Greetings. And welcome to the NETSTREIT Corp. Third Quarter 2022 Earnings 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, Amy An, Investor Relations Manager. Ma’am, you may begin your presentation.

We thank you for joining us for NETSTREIT’s third quarter 2022 earnings conference call. In addition to the press release distributed yesterday after market close, 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 31, 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 will turn the call over to Mark. Mark?

Good morning, everyone. And welcome to our third quarter 2022 earnings conference call. We are pleased to share that NETSTREIT continued to perform very well in the third quarter, despite high inflation, rising interest rates and macroeconomic uncertainty. With diligent planning and strong execution, we believe we can continue to create value throughout all stages of this economic cycle. During the quarter, we completed $130 million of net investment activity, closed on both our second forward equity offering of 10.35 million shares and our $600 million sustainability linked credit facility, locking in attractively priced capital before the latest interest rate hikes, and site and heightened market volatility. As stated in last night’s earnings release, given the nature of today’s environment and anticipated pricing adjustments and net lease assets, reflecting the disconnect between the current capital markets and property markets, we believe it is prudent to take a more opportunistic approach to capital deployment. While we are pleased with our investment activity to-date and are seeing no shortage of opportunities, rising marginal borrowing cost and increased equity cost across the sector, make it prudent for us to eliminate our quantitative investment targets. At the same time, the positive investment decisions we have made, the limited operating risk associated with our current tenant line-up and our ability to lock in significant portions of our capital structure in the third quarter, allow us to narrow our AFFO per share guidance range to $1.15 per share to $1.17 per share, resulting in a small increase in our midpoint of expectations. Given the current economic uncertainties, our portfolio of high quality assets is best positioned to weather the road ahead. With over 88% of our portfolio and defensive industries and partnering with retailers that have strong access to capital and experienced management teams, we believe…

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 $0.03, core FFO of $0.28 and AFFO of $0.30 per diluted share for the third quarter. The portfolio’s annualized base rent grew to $92 million in the third quarter, up 55% from September 30, 2021. Interest expense increased to $3 million from $895,000 in third quarter 2021, due to higher borrowing costs and increased debt balances. G&A increased to $4.6 million in the third quarter, compared to $3.8 million from third quarter 2021, primarily due to building out our team to 32 employees. As Mark stated in his opening comments, we had an active third quarter with regards to our financing activities, opportunistically completing over $800 million of capital raising and refinancing. We completed a forward equity offering for 10.35 million shares in August. Similar to our last two offerings, the deal was upsized and underwriters exercise the shoe, demonstrating the continued support from investors on our strategy and execution. Following our equity deal, we completed a new $600 million sustainability linked credit facility. The new credit facility includes a $400 million revolver that matures in August 2026, subject to an extension option and replaces our previous $250 million revolver. The credit facility also features a new $200 million, five and a half-year term loan, set to mature in February 2028, which is fully hedged at 3.88%. If we were to hedged term loan today, the all-in rate would be above 5%. As part of the recast, we have made some notable enhancements to our credit facility. Our cap rate utilized for valuing our asset base decreased from 7.25% to 6.5%. Covenants have been adjusted to offer greater flexibility for our…

Thank you. [Operator Instructions] Our first question comes from R.J. Milligan with Raymond James.

Hey. Good morning, guys.

Good morning.

Good morning, R.J.

Okay. I am curious, obviously, you highlighted the disconnect between the capital markets and private markets. I am just curious how you view your current cost of capital, what is it today and how do you calculate it?

Sure, R.J. And welcome aboard to the NETSTREIT team. I think the question that you are asking really is and shouldn’t be the question of the day, based on the changes that we are seeing in the capital markets. So whether we think about it is, we start by assuming our target capital structure, which you know, since the beginning of our existence, we said is a third debt and two-third equity. Our current capital structure is somewhat more conservative than that in under 30% on market cap basis. On the debt side, we think about our marginal cost of borrowing, which is somewhere between 4.1% and 4.2% on an all-in spot basis. But the forward curve is really indicating an increase in that all-in rate to about 5.6% year out, maybe 5.42% years out. So we need to take that into consideration, and if we are going to access the private placement market with term, that fixed rate slightly north of 6%. From our perspective, we really think utilizing a spot marginal borrowing rate or even our weighted average cost of debt, actually underestimates the true borrowing costs in the current market and the risks there is, it potentially produces false positive investment decisions for assets we intend to hold for the long-term. So that’s the debt side. On the equity side, we have historically utilized implied cap rate as a proxy for our marginal cost of equity. Just as look at this morning at the current trading levels, our implied cap rate is somewhere in the 6.5% to 6.75% range, and even if you use an AFFO yield, probably, produces a result that’s very similar to that range. The marginal cost of the undrawn $200 million forward is probably about 50 basis points inside of that. And similar to the way that we were thinking about the spot rate on the debt side, the benefit of the undrawn forward could produce positive investment decision for assets that our spot equity cost wouldn’t, right, and really our preference with respect to that is to utilize the benefit to provide additional accretion to our shareholders for less marginal investment decisions. So those are kind of the components. So if you are asking me to peg a specific range, I’d probably put our WACC for investment decision-making purposes in the low-to-mid 6s. If you want me to pinpoint something, probably, the best number that we have in a volatile market, it’s about 6.25%.

