NNN REIT, Inc. (NNN) Q2 2022 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the National Retail Properties Second Quarter 2022 Earnings Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Steve Horn, CEO. Sir, the floor is yours.

Thank you, Ali. Good morning, and welcome to the National Retail Properties Second Quarter 2022 Earnings Call. Joining me on the call is Chief Financial Officer, Kevin Habicht. As this morning's press release reflects National Retail Properties performance in 2022 continues to produce strong results, including continued high occupancy, impressive recons and solid acquisitions driven by our proprietary tenant relationships. We are in a position to continue enhancing shareholder value as we move into the second half of 2022 and beyond. In July, we announced roughly a 4% increase in our common stock dividend to be paid on 15 August, thus making 2022 our 33rd consecutive annual dividend increase. National Retail Properties is one of the select companies of under 90 U.S. public companies, including only two other REITs, which have achieved this impressive track record. Based on our continued consistent performance, we announced today a further increase in our 2022 guidance of core FFO per share to a range of $3.07 to $3.12 per share. Our long-standing strategy is designed to deliver consistent per share growth on a multiyear basis. This discipline of long growth is reflected in our second guidance increase this year. Turning to the highlights of National Retail Properties second quarter financial results. Our portfolio of 3,305 freestanding single-tenant retail properties continue to perform exceedingly well, maintained high occupancy level of 99.1%, which remains above our long-term average of 98% plus or minus a fraction. We also collected 99.7% of the rents due for the second quarter. Staying a little bit more on rent collections. The rent deferrals that we provided to a select tenants during the early days of the pandemic continue to track as we expect. At the end of 2022, 87% or $49.5 million of the original $56.7 million deferred rent will have been paid back, which is 100% that is due at the time. While we continue on the topic of the portfolio, Dave & Buster’s moved in our top 10 tenants with the acquisition of one of our top 15 tenants main event in June. With regard to acquisitions, during the quarter, we invested just north of $150 million, 43 new properties at an initial cap rate of 6.2%, with an average lease duration of over 19 years, which 14 of the 16 deals were from relationship tenants, with which we do repeat programmatic business. The first half of the year, we invested over $350 million in 102 new properties with the initial cap rate of 6.2%, with an average of lease duration of 16.7. In an environment where cap rates are still near historic lows, but showing signs of adjusting, we continue our thoughtful and disciplined underwriting approach. NNN will continue to emphasize acquisition volume through sale-leaseback transactions with our stable of relationship tenants. Based on our pipeline and dialogue with our partners, we remain comfortable with our ability to meet and hopefully exceed our '22 increased acquisition guidance of $600 million to $700 million, primarily via direct sale-leaseback deals with our company's long-duration, triple-net lease form, which is more landlord-friendly than a 1031 market deal. During the second quarter, we also sold 8 properties, raised almost $8 million of proceeds to be reinvested in the new acquisitions. Year-to-date, we have now raised $28 million of proceeds from the sale of 18 properties, including 11 vacant. Although job one is always a release vacancies and our leasing team does an outstanding job of it. We will continue to sell nonperforming assets, if we do not see a clear path to generating rental income within a reasonable time frame. Our balance sheet remains one of the strongest in the sector. Our credit facility has plenty of capacity with only a balance outstanding of approximately $40 million, and we have no material debt maturities until mid-2024. NNN is well positioned to fund our 2022 acquisition guidance. In closing, I'd like to thank our associates for their dedication and hard work putting NNN back to pre-pandemic momentum as we look to finish 2022 strong and position NNN for success over multiple years in the future. With that, let me turn the call over to Kevin for more color and detail on our quarterly numbers and updated guidance.

