NETSTREIT Corp. - Quarter Report: 2022 March (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q | ||
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2022
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 001-39443
NETSTREIT Corp. | ||||||||
(Exact name of registrant as specified in its charter) | ||||||||
| Maryland | 84-3356606 | |||||||||||||
| (State or other jurisdiction of | (I.R.S. Employer | |||||||||||||
| incorporation or organization) | Identification No.) | |||||||||||||
2021 McKinney Avenue Suite 1150 | ||||||||||||||
Dallas, Texas | 75201 | |||||||||||||
| (Address of principal executive offices) | (Zip Code) | |||||||||||||
(972) 200-7100 | ||||||||||||||
| (Registrant’s telephone number, including area code) | ||||||||||||||
| Securities registered pursuant to Section 12(b) of the Act: | ||||||||||||||
| Title of Each Class | Trading Symbol(s) | Name of Each Exchange on Which Registered | ||||||||||||
| Common stock, par value $0.01 per share | NTST | The New York Stock Exchange | ||||||||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☒ | Accelerated filer | ☐ | |||||||||||
| Non-accelerated filer | ☐ | Smaller reporting company | ☐ | |||||||||||
| Emerging growth company | ☐ | |||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares of the issuer’s common stock, par value $0.01, outstanding as of April 26, 2022 was 47,921,988.
NETSTREIT CORP. AND SUBSIDIARIES
TABLE OF CONTENTS
| Page | ||||||||
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
NETSTREIT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)
| March 31, 2022 | December 31, 2021 | ||||||||||
| Assets | |||||||||||
| Real estate, at cost: | |||||||||||
| Land | $ | 313,366 | $ | 299,935 | |||||||
| Buildings and improvements | 693,279 | 626,457 | |||||||||
| Total real estate, at cost | 1,006,645 | 926,392 | |||||||||
| Less accumulated depreciation | (37,394) | (30,669) | |||||||||
| Property under development | 18,246 | 17,896 | |||||||||
| Real estate held for investment, net | 987,497 | 913,619 | |||||||||
| Assets held for sale | 7,748 | 2,096 | |||||||||
| Mortgage loan receivable, net | 40,413 | — | |||||||||
| Cash, cash equivalents and restricted cash | 4,687 | 7,603 | |||||||||
| Lease intangible assets, net | 128,856 | 124,772 | |||||||||
| Other assets, net | 30,528 | 20,351 | |||||||||
| Total assets | $ | 1,199,729 | $ | 1,068,441 | |||||||
| Liabilities and equity | |||||||||||
| Liabilities: | |||||||||||
| Term loan, net | $ | 174,386 | $ | 174,330 | |||||||
| Revolving credit facility | 120,000 | 64,000 | |||||||||
| Lease intangible liabilities, net | 24,015 | 23,316 | |||||||||
| Liabilities related to assets held for sale | 115 | — | |||||||||
| Accounts payable, accrued expenses and other liabilities | 16,166 | 16,980 | |||||||||
| Total liabilities | 334,682 | 278,626 | |||||||||
| Commitments and contingencies | |||||||||||
| Equity: | |||||||||||
| Stockholders’ equity | |||||||||||
Common stock, $0.01 par value, 400,000,000 shares authorized; 47,921,988 and 44,223,050 shares issued and outstanding as of March 31, 2022 and December 31, 2021, respectively | 479 | 442 | |||||||||
| Additional paid-in capital | 886,351 | 809,724 | |||||||||
| Distributions in excess of retained earnings | (42,193) | (35,119) | |||||||||
| Accumulated other comprehensive income | 10,258 | 4,123 | |||||||||
| Total stockholders’ equity | 854,895 | 779,170 | |||||||||
| Noncontrolling interests | 10,152 | 10,645 | |||||||||
| Total equity | 865,047 | 789,815 | |||||||||
| Total liabilities and equity | $ | 1,199,729 | $ | 1,068,441 | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
NETSTREIT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands, except share and per share data)
(Unaudited)
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Revenues | |||||||||||
| Rental revenue (including reimbursable) | $ | 20,921 | $ | 11,932 | |||||||
| Interest income on mortgage loan receivable | 411 | — | |||||||||
| Total revenues | 21,332 | 11,932 | |||||||||
| Operating expenses | |||||||||||
| Property | 2,932 | 950 | |||||||||
| General and administrative | 4,190 | 3,137 | |||||||||
| Depreciation and amortization | 10,980 | 5,929 | |||||||||
| Provisions for impairment | — | 69 | |||||||||
| Transaction costs | 165 | 151 | |||||||||
| Total operating expenses | 18,267 | 10,236 | |||||||||
| Other income (expense) | |||||||||||
| Interest expense, net | (1,169) | (905) | |||||||||
| Gain on sales of real estate, net | 161 | — | |||||||||
| Total other income (expense), net | (1,008) | (905) | |||||||||
| Net income before income tax expense | 2,057 | 791 | |||||||||
| Income tax expense | (91) | (50) | |||||||||
| Net income | 1,966 | 741 | |||||||||
| Net income attributable to noncontrolling interests | 24 | 40 | |||||||||
| Net income attributable to common stockholders | $ | 1,942 | $ | 701 | |||||||
| Amounts available to common stockholders per common share: | |||||||||||
| Basic | $ | 0.04 | $ | 0.02 | |||||||
| Diluted | $ | 0.04 | $ | 0.02 | |||||||
| Weighted average common shares: | |||||||||||
| Basic | 44,415,807 | 28,348,975 | |||||||||
| Diluted | 45,600,810 | 30,052,940 | |||||||||
| Other comprehensive income: | |||||||||||
| Net income | $ | 1,966 | $ | 741 | |||||||
| Change in value on derivatives, net | 6,211 | 2,323 | |||||||||
| Total comprehensive income | 8,177 | 3,064 | |||||||||
| Comprehensive income attributable to noncontrolling interests | 100 | 164 | |||||||||
| Comprehensive income attributable to common stockholders | $ | 8,077 | $ | 2,900 | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
NETSTREIT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(In thousands, except share data)
(Unaudited)
| Common stock | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Par Value | Additional Paid-in Capital | Distributions in Excess of Retained Earnings | Accumulated Other Comprehensive Income | Total Stockholders’ Equity | Noncontrolling Interests | Total Equity | |||||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2021 | 44,223,050 | $ | 442 | $ | 809,724 | $ | (35,119) | $ | 4,123 | $ | 779,170 | $ | 10,645 | $ | 789,815 | |||||||||||||||||||||||||||||||||||
| Issuance of common stock in public offering, net of issuance costs | 3,604,736 | 36 | 75,461 | — | — | 75,497 | — | 75,497 | ||||||||||||||||||||||||||||||||||||||||||
| OP Units converted to common stock | 25,629 | — | 484 | — | — | 484 | (484) | — | ||||||||||||||||||||||||||||||||||||||||||
| Dividends and distributions declared on common stock and OP units | — | — | — | (8,888) | — | (8,888) | (109) | (8,997) | ||||||||||||||||||||||||||||||||||||||||||
| Dividends declared on restricted stock, net | — | — | — | (128) | — | (128) | — | (128) | ||||||||||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units | 85,224 | 1 | (1) | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Repurchase of common stock for tax withholding obligations | (16,651) | — | (362) | — | — | (362) | — | (362) | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation, net | — | — | 1,045 | — | 1,045 | — | 1,045 | |||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | 6,135 | 6,135 | 76 | 6,211 | ||||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | 1,942 | — | 1,942 | 24 | 1,966 | ||||||||||||||||||||||||||||||||||||||||||
| Balance at March 31, 2022 | 47,921,988 | $ | 479 | $ | 886,351 | $ | (42,193) | $ | 10,258 | $ | 854,895 | $ | 10,152 | $ | 865,047 | |||||||||||||||||||||||||||||||||||
| Common stock | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Par Value | Additional Paid-in Capital | Distributions in Excess of Retained Earnings | Accumulated Other Comprehensive Income | Total Stockholders’ Equity | Noncontrolling Interests | Total Equity | |||||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2020 | 28,203,545 | $ | 282 | $ | 501,045 | $ | (7,464) | $ | 235 | $ | 494,098 | $ | 33,975 | $ | 528,073 | |||||||||||||||||||||||||||||||||||
| OP Units converted to common stock | 253,344 | 3 | 4,920 | — | — | 4,923 | (4,923) | — | ||||||||||||||||||||||||||||||||||||||||||
| Dividends and distributions declared on common stock and OP units | — | — | — | (5,687) | — | (5,687) | (307) | (5,994) | ||||||||||||||||||||||||||||||||||||||||||
| Dividends declared on restricted stock | — | — | — | (132) | — | (132) | — | (132) | ||||||||||||||||||||||||||||||||||||||||||
| Vesting of restricted stock units | 15,190 | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Repurchase of common stock for tax withholding obligations | (4,962) | — | (90) | — | — | (90) | — | (90) | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | 557 | — | 557 | — | 557 | |||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | 2,199 | 2,199 | 124 | 2,323 | ||||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | 701 | — | 701 | 40 | 741 | ||||||||||||||||||||||||||||||||||||||||||
| Balance at March 31, 2021 | 28,467,117 | $ | 285 | $ | 506,432 | $ | (12,582) | $ | 2,434 | $ | 496,569 | $ | 28,909 | $ | 525,478 | |||||||||||||||||||||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
NETSTREIT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except share and per share data)
(Unaudited)
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Cash flows from operating activities | |||||||||||
| Net income | $ | 1,966 | $ | 741 | |||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | 10,980 | 5,929 | |||||||||
| Amortization of deferred financing costs | 157 | 157 | |||||||||
| Noncash revenue adjustments | (807) | (430) | |||||||||
| Stock-based compensation expense | 1,045 | 557 | |||||||||
| Gain on sales of real estate, net | (161) | — | |||||||||
| Provisions for impairment | — | 69 | |||||||||
| Changes in assets and liabilities, net of assets acquired and liabilities assumed: | |||||||||||
| Other assets, net | (1,484) | (1,109) | |||||||||
| Accounts payable, accrued expenses and other liabilities | (2,742) | (1,644) | |||||||||
| Net cash provided by operating activities | 8,954 | 4,270 | |||||||||
| Cash flows from investing activities | |||||||||||
| Acquisitions of real estate | (89,973) | (88,225) | |||||||||
| Real estate development and improvements | (4,378) | (1,346) | |||||||||
| Investment in mortgage loan receivable | (40,426) | — | |||||||||
| Earnest money deposits | (630) | (451) | |||||||||
| Purchase of computer equipment and other corporate assets | (595) | — | |||||||||
| Proceeds from sale of real estate | 2,294 | — | |||||||||
| Net cash used in investing activities | (133,708) | (90,022) | |||||||||
| Cash flows from financing activities | |||||||||||
| Issuance of common stock in public offerings, net | 75,497 | — | |||||||||
| Payment of common stock dividends | (8,888) | (5,687) | |||||||||
| Payment of OP unit distributions | (109) | (307) | |||||||||
| Payment of restricted stock dividends | (106) | (5) | |||||||||
| Proceeds under revolving credit facility | 128,000 | 13,000 | |||||||||
| Repayments under revolving credit facility | (72,000) | — | |||||||||
| Proceeds under property development incentives | 375 | — | |||||||||
| Repurchase of common stock for tax withholding obligations | (363) | (90) | |||||||||
| Deferred offering costs | (568) | (86) | |||||||||
| Net cash provided by financing activities | 121,838 | 6,825 | |||||||||
| Net change in cash, cash equivalents and restricted cash | (2,916) | (78,927) | |||||||||
| Cash, cash equivalents and restricted cash at beginning of the period | 7,603 | 92,643 | |||||||||
| Cash, cash equivalents and restricted cash at end of the period | $ | 4,687 | $ | 13,716 | |||||||
| Supplemental disclosures of cash flow information: | |||||||||||
| Cash paid for interest | $ | 1,108 | $ | 758 | |||||||
| Supplemental disclosures of non-cash investing and financing activities: | |||||||||||
| Dividends declared and unpaid on restricted stock | $ | 128 | $ | 132 | |||||||
| Cash flow hedge change in fair value | $ | 6,211 | $ | 2,323 | |||||||
| Accrued capital expenditures and real estate development and improvement costs | $ | 1,418 | $ | — | |||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
NETSTREIT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1 – Organization and Description of Business
NETSTREIT Corp. (“Company”) was incorporated on October 11, 2019 as a Maryland corporation and commenced operations on December 23, 2019. The Company conducts its operations through NETSTREIT, L.P., a Delaware limited partnership (the “Operating Partnership”). NETSTREIT GP, LLC, a Delaware limited liability company and a wholly owned subsidiary of the Company, is the sole general partner of the Operating Partnership.