That’s helpful, Andy. And so, then, what is the spread, assuming that you maintained the sort of credit quality that you guys have been buying, what is the spread that you need to achieve to go out there and become more aggressive on the acquisition side?

Yeah. Sure, R.J. So there’s a couple of pieces of that. One, we do feel like the fundamentals in the market should indicate that cap rate should be a little bit higher than they are and we are starting to see some cracks there. So while we have been buying at a blended 6.6% cap rate over the past couple of quarters, and like you said, we are not interested in dropping our investment criteria in any way, we really feel like we are not really getting paid enough currently, but there is a light at the end of the tunnel. So it’s a little bit of a tough question as it will depend on credit quality, real estate quality, lease term, rental increases and then the capital markets are going to be fluid. So, like, if there is a good asset with a AAA rated tenant and a 25-year lease and good rental increases, would we move forward at Andy’s number as a 6.25% to improve the portfolio potentially. But then on the flip side of that, if there is a weaker asset with some issues that’s really on the edge of our investment criteria at a 7.5%, we probably would not move forward with that. So certainly a lot of variables there, but the fact that we really do see that, there is a number of opportunities that is really coming back to us on pricing and seeing the signs of our -- the early signs are that our patience is paying off. So feel like we are -- everything is accretive right now. It’s just when you kind of run the sensitivity on our model. Volume usually really dictates how much more you are going to make in the next year, it really just doesn’t have as much of an impact right now. So we feel like it’s prudent to be very cautious and really try to make sure that we are maximizing the capital that we have raised.

Thanks, Mark. And just a follow-up to that is, you said that, you are starting to see signs of the market is cracking and I am curious what do you think the catalyst is for the market to really open up and cap rates to acquire…

Yeah. No. Yeah. I think that’s a great question. I think that’s been what every net lease company is really trying to figure out over the past six months and probably for the next couple of quarters. Like we said, I mean, the fundamentals clearly show that cap rates should be moving up as we have seen everyone’s cost of equity and cost of debt increase. But really what we are seeing, sellers really got used to very aggressive cap rates that we were seeing in 2021 and before that. So if sellers can hold off on selling, they are going to hold off. Those that have pressures to sell, they are going to be very patient and try to find a 1031 buyer, who is willing to pay 2021 prices and that does exist. It’s just getting a much harder to find those types of buyers. Then those that can’t be patient, have to sell, they have got to sell at prices that make more sense for us and we have been able to pick off a few so far this quarter. We just don’t know how many we are going to be able to pick off. The market is not completely there yet, but we feel like it’s certainly on there.

Appreciate the comments. Thank you.

Thank you. Our next question is with Nick Joseph with Citi.

Thank you. Completely understand being opportunistic and disciplined. I was hoping you can kind of quantify where the current pipeline is today and then just compare that to where it normally looks on the forward. I don’t know either kind of three months or whatever kind of metric you focus on?

Yes. Yeah. Sure. So, I think the opportunity set that we have is drastically larger, just as you have got the leverage buyers largely out of the market. I think a less competitive or less deep 1031 market. It’s really just coming down to pricing and what we -- where we see potential cracks. And I think that -- so when we basically took away the quantitative piece of the fourth quarter acquisitions guidance, we could still hit it. It’s just debatable how many of the sellers are going to come to our pricing. Starting to see a little bit more of that really in the last week or so, so difficult to say how much of that’s going to come our way. But in terms of the opportunity set that we could move forward with right now it’s larger than it’s ever been.

That’s helpful. And then just on that movement in cap rates. So there are different categories or retailers or tenants adjusted more versus others thus far.