Thanks, Steve. As usual, I'll start with the cautionary note that we will make certain statements that may be considered to be 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 provisions to these 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 this morning's press release. With that, headlines from this morning's press release report quarterly core FFO results of $0.79 per share for the second quarter of 2022. That's up $0.09 or 12.9% over second quarter of 2021, and that's up $0.02 or 2.6% from the immediately preceding first quarter of 2022. First half year-to-date core FFO results were up 11.4% to $1.56 per share. Today, we also reported that AFFO per share was $0.81 per share for the second quarter. That's up $0.02 from the immediately preceding first quarter's $0.79. We did footnote second quarter AFFO included $1.7 million of deferred rent repayments in our accrued rental income adjustment for the second quarter without which that would have produced AFFO of $0.80 per share for the quarter. And likewise, the first half of 2022, AFFO included $3.5 million of deferred rent repayments in our accrued rental income adjustment for the first half, without which would have produced AFFO of $1.58 per share for the first half of 2022, which will on the same basis compares to $1.43 per share for the first half of 2021, and that represents a 10.5% increase year-over-year. As the scheduled deferred rent repayments continue to taper off from the peak levels in the first half of 2021, we are seeing improved results kicking in from 2021 and 2022 property acquisitions. I will also note that we took a $2.7 million charge in the second quarter in connection with the retirement of our CEO in April. And that was excluded from our core FFO and AFFO calculations. Excluding deferred rent repayments, our AFFO dividend payout ratio for the first half of 2022 was about 67%. And with the recent dividend increase, should run approximately 68% for the full year 2022. All that suggests that we will create approximately $180 million of free cash flow after the payment of all expenses and dividends for 2022. And as we've discussed with investors, we burdened this "free cash flow at a cost of 8% for purposes of making capital allocation decisions and new properties.” So there's nothing free about it in our mind, but it is a significant part of the equity need for, say, $600 million of acquisitions, especially if you couple it with $100 million of proceeds from dispositions. Occupancy was 99.1% at quarter end. That's been, as Steve mentioned, consistent with recent quarters. G&A expense was $9.7 million for the quarter. That is down from second quarter year ago levels to -- moving on. Today, we did increase our 2022 core FFO per share guidance to a rate from a range of $3.01 to $3.08 per share to a new range of $3.07 to $3.12 per share. And similarly, increased our AFFO guidance to a range of $3.14 to $3.19 per share, which reflects the scheduled slowdown in deferral repayments in 2022, as noted on Page 13 of the press release. The guidance midpoint for both core FFO and AFFO were increased by $0.05 compared to previous guidance. And the supporting assumptions for our new 2022 guidance are on Page 7 of today's press release and are modestly fine-tuned from last quarter's guidance. We are, as I mentioned, excluding any executive retirement charges from our guidance and 2022 acquisition volume was bumped up by $50 million. As usual, we don't give any guidance on our assumptions for capital markets activity, except for the general assumption that we intend to behave in a fairly leverage-neutral manner over the long term. The most important takeaway from all this is that we expect to grow core FFO per share results in 2022 by about 8% to the new guidance midpoint. Switching over to the balance sheet. The second quarter was quiet in terms of capital markets activity. We were very active in the debt markets in 2021 and are not unhappy to be on the sidelines at the moment. We did issue a modest amount of equity, $32 million during the second quarter and ended the quarter with only $40 million outstanding on our $1.1 billion bank credit facility despite investing $365 million in the first half of the year. So our liquidity remains in excellent shape. Our weighted average debt maturity is now 14.2 years, which seems to be among the longest in the industry. Our next debt maturity is $350 million with a 3.9% coupon due in mid-2024. And all of our outstanding debt is fixed rate with the exception of that $40 million on our bank line. Net debt to gross book assets was 40.9% at quarter end. Net debt to EBITDA was 5.4x at June 30. Interest coverage and fixed charge coverage was 4.7x for the second quarter. So we're in very good shape to produce strong core FFO per share growth with our 2022 guidance suggesting about 8% growth to a midpoint, importantly, without any heroic assumptions. Our focus remains on growing per share results over the long term. We think the asset growth-focused acquisition volume contest in many sectors in recent quarters, may be slowing a bit or at least getting a little more disciplined on price. If so, we think renewed investor focus on per share results and managing balance sheet will accrue to our benefit. But time will tell. While there is currently an increased level of -- increased levels of economic and capital market uncertainty, we are well positioned for such. So I'll close it there. And Ali, with that, we'll open it up to any questions.

[Operator Instructions] Your first question is coming from Brad Heffern.

Bradley Heffern from RBC. Can you talk about how much cap rates have moved? And has there been much of a difference across the industry or across credit quality?