The Company elected to be treated and to qualify as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning with its short taxable year ended December 31, 2019. Additionally, the Operating Partnership formed NETSTREIT Management TRS, LLC (“NETSTREIT TRS”), which together with the Company jointly elected to be treated as a taxable REIT subsidiary under Section 856(a) of the Internal Revenue Code of 1986, as amended, (the “Code”) for U.S. federal income tax purposes.
The Company is structured as an umbrella partnership real estate investment trust (commonly referred to as an “UPREIT”) and is an internally managed real estate company that acquires, owns and manages a diversified portfolio of single-tenant, retail commercial real estate leased on a long-term basis to high credit quality tenants across the United States. As of March 31, 2022, the Company owned or had investments in 363 properties, located in 42 states.
Note 2 – Summary of Significant Accounting Policies
Basis of Presentation
The accompanying interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and the rules and regulations of the U.S. Securities and Exchange Commission (SEC). The accompanying condensed consolidated financial statements include the accounts of the Company and subsidiaries in which the Company has a controlling financial interest. All intercompany accounts and transactions have been eliminated in consolidation and the Company’s net income is reduced by the portion of net income attributable to noncontrolling interests.
Interim Unaudited Financial Information
The accompanying unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These unaudited interim condensed consolidated financial statements do not include all of the information and notes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements, and should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto on the Annual Report on Form 10-K as of and for the year ended December 31, 2021, which provide a more complete understanding of the Company’s accounting policies, financial position, operating results, business properties, and other matters. In the opinion of management, all adjustments of a normal recurring nature necessary for a fair presentation have been included. The results of operations for the three months ended March 31, 2022 and 2021 are not necessarily indicative of the results for the full year.
Noncontrolling Interests
The Company presents noncontrolling interests, which represent limited partnership units in the operating partnership (the “OP Units”) not owned by the Company, as a component of permanent equity, separate from the Company's stockholders’ equity. Noncontrolling interests were created as part of an asset acquisition and recognized at fair value as of the date of the transaction. Effective with the Company’s initial public offering, each limited partner of the Operating Partnership has the right to require the Operating Partnership to redeem part or all of its OP Units for cash, based upon the value of an equivalent number of shares of the Company’s common stock at the time of the redemption, or, at the Company’s election, shares of the Company’s common stock on a one-for-one basis, subject to certain adjustments and the restrictions on ownership and transfer of the Company’s common stock. The election to pay cash or issue common stock is solely within the control of the Company to satisfy a noncontrolling interest holder's redemption request.
7
Net income of the Operating Partnership is allocated to its noncontrolling interests based on the noncontrolling interests’ ownership percentages in the Operating Partnership throughout the period. Ownership percentage is calculated by dividing the number of OP Units held by the noncontrolling interests by the total OP Units outstanding.
Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company’s most significant assumptions and estimates relate to the useful lives of real estate assets, lease accounting, real estate impairment assessments, and allocation of fair value of purchase consideration. These estimates are based on historical experience and other assumptions which management believes are reasonable under the circumstances. The Company evaluates its estimates on an ongoing basis and makes revisions to these estimates and related disclosures as experience develops or new information becomes known. Further, the uncertainty over the ultimate impact COVID-19 will have on the global economy and the Company’s business makes any estimates and assumptions as of March 31, 2022 inherently less certain than they would be absent the current and potential impacts of COVID-19. Actual results could differ from those estimates.
Risk and Uncertainties
COVID-19
The ongoing COVID-19 pandemic, and the measures taken to limit its spread have negatively impacted the economy across many industries, including industries in which our tenants operate. The impacts may continue and/or increase in severity as the duration of the pandemic lengthens. The Company continues to monitor the global outbreak of COVID-19 and to take steps to mitigate the potential risks to us posed by the pandemic, including the identification and spread of variants. However, the Company’s operations and cash flows during the years presented in the consolidated financial statements were not materially impacted by COVID-19.
Real Estate Held for Investment
Real estate is recorded and stated at cost less any provision for impairment. At acquisition date, the purchase price of an acquired property is allocated to tangible and identifiable intangible assets or liabilities based on their relative fair values. For properties developed by the Company, all direct and indirect costs related to planning, development and construction, including interest, real estate taxes and other miscellaneous costs incurred during the construction period, are capitalized for financial reporting purposes and recorded as property under development until construction has been completed.
The Company evaluates each acquisition transaction to determine whether the acquired asset meets the definition of a business and therefore accounted for as a business combination or if the acquisition transaction should be accounted for as an asset acquisition. Under Accounting Standards Update (“ASU”) 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business” (“ASU 2017-01”), an acquisition does not qualify as a business when substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets or the acquisition does not include a substantive process in the form of an acquired workforce or an acquired contract that cannot be replaced without significant cost, effort or delay. Transaction costs related to acquisitions that qualify as asset acquisitions are capitalized as part of the cost basis of the acquired assets, while transaction costs for acquisitions that are deemed to be acquisitions of a business are expensed as incurred.
The Company allocates the purchase price of acquired properties accounted for as asset acquisitions to tangible and identifiable intangible assets or liabilities based on their relative fair values. Tangible assets may include land, buildings, site improvements and tenant improvements. Intangible assets include the value of in-place leases and above-market leases and intangible liabilities include below-market leases.
8
The fair value of the tangible assets of an acquired property with an in-place operating lease is determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to the tangible assets based on the fair value of the tangible assets. The fair value of in-place leases is determined by considering estimates of carrying costs during the expected lease-up periods, current market conditions, as well as costs to execute similar leases based on the specific characteristics of each tenant’s lease. The Company estimates the cost to execute leases with terms similar to the remaining lease terms of the in-place leases, including leasing commissions, legal and other related expenses. The fair value of above-market or below-market leases is recorded based on the net present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between the contractual amount to be paid pursuant to the in-place lease and the Company’s estimate of the fair market lease rate for the corresponding in-place lease, measured over the remaining non-cancelable term of the lease including any below-market fixed rate renewal options for below-market leases. In making estimates of fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including real estate valuations prepared by an independent valuation firm. The Company also considers information and other factors including market conditions, the industry that the tenant operates in, characteristics of the real estate; e.g., location, size, demographics, value and comparative rental rates; tenant credit profile and the importance of the location of the real estate to the operations of the tenant’s business. Additionally, the Company considers information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets and liabilities acquired. Based on these inputs for measuring and allocating the fair value of real estate acquisitions, the Company utilizes both observable market data (categorized as level 2 on the three-level valuation hierarchy of Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurement), and unobservable inputs that reflect the Company’s own internal assumptions (categorized as level 3 under ASC Topic 820).
Depreciation and Amortization
Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets:
Buildings | 13 – 35 years | ||||
Building improvements | 15 years | ||||
Tenant improvements | Shorter of the term of the related lease or useful life | ||||
Acquired in-place leases or leasing commissions | Remaining terms of the respective leases | ||||
Assembled workforce | 3 years | ||||
Computer equipment and other corporate assets | 3 – 5 years | ||||
Total depreciation and amortization expense was $11.0 million and $5.9 million during the three months ended March 31, 2022 and 2021, respectively.
Depreciation expense on real estate held for investment and computer equipment and other corporate assets was $7.3 million and $4.1 million during the three months ended March 31, 2022 and 2021, respectively.
Amortization expense on acquired in-place lease and assembled workforce intangible assets, and leasing commission costs were $3.6 million and $1.8 million during the three months ended March 31, 2022 and 2021, respectively.
Repairs and maintenance are charged to property operating expense as incurred; major renewals and betterments that extend the useful life or improve the operating capacity of the asset are capitalized. Upon the sale or disposition of a property, the asset and the related accumulated depreciation are removed from the condensed consolidated balance sheets with the difference between the proceeds received, net of sales costs, and the carrying value of the asset group recorded as a gain or loss on sale, subject to impairment considerations.
9
Assets Held for Sale
Properties classified as held for sale, including the related intangibles, on the condensed consolidated balance sheets include only those properties available for immediate sale in their present condition, which are actively being marketed, and for which management believes that it is probable that a sale of the property will be completed within one year. Properties held for sale are carried at the lower of cost or fair value, less estimated selling costs. No depreciation expense or amortization expense is recognized on properties held for sale and the related intangible assets or liabilities once they have been classified as such. Only disposals representing a strategic shift in operations are presented as discontinued operations. Accordingly, we have not reclassified results of operations for properties disposed during the interim period ended March 31, 2022 or held for sale as discontinued operations, as these events are a normal part of the Company’s operations and do not represent strategic shifts in the Company’s operations. As of March 31, 2022 and December 31, 2021, there was one property classified as held for sale.
Impairment of Long-Lived Assets
Fair value measurement of an asset group occurs when events or changes in circumstances related to an asset indicate that the carrying amount of the asset is no longer recoverable. An example of an event or changed circumstance is a reduction in the expected holding period of a property. If indicators are present, the Company will prepare a projection of the undiscounted future cash flows of the property, excluding interest charges, and determine if the carrying amount of the asset group is recoverable. When a carrying amount is not recoverable, an impairment loss is recognized to the extent that the carrying amount of the asset group exceeds its fair market value. The Company estimates fair value using data such as operating income, estimated capitalization rates or multiples, leasing prospects, local market information, and with regard to assets held for sale, based on the estimated or negotiated selling price, less estimated costs of disposal. Based on these unobservable inputs, the Company determined that its valuations of impaired real estate and intangible assets fall within Level 3 of the fair value hierarchy under ASC Topic 820.
The following table summarizes the provision for impairment during the periods indicated below (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Total provision for impairment | $ | — | $ | 69 | |||||||
Number of properties: (1) | |||||||||||
| Classified as held for sale | — | 1 | |||||||||
| Disposed within the period | — | — | |||||||||
(1) Includes the number of properties that were impaired and classified as held for sale or impaired and disposed of during the respective periods. Excludes properties that did not have impairment recorded during the period.
Cash, Cash Equivalents and Restricted Cash
The Company considers all cash balances, money market accounts and highly liquid investments with original maturities of three months or less to be cash and cash equivalents. Restricted cash includes cash restricted for property tenant improvements and cash proceeds from the sale of assets held by qualified intermediaries in anticipation of the acquisition of replacement properties in tax-free exchanges under Section 1031 of the Code. Restricted cash is included in cash, cash equivalents, and restricted cash on the condensed consolidated balance sheets. The Company had no restricted cash as of March 31, 2022 or December 31, 2021.
The Company’s bank balances as of March 31, 2022 and December 31, 2021 include certain amounts over the Federal Deposit Insurance Corporation limits.
Revenue Recognition and Related Matters
The Company’s rental revenue is primarily related to rent received from tenants under leases accounted for as operating leases. Rent from leases that have fixed and determinable rent increases is recognized on a straight-line basis over the non-cancellable initial term of the lease and reasonably certain renewal periods, from the later of the date of the commencement of the lease or the date of acquisition of the property subject to the lease. The difference between rental revenue recognized and the cash rent
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due under the provisions of the lease is recorded as deferred rent receivable and included as a component of other assets in the condensed consolidated balance sheets.
Variable lease revenues include tenant reimbursements, lease termination fees, changes in the index or market-based indices after the inception of the lease or percentage rents. Variable lease revenues are not recognized until the specific events that trigger the variable payments have occurred. The Company recognized variable lease revenue related to tenant reimbursements and lease termination fees for the periods presented.
Capitalized above-market and below-market lease values are amortized on a straight-line basis as a reduction or increase of rental revenue as appropriate over the remaining non-cancellable terms of the respective leases.
Reserves for uncollectible amounts are provided against the portion of accounts receivable, net including straight-line rents, which is estimated to be uncollectible, which includes a portfolio-based reserve and reserves for specifically disputed amounts. Such reserves are reviewed each period based upon recovery experience and the specific facts of each outstanding amount. As of March 31, 2022 and December 31, 2021, the Company had an immaterial reserve for uncollectible amounts specific to uncharged reimbursable expenses.
Mortgage Loan Receivable
The Company holds one loan receivable, which is a mortgage loan secured by real estate, for long-term investment. The loan receivable is carried at amortized cost.
The Company recognizes interest income on the loan receivable using the effective-interest method. Direct costs associated with originating loans, along with any premium or discount, is deferred and amortized as an adjustment to interest income over the term of the related loan receivable using the effective interest method. The Company evaluates its loans receivable balance, including accrued interest, for potential credit losses by analyzing the credit of the borrower, the remaining time to maturity of the loan, collateral value and quality (if any), and other relevant factors. A loan receivable is placed on nonaccrual status when management determines that full recovery of the contractually specified payments of principal and interest is doubtful.