You know it’s funny. We get asked that question a lot over the last couple of quarters, is it investment grade, is at this tenant, is that tenant. It really comes down to the situation that the sellers and how much pressure they have on them to sell and whether they can be patient or not and so that’s -- it really has had very little to do with what type of asset. I am sure if you are down, the four cap rate range like some of the industrial was, that’s going to -- you are going to get negative leverage a lot more quickly on the lower cap rate deals, but it’s really come down to what type of seller are we working with.

Thank you very much.

Thank you. Our next question comes from Ki Bin Kim with Truist.

Thanks and good morning.

Good morning.

So I was wondering if you can help paint the landscape as we look into next year. Obviously, the acquisition part of that is a little bit more ambiguous, which makes sense. But how about things like G&A, interest expense, and I am not sure if there was, I remember, while back, there was a topic about the insurance costs as well for the company. I just want make sure that we don’t get surprise in any one way or another?

Yeah, Ki Bin. So interest expense with 93% of debt costs locked, right? We have only got $30 million of floating rate balances except for what we would used to fund incremental acquisitions. I think that we were able to provide some -- you can just get from our disclosure, some certainty around that. With respect to G&A, over the course of 2022, we have been building out our team. We are currently 32 boxes on our org chart. A couple of them have people in -- apparently currently that we are going to be looking to replace, but I don’t see the staff really going beyond that. So I think that you are going to start seeing some stabilization of G&A on the income statement. Just be aware, there is some seasonality with respect to it, whether its tax or auditor fees, that are a little bit more heavy -- heavier weighted to the first quarter and second quarter. But outside of that, I think, that we are getting to stabilization with respect to things like salary and benefits. As it related to the D&O, we have been performing well there. We didn’t get the D&O increase that we felt that we were going to get, so some of that is some of the pickup that you are seeing in G&A. It’s not a lot. It’s $100,000 -- a couple of $100,000 on an annual basis. But we are getting to the point where we are just over two years to the public company journey and we are really doing a good job of stabilizing that part of the income statement.

And I can’t remember, if I missed it, but did you guys give an update on the assets you closed in the fourth quarter to-date?

We have not.

Are you able to provide just some color around that?

Yeah. I mean, it’s pretty similar to the types of assets that we have acquired, but we are not providing a dollar figure on that.

Okay. Thank you, guys.

Thanks.

Thank you. Our next question comes from Wes Golladay with Baird.

Hey. Good morning, everyone. Guys a little bit more on the developer side [Technical Difficulty] right now [Technical Difficulty]

I really could not understand. Maybe if you get little closer to the mic or pickup the handset, I couldn’t hear you, Wes.

Oh! Sorry. Okay. Actually my phone got unplugged. For the developers that are not, I guess, what I am looking for is the developers, you mentioned the 1031 market was not that robust right now. So I am kind of curious what are the developers doing if they are not hitting the bid right now? Are they holding off on new developments and is this a segment you typically get a higher yield from?

Yeah. That’s -- It’s a great question. So especially the larger developers that are going out and developing 150 locations, various tenants that we try to acquire, typically we have reached out to a lot of those types of developers, they either don’t call us back or we don’t really get anywhere near where we need to be on pricing, because of the robust 1031 market. And so, they are having a lot more difficulty, historically, selling, 15, 20, 25 locations every month. Now they are only able to sell two or three locations every month. So their -- either their equity sources and their debt sources are getting stretched pretty thin as their inventory is growing. So we have been having a lot more conversations with those developers. But developers by their nature are very optimistic for as long as they possibly can. So I am not sure exactly when the levy is going to break there, but that does feel like an area where there could be some opportunity.

And just a follow-up on that, it’s typically a higher yield when you look at the way you source deals throughout the year. You have multiple channels, is this one of the higher cap rate channels and probably the tight band, which is the debt is up unusually?

Yeah. It’s a good question. So developers, if they are able to finance themselves and develop properties all the way to certificate of occupancy and then they sell into the 1031 market, they are going to get more aggressive pricing than what we are willing to pay. But then the developers that would prefer for us to finance their development, so whether we are buying the land and funding development or providing a guaranteed equity takeout, we do typically get better cap rates on those types of transactions.

Got it. And then one modeling question, do you happen to have the end of period rent for the -- on a cash basis, excluding the active developments?

Yeah. We will follow up with you offline on that one.

Okay. Sounds good Thanks, everyone.

Thanks, Wes.

Thank you. Our next question comes from Joshua Dennerlein with Bank of America.

Yeah. Hi, everyone. Just curious, you mentioned in your press release appropriate pricing for assets. What do you think is appropriate pricing in today’s environment, last quarter was the 6.6% on the acquisitions, just kind of curious?