The cap rates, yes, we're starting to see cracks in kind of the second half of the quarter. We kind of started seeing movement in cap rates. More -- this conversation we had before when interest rates started moving up, a lot of the private equity money moved out of the market. And now with the interest rates moving up, we're seeing some institutions in the net lease business are drawing the line in the sand call it, 7 cap or high 6s. So we've lost a little competition there within our market. But yes, we're starting to see about a 20 basis -- 25 basis move for the asset quality that we target, meaning the sale-leaseback transaction, but more importantly, given the long-term triple net lease by way of -- we did a 19-year average for the quarter.

Okay. And then any thoughts on the amount of exposure that you have in the tenant roster to variable rate debt and whether that represents a potential credit risk as that flows through?

Yes. No, we don't feel like we have any notable exposure. It's really only the $40 million out of our $3.8 billion of debt. It's only $40 million related to our bank credit facility. So we don't feel like we have any real exposure at all to variable interest rate risk.

Sorry, Kevin, I meant at the tenant level. So like tenants who have variable rate debt in their capital structure. And so perhaps at the store level, things look fine, but they might face issues with rising interest costs.

Yes. Thanks for clarifying that. Yes, clearly, some of our tenants definitely do, I'd say about 1/3 of our tenant roster is private equity backed and they tend to operate under kind of debt terms that are variable rate. To date, we have not seen a lot of stress, if you will, at the property level and not too much really at the corporate level at this point in time. I think some -- it gets a little -- it can get a little more challenging is if you've got some near-term debt maturities that you have to refinance. It's just a tough market for refinancing sub investment-grade debt in today's world. But we found -- it appears that our tenants are not having any challenges on the credit side at the moment.

Our next question is coming from Spenser Allaway.

It's Green Street. I know you guys have had success on the deal front, as evidenced by your 2Q results and obviously guidance. But can you just talk a little bit about existing customer sentiment in regards to growth, just given the broader economic backdrop. Just curious how recent conversations have gone? And if there are any tenant industries that are perhaps a little bit more cautious at this point than others?

The conversations, obviously, we entered in conversations on a daily, weekly basis with our tenant base and the relationships. What are we seeing? We've seen a lot of kind of organic growth increasing over the first 6 months of the year with our tenants where they're doing new store development and NNN's participating on that deal front. And there's been a little bit less M&A in the second quarter that we found, and that was more of the tenants being a little bit cautious, more of the debt market than the consumer. The consumer has been pretty resilient in our tenant base. So they're not worried about the top line growth. And obviously, with inflation, the margins are getting squeezed a little bit more on the profitability. But it's not stopping them from growing, but they're just going to be a little hesitant in finding the low price discovery.

Okay. That makes a lot of sense. And then just as you are executing some new lease agreements and whether that's with new tenants or with existing tenants, have there been any shifts or changes just in terms of what tenants are looking for in regards to term or escalators being CPI-linked or whatnot?

I think in my entire 19-year career here at NNN, the tenant always want shorter term and less rent escalators. But -- so that's a constant dialogue we have in negotiations we're pushing as hard as we can for higher rent escalators. But the reality is we deal with large regional sophisticated tenants. So the commercial product right now in our market is that 2% annual, 10% every 5 years. So we're not seeing any increase currently. If the market shifts and enough institutions keep pushing it, it might shift. But in the foreseeable future, it's been pretty steady over the course of 20 years.

Our next question is coming from Nicholas Joseph.

This is Nick from Citi. Maybe back to the transaction market. You touched on the cap rate movement in the broader market. But how does that play into the back half of the year guidance? Obviously, you raised acquisition guidance, but the second half does assume a decel from what you've accomplished year-to-date.

Yes. The back half of the year, we're anticipating a little bit higher of a cap rate. A lot of the deals that closed in the second quarter reflected the 6.2% cap rate. We had a fair amount of April closings. So those cap rates were negotiated in February, call it, it's a 60- to 90-day window to get a deal closed. And we locked in the price, and that was the deal we cut. Now the second half of Q2 pricing for the third quarter, we're seeing that 20, 25 basis point increase.

And I guess just on the volume. Is that also kind of decision, either active decision by you? Or is it more just kind of the market is pausing a bit? Or is it just being a bit conservative in what you're assuming for volume in the back half of the year?

Our main focus is growing the FFO per share, not looking for the headline of acquisition volume. And we're comfortable in the third quarter. The numbers we're going to hit. Obviously, we don't have visibility quite yet to the fourth quarter, but we're creeping towards that. But yes, we're not looking to blow out acquisitions at the expense of 2023.