Stock-Based Compensation
The Company has a share-based compensation award program for our employees and directors. Stock-based compensation expense associated with these awards is recognized in general and administrative expenses in our condensed consolidated statements of operations and comprehensive income. We classify stock-based payment awards either as equity awards or liability awards based upon an analysis of ASC 718 and ASC 480. Equity classified awards are measured based on the fair value on the date of grant. Liability classified awards are remeasured to fair value each reporting period. Stock-based compensation expense is recognized over the requisite service or performance period. The Company recognizes forfeitures as they occur.
Forward Equity Sales
The Company occasionally sells shares of common stock through forward sale agreements to enable the Company to set the price of such shares upon pricing the offering (subject to certain adjustments) while delaying the issuance of such shares and the receipt of the net proceeds by the Company.
To account for the forward sale agreements, the Company considers the accounting guidance governing financial instruments and derivatives. To date, the Company has concluded that its forward sale agreements are not liabilities as they do not embody obligations to repurchase its shares nor do they embody obligations to issue a variable number of shares for which the monetary value are predominantly fixed, varying with something other than the fair value of the shares, or varying inversely in relation to its shares. The Company then evaluates whether the agreements meet the derivatives and hedging guidance scope exception to be accounted for as equity instruments. The Company has concluded that the agreements are classifiable as equity contracts based on the following assessments: (i) none of the agreements’ exercise contingencies are based on observable markets or indices besides those related to the market for the Company’s own stock price and operations; and (ii) none of the settlement provisions precluded the agreements from being indexed to its own stock.
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The Company also considers the potential dilution resulting from the forward sale agreements on the earnings per share calculations. Prior to settlement, a forward sale agreement will be reflected in the diluted earnings per share calculations using the treasury stock method. Under this method, the number of shares of the Company’s common stock used in diluted earnings per share is deemed to be increased by the excess, if any, of the number of shares of the Company’s common stock that would be issued upon full physical settlement of such forward sale agreement over the number of shares of the Company’s common stock that could be purchased by the Company in the market (based on the average market price during the period) using the proceeds receivable upon full physical settlement (based on the adjusted forward sale price at the end of the reporting period). Consequently, prior to settlement of a forward sale agreement, there will be no dilutive effect on the Company’s earnings per share except during periods when the average market price of the Company’s common stock is above the adjusted forward sale price. However, upon settlement of a forward sales agreement, if the Company’s elects to physically settle or net share settle such forward sale agreement, delivery of the Company’s shares will result in dilution to the Company’s earnings per share.
Transaction Costs
Transaction costs were $0.2 million for each of the three months ended March 31, 2022 and 2021, respectively, and represent acquisition related expenses, including costs associated with abandoned acquisitions.
Income Taxes
The Company elected to be treated and qualify as a REIT for U.S. federal income tax purposes beginning with its short taxable year ended December 31, 2019. To qualify as a REIT, the Company must meet certain organizational, income, asset and distribution tests. Accordingly, the Company will generally not be subject to corporate U.S. federal or state income tax to the extent that it makes qualifying distributions of all of its taxable income to its stockholders and provided it satisfies on a continuing basis, through actual investment and operating results, the REIT requirements, including certain asset, income, distribution and share ownership tests. The Company intends to make sufficient distributions during 2022 to receive a full dividends paid deduction.
NETSTREIT TRS is treated as a taxable REIT subsidiary which may be subject to U.S. federal, state, and local income taxes on its taxable income. In general, NETSTREIT TRS may perform services for tenants of the Company, hold assets that the Company cannot hold directly and may engage in any real estate or non-real estate-related business.
The Company recognizes franchise and other state and local tax expenses in general and administrative and recognized state and federal income tax expense in income tax expense in the accompanying condensed consolidated statements of operations and comprehensive income.
All provisions for federal income taxes in the accompanying condensed consolidated financial statements are attributable to NETSTREIT TRS. Deferred income tax expense and its ending balance in deferred tax assets and liabilities were immaterial for the years and periods presented.
The Company has elected to record related interest and penalties, if any, as general and administrative expense or as income tax expense based on the nature of the tax on the condensed consolidated statements of operations and comprehensive income. The Company had no material interest or penalties relating to income, franchise, and other state and local taxes for the years and periods presented. Additionally, there were no material accruals for interest or penalties as of March 31, 2022 and December 31, 2021.
The Company files federal, state and local income tax returns. The Company regularly analyzes its various federal and state filing positions and only recognizes the income tax effect in its financial statements when certain criteria regarding uncertain income tax positions have been met. The Company believes that its income tax positions would more likely than not be sustained upon examination by all relevant taxing authorities. Therefore, no provisions for uncertain income tax positions have been recorded in the condensed consolidated financial statements.
All federal tax returns for years prior to 2019 are no longer subject to examination. Additionally, state tax returns for years prior to 2017 are generally no longer subject to examination.
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Earnings Per Share
Earnings per common share has been computed pursuant to the guidance in FASB ASC Topic 260, Earnings per Share. Basic earnings per share (“EPS”) is computed by dividing net income allocated to common stockholders by the weighted-average number of common shares outstanding for the reporting period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. No effect is shown for any securities that are anti-dilutive. Net income allocated to common stockholders represents net income less income allocated to participating securities and noncontrolling interests. None of the Company’s equity awards are participating securities.
Fair Value Measurement
Fair value measurements are utilized in the accounting of the Company’s assets acquired and liabilities assumed in an asset acquisition and also affect the Company’s accounting for certain of its financial assets and liabilities. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The hierarchy described below prioritizes inputs to the valuation techniques used in measuring the fair value of assets and liabilities. This hierarchy maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring the most observable inputs to be used when available. The hierarchy is broken down into three levels based on the reliability of inputs as follows: Level 1 inputs, such as quoted prices in an active market; Level 2 inputs, which are observable inputs for similar assets; or Level 3 inputs, which are unobservable inputs.
The Company uses the following inputs in its fair value measurements:
–Level 2 inputs for its debt and derivative financial instrument fair value disclosures. See “Note 6 - Debt” and “Note 7 - Derivative Financial Instruments,” respectively; and
–Level 2 and Level 3 inputs when assessing the fair value of assets and liabilities in connection with real estate acquisitions and impairment. See “Note 4 - Real Estate Investments.”
The fair value of the Company’s cash, cash equivalents and restricted cash (including money market accounts), other assets and accounts payable, accrued expenses and other liabilities approximate their carrying value because of the short-term nature of these instruments. Provisions for impairment recognized in the three months ended March 31, 2021 related to an asset held for sale and the impairment was determined based on the estimated or negotiated selling price, less costs of disposal, compared to the carrying value of the property.
Concentrations of Credit Risk
Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents. The Company is exposed to credit risk with respect to cash held at various financial institutions, access to its Credit Facility, amounts due under the mortgage loan receivable, and amounts due or payable under derivative contracts. The credit risk exposure with regard to the Company’s cash, credit facilities, and derivative instruments is spread among a diversified group of investment grade financial institutions.
During the three months ended March 31, 2022, the Company’s rental revenues were derived from 71 separate tenants leasing 354 total properties. During this period there were no tenants with rental revenue that exceeded 10% of total rental revenue.
During the three months ended March 31, 2021, the Company’s rental revenues were derived from 63 separate tenants leasing 234 total properties. During this period there were no tenants with rental revenue that exceeded 10% of total rental revenue.
Segment Reporting
The Company considers each one of its properties to be an operating segment, none of which meets the threshold for a reportable segment. The Company allocates resources and assesses operating performance based on individual property needs. All of the Company’s operating segments meet the aggregation criteria, and thus, the Company reports one segment, rental operations. There were no intersegment sales during the periods presented.
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Recent Accounting Pronouncements Adopted
In March 2020, the FASB issued ASU 2020-04 “Topic 848: Reference Rate Reform.” ASU 2020-04 contains practical expedients for reference rate reform related activities that impact debt, leases, derivatives, and other contracts. The guidance in ASU 2020-04 is optional and may be elected over time as reference rate reform activities occur. On July 1, 2020, the Company has elected to apply the hedge accounting expedients related to probability and the assessments of effectiveness for future LIBOR-indexed cash flows to assume that the index upon which future hedged transactions will be based matches the index on the corresponding derivatives. Application of these expedients preserves the presentation of derivatives consistent with past presentation. The Company determined these elections have not materially impacted the Company's condensed consolidated financial statements. The Company continues to evaluate the impact of the guidance and may apply other elections as applicable as additional changes in the market occur.
In August 2020, the FASB issued ASU 2020-06, “Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” ASU 2020-06 simplifies accounting for convertible instruments by removing major separation models currently required. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument with no separate accounting for embedded conversion features. ASU 2020-06 also removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. ASU 2020-06 also simplifies the diluted earnings per share calculation in certain areas. Effective January 1, 2022 the Company adopted this standard with no material impact to the condensed consolidated financial statements.
Note 3 – Leases
The Company acquires, owns and manages commercial single-tenant lease properties, with the majority being long-term triple-net leases where the tenant is generally responsible for all improvements and contractually obligated to pay all operating costs (such as real estate taxes, utilities and repairs and maintenance costs). As of March 31, 2022, the Company had investments in 361 single-tenant retail net leased properties spanning 42 states, with 71 different tenants represented across 23 retail sectors. As of March 31, 2022, the remaining terms of leases range from to 32 years, with weighted average lease term of 9.6 years.
The Company’s property leases have been classified as operating leases and some have scheduled rent increases throughout the lease term. The Company’s leases typically provide the tenant one or more multi-year renewal options to extend their leases, subject to generally the same terms and conditions, including rent increases, consistent with the initial lease term.
All lease-related income is reported as a single line item, rental revenue (including reimbursable), in the condensed consolidated statements of operations and comprehensive income and is presented net of any reserves for uncollectible amounts. There were no material reserves for uncollectible amounts during the three months ended March 31, 2022.
The following table provides a disaggregation of lease income recognized under ASC 842 (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Rental revenue | |||||||||||
Fixed lease income (1) | $ | 18,067 | $ | 10,953 | |||||||
Variable lease income (2) | 2,689 | 789 | |||||||||
| Other rental revenue: | |||||||||||
| Above/below market lease amortization, net | 283 | 190 | |||||||||
| Lease incentives | (118) | — | |||||||||
| Rental revenue (including reimbursable) | $ | 20,921 | $ | 11,932 | |||||||
(1) Fixed lease income includes contractual rents under lease agreements with tenants recognized on a straight-line basis over the lease term.
(2) Variable lease income primarily includes tenant reimbursements for real estate taxes, insurance, common area maintenance, and lease termination fees, and the write-off of uncollectible amounts.
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Scheduled future minimum base rental payments (excluding base rental payments from properties classified as held for sale and straight-line rent adjustments for all properties) due to be received under the remaining non-cancelable term of the operating leases in place as of March 31, 2022 are as follows (in thousands):
| Future Minimum Base Rental Receipts | |||||
| Remainder of 2022 | $ | 56,738 | |||
| 2023 | 75,995 | ||||
| 2024 | 76,606 | ||||
| 2025 | 76,332 | ||||
| 2026 | 73,436 | ||||
| Thereafter | 406,911 | ||||
| $ | 766,018 | ||||
Future minimum rentals exclude amounts that may be received from tenants for reimbursements of operating costs and property taxes. In addition, the future minimum rents do not include any contingent rents based on a percentage of the lessees' gross sales or lease escalations based on future changes in the Consumer Price Index (“CPI”) or other stipulated reference rate.
Corporate Office Lease
In August 2021, the Company entered into a lease agreement on a new corporate office space, which commenced in October 2021 and is classified as an operating lease. The Company began operating out of the new office in February 2022. The lease has a remaining noncancellable lease term of 10.3 years that expires on July 31, 2032, with a one-time option to terminate in 2029 exercisable by the Company. The lease is also renewable at the Company’s option for two additional periods of five years. No renewals were incorporated in the calculation of the corporate lease right-of-use asset and liability as it is not reasonably certain that the Company will exercise the options. Further, the lease agreement does not contain any material residual value guarantees or material restrictive covenants. The corporate office lease contains variable lease costs related to the lease of parking spaces and non-lease components related to the reimbursement of property operating expenses and certain common area maintenance expenses, all of which are recognized as incurred. The Company elected to use the component practical expedient, which permits the Company to not separate non-lease components from lease components if timing and pattern of transfer is the same.
The following table presents the lease expense components for the three months ended March 31, 2022 (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Operating lease cost | $ | 135 | $ | — | |||||||
Variable lease cost | $ | 3 | $ | — | |||||||
The Company recorded a right-of-use asset and operating lease liability of approximately $4.5 million at lease commencement. As of March 31, 2022, the right-of-use asset and operating lease liability were $4.5 million and $5.5 million, respectively. The right-of-use asset is included in other assets, net and the operating lease liability is included in accounts payable, accrued expenses and other liabilities in the accompanying condensed consolidated balance sheets.
