the whole shopping center."
There's some Junior Boxes, there's a Tuesday Morning, there's some shop space, shorter term leases and some hairy stuff that we don't really want to own. And so we said, "Okay, great. We've partnered with a Dallas-based value add multi-tenant buyer." And put the deal together, had to make a lot of changes to the REA.
It took five months to close the deal, but closed concurrently with that partner, they bought the rest of the center. They've done a phenomenal job re-leasing it and really enhancing the value of the adjacent property. And we get the Sam's Club and the Walmart, 12 years of lease term, the main retail corridor in Tupelo Mississippi. Cheap brands, which we love because those are going to be replaceable in a downside scenario.
And we've got a 6.6% cap rate, which I think if you just go out on the market and go try to find a Walmart for 12 years lease term that's a strong performer, it's going to be in the five somewhere, probably low to mid five. So, us taking the five months to go through all the brain damage to get that deal done, moves the needle for us. And so that's going to be the case for a long period of time.
A 6.8% cap rate that we achieved in the fourth quarter is substantially higher than the other two peers that focus in what people view as our sandbox of high-quality Net Lease. But when we have to acquire 80 million a quarter, we can do a bunch of those deals. We'll do blend and extends, which I'm sure you're familiar with, where you find a shorter term lease on the market which trades at a higher cap rate.
We get that under LOI. We're really competing with 1031 individual site buyers that likely don't have a relationship with the tenant. We get it under LOI. We contact the tenant. We say, "Hey, is this the site you want to be in longterm? If so, we're happy to cut your rent if you extend the lease." And then we typically will come in at a slightly higher cap rate. We've got a location that the tenant's committed to long-term and we've got a lower basis. So, the rent's cheaper so if something goes wrong, it's easier to replace that rent.
That's great, this really speaks my language. This reminds me of the old days when I was a developer and you're right. There's a lot of ways you can create value and your bigger peers just aren't equipped for that. They're too big and they need $200 million portfolios to grow and you can take a little more time, be a little more tactical and hence create more value.
So now that I'm not a developer, maybe I just need to buy Netstreit and then continue to buy... Full disclosure, I do own a few shares now. Mark, can you also touch on... I know being small, you don't have the rating's yet from S & P, Moody's, Fitch, et cetera. So obviously... But I know you're really trying to ultimately move towards those types of ratings. Can you talk a little bit about how you plan to evolve to really get better pricing power in terms of your cost of capital?
Yeah, absolutely. So ironically in the short-term, our cost of capital is artificially low. We've got a $175 million term loan, all in a sense, it's a maturity, it's 136 basis points. So that's about as cheap as you can get, but it's not really sustainable to operate the balance sheet like that long-term. $725 million of assets at year end. We think when we get to about $2 billion in assets, which should come in the next year or two, we'll have the size to be able to go to the rating agencies, get a rating. And then very similar to the way the other public REIT's operate.
Now, we already have an unsecured credit facility at revolver, so we can borrow on the revolver. That starts to get... You start to use some of that and then you go out, you have two or $300 million on that. You go up to an equity offering or an unsecured bond offering with an investment grade rating. Great way to match fund. I think that's... Certainly, the way a lot of the REIT's do, it makes sense. We love simple, especially when it works. And so that's the long-term plan, but for right now, our spreads are even wider because we're artificially [mooring 00:17:32] well.
Okay. If you could also tell me a little bit about the dividend policy. It looks like now, at least on my screen, I'm seeing about a 4.5% yield today. And can you talk a little bit about your dividend policy? I know you listed in August, as I said earlier, and in terms of how do you feel about this current payout ratio today?
Yeah, sure. So, when we deployed the capital, which will happen up until our next equity offering, we think we're going to be in the two thirds to three quarters payout ratio, which of course very healthy allows us to reinvest in some properties. And it gives us a little bit of flexibility there. But you're right, with the growth profile that we have, it's significantly better than the other public REIT's.
So if the PO [grows 00:18:24] that allows our board to make the decision to increase our dividend making our conversations in the gate. We want to stay in that two thirds to three quarters payout ratio. So, always the board's decision. So there's always that caveat, but I think our goal is to keep that payout ratio in that range and increase the dividend as increase.
Great. The growth profile of the company is pretty impressive as you just pointed out. And it looks like according to our research, you've got around 10 analysts that are providing us with consensus growth estimates for 2000 in 21. But what's really, when you look at the year over year run rate, going out to 22, and I don't have that many analysts, I see double digit, mid double digit, 15% growth.
Even beyond that, I don't have that many analysts, a couple of three actually going out to 23, but I'm still seeing that. So at least a couple of analysts are in agreement that this is a pretty sustainable pipeline of growth opportunities out there. So I guess my last question Mark is obviously we know that the there's a lot of predictability in these long-term lease contracts, but I guess it really comes down to product and being able to access, source new deals.
You've touched on some really creative ways that you're sourcing new product. I want to, I guess, ask you two things. I know we've got the 1031 exchange law, which is now potentially being discussed. Could make some changes to that, but also in context with the 1031, what are your thoughts on that? But also, are you able to use the UPREIT structure, like some of your peers also? I know you need to have certain size, you're not going to take $2 million deals and trade stock, you need fairly good size, but is that a tool that you plan on, I guess, utilizing, going forward?
Yeah and it's a great point. We are set up as an UPREIT. We do have some Popeye unit holders in our capital structure right now, which are essentially the same as common stock other than that their shares don't trade on the exchange, but as far as...
Investors look at that as essentially the same exact thing. But the 1031, it's being talked about a lot more than it has in the past. I do think that there is likely a lot of lobbyists with a lot of power that will likely put up a pretty good fight there, but the winds of change seem to indicate that that could actually be on the table. And for us, we look at the 1031 as a great vehicle for us to be able to sell into.
It's a very deep, maybe a little bit less sophisticated market that we can sell some credit risk into, or if we want to diversify a 7- Elven exposure, it's a great tenant, but we have a little bit more than what we'd like. We can sell it at a very aggressive cap rate.
So, we certainly benefit from that on the margin, but we don't really think we're going to be big sellers of assets in the coming years, even though we've used that in the past and made some pretty good gains doing that. But really on the acquisition side, that's really who we compete with. We're not competing with the other public REIT's.
We're not really competing with larger institutions. We're competing with a small family office, 1031 site buyers. So if that law gets repealed, I think our opportunity set drastically increases and likely even get better yields than we have, which I think right now the risk adjusted rates and spreads that we're getting right now are awfully attractive. I think that could even get a little bit better. And then you bring up an excellent point. We've had conversations with people as it relates to the UPREIT structure.
It's a great way for people to do something very similar to the 1031, where they take their assets and they contribute them into our REIT, and they get operating partnership units, which they can exchange in for common shares one-to-one whenever they want, but they can sell their destiny as it relates to capital gains.
No capital gains until the exchange into common shares and realize that gain. So it's very similar to the 1031 other than it's the end of the line. So they can't keep doing it where the 1031, you can just keep doing that into perpetuity as long as that law is still intact. But it is a very attractive alternative already. I think if the 1031 goes away, I think we will see a lot of UPREIT transactions.
Right. Well, one of my email addresses has 1031 in it, so I'll have to get a new email address, so hope it didn't go away. Well, Mark, I really appreciate your time today and I wish you the best. In terms of this year, it looks like we're not out of the woods yet, but obviously we're seeing signs of recovery across the country. We call it the travel getting up phase, I guess. And I wish you the very best and we'll definitely circle back and catch up with you after the first quarter of this year later on.
Sounds great. Thanks, Brad.
Great, thank you.