And then you touched a bit on how you think about cost of equity or at least internally. You issued a little equity in the quarter, and it came, I think, $43 a share, which is a little below where Street NAV is. So how do you think about equity issuance relative to NAV. And relative to that cost of capital, I think you mentioned around 8%, at least internally, how you think about it?

Yes, Nick, it's Kevin. Yes, we put a modest amount out. So I wouldn't read too much into that. It was, I think, gross price a little over 44 and then at a little under 44. But yes, we're sensitive to that. We're not exclusively driven by NAV in our shop as you and investors know we're very trying to focus on growing per share results, which we think over a long time creates total returns that are attractive. And it's not at cross purposes with NAV with that approach either. So -- so that's the good news. So time will tell. But you will note, we have not issued very much equity in the last, call it, 6 quarters. In large part, for the very reason you're mentioning is we just didn't feel like it was appropriately priced. And so to the extent that changes, and we may have more interest as the share price rises. And like I've mentioned before, it was a piece of the equation that we executed last year where we didn't really do much equity at all. But we did a lot of debt because debt was very attractive. And so we try to pivot to the piece of capital that's the most attractive at the time, while keeping our eye on managing the balance sheet and our leverage metrics and liquidity and all those things. And so it's a bit of an art and not a little bit of science, but we'll see where it goes from here in terms of our interest in issuing any equity.

Our next question is coming from Wes Golladay.

Wesley Golladay. Just maybe sticking with that last question on cost of equity, maybe a little bit broader. Can you talk about how you want to fund the near-term pipeline when you look at it and you called out free cash flow, maybe a little bit of equity. It doesn't sound like maybe issuing debt would be high on the list, but maybe could you talk about your appetite for running a little bit higher line balance. You called out earlier, your weighted average return is 14 years. And typically, I don't think you carry a line, but in the context of where capital markets are and how you've positioned the balance sheet? How high would you want to take that line? Or could you take that line and be comfortable with?

I never want to take it very high. But to your point, which is we've articulated a little bit with investors in recent months and in line with what I think what you're asking is that given that we have a 14-year weighted average debt maturity and little near-term debt maturities. We now have the luxury and it's all fixed rate. We have the luxury of being able to use our line more than what we've had in the recent past. I think on the average over the last 6 years, I think the weighted average outstanding bank line usage over the last 6 years is something like $55 million. And so because -- and people say, well, why was that? The debt -- the long-term debt and the equity markets were so attractive. We just found ourselves raising copious amount of that kind of capital and didn't really use their line. Now that the capital markets are rockier, we can now pivot and use our bank line more and still have a balance sheet that's in very good shape and still have lots of liquidity. So that's the good news. How high does it need to go before we get nervous. We're going to use well less than half of our bank line, let's put it that way. And so if it gets to the $300 million or $400 million, then maybe we'll have to get more serious about thinking about terming out that capital with even debt and/or equity. But as I alluded to in my prepared remarks, $180 million of annual cash flow plus $100 million a year of dispositions, just on average, that's $280 million. And that goes a long way to funding $600 million, $700 million a year of acquisition. So -- so the need is not that great for either equity and/or debt. And as I just said, we've got plenty of availability on the bank line and still stay within very conservative metrics.

Got it. And then I saw the Ahern made it into the top 20 tenant list. Are you doing more business with them? Or is this just a function of combining your 2 tenants that you mentioned at the top of the call.

It was largely a function of -- yes, we had 2 tenants combined up above them, and so that pulled them from #21 to #20 on the list. And so we are aware that that's a tenant that we are comfortable with our property level metrics are -- we're very comfortable with, and the world is moving their way I think, in terms of just infrastructure. And so they will, we think, be in good shape. They are staring at a debt refinance issue that's, I think, weighing on them a bit at the corporate level. But we think that will get worked down satisfactory in the coming quarters.

Yes. And then one last one, if I could. I know the -- some of these half capital structure issues like you just mentioned with Ahern, and the cover is pretty good for you. Would you happen to have a ballpark estimate of your typical recovery in scenarios where there are, call it, a capital structure issue with strong coverage. It seems that -- I think in the past it was pretty high. I don't know if you have an exact stat for that.