The following table reflects the maturity analysis of payments due from the Company over the next five years and thereafter for the corporate office lease obligation as of March 31, 2022 (in thousands):
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| Future Minimum Lease Payments | |||||
| Remainder of 2022 | $ | 150 | |||
| 2023 | 533 | ||||
| 2024 | 617 | ||||
| 2025 | 636 | ||||
| 2026 | 653 | ||||
| Thereafter | 3,981 | ||||
| Total lease payments | 6,570 | ||||
Less: amount representing interest (1) | (1,090) | ||||
| $ | 5,480 | ||||
(1) Imputed interest was calculated using a discount rate of 3.25%. The discount rate is based on the estimated incremental borrowing rate, calculated as the treasury rate for the same period as the underlying lease term, plus a spread determined using factors including REIT industry performance.
Note 4 – Real Estate Investments
As of March 31, 2022, the Company owned or had investments in 363 properties, including nine properties currently under development. The gross real estate investment portfolio, including properties under development, totaled approximately $1.15 billion and consisted of the gross acquisition cost of land, buildings, improvements, and lease intangible assets and liabilities. The investment portfolio is geographically dispersed throughout 42 states with gross real estate investments in Texas and Illinois representing 11.2% and 10.5%, respectively, of the total gross real estate investment of the Company’s entire portfolio.
Acquisitions
During the three months ended March 31, 2022, the Company acquired 34 properties for a total purchase price of $90.0 million, inclusive of $1.2 million of capitalized acquisition costs. During the three months ended March 31, 2021, the Company acquired 31 properties for a total purchase price of $88.2 million, inclusive of $1.1 million of capitalized acquisition costs.
The acquisitions were all accounted for as asset acquisitions. An allocation of the purchase price and acquisition costs paid for the completed acquisitions is as follows (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Land | $ | 14,654 | $ | 21,490 | |||||||
| Buildings | 60,088 | 48,999 | |||||||||
| Site improvements | 6,538 | 7,545 | |||||||||
| Tenant improvements | 1,160 | 1,587 | |||||||||
| In-place lease intangible assets | 8,872 | 10,942 | |||||||||
| Above-market lease intangible assets | 108 | — | |||||||||
| Construction-in-progress assets | — | — | |||||||||
| 91,420 | 90,563 | ||||||||||
| Liabilities assumed | |||||||||||
| Below-market lease intangible liabilities | (1,423) | (2,338) | |||||||||
| Accounts payable, accrued expense and other liabilities | (24) | — | |||||||||
| Purchase price (including acquisition costs) | $ | 89,973 | $ | 88,225 | |||||||
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Development
As of March 31, 2022, the Company had nine property developments under construction. During the three months ended March 31, 2022, the Company invested $5.0 million in property developments, including the acquisition of one new build-to-suit project with an initial purchase price of $1.0 million. During the three months ended March 31, 2022, the Company completed development on one project under development and reclassified approximately $4.7 million from property under development to land, building, and improvements in the accompanying condensed consolidated balance sheets. Additionally, on January 1, 2022, rent commenced on a development that was previously completed in the fourth quarter of 2021. The remaining nine developments in progress are expected to be substantially completed with rent commencing at various points throughout 2022. The purchase price, including acquisition costs, and subsequent development are included in property under development in the accompanying condensed consolidated balance sheets as of March 31, 2022.
Additionally, during the first three months of 2022, the Company capitalized less than $0.1 million of interest expense associated with properties under development. No interest expense was capitalized during the first three months of 2021.
During the three months ended March 31, 2021, the Company invested a combined total of $1.3 million in a development project in Yuma, Arizona. The Company has a non-binding purchase option to acquire the property upon completion. The Company’s total investment is expected to be $4.4 million with the sole tenant in the property commencing lease payments in 2022. These amounts are included in property under development in the accompanying condensed consolidated balance sheets as of December 31, 2021.
Dispositions
During the three months ended March 31, 2022, the Company sold one property for a total sales price, net of disposal costs, of $2.3 million, recognizing a net gain of $0.2 million on the sale.
There were no dispositions for the three months ended March 31, 2021.
Investment in Mortgage Loan Receivable
On January 26, 2022, the Company executed a fully collateralized $40.3 million loan receivable with a stated interest rate of 6.0%. The scheduled maturity date is July 26, 2023, however the Company has the right, subject to certain terms and conditions, to purchase a portion of the underlying collateralized property. The loan receivable is collateralized by real estate that is leased by three separate investment-grade tenants. The funds provided under the loan, in addition to loan origination costs of $0.1 million, are included in loan receivable, net in the accompanying condensed consolidated balance sheets as of March 31, 2022.
Note 5 – Intangible Assets and Liabilities
Intangible assets and liabilities consisted of the following (in thousands):
| March 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||||||||||||||||||||||
| Assets: | |||||||||||||||||||||||||||||||||||
| In-place leases | $ | 124,605 | $ | (16,724) | $ | 107,881 | $ | 116,368 | $ | (13,408) | $ | 102,960 | |||||||||||||||||||||||
| Above-market leases | 17,455 | (1,843) | 15,612 | 17,348 | (1,516) | 15,832 | |||||||||||||||||||||||||||||
| Assembled workforce | 873 | (665) | 208 | 873 | (592) | 281 | |||||||||||||||||||||||||||||
| Lease incentives | 5,343 | (188) | 5,155 | 5,821 | (122) | 5,699 | |||||||||||||||||||||||||||||
| Total intangible assets | $ | 148,276 | $ | (19,420) | $ | 128,856 | $ | 140,410 | $ | (15,638) | $ | 124,772 | |||||||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||||||||||||||
| Below-market leases | $ | 27,425 | $ | (3,410) | $ | 24,015 | $ | 26,185 | $ | (2,869) | $ | 23,316 | |||||||||||||||||||||||
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The remaining weighted average amortization period for the Company’s intangible assets and liabilities as of March 31, 2022 and as of December 31, 2021 by category were as follows:
| Years Remaining | |||||||||||
| March 31, 2022 | December 31, 2021 | ||||||||||
| In-place leases | 7.3 | 9.7 | |||||||||
| Above-market leases | 11.8 | 12.8 | |||||||||
| Below-market leases | 9.8 | 12.3 | |||||||||
| Assembled workforce | 0.8 | 1.0 | |||||||||
| Lease incentives | 11.8 | 12.7 | |||||||||
The Company records amortization of in-place lease assets and assembled workforce intangible assets to amortization expense, and records net amortization of above-market and below-market lease intangibles as well as amortization of lease incentives to rental revenue. The following amounts in the accompanying condensed consolidated statements of operations and comprehensive income related to the amortization of intangibles assets and liabilities for all property and ground leases (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Amortization: | |||||||||||
| Amortization of in-place leases | $ | 3,555 | $ | 1,719 | |||||||
| Amortization of assembled workforce | 73 | 73 | |||||||||
| $ | 3,628 | $ | 1,792 | ||||||||
| Net adjustment to rental revenue: | |||||||||||
| Above-market lease assets | (327) | (183) | |||||||||
| Below-market lease liabilities | 610 | 373 | |||||||||
| Lease incentives | (118) | — | |||||||||
| $ | 165 | $ | 190 | ||||||||
The following table provides the projected amortization of in-place lease assets and assembled workforce intangible assets to amortization expense, and the net amortization of above-market, below-market, and lease incentive lease intangibles to rental revenue as of March 31, 2022, for the next five years and thereafter (in thousands):
Remainder of 2022 | 2023 | 2024 | 2025 | 2026 | Thereafter | Total | |||||||||||||||||||||||||||||||||||
| In-place leases | $ | 11,034 | $ | 13,704 | $ | 12,933 | $ | 12,642 | $ | 11,430 | $ | 46,138 | $ | 107,881 | |||||||||||||||||||||||||||
| Assembled workforce | 208 | — | — | — | — | — | 208 | ||||||||||||||||||||||||||||||||||
| Amortization expense | $ | 11,242 | $ | 13,704 | $ | 12,933 | $ | 12,642 | $ | 11,430 | $ | 46,138 | $ | 108,089 | |||||||||||||||||||||||||||
| Above-market lease assets | (997) | (1,330) | (1,326) | (1,325) | (1,324) | (9,310) | (15,612) | ||||||||||||||||||||||||||||||||||
| Below-market lease liabilities | 1,830 | 2,375 | 2,317 | 2,294 | 2,178 | 13,021 | 24,015 | ||||||||||||||||||||||||||||||||||
| Lease incentives | $ | (322) | $ | (428) | $ | (428) | $ | (428) | $ | (428) | $ | (3,121) | $ | (5,155) | |||||||||||||||||||||||||||
| Net adjustment to rental revenue | $ | 511 | $ | 617 | $ | 563 | $ | 541 | $ | 426 | $ | 590 | $ | 3,248 | |||||||||||||||||||||||||||
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Note 6 – Debt
Debt consists of the following (in thousands):
| Maturity Date | Interest Rate | March 31, 2022 | December 31, 2021 | |||||||||||||||||||||||
Term Loan (1) | December 23, 2024 | 1.36% | $ | 175,000 | $ | 175,000 | ||||||||||||||||||||
Revolver (2) | December 23, 2023 | 1.64% | 120,000 | 64,000 | ||||||||||||||||||||||
| Total debt | 295,000 | 239,000 | ||||||||||||||||||||||||
| Unamortized discount and debt issuance costs | (613) | (670) | ||||||||||||||||||||||||
Unamortized deferred financing costs, net (3) | (696) | (796) | ||||||||||||||||||||||||
| Total debt, net | $ | 293,691 | $ | 237,534 | ||||||||||||||||||||||
(1) Interest rate includes the effect of a variable interest rate that has been swapped to a fixed interest rate.
(2) The annual interest rate of the Revolver assumes one-month LIBOR as of March 31, 2022 of 0.44%. Additionally, the Revolver may be extended up to one year.
(3) The Company records deferred financing costs for the Revolver in other assets, net on its condensed consolidated balance sheets.
Credit Facility
In December 2019, the Company entered into a senior credit facility consisting of (i) a $175.0 million senior secured term loan (“Term Loan”) and (ii) a $250.0 million senior secured revolving credit facility (“Revolver”, and collectively with the Term Loan, the “Credit Facility”). Wells Fargo Securities, LLC is lead arranger and bookrunner and Wells Fargo Bank, National Association is administrative agent under the Credit Facility (the “Administrative Agent”).
The Term Loan matures on December 23, 2024 and the Revolver matures on December 23, 2023, subject to extension up to one year. The Credit Facility, effective during the fourth quarter of 2020, is unsecured as the Administrative Agent released the collateral in connection with the Company’s satisfaction of the collateral release requirements. Therefore interest rates under the Credit Facility are based on the Company’s consolidated total leverage ratio, and are determined by (A) in the case of Term Loan either (i) LIBOR, plus a margin ranging from 1.15% to 1.60%, based on the Company’s consolidated total leverage ratio, or (ii) a Base Rate (as defined in the Credit Facility), plus a margin ranging from 0.15% to 0.60%, based on the Company’s consolidated total leverage ratio and (B) in the case of Revolving Loans either (i) LIBOR, plus a margin ranging from 1.20% to 1.80%, based on the Company’s consolidated total leverage ratio, or (ii) a Base Rate (as defined in the Credit Facility), plus a margin ranging from 0.20% to 0.80%, based on the Company’s consolidated total leverage ratio. Interest is payable monthly or at the end of the applicable interest period in arrears on any outstanding borrowings.
The Company is required to pay a Revolver facility fee at an annual rate of 0.15% of the unused capacity if usage exceeds 50% of the total available facility, or 0.25% of the unused facility if usage does not exceed 50%. Loans from the Revolver are generally restricted if, among other things, the proposed usage of the proceeds from the loan do not meet certain criteria as outlined in the Credit Facility Agreement, if an event of default exists, or if the requested loan will create an event of default. Loans from the Revolver may not exceed the total revolving commitments.
Effective September 28, 2020, the Company entered into an interest rate derivative contract to fix the base interest rate (one-month LIBOR) on the Term Loan. The total interest rate includes the fixed base interest rate of 0.21% plus a leverage-based margin of 1.15% as of March 31, 2022. The interest rate hedge is further described in “Note 7 - Derivative Financial Instruments.”
Deferred financing, discount and debt issuance costs are being amortized over the remaining terms of each respective loan. Total costs amortized on the Term Loan and Revolver were $0.2 million for each of the three months ended March 31, 2022 and March 31, 2021, respectively. This is included in interest expense, net on the Company’s condensed consolidated statements of operations and comprehensive income
For the three months ended March 31, 2022 and 2021, the Term Loan had a weighted average interest rate, exclusive of amortization of deferred financing costs and the effects of the interest rate hedge, of 1.32% and 1.30%, respectively.
The Company incurred interest expense of $0.6 million in connection with the Term Loan for each of the three months ended March 31, 2022 and 2021, respectively.
