Greetings and welcome to the NETSTREIT Corp. Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Cathy [indiscernible], Investor Relations. Thank you, Cathy. You may begin.

We thank you for joining us for NETSTREIT's second quarter 2022 earnings conference call. In addition to the press release distributed yesterday after market closed, we posted a supplemental package and an updated investor presentation. Both can be found in the Investor Relations section of the company's website at www.netstreit.com. On today's call, management's remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. For more information about these risk factors, we encourage you to review our Form 10-K for the year ended December 31st, 2021, and our other SEC filings. All forward-looking statements are made as of the date hereof and NETSTREIT assumes no obligation to update any forward-looking statements in the future. In addition, certain financial information presented on this call includes non-GAAP financial measures. Please refer to our earnings release and supplemental package for definitions, GAAP reconciliations, and an explanation of why we believe such non-GAAP financial measures are useful to investors. Today's conference call is hosted by NETSTREIT's Chief Executive Officer, Mark Manheimer, and Chief Financial Officer, Andy Blocher. They will make some prepared remarks and then we will open the call for your questions. Now, I'll turn the call over to Mark. Mark?

Good morning everyone, and welcome to our second quarter 2022 earnings conference call. Before I discuss our investment activity for the quarter, I want to take a moment and say how pleased I am with the team's ability to consistently source attractive investment opportunities at strong yields and continue to be nimble and creative in a dynamic market. We have a unique and proven strategy and our performance demonstrates our continued ability to execute and drive strong and steady results. With that, I am pleased to report that we completed $122.7 million of net investment activity for the quarter. In a market that is evolving rapidly with higher interest rates and macroeconomic uncertainty, we have remained disciplined and selective with opportunities -- with the opportunities we pursue. As we started to see changes in the acquisitions market, we pivoted to higher quality and better priced acquisitions, as shown by the higher yield for the quarter, which resulted in approximately $375,000 in debt deal costs in the quarter. We believe this was the right strategy as there was a clear economic benefit to being nimble in an evolving market. Since our IPO less than two years ago, we have more than doubled our portfolio size from 163 properties to 381 properties. Our ABR from $34.5 million to $84.2 million and enhanced our diversification metrics, while maintaining the highest credit quality and stable portfolio in the net lease space, increasing investment grade and investment grade profile tenancy about 900 basis points to 81%. Our portfolio is largely made up of tenants in the necessity, discount and service industries, all of which are well insulated from recessionary and/or inflationary pressures. Despite uncertainty in the current economic environment, we believe that the defensive nature of our portfolio will allow us to continue to outperform…

Thank you, Mark. And once again, thank you all for joining us on today's call. In our earnings release published yesterday after market close, we reported net income of $0.04, core FFO of $0.26 and AFFO of $0.28 per diluted share for the second quarter. The portfolio's annualized base rent grew to over $84 million in the second quarter, up 52% from June 30, 2021, driven by 114 acquisitions, seven developments and two mortgage loan receivables since the end of the prior year second quarter. Interest expense increased $600,000 to $1.5 million from $900,000 in second quarter 2021, due principally to our higher average balance outstanding on the revolver and increased base rates compared to second quarter 2021. G&A increased to $4.9 million in the second quarter compared to $4 million from second quarter 2021 and primarily due to an increase in the number of employees from 24 to 30 to support our growing portfolio. In addition, as Mark referenced, we had approximately $375,000 of dead deal costs in the quarter, but we do not expect this increased level of debt deal costs in the future quarters. Turning to our balance sheet. At quarter-end, we had over $39 million in escrow to facilitate acquisitions that closed on July 1 and total debt of $412 million outstanding, of which $175 million is from our fully hedged term loan, with the remaining balance from our revolving line of credit. We launched a recast of our credit facility on July 11 to expand our revolver from $250 million to $400 million and to add a $200 million loan five-year term loan to our debt structure. The new term loan is expected to be freely prepayable at any time, providing optionality to access the private placement market or to seek other capital markets alternatives…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is from Todd Thomas with KeyBanc Capital Markets. Please proceed with your question.

Hi, good morning. First question, in terms of funding investments throughout the balance of the year, you have the remaining shares to settle from the forward equity in January. And Andy, you just discussed a little bit of the -- in the revised guidance, the -- your expectation for the weighted average shares. But I was just wondering if you could just talk about plans to permanently finance the line balance from here and also discuss thoughts on raising equity capital in the back half of the year, as you look towards the $500 million net investment guidance that you maintained?