Yeah. No. It’s a good question. So, I mean, I think, it’s really going to be asset dependent, depending on credit quality, real estate quality, lease term, rental increases, et cetera. And so, feels like we are going to start to see some pretty good increases in cap rate as just that’s kind of what we are expecting and from the conversations that we are having with various sellers. How much higher that goes, I think, is -- it depends on what happens in capital markets, as well as whether other buyers are able to kind of come back to the market. So it’s got a lot of different factors there, hard to say where it goes, but I think it should be meaningful to us.

Appreciate that. And then, you mentioned Big Lots. You said it’s no longer an IG like credit after rich resource.

Correct.

How do you think about that in the portfolio? Is that a temporary blip for them or something that maybe-- is that something you would maybe you look to like monetize?

Yeah. I mean, obviously, we are always looking at what we can sell and what the best economic outcome is for various different strategies by assets. But, yeah, I mean, look, I mean, Big Lots has got supply chain concerns, freight costs, both via truck and over the ocean have really pressured margins. That being said, their total debt to EBITDA is 2.1 times which almost still meets our investment grade profile definition. But we know -- look, I mean, I do think we are going to see margin pressures persist, but they have got over $400 million of liquidity. So I think they are going to be able to weather what’s going on right now and really doesn’t provide any real concern as it relates to their ability to meet their financial obligations and then we have got 10 locations that I think we feel really strongly in the real estate where the rent is replaceable. So I think we have got a long way to go before we start to really have major concerns there. But certainly, the trend is not going in a positive direction with that tenant.

Okay. Thank you.

Thank you. Our next question comes from Todd Thomas with KeyBanc.

Hi. Thanks. Good morning. I just wanted to follow up a little bit on the investment activity and the slowing pace of investments that you are talking about, which we think makes sense, just given the volatility in your cost of capital in the market more broadly. But we are through October and I am curious if there’s any way to size up what the fourth quarter might look like in terms of acquisitions and just maybe help us also think about deal volume heading into 2023? Again, I realize the world has changed quite a bit, but the pace of external growth that I think investors have been thinking about was sort of in the $500 million range per year. I am just curious what you might be thinking about over the next few quarters, if you could maybe provide some insight?

Honestly, I wish I could give you better guidance other than it’s going to be facts and circumstances driven, based off what the opportunity set is and whether we start to see enough volume move into the cap rates where we feel like we are, maybe not making the same spread that we did over the past couple of years, but kind of trending more in that direction. So it’s just a little bit difficult for us to give guidance on what we think we are going to do in 2023 when we were struggling to tell you what we are going to do in the fourth quarter of this year.

Todd, if I could just add a little bit to that. I think you go and take a look back, I mean, beginning of the year SOFR was like zero, right. It’s 3% now. You have seen equity costs go up dramatically, right? And we have been able to kind of make hay by buying assets, as I said in my prepared remarks, better yields than the peer group. But I just think that the pace of change of the capital markets has just been so great in such a short period of time. It would almost be irresponsible for us to go and start throwing numbers out there without getting a better look as to some of the changes that Mark talked about earlier that we are starting to see at the beginning, so.

Okay. And in terms of the fourth quarter, is this sort of -- off of sort of the $125 million maybe $135 million pace that we have seen. Are you thinking something more in the $450 million range or might just sort of fall, just a touch short of the $500 million for the full year as we kind of think about like the exit rate heading into 2023?

Yeah. I mean it’s going to be opportunity based. I mean, we are going to be opportunistic. I think all things are on the table. We have got some opportunity to take advantage of the fact that there is a 1031 market out there and potentially sell some assets and then redeploy. So there’s a lot of different factors that we are considering and a lot of different options that I think are on the table. The thing that we don’t want to do is take money in one pocket and just put it in the other and we are bigger without really any benefit to shareholders. So we think the best thing for shareholders is to consider all options on the acquisitions and dispositions side and try to maximize the transaction volume that we are going to do. And what that looks like, is it still in flux.

Okay. Got it. And then, just last question also, just following up, I guess, on the underlying credit of the portfolio and in the context of the discussion around Big Lots being lowered to sub-IG during the quarter. I am just curious as you look out, if there are other retailers, other tenants on your credit watch list over the course of the next few quarters as we head further into the cycle where you see potential risk and not looking for names specifically, but just in the context of the overall portfolio and your exposure to IG and IG like profiles?