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The estimated fair value of the Company’s Term Loan has been derived based on market observable inputs such as interest rates and discounted cash flow analysis using estimates of the amount and timing of future cash flows. These measurements are classified as Level 2 within the fair value hierarchy. The Company determined that the carrying value materially approximated the estimated fair value of the Term Loan as of March 31, 2022 and December 31, 2021.
During the three months ended March 31, 2022 and March 31, 2021, the Company incurred interest expense, exclusive of facility fees for unused capacity, on borrowings under the Revolver of $0.4 million and less than $0.1 million, respectively, with a weighted average interest rate, exclusive of amortization of deferred financing costs, of 1.39% and 1.29%, respectively. As of March 31, 2022 and December 31, 2021, the Company had $120.0 million and $64.0 million in borrowings outstanding under the Revolver. The Company also incurred interest expense in connection with unused capacity for the three months ended March 31, 2022 and 2021 of $0.1 million and $0.2 million, respectively.
During the first three months of 2022, the Company capitalized less than $0.1 million of interest expense associated with properties under development. No interest expense was capitalized during the first three months of 2021.
The Company was in compliance with all of its debt covenants as of March 31, 2022 and expects to be in compliance for the following twelve-month period.
Debt Maturity
Payments on the Term Loan are interest only through maturity. All outstanding amounts on the Term Loan are due on December 23, 2024.
Note 7 – Derivative Financial Instruments
The Company uses interest rate derivative contracts to manage its exposure to changes in interest rates on its variable rate debt. These derivatives are considered cash flow hedges and are recorded on a gross basis at fair value. Assessments of hedge effectiveness are performed quarterly using either a qualitative or quantitative approach. The Company recognizes the entire change in the fair value in Accumulated Other Comprehensive Income (“AOCI”) and the change is reflected as cash flow hedge changes in fair value in the supplemental disclosures of non-cash investing and financing activities in the consolidated statement of cash flows. Effective September 28, 2020, such derivatives were initiated to hedge the variable cash flows associated with Term Loan. Accordingly, the interest rate for the variable rate Term Loan is based on the hedged fixed rate (one-month) of 0.21% compared to the variable Term Loan one-month LIBOR rate as of March 31, 2022 of 0.23%, plus a margin of 1.15%. The maturity date of the interest rate swaps coincide with the maturity date of the Term Loan.
Amounts will subsequently be reclassified to earnings when the hedged item affects earnings. The Company does not enter into derivative contracts for speculative or trading purposes and does not have derivative netting arrangements.
The Company is exposed to credit risk in the event of non-performance by its derivative counterparties. The Company evaluates counterparty credit risk through monitoring the creditworthiness of counterparties, which includes review of debt ratings and financial performance. To mitigate credit risk, the Company enters into agreements with counterparties it considers credit-worthy, such as large financial institutions with favorable credit ratings.
The Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk (in thousands, except number of instruments):
| Number of Instruments | Notional | |||||||||||||||||||||||||
| Interest Rate Derivatives | March 31, 2022 | December 31, 2021 | March 31, 2022 | December 31, 2021 | ||||||||||||||||||||||
| Interest rate swaps | 4 | 4 | $ | 175,000 | $ | 175,000 | ||||||||||||||||||||
The following table presents the fair value of the Company's derivative financial instruments as well as their classification on the condensed consolidated balance sheets as of March 31, 2022 and December 31, 2021 (in thousands):
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| Derivative Assets | ||||||||||||||||||||
| Fair Value at | ||||||||||||||||||||
| Derivatives Designated as Hedging Instruments: | Balance Sheet Location | March 31, 2022 | December 31, 2021 | |||||||||||||||||
| Interest rate swaps | Other assets, net | $ | 10,520 | $ | 4,310 | |||||||||||||||
The following table presents the effect of the Company's interest rate swaps on the condensed consolidated statements of operations and comprehensive income for the three months ended March 31, 2022 and 2021 (in thousands):
| Amount of Gain or (Loss) Recognized in OCI on Derivative (Effective Portion) | Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) | Amount of (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) | ||||||||||||||||||||||||||||||
| Derivatives in Cash Flow Hedging Relationships | 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||||||||||
| For the Three Months Ended March 31 | ||||||||||||||||||||||||||||||||
| Interest Rate Products | $ | 6,188 | $ | 2,290 | Interest expense, net | $ | (23) | $ | (34) | |||||||||||||||||||||||
The Company did not exclude any amounts from the assessment of hedge effectiveness for the three months ended March 31, 2022 and 2021. During the next twelve months, the Company estimates that $2.8 million will be reclassified as a decrease to interest expense.
The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves.
To comply with the provisions of ASC 820, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2022, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
The table below presents the Company’s derivative liabilities measured at fair value on a recurring basis as of March 31, 2022, aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands):
| Fair Value Hierarchy Level | ||||||||||||||||||||||||||
| Description | Level 1 | Level 2 | Level 3 | Total Fair Value | ||||||||||||||||||||||
| March 31, 2022 | ||||||||||||||||||||||||||
| Derivative assets | $ | — | $ | 10,520 | $ | — | $ | 10,520 | ||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||||
| Derivative assets | — | 4,310 | — | 4,310 | ||||||||||||||||||||||
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Note 8 – Supplemental Detail for Certain Components of the Condensed Consolidated Balance Sheets
Other assets, net consist of the following (in thousands):
| March 31, 2022 | December 31, 2021 | ||||||||||
| Accounts receivable, net | $ | 4,147 | $ | 2,801 | |||||||
| Deferred rent receivable | 2,918 | 2,263 | |||||||||
| Prepaid assets | 2,589 | 1,473 | |||||||||
| Earnest money deposits | 1,483 | 853 | |||||||||
| Fair value of interest rate swaps | 10,520 | 4,309 | |||||||||
| Deferred offering costs | 598 | 615 | |||||||||
| Deferred financing costs, net | 696 | 796 | |||||||||
| 4,490 | 4,581 | ||||||||||
| Leasehold improvements and other corporate assets | 2,212 | 1,657 | |||||||||
| Interest receivable | 202 | — | |||||||||
| Other assets, net | 673 | 1,003 | |||||||||
| $ | 30,528 | $ | 20,351 | ||||||||
Accounts payable, accrued expenses and other liabilities consists of the following (in thousands):
| March 31, 2022 | December 31, 2021 | ||||||||||
| Accrued expenses | $ | 5,851 | $ | 6,254 | |||||||
| Accrued bonus | 396 | 1,742 | |||||||||
| Prepaid rent | 1,791 | 1,918 | |||||||||
| Operating lease liability | 5,480 | 5,442 | |||||||||
| Accounts payable | 1,014 | 419 | |||||||||
| Other liabilities | 1,634 | 1,205 | |||||||||
| $ | 16,166 | $ | 16,980 | ||||||||
Note 9 – Shareholders’ Equity, Partners’ Capital and Preferred Equity
Common Stock
On January 13, 2022, the Company completed a registered public offering of 10,350,000 shares of its common stock at a public offering price of $22.25 per share. In connection with the offering, the Company entered into forward sale agreements for 10,350,000 shares of its common stock. The Company did not initially receive any proceeds from the sale of shares of common stock by the forward purchasers. The Company expects to physically settle the forward sale agreements (by the delivery of shares of common stock) and receive proceeds from the sale of those shares upon one or more forward settlement dates, which shall occur no later than January 10, 2023. The Company may also elect to cash settle or net share settle all or a portion of its obligations under a forward sale agreement if it concludes it is in its best interest to do so. If the Company elects to cash settle a forward sale agreement, it may not receive any proceeds and may owe cash to the relevant forward counterparty in certain circumstances.
On March 30, 2022, the Company settled 3,440,962 shares of common stock at a price of $22.25 per share in accordance with the forward sale agreements. The Company received net proceeds from the offering of $72.0 million, net of underwriting discounts and offering costs of $4.6 million. The Company contributed the net proceeds to the Operating Partnership in exchange for 3,440,962 Class A OP Units.
On September 1, 2021, the Company entered into a new $250.0 million at-the-market equity program (the “ATM Program”) through which, from time to time, it may sell shares of its common stock in registered transactions. For the three months ended March 31, 2022, the Company issued 163,774 shares of common stock at a weighted average price of $22.08 per share in connection with the ATM Program for net proceeds of approximately $3.5 million, net of sales commissions and offering costs
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of less than $0.1 million. The Company contributed the net proceeds to the Operating Partnership in exchange for 163,774 Class A OP Units.
During the three months ended March 31, 2022, portions of restricted stock unit awards (“RSUs”) granted to certain of the Company’s officers, directors, and employees vested. The vesting of these awards, granted pursuant to the NETSTREIT Corp. 2019 Omnibus Incentive Compensation Plan (the “Omnibus Incentive Plan”), resulted in federal and state income tax liabilities for the recipients. As permitted by the terms of the Omnibus Incentive Plan and the award grants, certain executive officers and employees elected to surrender 17 thousand RSUs valued at approximately $0.4 million, solely to pay the associated statutory tax withholding. The surrendered RSUs are included in the row entitled “repurchase of shares of common stock” on the condensed consolidated statements of cash flows.
Dividends
During the three months ended March 31, 2022, the Company declared and paid the following common stock dividends (in thousands, except per share data):
| Declaration Date | Dividend Per Share | Record Date | Total Amount | Payment Date | ||||||||||||||||||||||
| February 22, 2022 | $ | 0.20 | March 15, 2022 | $ | 8,888 | March 30, 2022 | ||||||||||||||||||||
The holders of OP Units are entitled to an equal distribution per Class A OP Unit and Class B OP Unit held as of each record date. Accordingly, during the three months ended March 31, 2022, the Operating Partnership paid distributions of $0.1 million to holders of OP Units.
Noncontrolling Interests
Noncontrolling interests represent noncontrolling holders of OP Units in the Operating Partnership. OP Units are convertible into common stock as the OP Units may be redeemed for cash or, at the Company’s election, exchanged for shares of the Company’s common stock on a one-for-one basis. As of March 31, 2022 and December 31, 2021, noncontrolling interests represented 1.1% and 1.3%, respectively, of OP Units. During the three months ended March 31, 2022, OP Unit holders redeemed 25,629 OP units into shares of common stock on a one-for-one basis. During the three months ended March 31, 2021, OP Unit holders redeemed 253,344 OP units into shares of common stock on a one-for-one basis.
Note 10 – Stock-Based Compensation
Under the Omnibus Incentive Plan 2,094,976 shares of common stock are reserved for issuance. The Omnibus Incentive Plan provides for the grant of stock options, stock appreciation rights, restricted shares, RSUs, long-term incentive plan units, dividend equivalent rights, and other share-based, share-related or cash-based awards, including performance-based awards, to employees, directors and consultants, with each grant evidenced by an award agreement providing the terms of the award. The Omnibus Incentive Plan is administered by the Compensation Committee of the Board of Directors.
As of March 31, 2022, the only stock-based compensation granted by the Company were RSUs. The total amount of stock-based compensation costs recognized in general and administrative expense in the accompanying condensed consolidated statements of operations and comprehensive income was $1.0 million and $0.6 million for the three months ended March 31, 2022 and 2021. All awards of unvested RSUs are expected to fully vest over the next to five years.
Performance-Based RSUs (effectiveness of shelf registration)
Pursuant to the Omnibus Incentive Plan, the Company granted performance-based RSUs to certain employees and non-employee directors. The performance condition required the Company to effectively file a shelf registration statement. Up until the point of filing the registration statement, performance was not deemed probable and accordingly, no RSUs had the capability of vesting, and no stock-based compensation expense was recorded. As a result of the Company's initial public offering in August 2020, the performance condition was satisfied, and the Company recorded a stock-based compensation expense catch-up adjustment of $1.4 million. The vesting terms of these grants are specific to the individual grant and vest in equal annual installments over the next to three years.
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The following table summarizes performance-based restricted stock unit activity for the period ended March 31, 2022:
| Shares | Weighted Average Grant Date Fair Value per Share | ||||||||||
| Unvested restricted stock grants outstanding as of December 31, 2021 | 157,380 | $ | 19.75 | ||||||||
| Vested during the period | (15,190) | 19.75 | |||||||||
| Unvested restricted stock grants outstanding as of March 31, 2022 | 142,190 | $ | 19.75 | ||||||||
For the three months ended March 31, 2022, the Company recognized $0.2 million in stock-based compensation expense associated with performance-based RSUs. As of March 31, 2022 and December 31, 2021, the remaining unamortized stock-based compensation expense totaled $1.1 million and $1.3 million, respectively, and as of March 31, 2022, these awards are expected to be recognized over a remaining weighted average period of 2.0 years. These units are subject to graded vesting and amortization is recognized ratably over the requisite service period for each vesting tranche in the award.