Yeah. Thanks Todd. Yeah. So, from our perspective, look, we're taking a big step by funding line balance with the recap that we just talked about. That’s a -- it's a $600 million recast where we stand right now. We've got about $900 million of current in-place commitments. We're waiting on another $170 million more. We'd anticipate that, that would close in the next couple of weeks, but it is fully committed. That's like I said, it's a long five-year, a new long five-year term loan that goes along with the existing term loans that comes to maturity at the end of 2024. So, we feel like from a debt perspective, we're pretty locked up, and we're adding -- as I said in my remarks, we're adding another $350 million worth of debt liquidity on the balance sheet. On the equity side, yeah, we've got $95 million roughly of equity that remains undrawn under the forward from -- on the leverage and lowering the share count expectation. The real key there is we just wanted to get greater certainty on the debt financing before we decided to be more efficient on the funding mix, right? So, if you recall, we started off the year -- we were talking about a private placement, the private placement market closed very, very quickly. That's when we move to the debt market. And we're really thankful for the support that we have. We still have access to -- I think it's roughly $160 million worth of equity through the ATM, and just feel very confident with where we stand as we look out at the opportunity set that Mark and his team is looking at on the asset side.

Okay. Does the current budget have any additional equity capital being raised throughout the balance of the year? It looks like you would be in sort of the high five times range on a net debt-to-EBITDA basis, pro forma the remaining $250 million of acquisitions or so. You mentioned the 4.5 to 5.5 times target leverage level. I realize you've been below that by a wide margin for many quarters, and it may bounce around a little bit above that in the near-term. But where would you expect to be at year-end?

Yeah. I mean, I would think that we would probably be a more efficient leverage, probably around size. And like I said, we're never going to talk about specifically a -- the specific methods that we have available to us. But we have not been active on the ATM, and we do have that as a tool at our disposal to take advantage on a go forward basis.

Okay. And then, in terms of asset pricing and acquisition cap rates, I was just curious if you could talk about pricing trends whether you are seeing cap rates widen a bit as buyers and sellers begin to adjust the higher interest rate environment and sort of what you're seeing in the pipeline today.

Yeah. Absolutely. So, yeah, I mean, you saw a pretty big pivot from us early on in the quarter, which resulted in a little bit of dead deal costs, which we always like to try to avoid, but the increase in pricing was just the -- a lot of the typical buyers falling out of the market. I think a lot of the 1031 buyers that use leverage the ones that were locked in an exchange needed to close on those transactions. But once those kind of really flowed through the market, we've really seen less activity with 1031 buyers. They're still there, but -- any of them that use a decent amount of leverage are not going to be -- we don't anticipate being as active. And then certainly, the larger private equity firms that are using a lot of leverage are more or less completely out of the market. And so, we pivoted during the quarter. And I think it shouldn't be lost on everybody that not only did we get a 6.7% cash cap rate on acquisitions. But then when you look at the quality of what we acquired during the quarter from a credit standpoint, weighted average lease term, et cetera, we are really excited about the opportunities that we saw during the quarter, which is why we pivoted. And so, certainly, in my view, our highest quality portfolio acquisitions during the quarter. So, we hope that continues to be the case. But I think, certainly, we've seen in the neighborhood of 25 basis points on average increase in the areas that we're looking for.

Okay. Great. And one last one. Andy, if I could just go back to the recast and the term loan. Is the term loan fixed or variable? And do you plan to put hedges in place?

Yeah. I mean, so that's -- when we talk about the interest expense guidance expectations, the -- so the forward surfer curve has just been like literally all over the place, right? We had shown our rate to our Board recently and the current market is well inside of that. So, we're going to evaluate. I think, our thought at this point is while it has a delayed draw feature, we would likely fully drawn it down at closing. And then the question is going to be what is the forward-curve look like at that point? And how do we think about fixing that in either in full or in part based on market conditions at that point in time. But with the fed increase in rates by 75 basis points with GDP read, yesterday, I think that you've seen a little bit better forward-curve recently than we have seen not, but like a week or two ago, right? So, that's an evaluation that we'll make and we'll certainly make you aware of that at that point in time.

Okay. Great. All right. Thank you.