Yeah. No. I think it’s a good question. And really what we have seen with the tenants within our portfolio, as you know, it’s a very defensive portfolio, very high credit quality portfolio, not a lot of debt coming due for these tenants, which I think is going to be interesting to see how some of the retailers are able or not able to refinance their debt. But I think it should be indicative of the quality of the portfolio when you consider Big Lots is a company with almost $1 billion tangible net worth with $400 million of liquidity and total debt to EBITDA is 2.1 times, which by most definitions is not very leverage. If that’s the one that we are talking about on the call, I think, that should be seen as a good sign, and in fact, we have had a couple of credit upgrades within the portfolio.

Okay. All right. Thank you.

Thank you.

Thank you. Our next question comes from Nick Yulico with Scotiabank.

Hi, everyone. First question is on drugstore investments, you did take your exposure up to this segment and also the CVS now specifically 11% of ABR. I mean how much higher are you willing to take the exposure for CVS and for the drugstore category?

Yeah. No. Great question. It was really -- we weren’t really planning on increasing our pharmacy exposure as much as we did, but we saw a couple of opportunities specific with CVS and Walgreens that were very attractive pricing. Really strong locations that we felt where the best risk adjusted returns that we could provide investors. I would not expect us to be adding to those names. In fact, we just mentioned disposition that could be something that we look to maybe offload a couple of those locations in the 1031 market at pretty attractive cap rates and redeploy into other retailers that we like, just to improve our diversification. But, yeah, I mean, when we are the size that we are one or two transactions, certainly, can drive up the concentration, but we -- I wouldn’t expect to see us move our concentration higher in the near future.

Okay. Thanks. And second question then, Andy, is on, when we were talking about earlier how you thought about your weighted average cost of capital, it kind of sounded like to me that if -- where you are looking at your cost of debt, If you look forward based on the curve that it’s not necessarily that debt is a cheaper cost than equity over the next year. If you kind of look at over a full year on where interest rates could be. I guess, how are you thinking about that equity versus debt mix and going back to as well, I know your leverage target, I think, it’s 4.5 times to 5.5 times debt-to-EBITDA. So, I mean, are these situations where you are going to over equitize, perhaps, because of some of these dynamics?

Yeah. I mean, look, and we have over equitize today, right? I mean, we are below 30% on a market cap basis, debt-to-equity with the target of 33%. Yeah, we are constantly thinking about the tools that we have in our toolbox and the $200 million forward that we did in August is a great tool for us to use. If equity prices start trading in a more acceptable range, the ATM, either spot or forward, is another tool that we can use there. But the point that I was really trying to make is, I think that, just looking at spot rates in the current environment, could really cause you to regret some of your decisions, can lead to false positive investment decisions. And we -- and similarly, the idea that the balance sheet is over equitized, if debt capital, we saw great opportunities with respect to debt capital utilizing that to get a little bit more in lines is an option on the table too. So, I mean, Mark and I, Randy and Amy, we talked about this like literally every day, right? So we are constantly looking at the menu of opportunities that are out there. And I think the greatest thing that we have been able to add is, we have been able to be very, very nimble, right? We are able to pull off that August offering right after we announced second quarter earnings. And similarly, we were very early in the Q for term loan market, which is a market that’s becoming significantly tougher. So, yeah, all of those options are on the table.

All right. Makes sense. Thank you.

Thank you. Our next question comes from Linda Tsai with Jefferies.

Hi. Appreciate the prudence with which you are allocating capital going forward. Is your assumption that you stick with the 65% IG profile or would you expect to capitalize on more IG like tenants?

Yeah. I mean, I think, we would like the investment grade profile tenant just as much as we like the investment grade tenants. In that the risk profile is, in most cases even slightly better for investment grade profile as they carry no debt and generate strong cash flow of larger retailers. There are just fewer of them out there. So, I think, the opportunity set will likely dictate what we buy, but I would expect the ratios of the portfolio to remain fairly constant.

And then can you comment on any general trends in the sale leaseback environment and whether higher cost inflation are catalyst for operators to do more sale leasebacks?

Yeah. And as you know and we have only done a handful of sale leasebacks, but I do think that when CFOs start looking at refinancing their debt and they may have a little bit of sticker shock, I would assume that sale leaseback could start to make a little bit more sense than it has in the past.

Thanks.

Thanks, Linda.

Ladies and gentlemen, there are no further questions at this time. I would like to turn the floor back over to Mr. Mark Manheimer for closing comments.

Thanks everyone for joining today and for those of you attending the upcoming conferences, we will look forward to seeing you then.

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