Yes. We don't have an exact one. But yes, our experience is, if you have well-located properties that have good unit-level metrics. And even in the event of a corporate balance sheet issue, we come out just fine. I mean we -- obviously, the pandemic had a piece of that flavor to it. 2008 and '09 had that, and our occupancy has held up very, very well through both of those stress tests, if you will. And so that's been our experience.

Our next question is coming from Ronald Kamdem.

This is Ron from Morgan Stanley. A couple of quick ones. Just one on the guidance. Can you remind us what you're assuming for bad debt reserves for this year?

Yes. We have been consistent within the last many years in our shop, we -- in our projections internally, we've always assumed about a 100 basis point potential loss for rent despite the fact that our experience has been better than that, meaning 50 basis points or less. And so -- but we keep that general assumption out there just to be somewhat conservative.

Makes sense. And then just staying on tenant health and so forth. Just what are you hearing from the tenant side? I know that others have already asked questions on that. But just more broadly, when you're -- is there anything -- or when you're looking at different industries and so forth. Is there anything that you're thinking or doing differently as we potentially go into a downturn sectors that you're either doing more in or sectors that you may be pausing or trying to do less in.

Going forward, the strategy still will be minding our relationships of our current portfolio. And the tenant knows their consumer even better than we know. So when they're comfortable to drop, just through M&A or new store growth, we'll participate. Remember, when you do sale leaseback, the underwriting is a little bit different because you do have the benefit of the tenant selling you the asset, and they're selling you assets that are pretty good because they're willing to sign a 15-, 20-year lease. So there's a self-selection aspect to our underwriting, which goes overlooked. Hence, why we have a high 85% renewal rate typically over the year. So yes, we're not -- we never target what sectors we want to go into more because we can only buy stuff that's for sale, first and foremost. But remember, Ron, we do the bottoms-up approach. We want to grow the FFO, that mid-single-digit area. And then we grow and say, "Hey, what acquisitions we have to do to achieve that. So that's really the first thing we target. Now our thought process on movie theatres is still the same. We got out of those a couple of years before the pandemic, so we're not looking to add in that industry. But the other industries, if you focus on real estate first, the credit isn't as important. So we're -- at the heart, we underwrite the real estate and find a small good locations.

Great. And then just my last one, if I may. So if I think about the AFFO number, which is basically $0.80 once you back out all the -- sort of all the back deferred rent collections and so forth. So as you're going forward and you're thinking about sort of that run rate, it sounds like potentially the interest cost could be higher, obviously as you're going to a higher rate environment. But is there -- is there anything else? Because the acquisitions obviously are coming through and so forth, but is there anything else that's in that $0.80 number that's maybe nonrecurring or onetime that we should be mindful of?

No. The second quarter was relatively clean. We didn't have much -- hardly any lease termination kinds of income, which we did have some in the first quarter. But as usual, the big variable that we don't give guidance on that has the potential to be a material impact is just capital markets activity. And so we obviously make some assumptions around that. We don't publish those in part because we want to retain maximum flexibility to do what we think is best at the moment for raising capital. And since -- the last years, in the past in the history, I can talk a little bit about what we assumed last year and what we actually did last year and our initial -- before the beginning of 2021, we assume we'd issued 5 million shares of equity, and we've issued no debt. Well, it turns out, we issued no equity and $900 million of 30-year debt. And we just felt like the relative value of debt at that point was a better place for us to raise capital and with the benefit of at least 6 months or 12 months of hindsight, we like that decision. But that's the rationale for not really -- part of the rationale for not kind of laying out our thought process is that it's always evolving and tries to take advantage of what's available in the marketplace at the time.

Our next question is coming from Tayo Okusanya.

Gentlemen, just a quick question around the acquisition outlook and just again, the level of acquisitions currently happening. I mean I would have ventured when we were all talking at the end of first quarter earnings, concerns about rising rates. Everyone's stock price was down year-to-date. One would have ventured that everyone would kind of have slowed down on the acquisition front. But you guys, a lot of your peers kind of have a strong acquisition quarter or reading acquisition guidance. And I guess I'm curious, the backdrop doesn't seem to have changed that much, why there's still such a -- an appetite or so much positivity on the acquisition front, just kind of still given some of these headwinds on the capital market side, some concern about credit, cap rates not moving and things of that ilk.