Thank you. Our next question is from Nicholas Joseph with Citi. Please proceed with your question.

Hey, guys. It's Chris Wetherbee on with -- Nick Joseph. Are you seeing any -- I just want to follow back up on the transaction market. Are you seeing any buyers pull out of certain markets more so than other markets? And has there been differences in buyer appetite across different qualities across the quality spectrum for different assets?

Yeah. It's a good question. I think really where we started to see more buyers pull out, it really had to do with more of the leverage buyers at lower cap rates. So, the higher quality transactions that were, in many cases, well below the cap rates that we're acquiring assets at. A lot of those deals started -- we started to get a lot more calls on those types of transactions as kind of the lower four cap rate range transactions, people relying on debt, you start getting to leverage a lot more quickly on those types of transactions. So, as you start moving up the cap rate scale, that started to creep in more and more as interest rates continue to rise. So, I think it's really been much more the buyer that's relying on leverage. You saw it really in industrial, which we're not really active there at all, which had lower cap rates. You've seen like Amazon. Distribution centers kind of that we're trading in the three, is kind of trading at kind of the higher fours, up to a five cap. So, really pretty big displacement in that market. And then, as you start creeping up into retail and some of the lower cap rate deals, just the debt doesn't pencil for the higher leverage buyers. So that's really where we've seen the biggest impact. And so, we've certainly just seen a massive increase in our opportunity set, which allowed us to be significantly more selective on the quality, as well as on pricing this particular quarter. And we're seeing that into the third quarter. So, we're pretty excited about what we're seeing in the third quarter as well.

Got it. And then, with a tougher macro backdrop today, how are you guys thinking about the watchlist? Are there any tenants on the watchlist that maybe you're keeping a closer eye on? Or how is the watchlist evolved?

Yeah. Sure. Yeah. And it's pretty similar to what we were starting to see last quarter as it relates to the consumer, especially on the lower end. They're really starting to get under more and more pressure, savings for the consumer or back to pre-pandemic levels. You're starting to see consumers rely more on credit cards. And Walmart and Target results, I think, illustrate necessity products they're selling and discretionary is not. So, we took a pretty deep dive into our portfolio. Feel really good about the defensive nature about what's in our portfolio. I think if we have one tenant in particular that I think has seen pretty poor results most recently, that would be Best Buy. They've had a bit of a rough year, is really just the health and the preferences of the consumer have shifted, but their sales are above pre-pandemic levels. And we're very confident in the tenant's resilience and the assets that we own. So, we don't feel like there's any risk to the rent or anything like that. But I think we need to be pretty cautious on that particular tenant. But we do -- I think we do a pretty good job of underwriting not only in the tenant health, but the cyclicality and predictability of tenant health in various different economic environments. And we certainly have a pretty volatile market out there. And then, I think, we also do a pretty good job of applying an appropriate asset management plan after we acquired the assets. If you recall, last year, we sold an RV asset, which was -- that was kind of at the peak of its cyclicality doing extraordinarily well last year. You're starting to see Keystone and Winnebago in the news was, not so positive news. So, we're really happy that we moved out of that asset last year. So, I think that speaks to how we're thinking about when we can opportunistically move out of certain assets and really trying to focus on assets that we feel like are going to do very well in any economic environment.

Good color. Thank you.

Thank you. [Operator Instructions] Our next question comes from Connor Siversky with Berenberg. Please proceed with your question.

Hey, out there. Thanks for having me on the call. Just quickly on the development pipeline. I noticed the spend this quarter was around $5 million. And again, in the context of kind of these heightened risk factors and maybe seeing some of your developers pulling back from activities. Can you provide any expectation for what that run rate spend might look like through the end of the year and possibly into 2023?

Yeah. Sure. I mean, it's going to be pretty dependent on what's going on with construction costs, labor costs, et cetera. So, a typical development deal for us is where we're partnering with a developer, they cut a deal with -- they've got their construction budget and they've got whatever they paid for the land or whatever they've signed up to get the land under contract for and then, they negotiate what the rent is going to be with a tenant and that kind of locks in what their yield should be and what they can flip the asset at. And so, we've been very active in having conversations with the developers that we work with. And they're really just getting squeezed. So, the construction cost being higher, labor cost being higher as well as more difficulty -- even really getting labor. So, seeing the pressure that they are under and knowing that the tenants are typically not willing to renegotiate the rents that they've agreed to, we don't want to be put in a situation where the developer is coming back to us and asking us to take the pain. So, we're like -- we just see a lot of opportunity in other areas right now where we think it's prudent for us to kind of take a step back and really see where that -- how that plays out and take a cautious approach and especially in an environment where we have ample acquisitions opportunities.