The weighted average grant date fair value of unvested restricted units is calculated as the per share price determined on December 23, 2019, through a series of completed transactions (collectively the “Private Offering”).
Service-Based RSUs
Pursuant to the Omnibus Incentive Plan, the Company has granted service-based restricted stock unit grants to certain employees and non-employee directors. The vesting terms of these grants are specific to the individual grant and vest in equal annual installments over the next to five years.
The following table summarizes service-based restricted stock unit activity for the period ended March 31, 2022:
| Shares | Weighted Average Grant Date Fair Value per Share | ||||||||||
| Unvested restricted stock grants outstanding as of December 31, 2021 | 295,207 | $ | 17.84 | ||||||||
| Granted during the period | 141,833 | 22.14 | |||||||||
| Forfeited during the period | (12,082) | 18.62 | |||||||||
| Vested during the period | (70,034) | 17.47 | |||||||||
| Unvested restricted stock grants outstanding as of March 31, 2022 | 354,924 | $ | 19.23 | ||||||||
For the three months ended March 31, 2022, the Company recognized $0.6 million in stock-based compensation expense associated with service-based RSUs. As of March 31, 2022 and December 31, 2021, the remaining unamortized stock-based compensation expense totaled $5.5 million and $4.1 million, respectively, and as of March 31, 2022, these awards are expected to be recognized over a remaining weighted average period of 2.6 years. Amortization is recognized on a straight-line basis over the total requisite service period for the entire award.
The grant date fair value of service based unvested restricted units is calculated as the per share price determined in the initial public offering for awards granted in 2020 and as the per share price of the Company’s stock on the date of grant for those granted in 2021.
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Performance-Based RSUs (total shareholder return)
Pursuant to the Omnibus Incentive Plan, the Company has granted performance-based RSUs to certain employees. These grants are subject to the participant’s continued service over a three-year period with 40% of the award based on the Company’s total shareholder return (“TSR”) as compared to the TSR of 32 peer companies and 60% of the award based on total absolute TSR over the cumulative three-year period. The performance periods of these grants run through March 8, 2024 and February 28, 2025. Grant date fair values of the performance-based share awards were calculated using the Monte Carlo simulation model, which incorporated stock price volatility of the Company and each of the Company’s peers and other variables over the performance period. Significant inputs for the 2022 calculation were expected volatility of the Company of 36.3% and expected volatility of the Company's peers, ranging from 28.7% to 95.3%, with an average volatility of 46.6% and a risk-free interest rate of 1.61%. The fair value per share on the grant date specific to the target TSR relative to the Company’s peers was $26.13 and the target absolute TSR was $20.42 for a weighted average grant date fair value of $22.38 per share. Stock-based compensation expense associated with unvested performance-based share awards is recognized on a straight-line basis over the minimum required service period, which is three years.
The following table summarizes performance-based restricted stock unit activity for the period ended March 31, 2022:
| Shares | Weighted Average Grant Date Fair Value per Share | ||||||||||
| Unvested restricted stock grants outstanding as of December 31, 2021 | 134,467 | $ | 17.77 | ||||||||
| Granted during the period | 106,645 | 22.38 | |||||||||
| Forfeited during the period | (1,722) | 17.77 | |||||||||
| Unvested restricted stock grants outstanding as of March 31, 2022 | 239,390 | $ | 19.82 | ||||||||
For the three months ended March 31, 2022, the Company recognized $0.3 million in stock-based compensation expense associated with performance-based RSUs. As of March 31, 2022, the remaining unamortized stock-based compensation expense totaled $3.8 million and as of March 31, 2022, these awards are expected to be recognized over a remaining weighted average period of 2.6 years.
Alignment of Interest Program
During March 2021, the Company adopted the Alignment of Interest Program (the “Program”), which allows employees to elect to receive a portion of their annual bonus in unvested RSUs in the first quarter of the following year that would then vest over a four-year service period beginning in the period that the bonus relates. The Program is deemed to be a liability-classified award (accounted for as an equity-classified award as the service date precedes the grant date and the award would otherwise by classified as equity on grant date), which will be fair-valued and accrued over the applicable service period. The total estimated fair value of the elections made for 2022 under the Program as of March 31, 2022 was approximately $0.9 million. The award will be remeasured to fair value each reporting period until the unvested RSUs are granted. For the three months ended March 31, 2022, the Company recognized approximately $0.1 million in stock-based compensation expense associated with these awards. Previous awards under the Program that have been granted are included within service based RSUs above.
Note 11 – Earnings Per Share
Net income per common share has been computed pursuant to the guidance in the FASB ASC Topic 260, Earnings per Share. Basic earnings per share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is similarly calculated except that the denominator is increased by using the treasury stock method to determine the potential dilutive effect of the Company’s outstanding unvested RSUs and unsettled shares under open forward equity contracts and using the if-converted method to determine the potential dilutive effect of the OP Units. The Company has noncontrolling interests in the form of OP Units which are convertible into common stock and represent potentially dilutive securities, as the OP Units may be redeemed for cash or, at the Company’s election, exchanged for shares of the Company’s common stock on a one-for-one basis. The following table is a reconciliation of the numerator and denominator used in the computation of basic and diluted net income per common share for the three months ended March 31, 2022 and 2021.
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| Three Months Ended March 31, | |||||||||||
| (In thousands, except share and per share data) | 2022 | 2021 | |||||||||
| Numerator: | |||||||||||
| Net income | $ | 1,966 | $ | 741 | |||||||
| Net (income) attributable to noncontrolling interest | (24) | (40) | |||||||||
| Net income attributable to common shares, basic | 1,942 | 701 | |||||||||
| Net (income) attributable to noncontrolling interest | (24) | (40) | |||||||||
| Net income attributable to common shares, diluted | $ | 1,966 | $ | 741 | |||||||
| Denominator: | |||||||||||
| Weighted average common shares outstanding, basic | 44,415,807 | 28,348,975 | |||||||||
| Effect of dilutive shares for diluted net income per common share: | |||||||||||
| OP Units | 550,673 | 1,616,005 | |||||||||
| Unvested RSUs | 294,272 | 87,960 | |||||||||
| Unsettled shares under open forward equity contracts | 340,058 | — | |||||||||
| Weighted average common shares outstanding, diluted | 45,600,810 | 30,052,940 | |||||||||
| Net income available to common stockholders per common share, basic | $ | 0.04 | $ | 0.02 | |||||||
| Net income available to common stockholders per common share, diluted | $ | 0.04 | $ | 0.02 | |||||||
As of March 31, 2022 and December 31, 2021, there were 537,155 and 562,784 of OP Units outstanding, respectively.
Note 12 – Commitments and Contingencies
Litigation and Regulatory Matters
In the ordinary course of business, from time to time, the Company may be subject to litigation, claims and regulatory matters, none of which are currently outstanding, which the Company believes could have, individually or in the aggregate, a material adverse effect on its business, financial condition or results of operations, liquidity or cash flows.
Environmental Matters
The Company is subject to environmental regulations related to the ownership of real estate. The cost of complying with the environmental regulations was not material to the Company’s results of operations for any of the periods presented. The Company is not aware of any environmental condition on any of its properties that is likely to have a material adverse effect on the condensed consolidated financial statements when the fair value of such liability can be reasonably estimated and is required to be recognized.
Commitments
In the normal course of business, the Company enters into various types of commitments to purchase real estate properties or fund development projects. These commitments are generally subject to the Company’s customary due diligence process and, accordingly, a number of specific conditions must be met before the Company is obligated or receives an option to purchase the properties. Additionally, as of March 31, 2022, the Company had commitments to fund nine properties under development totaling $20.9 million which is expected to be funded over the next twelve months.
In August 2021, the Company entered into a lease agreement on a new corporate office space, which is classified as an operating lease. The Company began operating out of the new office in February 2022. The lease has an initial noncancellable term of 10.3 years that expires on July 31, 2032 and is renewable at the Company’s option for two additional periods of five years. Future minimum base rental payments under the lease are outlined in “Note - 3 - Leases.” Annual rent expense, excluding operating expenses, is expected to be approximately $0.5 million during the initial term.
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As of March 31, 2022, the Company did not have any other material commitments for re-leasing costs, recurring capital expenditures, non-recurring building improvements, or similar types of costs.
Note 13 – Related-Party Transactions
Effective with the Private Offering and commencement of the Company’s operations on December 23, 2019, the Company executed a facilities agreement with a subsidiary of EB Arrow Holdings, LLC, which was subsequently amended in April 2021 and ultimately terminated in July 2021. Under the facilities agreement, the Company shared in office rent by paying a fixed monthly rate and office related expenses based on employee headcount. For the three months ended March 31, 2021, the Company incurred less than $0.1 million in related expenses.
Note 14 – Subsequent Events
The Company has evaluated all events that occurred subsequent to March 31, 2022 through the date on which these condensed consolidated financial statements were issued to determine whether any of these events required disclosure in the financial statements.
Common Stock Dividend
On April 26, 2022, the Company's Board of Directors declared a cash dividend of $0.20 per share for the second quarter of 2022. The dividend will be paid on June 15, 2022 to stockholders of record on June 1, 2022.
Revolver Activity
In April 2022, the Company borrowed $20.0 million on the Revolver which will be used for general corporate purposes, including the acquisition of properties in the Company’s pipeline.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include, without limitation, statements concerning our business and growth strategies, investment, financing and leasing activities and trends in our business, including trends in the market for single-tenant, retail commercial real estate. Words such as “expects,” “anticipates,” “intends,” “plans,” “likely,” “will,” “believes,” “seeks,” “estimates,” and variations of such words and similar expressions are intended to identify such forward-looking statements. Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from the results of operations or plans expressed or implied by such forward-looking statements. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore such statements included in this Quarterly Report on Form 10-Q may not prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved. For a further discussion of these and other factors that could impact future results, performance or transactions, see the information under the heading “Risk Factors” Part I, Item 1A. in our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the Securities and Exchange Commission (the “SEC”) on February 24, 2022, and other reports filed with the Securities and Exchange Commission from time to time.
Forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Quarterly Report on Form 10-Q. New risks and uncertainties may arise over time and it is not possible for us to predict those events or how they may affect us. We expressly disclaim any obligation or undertaking to update or revise any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based, except to the extent otherwise required by law.
Overview
We are an internally managed real estate company that acquires, owns and manages a diversified portfolio of single-tenant, retail commercial real estate subject to long-term net leases with high credit quality tenants across the United States. Our diversified portfolio consists of 361 single-tenant retail net leased properties spanning 42 states, with 71 different tenants represented across 23 retail sectors. Our portfolio generates ABR1 of $77.0 million and is 100% occupied, with a weighted average lease term (“WALT”) of 9.6 years and consisting of approximately 64% and 17% of investment grade tenants and investment grade profile tenants, respectively, by ABR, which we believe provides us with a strong, stable source of recurring cash flow. We focus on tenants in industries where a physical location is critical to the generation of sales and profits, with a focus on necessity goods and essential services in the retail sector, including home improvement, auto parts, drug stores and pharmacies, general retail, grocers, convenience stores, discount stores, and quick-service restaurants, which we refer to as defensive retail industries. We believe these characteristics make our tenants' businesses e-commerce resistant and resilient through all economic cycles.
COVID-19
We continue to monitor the global outbreak of COVID-19 and to take steps to mitigate the potential risks to us posed by the pandemic. In addition, we continue to stay in close contact with our tenants and monitor the timeliness of rental payments and any significant changes in our tenants' businesses. See “Note 2 - Summary of Significant Accounting Policies” to our condensed consolidated financial statements included herein. The Company’s operations and cash flows for the three months ended March 31, 2022 and 2021 were not materially impacted by COVID-19.
(1) ABR is calculated by multiplying (i) cash rental payments (a) for the month ended March 31, 2022 (or, if applicable, the next full month's cash rent contractually due in the case of rent abatements, rent deferrals, recently acquired properties and properties with contractual rent increases, other than properties under development) for leases in place as of March 31, 2022, plus (b) for properties under development, the first full month's estimated permanent cash rent contractually due after the development period by (ii) 12.
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Financing Activities
On January 13, 2022, we completed a registered public offering of 10,350,000 shares of our common stock at a public offering price of $22.25 per share. In connection with the offering, we entered into forward sale agreements for 10,350,000 shares of our common stock. We did not initially receive any proceeds from the sale of shares of common stock by the forward purchasers. We expect to physically settle the forward sale agreements (by the delivery of shares of common stock) and receive proceeds from the sale of those shares upon one or more forward settlement dates, which shall occur no later than January 10, 2023. We may also elect to cash settle or net share settle all or a portion of our obligations under a forward sale agreement if we conclude it is in our best interest to do so. If we elect to cash settle a forward sale agreement, we may not receive any proceeds and we may owe cash to the relevant forward counterparty in certain circumstances.