I can take part of it, and Kevin can just kind of chime in here on the capital markets side of it. As far as the appetite at the beginning of the year, we guided, it was -- 550 was the midpoint, or 600 was the midpoint. And that was based on the first quarter pipeline. And then we've been in the business a long time and talking to the relationships with kind of the outlook for the year. Cap rates now kind of what I touch based on, they're starting to move. We came into the year -- we were fortunate, I think we had $173 million of cash at year-end. So we do -- we had our acquisitions well-funded going into the year. And now talking to our current tenants that they're looking to grow, cap rates will adjust accordingly. So we're bullish on the second half of the year. We're comfortable with our acquisition number.

I'm fully understanding the sentiment of your question, but we might not be the best one to ask on that in some respect. I mean it was a surprise to us over the last, call it, 18 months coming in prior to 2022, that so many decided to double down on acquisition volume at record low cap rates. And to us, that didn't -- on its pace make a lot of sense, and it -- and at the cap rates where the market was, it just, to us, was not driving a sufficient amount of accretion per share growth, which, like we've talked about in our minds is job one. And so yes, I think your observation is generally right that there hasn't been a real pause there. As I mentioned, I think in my prepared comments that we think the asset growth focus, acquisition volume contest of recent quarters may be slowing a bit, but we've not seen much of it yet. But we're optimistic about that. And I hope it gets a little more disciplined on price. And so -- but fully understand the sentiment of your question.

Our next question is coming from John Massocca.

I'm with Ladenburg Thalmann. So maybe going back to the balance sheet for a little bit. Has the outlook on long-term debt changed at all recently? I'm just thinking, given some of the -- I know it's probably volatile, but given where the yield curve kind of is today from a kind of inversion to kind of flatten this aspect, I mean does that change the outlook versus maybe when we were talking last quarter or even back at NAREIT.

Yes. Clear. I mean clearly, the pricing has, and it -- the shape of that curve might alter one's view of what kind of debt they want to be using at the moment. And for us, like I'd mentioned on a previous question, for us, because of the very long duration debt we issued in recent years, 3 of the last 4 debt offerings we did were 30-year variety. And we could have gotten cheaper debt with shorter term debt, but we just wanted to lock in those low rates for a longer period of time. Because of that kind of that work and activity we did in the last couple of years, it affords us the opportunity to lean a little bit more on our bank line, which has largely been unused year-to-date. But the pricing clearly is a factor, and that's why you think you got to see some movement firms -- firming up of cap rates because the pricing clearly has moved materially on the debt front for sure. Whether people -- the curve is so flat, it's -- I'll be interested to see where any debt -- not much debt getting issued in REIT world, but if it gets extended out further or it comes in shorter and that might go to one's belief about how help long term these interest rates will be. Are they going to be at these levels for the next 5 years or the next 5 quarters. And so I'm not -- I don't have a good answer to your question, but that's just some of our thoughts around that.

Okay. And then maybe switching to kind of the disposition outlook. I know it's not markedly lower than 50% of the low end of guidance, but maybe kind of what gives you confidence in kind of getting to the guidance target on disposition front as we hit the back half of the year here?

Yes, as far as dispositions, what gives us a comfort level that we're below the 50%. I know what's happening on the disposition front of what our team is working on. A lot of it was kind of -- the lower number was more of a timing issue with the interest rates moving up. The 1031 market is still very robust, but a couple of deals we're working on just got delayed. So that's it. So that's why we didn't budge guidance, and we remain the same to the $80 million to $100 million for the year.

Our next question is coming from Spenser Allaway.

Green Street, again. I just had two follow-ups. So -- my first question, so just in regards to the inflationary pressure, have you guys had conversations with tenants regarding their ability to pass through cost to customers? And then kind of in line with that, can you comment on how rent coverage is trending, given this dynamic?

Yes. The conversations that we've been having with our tenants, it's kind of the same at the -- throughout the quarter that they were able to pass through the sales, not quite at the rate of inflation. It's still early in the cycle. But the conversations, they're not concerned with it. They're still very profitable. And then the interesting thing is in the inflationary market where rent is held constant, the coverages are holding up even though the profitability has come down slightly. But in the long run, our coverages are very healthy at the property level. And the tenants kind of what I'll reiterate, they are having the ability to pass through some of it, but not all of it.

