Essential Properties Realty Trust, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Dollar amounts are in millions unless noted. The company was formed in January 2018 and completed its IPO on June 25; comparative operating results include its predecessor, so they are not a like-for-like comparison of a public-company operating history.
Business context and portfolio
Essential Properties is an internally managed net-lease REIT focused primarily on freestanding, single-tenant properties leased long term to middle-market service-oriented and experience-based businesses. At June 30, the portfolio had 604 property locations, annualized base rent of $90.4 million, and 99.3% occupancy. The weighted-average remaining lease term was 14.3 years; 93.5% of annualized base rent came from triple-net leases. The company intended to qualify as a REIT beginning with tax year 2018.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $21.7 | $13.3 | $41.9 | $23.4 |
| Net income | $3.5 | $2.0 | $4.6 | $2.6 |
| Net income attributable to stockholders and members | $3.4 | $2.0 | $4.5 | $2.6 |
| Operating cash flow | Not separately stated | Not separately stated | $13.6 | $9.7 |
| FFO | $9.6 | $5.3 | $17.8 | $9.5 |
| AFFO | $8.5 | $5.0 | $15.9 | $8.9 |
Q2 revenue increased 62.9% year over year and six-month revenue increased 78.9%, principally reflecting acquisitions. Rental revenue was $21.5 million in Q2 and $41.6 million for the first half. Net income included real-estate disposition gains of $2.4 million for Q2 and $3.6 million for the first half. Income before those gains was $1.1 million and $1.0 million, respectively. FFO and AFFO are company-reported non-GAAP measures and should not be treated as substitutes for GAAP earnings or operating cash flow.
At June 30, total assets were $1.312 billion, total equity $784.4 million, and secured borrowings were $519.0 million principal ($508.8 million net of deferred financing costs). Cash and cash equivalents were $131.4 million, with $8.6 million of restricted cash. Reported net debt was $379.0 million. The company had no balance drawn on its new $300 million unsecured revolving facility. Six-month investing cash outflow was $257.1 million, largely for property acquisitions; financing cash inflow was $364.2 million, chiefly from the IPO and private placements.
Material changes versus prior period
- Rental revenue grew with portfolio expansion: 112 properties were acquired in the first half, for an acquisition purchase price of approximately $275.0 million. The portfolio increased from 508 property locations at December 31, 2017 to 602 locations as reported in the investment note; MD&A reports 604 including land parcels and loan-collateral properties.
- Depreciation and amortization rose to $7.6 million in Q2 from $4.3 million and to $14.1 million in the first half from $8.1 million, primarily reflecting acquisitions and accelerated amortization on ground leases that could not be renewed.
- Interest expense rose to $8.6 million in Q2 from $5.2 million and to $16.9 million in the first half from $8.9 million, reflecting additional securitized debt and prior-period related-party acquisition financing.
- Real-estate impairment expense increased to $0.9 million in Q2 and $2.8 million in the first half, compared with $0.4 million and $0.6 million, respectively, in 2017. First-half impairments covered 13 properties, including vacant and tenanted assets.
- The June IPO raised $455 million gross; a concurrent private placement raised a further $125 million. The company repaid all $334 million of outstanding related-party warehouse notes at the IPO closing. After quarter-end, the underwriters purchased an additional 2.77 million shares, providing $36.5 million net.
Outlook, risks, and unusual items
Management stated that cash from operations, cash on hand, the revolving facility, and access to long-term debt capital should fund operations and current commitments for the foreseeable future. No quantified earnings or acquisition guidance was provided. As of August 8, the company was under contract to acquire 29 properties for $57.3 million, subject to due diligence and customary conditions. It expected to fund the remaining portion of a $29.2 million tenant-development reimbursement commitment by year-end; approximately $18.5 million had been funded by June 30.
Secured debt carried a 4.35% weighted-average fixed rate and was non-recourse. The principal repayment schedule includes a significant anticipated balloon payment: $259.5 million due in November 2021 on the 2016-1 notes; the 2017-1 notes have an anticipated repayment date in June 2024. The company reported compliance with facility covenants. The revolver bears floating-rate interest when drawn, and future refinancing, access to capital, tenant defaults, property vacancies, acquisition availability, and REIT qualification are identified risks. The Master Trust Funding Program’s three-month cash-collection-to-debt-service ratio was approximately 1.55x in Q2; cash-flow trapping and early-amortization thresholds apply if coverage falls.
Other notable items: the company recorded $3.645 million of first-half disposition gains and $2.756 million of impairment charges. It disclosed no material pending litigation, no off-balance-sheet arrangements, and no material change to the IPO prospectus risk factors. Adoption of the new lease standard was planned for January 1, 2019; gross presentation of certain tenant-paid expenses could increase reported revenue and property expenses without an expected effect on net income or cash flows.
Important facts for investors to verify
- How the large 2021 anticipated debt repayment will be funded or refinanced, and whether covenant and coverage headroom remains adequate.
- Whether acquisition growth translates into sustainable cash earnings after interest, overhead, depreciation, and property impairment.
- Tenant and industry exposure: the top ten tenants represented 38.6% of annualized base rent; service businesses represented 76.4%.
- Performance and collectability of impaired properties, vacant assets, and the two new loan arrangements, including the construction loan’s ground-lease-related forgiveness provision.
- Completion and cost of the committed acquisitions and tenant reimbursements, alongside liquidity use following the IPO.
- REIT qualification and the financial-statement presentation effects of adopting the new lease accounting standard.