On March 30, 2022, we settled 3,440,962 shares of common stock at a price of $22.25 per share in connection with the forward sale agreements. We received net proceeds from the offering of $72.0 million, net of underwriting discounts and offering costs of $4.6 million.
On September 1, 2021, we entered into a $250.0 million ATM Program through which, from time to time, we may sell shares of our common stock in registered transactions. During the first quarter of 2022, we issued 163,774 shares of common stock at a weighted average price of $22.08 per share in connection with the ATM Program for net proceeds of approximately $3.5 million, net of sales commissions and offering costs of less than $0.1 million.
Results of Operations
Overall
The Company continued to grow its assets held for investment during the first quarter of 2022 by increasing its property portfolio from 328 properties as of December 31, 2021 to 363 properties as of the end of March 31, 2022. This includes nine real estate development projects owned by the Company, one property under development with a non-binding option to purchase, and one property fully collateralized by an investment in loan receivable. This growth was financed through the settlement of shares of common stock through our forward sale agreements in an amount of $72.0 million, the issuance of common stock under the ATM Program in an amount of $3.5 million, and net borrowings of $56.0 million on our Revolver during the three months ended March 31, 2022.
Acquisitions
During the three months ended March 31, 2022, we acquired 34 properties for a total purchase price of $90.0 million, including $1.2 million of capitalized acquisition costs. The acquisitions were all accounted for as asset acquisitions. These properties are located in 17 states with a WALT of approximately 8.2 years. The underwritten weighted-average capitalization rate on first quarter acquisitions was approximately 6.3%.
Development
During the three months ended March 31, 2022, we invested $5.0 million in our property developments, including the acquisition of one new build-to-suit project with an initial purchase price of $1.0 million. During the three months ended March 31, 2022, we completed development on one project under development and reclassified approximately $4.7 million from property under development to land, building, and improvements in the accompanying condensed consolidated balance sheets. The remaining nine developments are expected to be substantially completed with rent commencing at various points throughout 2022. The purchase price, including acquisitions costs, and subsequent development are included in property under development in the accompanying condensed consolidated balance sheets of March 31, 2022.
Dispositions
During the three months ended March 31, 2022, we sold one property for a total sales price, net of disposal costs of $2.3 million, recognizing a net gain of $0.2 million on the sale.
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Investment in Mortgage Loan Receivable
On January 26, 2022, we executed a fully collateralized $40.3 million loan receivable with a stated interest rate of 6.0%. The scheduled maturity date is July 26, 2023, however we have the right, subject to certain terms and conditions, to purchase a portion of the underlying, collateralized property. The loan receivable is collateralized by real estate that is leased by three separate investment-grade tenants. The funds provided under the loan, in addition to loan origination costs of $0.1 million, are included in loan receivable, net in the accompanying condensed consolidated balance sheets as of March 31, 2022.
Three Months Ended March 31, 2022 Compared with Three Months Ended March 31, 2021
The following table sets forth our operating results for the periods indicated (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Revenues | |||||||||||
| Rental revenue (including reimbursable) | $ | 20,921 | $ | 11,932 | |||||||
| Interest income on mortgage loan receivable | 411 | — | |||||||||
| Total revenues | 21,332 | 11,932 | |||||||||
| Operating expenses | |||||||||||
| Property | 2,932 | 950 | |||||||||
| General and administrative | 4,190 | 3,137 | |||||||||
| Depreciation and amortization | 10,980 | 5,929 | |||||||||
| Provisions for impairment | — | 69 | |||||||||
| Transaction costs | 165 | 151 | |||||||||
| Total operating expenses | 18,267 | 10,236 | |||||||||
| Other income (expense) | |||||||||||
| Interest expense, net | (1,169) | (905) | |||||||||
| Gain on sales of real estate, net | 161 | — | |||||||||
| Total other income (expense), net | (1,008) | (905) | |||||||||
| Net income before income tax expense | 2,057 | 791 | |||||||||
| Income tax expense | (91) | (50) | |||||||||
| Net income | $ | 1,966 | $ | 741 | |||||||
Revenue. Revenue for the three months ended March 31, 2022 increased by $9.4 million to $21.3 million from $11.9 million for the three months ended March 31, 2021. This is primarily due to an increase in the real estate portfolio from 203 operating properties as of January 1, 2021 to 352 operating properties as of March 31, 2022. The increase includes an increase in cash rental receipts of $6.7 million, combined with net increases of property expense reimbursements of $1.7 million, of which $0.9 million was related to tax reimbursements, an increase of $0.4 million in straight-line rental revenue, and an increase of $0.4 million related to interest income on the mortgage loan receivable.
Total Operating Expenses. Total expenses increased by $8.1 million to $18.3 million for the three months ended March 31, 2022 as compared to $10.2 million for the three months ended March 31, 2021. The increase in operating expenses is primarily attributed to the increase in the number of operating properties with the most significant increases being depreciation and amortization expense and property-specific expenses, in addition to an increase in stock-based compensation. Total operating expenses include the following:
•Property Expenses. Property expenses increased $1.9 million to $2.9 million for the three months ended March 31, 2022. The increase is primarily attributed to the increase in the real estate portfolio from 203 to 352 operating properties. The largest increases are from reimbursable property taxes of $0.8 million and reimbursable maintenance expense of $0.8 million. Remaining net increases are from non-reimbursable expenses of $0.2 million.
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•General and Administrative Expenses. General and administrative expenses increased $1.1 million to $4.2 million for the three months ended March 31, 2022. The increase is primarily due to an increase in stock-based compensation expense of $0.5 million and due to increases in payroll and payroll-related expenses of $0.2 million associated with the Company’s continued growth.
•Depreciation and Amortization. Depreciation and amortization expense increased $5.1 million to $11.0 million for the three months ended March 31, 2022. The increase in depreciation and amortization is proportionate to the increase in the size of the portfolio over the comparable period primarily with associated increases in building depreciation expense of $2.1 million, in-place lease amortization expense of $1.8 million, building improvements depreciation expense of $0.9 million, and leasehold improvement depreciation expense of $0.2 million.
•Provision for Impairment. For the three months ended March 31, 2022, no provision for impairment was recorded, however, we recorded a provision for impairment of approximately $0.1 million for the three months ended March 31, 2021 on one property which was classified as held-for-sale as of December 31, 2020 and sold in April 2021. This impairment and subsequent disposal relate to our plan of strategically identifying properties that can be re-leased or disposed of in an effort to improve returns and manage risk exposure.
Interest Expense. Interest expense increased by $0.3 million to $1.2 million for the three months ended March 31, 2022. The increase is primarily due to the increase in the average balances outstanding under the Revolver (as defined in “Note 6 - Debt” to our condensed consolidated statements of operations and comprehensive income), offset by decreases in facilities fees incurred for unused capacity and interest expense associated with the interest rate swap.
Gain on sales of real estate, net. For the three months ended March 31, 2022, we recorded a net gain on the sales of real estate of $0.2 million. No disposals occurred during the three months ended March 31, 2021. The table below summarizes the properties sold for the periods indicated (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Number of properties sold | 1 | — | |||||||||
| Sales price, net of disposal costs | $ | 2,294 | $ | — | |||||||
| Gain on sales of real estate, net | $ | 161 | $ | — | |||||||
Net income. Net income increased $1.3 million to $2.0 million for the three months ended March 31, 2022. Net income increased primarily due to the growth in the size of our real estate investment portfolio, which generated additional rental revenues, offset by the impact of increases in depreciation and amortization expenses and to increases in general and administrative expenses, as set forth above.
Liquidity and Capital Resources
Our primary capital requirements are to fund property acquisitions and required interest payments, as well as working capital needs, operating expenses, and capital expenditures. Our capital resources primarily consist of cash from operations, sales of equity securities and borrowings under our senior credit facility. As of March 31, 2022, we had a $175.0 million senior secured term loan (“Term Loan”) and $120.0 million of borrowings outstanding under our $250.0 million senior secured revolving credit facility (“Revolver”, and collectively with the Term Loan, the “Credit Facility”). Additionally, as of March 31, 2022, we had 6,909,038 shares that were unsettled under open forward equity contracts. We believe that the availability of proceeds from future issuances of shares of our common stock under the ATM Program and the physical settlement of forward sales of our common stock, coupled with our cash flows from operations and available borrowing capacity, will be adequate to support our ongoing operations and to fund our debt service requirements, capital expenditures and working capital for at least the next 12 months.
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Contractual Obligations and Commitments
As of March 31, 2022, our contractual obligations include the maturity of our $175.0 million Term Loan with the scheduled principal payment due on December 23, 2024 and repayment of borrowings on our $250.0 million Revolver with a maturity of December 23, 2023. During the three months ended March 31, 2022, we borrowed $128.0 million and repaid $72.0 million on our Revolver at a weighted-average interest rate of 1.39% to fund specifically identified property acquisitions.
The following table provides information with respect to our commitments as of March 31, 2022 (in thousands):
| Payment Due by Period | ||||||||||||||||||||||||||
| Total | From April 1, 2022 to December 31, 2022 | 1 – 3 Years | 3 – 5 Years | |||||||||||||||||||||||
| Contractual Obligations | ||||||||||||||||||||||||||
| Term Loan – Principal | $ | 175,000 | $ | — | $ | 175,000 | $ | — | ||||||||||||||||||
Term Loan – Variable interest (1) | 6,482 | 1,782 | 4,700 | — | ||||||||||||||||||||||
| Revolver – Borrowings | 120,000 | — | 120,000 | — | ||||||||||||||||||||||
| Revolver – Variable interest | 3,410 | 1,480 | 1,930 | |||||||||||||||||||||||
Unutilized borrowing fees on Revolver (2) | 562 | 244 | 318 | — | ||||||||||||||||||||||
| Property development under contract | 20,902 | 20,902 | — | |||||||||||||||||||||||
| Corporate office lease obligations | 6,570 | 150 | 1,150 | 5,270 | ||||||||||||||||||||||
| Total | $ | 332,926 | $ | 24,558 | $ | 303,098 | $ | 5,270 | ||||||||||||||||||
(1) Effective September 28, 2020, we entered into an interest rate hedge to fix the base interest rate (one-month LIBOR) on our Term Loan. Accordingly, the projected interest rate obligations for the variable rate Term Loan are based on the hedged fixed rate of 0.21% compared to the variable Term Loan one-month LIBOR rate as of March 31, 2022 of 0.23%, plus a margin of 1.15% based on the $175.0 million Term Loan outstanding through the maturity date of December 23, 2024.
(2) We are subject to a variable unutilized borrowing fee on the unused portion of our $250.0 million Revolver. This reflects our projected unutilized borrowing fee at 0.25% assuming no additional borrowing through the maturity date of December 23, 2023.
In August 2021, the Company entered into a lease agreement on a new corporate office space, which is classified as an operating lease. The Company began operating out of the new office in February 2022. The lease has an initial noncancellable term of 10.3 years that expires on July 31, 2032, with a one-time option to terminate in 2029 exercisable by the Company. The lease is also renewable at the Company’s option for two additional periods of five years. Future minimum base rental payments under the lease are outlined in “Note - 3 - Leases”. Annual rent expense, excluding operating expenses, is expected to be approximately $0.5 million during the initial term.
Additionally, in the normal course of business, the Company enters into various types of commitments to purchase real estate properties or fund development projects. These commitments are generally subject to the Company’s customary due diligence process and, accordingly, a number of specific conditions must be met before the Company is obligated or receives an option to purchase the properties. As of March 31, 2022, the Company had commitments to fund properties under development totaling $20.9 million, all of which is expected to be funded over the next 12 months.
Credit Facility
In December 2019, the Company entered into the Credit Facility which consisted of (i) the $175.0 million Term Loan and (ii) the $250.0 million Revolver. Wells Fargo Securities, LLC is lead arranger and bookrunner and Wells Fargo Bank, National Association is the administrative agent under the Credit Facility (the “Administrative Agent”).
The Term Loan matures on December 23, 2024 and the Revolver matures on December 23, 2023, subject to extension up to one year. The Credit Facility, effective during the fourth quarter of 2020, is unsecured as the Administrative Agent released the collateral in connection with the Company’s satisfaction of the collateral release requirements. Therefore interest rates under the Credit Facility are based on the Company’s consolidated total leverage ratio, and are determined by (A) in the case of the Term Loan either (i) LIBOR, plus a margin ranging from 1.15% to 1.60%, based on the Company’s consolidated total leverage ratio, or (ii) a Base Rate (as defined in the Credit Facility), plus a margin ranging from 0.15% to 0.60%, based on the Company’s
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consolidated total leverage ratio and (B) in the case of the Revolver either (i) LIBOR, plus a margin ranging from 1.20% to 1.80%, based on the Company’s consolidated total leverage ratio, or (ii) a Base Rate (as defined in the Credit Facility), plus a margin ranging from 0.20% to 0.80%, based on the Company’s consolidated total leverage ratio. Interest is payable monthly or at the end of the applicable interest period in arrears on any outstanding borrowings.