Got it. Understood. And then, maybe just a bit of a modeling question on the 26 investments included -- completed during the quarter. Can you give us any sense of time waiting as to when -- as to when those 26 were completed?

Yeah. Connor, I think that our -- from -- bringing them on to the portfolio, I think we had an average of about 20 days.

Sorry, say that one more time.

20 days, and that was somewhat influenced by early in the quarter where we started to see cap rates start to move and seeing better opportunities where we pushed back on some other transactions, anything that we saw in diligence, we pushed back pretty aggressively on some of the sellers. And so, we ended up with more of a backend weighted quarter, which I think will likely reverse itself in the third quarter.

Okay.

Yeah. And Connor, just recall, we obviously -- we closed roughly $40 million on the first day of the quarter, right, in the third quarter. So, we're well ahead of that pace.

Okay. So, for the second quarter, we're looking at just for clarification, 20 days after March 30 or 20 days before June 30.

Yeah. 20 days before.

20 days average outstanding is the way that I thought about it.

Got it. Okay. Thank you. That's all for me.

Our next question is from Josh Dennerlein with Bank of America. Please proceed with your question.

This is Dan [indiscernible] on behalf of Josh Dennerlein. I was hoping to see if you can elaborate more on, where you see the best opportunities for capital recycling within the portfolio?

Yeah. Sure. I mean, we're always kind of taking a look at the portfolio where we see potential risk. Fortunately, we took such a deep knife to the portfolio before going public that there really isn't much of anything, that has -- there's any concern. Now that being said, we do keep relationships with various other counterparties in the marketplace, whether they be DST operators or 1031 buyers or even brokers that have some relationships where somebody may find themselves in a trade and need to close on something quickly. So, we'll take advantage of those types of opportunities and sell assets here and there. I think like our 7x11 and some other assets within the portfolio, oftentimes, we get pretty aggressive offers on those, sub-five cap range. And so, in the event that we can sell some of those assets in at pretty aggressive cap rates, and we feel like we can redeploy the capital efficiently and accretively, we're always willing to do that, but we also don't want to be out the market selling $50 million, $60 million and not be able to replace it in the quarter, because that put some pressure on earnings.

Great. Thank you. And then also, could you also remind us on what the mix between the fixed rent bumps and inflation link bumps within your portfolio as well?

Yeah. Sure. I mean, we have a few assets in the portfolio that have CPI bumps, but I think oftentimes people think of that as inflation protection. But the reality is, almost all of the CPI rent bumps in the net lease retail space are three times CPI, the lesser of three times CPI or 2% or 1% or whatever the transaction is, depending on how that lease is structured, we would rather just have 1% or 2% fixed rate bumps for the periods of time where there isn't inflation to make sure that we're getting the maximum rent growth. So, having a few leases in the portfolio of CPI with caps, we kind of view those as inferior to the fixed rate bumps, but maybe two-thirds of the portfolio has some level of rental increases.

Thank you.

Thank you. Our next question is from Connor Siversky with Berenberg. Please proceed with your question.

Hey, just one more for me here. I'm just looking at the provision for impairment recognized in Q2, was that any -- was that related at all to any assets that were maybe slated for sale and then moved back on to your operating portfolio once mark-to-market?

Yeah. We kind of had a kind of a odd situation related to the advanced auto parts store that we sold in the quarter where we terminated the lease and then sold the property during the quarter. So -- and then we're expecting to get a lump sum of the remaining lease payments in the third quarter. So, just that timing led to what would be an impairment and then likely a gain after that or some revenue that is a little bit unusual. But all-in-all, if you put all those pieces together, it actually would result in a slight gain. So, it's just a little bit of a funky accounting scenario.

Got it. Can you quantify what that gain would be at all?

I mean, we're talking about $100,000 or something like that, so pretty much.

Okay. Understood. Thank you.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mark Manheimer for any closing comments.

Well, thanks everybody for joining us today, and we certainly look forward to continuing the dialogue in the future. Take care.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.