Okay. That's great color. And then maybe just one more going back to cap rates. It seems as though commentary from peers that they've been seeing cap rates rise slightly more thus far in the back half of '22 than maybe what you've cited. I know you obviously can't comment on where peers are executing deals or what they're sourcing, but any insight as to why perhaps cap rates have seemingly moved less on deals you've executed?

I think it's a function of the market we play in. The sale leaseback with the large regional operators. I think historically, when you had the investment-grade tenants and the cap rates were trading at 5.5, 5.25 or ground leases that were in the floors, those ones have moved up the 25, 50 basis points. And I would expect that going forward. And then the cap rates that were north of 7, they haven't moved 50 basis points. They moved near the 20. But that area that we play in, the low 6 market, they've trended up a little bit but not to the degree of the investment-grade market we're finding. And the other thing you got to think of is our deals are long-term leases and triple net. So it's really tough to compare our peers to what we market because if we were buying 10-year leases, those have moved up as well to 25, 50 basis points. But again, it's a function of our market, Spencer.

Yes. And as Steve said, this is Kevin. I think you're getting more movement up where cap rates had compressed the most over the last year or two. And so to the extent that we were buying 5.5 cap rate deals, we might be talking about a larger increase in cap rates than where we've operated, as Steve mentioned, in the low 6s.

Our next question is coming from Linda Tsai.

From Jefferies. In your investor deck on Page 14, you show the history of acquisition volume and how the relationship-based deals offer a 20 basis improvement over market auction deals. With interest rates higher now, does that delta shift for any reason?

We haven't done much of the market auction deals. But I would expect right now, there's a little dislocation in the market, where we've negotiated a lot of our relationship deals prior to the interest rates moving. But I would expect going forward, they would normalize to what historical levels were.

And then at NAREIT, you discussed the opportunity to increase the tenant renewal rate of 85%. Could you just remind us again the factors driving that initiative.

So yes, we're putting in place now -- we're a very seasoned NNN REIT, been operating in the space a lot longer than a lot of our peers. So we have a lot of leases now that are starting to come at the initial term. So we're putting in place an extremely active portfolio management team to start getting ahead of the curve in the future. And hopefully, in a few years, we'll start seeing increased benefit of that.

Just one last one. With real estate expense guidance down $1 million at the midpoint, what was driving that?

We really just have fewer vacancies. And so -- but the way I think -- the way we think about it here is we think of our property expense exposure as the tenant reimbursement minus our property expenses, it was about $1.8 million, I believe, for the second quarter, and that's detailed on Page 6, near the bottom of Page 6 of the press release. Normal is kind of a low $2 million number for net property expenses that's probably kind of more typical and -- but it's influenced notably by vacant properties or the lack thereof. And -- and so that's what will that number around a bit. It's never too volatile. Typically operates kind of in that $10 million to $12 million annual range, and we're at $9 million to $11 million for this year.

Our next question is coming from Chris Lucas.

Capital One Securities. Kevin, just a quick follow-up on a comment you made earlier related to the bad debt you typically assume in your guidance of 100 basis points. What's the first half number on that?

We collected 99.7% in the first half. So it's, call it, 30 basis points. We're not prepared to necessarily call it -- the 30 basis point bad debt in that in some respect at this point, we'll pursue collection of that, but that's what got collected. And it's what that reported, just so you know, sort of revenues.

Okay. And then, Steve, just taking a step back on the competitive or the competition, all the peers you guys have talked about the fact that private equity pullback when rates moved higher. Just curious as to whether or not you're hearing anything about their re-entry into the market, given a little bit of a pullback in rates, although again, the market is pretty unstable. Just curious as to what you're hearing from that competitive set?

Yes. In the second quarter, I think we did 16 transactions and 14 of them were through the relationship. So we didn't participate in a lot of the super large deals that might have been out there. But put it bluntly, I have not heard the private equity groups that came in the market second half of 2021, first quarter of 2022 back in the market at all.

[Operator Instructions] There appear to be no further questions in the queue. Do you have any closing comments you wish to finish with?

Yes. Thank you for joining us this morning, and we look forward to seeing many of you guys in person kind of as the fall conference season kicks off here, and we'll see you then. Thank you.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.