The Company uses interest rate derivative contracts to manage its exposure to changes in interest rates on its variable rate debt. These derivatives are considered cash flow hedges and are recorded on a gross basis at fair value. Effective September 28, 2020, such derivatives were used to hedge the variable cash flows associated with the Term Loan. The interest rate hedge is further described in “Note 7 - Derivative Financial Instruments.”
Historical Cash Flow Information
Three Months Ended March 31, 2022 Compared with Three Months Ended March 31, 2021
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In thousands) | (Unaudited) | ||||||||||
| Net cash provided by (used in): | |||||||||||
| Operating activities | 8,954 | 4,270 | |||||||||
| Investing activities | (133,708) | (90,022) | |||||||||
| Financing activities | 121,838 | 6,825 | |||||||||
Cash Flows Provided By Operating Activities. Net cash provided by operating activities increased by $4.7 million for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. The increase was largely attributed to the increase in the size of the Company’s real estate investment portfolio with an increase in rental receipts of $6.7 million, offset primarily by increases in operating and general and administrative expenses paid associated with our larger portfolio.
Cash Flows Used In Investing Activities. Net cash used in investing activities increased by $43.7 million for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. The increase was primarily due to acquisitions, including an investment in a mortgage loan receivable of $40.4 million. The remaining increase is related primarily to acquisition and development activity, which increased $4.9 million compared to the prior period, offset by $2.3 million more of proceeds received from the sale of assets.
Cash Flows Provided By Financing Activities. Net cash provided by financing activities increased by $115.0 million for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. The increase was primarily attributed to issuances of common stock in connection with our ATM Program and physical settlement of our common stock under the forward sale agreements, for combined net proceeds of $75.5 million. Additionally, we paid $3.0 million more of dividends and distributions during the three months ended March 31, 2022. Lastly, we net borrowed $43.0 million more under the Revolver during the three months ended March 31, 2022 than the prior period.
Income Taxes
The Company elected to be treated and qualify as a REIT for U.S. federal income tax purposes beginning with its short taxable year ended December 31, 2019. To qualify as a REIT, the Company must meet certain organizational, income, asset and distribution tests. Accordingly, the Company will generally not be subject to corporate U.S. federal or state income tax to the extent that it makes qualifying distributions of all of its taxable income to its stockholders and provided it satisfies on a continuing basis, through actual investment and operating results, the REIT requirements, including certain asset, income, distribution and share ownership tests. The Company intends to make sufficient distributions during 2022 to receive a full dividends paid deduction.
We maintain a taxable REIT subsidiary (“TRS”) which may be subject to U.S. federal, state, and local income taxes on its taxable income. In general, our TRS may perform services for tenants of the Company, hold assets that the Company cannot hold directly and may engage in any real estate or non-real estate-related business.
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During three months ended March 31, 2022 and 2021, the Company recognized franchise and other state and local tax expenses in general and administrative expense and recognized state and federal income tax expense in income tax expense in the accompanying condensed consolidated statements of operations and comprehensive income.
Recent Accounting Pronouncements
A discussion of new accounting standards and the possible effects of these standards on our condensed consolidated financial statements is included in “Note 2 - Summary of Significant Accounting Policies” of our condensed consolidated financial statements, included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Critical Accounting Policies and Estimates
Our accounting policies have been established to conform with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires us to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management believes that we have made these estimates and assumptions in an appropriate manner and in a way that accurately reflects our financial condition. We continually test and evaluate these estimates and assumptions using our historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions. If our judgment or interpretation of the facts and circumstances relating to the various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses. A summary of our critical accounting policies is included in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2021, which is accessible on the SEC’s website at www.sec.gov. There have been no material changes to these policies during the periods covered by this quarterly report.
Purchase Price Allocation of Acquired Properties
We evaluate each acquisition transaction to determine whether the acquired asset meets the definition of a business and therefore accounted for as a business combination or if the acquisition transaction should be accounted for as an asset acquisition. Under Accounting Standards Update (“ASU”) 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business” (“ASU 2017-01”), an acquisition does not qualify as a business when substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets or the acquisition does not include a substantive process in the form of an acquired workforce or an acquired contract that cannot be replaced without significant cost, effort or delay. Transaction costs related to acquisitions that qualify as asset acquisitions are capitalized as part of the cost basis of the acquired assets, while transaction costs for acquisitions that are deemed to be acquisitions of a business are expensed as incurred.
We allocate the purchase price of acquired properties accounted for as asset acquisitions to tangible and identifiable intangible assets or liabilities based on their relative fair values. Tangible assets may include land, buildings, site improvements and tenant improvements. Intangible assets include the value of in-place leases and above-market leases and intangible liabilities include below-market leases.
The fair value of the tangible assets of an acquired property with an in-place operating lease is determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to the tangible assets based on the fair value of the tangible assets. The fair value of in-place leases is determined by considering estimates of carrying costs during the expected lease-up periods, current market conditions, as well as costs to execute similar leases based on the specific characteristics of each tenant’s lease. We estimate the cost to execute leases with terms similar to the remaining lease terms of the in-place leases, including leasing commissions, legal and other related expenses. The fair value of above-market or below-market leases is recorded based on the net present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between the contractual amount to be paid pursuant to the in-place lease and our estimate of the fair market lease rate for the corresponding in-place lease, measured over the remaining non-cancelable term of the lease including any below-market fixed rate renewal options for below-market leases. In making estimates of fair values for purposes of allocating purchase price, we utilize a number of sources, including real estate valuations prepared by an independent valuation firm. We also consider information and other factors including market conditions, the industry that the tenant operates in, characteristics of the real
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estate; e.g., location, size, demographics, value and comparative rental rates; tenant credit profile and the importance of the location of the real estate to the operations of the tenant’s business. Additionally, we consider information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets and liabilities acquired.
Impairment of Long-Lived Assets
Fair value measurement of an asset group occurs when events or changes in circumstances related to an asset indicate that the carrying amount of the asset group is no longer recoverable. An example of an event or changed circumstance is a reduction in the expected holding period of a property. If indicators are present, we will prepare a projection of the undiscounted future cash flows of the property, excluding interest charges, and determine if the carrying amount of the asset group is recoverable. When a carrying amount is not recoverable, an impairment loss is recognized to the extent that the carrying amount of the asset group exceeds its fair market value. We estimate fair value using data such as operating income, estimated capitalization rates or multiples, leasing prospects, local market information, and with regard to assets held for sale, based on the estimated or negotiated selling price, less estimated costs of disposal.
Non-GAAP Financial Measures
Our reported results are presented in accordance with GAAP. We also disclose the following non-GAAP financial measures: Funds From Operations (“FFO”), Core FFO, Adjusted FFO (“AFFO”), earnings before interest expense, income tax expense, and depreciation and amortization (“EBITDA”), EBITDA adjusted to exclude gains (or losses) from the sales of depreciable property and real estate impairment losses (“EBITDAre”), EBITDAre further adjusted to exclude straight-line rent and non-cash compensation expense (“Adjusted EBITDAre”), net operating income (“NOI”) and cash net operating income (“Cash NOI”). We believe these non-GAAP financial measures are industry measures used by analysts and investors to compare the operating performance of REITs.
FFO, Core FFO and AFFO
The National Association of Real Estate Investment Trusts ("NAREIT"), an industry trade group, has promulgated a widely accepted non-GAAP financial measure of operating performance known as FFO. Our FFO is net income in accordance with GAAP, excluding gains (or losses) resulting from dispositions of properties, plus depreciation and amortization and impairment charges on depreciable real property.
Core FFO is a non-GAAP financial measure defined as FFO adjusted to remove the effect of unusual and non-recurring items that are not expected to impact our operating performance or operations on an ongoing basis. Historically, these have included gains from forfeited earnest money deposits, non-recurring public company costs, and gains from insurance proceeds.
AFFO is a non-GAAP financial measure defined as Core FFO adjusted for GAAP net income related to non-cash revenues and expenses, such as straight-line rent, amortization of above- and below-market lease-related intangibles, amortization of lease incentives, capitalized interest expense, non-cash compensation expense, and amortization of deferred financing and amortization of loan origination costs.
Historical cost accounting for real estate assets implicitly assumes that the value of real estate assets diminishes predictably over time. In fact, real estate values historically have risen or fallen with market conditions. FFO is intended to be a standard supplemental measure of operating performance that excludes historical cost depreciation and valuation adjustments from net income. We consider FFO to be useful in evaluating potential property acquisitions and measuring operating performance.
We further consider FFO, Core FFO and AFFO to be useful in determining funds available for payment of distributions. FFO, Core FFO and AFFO do not represent net income or cash flows from operations as defined by GAAP. You should not consider FFO, Core FFO and AFFO to be alternatives to net income as a reliable measure of our operating performance nor should you consider FFO, Core FFO and AFFO to be alternatives to cash flows from operating, investing or financing activities (as defined by GAAP) as measures of liquidity.
FFO, Core FFO and AFFO do not measure whether cash flow is sufficient to fund our cash needs, including principal amortization, capital improvements and distributions to stockholders. FFO, Core FFO and AFFO do not represent cash flows
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from operating, investing or financing activities as defined by GAAP. Further, FFO, Core FFO and AFFO as disclosed by other REITs might not be comparable to our calculations of FFO, Core FFO and AFFO.
The following table sets forth a reconciliation of FFO, Core FFO and AFFO for the periods presented to net income before allocation to noncontrolling interests, as computed in accordance with GAAP (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (Unaudited) | |||||||||||
| Net income | $ | 1,966 | $ | 741 | |||||||
| Depreciation and amortization of real estate | 10,862 | 5,852 | |||||||||
| Provision for impairment | — | 69 | |||||||||
| Gain on sales of real estate, net | (161) | — | |||||||||
| FFO | 12,667 | 6,662 | |||||||||
| Adjustments: | |||||||||||
| Gain on insurance proceeds | — | — | |||||||||
| Core FFO | 12,667 | 6,662 | |||||||||
| Adjustments: | |||||||||||
| Straight-line rent adjustments | (526) | (240) | |||||||||
| Amortization of deferred financing costs | 157 | 157 | |||||||||
| Amortization of loan origination costs | 13 | — | |||||||||
| Amortization of above/below market lease intangibles | (283) | (190) | |||||||||
| Amortization of lease incentives | 118 | — | |||||||||
| Capitalized interest expense | (56) | — | |||||||||
| Non-cash compensation expense | 1,045 | 557 | |||||||||
| AFFO | $ | 13,135 | $ | 6,946 | |||||||
EBITDA, EBITDAre and Adjusted EBITDAre
We compute EBITDA as earnings before interest expense, income tax expense, and depreciation and amortization. In 2017, NAREIT issued a white paper recommending that companies that report EBITDA also report EBITDAre. We compute EBITDAre in accordance with the definition adopted by NAREIT. NAREIT defines EBITDAre as EBITDA (as defined above) excluding gains (or losses) from the sales of depreciable property and impairment charges on depreciable real property.
Adjusted EBITDAre is a non-GAAP financial measure defined as EBITDAre further adjusted to exclude straight-line rent and non-cash compensation expense.
We present EBITDA, EBITDAre and Adjusted EBITDAre as they are measures commonly used in our industry. We believe that these measures are useful to investors and analysts because they provide supplemental information concerning our operating performance, exclusive of certain non-cash items and other costs. We use EBITDA, EBITDAre and Adjusted EBITDAre as measures of our operating performance and not as measures of liquidity.
EBITDA, EBITDAre and Adjusted EBITDAre do not include all items of revenue and expense included in net income, they do not represent cash generated from operating activities and they are not necessarily indicative of cash available to fund cash requirements; accordingly, they should not be considered alternatives to net income as a performance measure or cash flows from operations as a liquidity measure and should be considered in addition to, and not in lieu of, GAAP financial measures. Additionally, our computation of EBITDA, EBITDAre and Adjusted EBITDAre may differ from the methodology for calculating these metrics used by other equity REITs and, therefore, may not be comparable to similarly titled measures reported by other equity REITs.
The following table sets forth a reconciliation of EBITDA, EBITDAre and Adjusted EBITDAre for the periods presented to net income before allocation to noncontrolling interests, as computed in accordance with GAAP (in thousands):
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| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (Unaudited) | |||||||||||
| Net income | $ | 1,966 | $ | 741 | |||||||
| Depreciation and amortization of real estate | 10,862 | 5,852 | |||||||||
| Amortization of above/below market lease intangibles | (283) | (190) | |||||||||
| Amortization of lease incentives | 118 | — | |||||||||
| Non-real estate depreciation and amortization | 117 | 77 | |||||||||
| Interest expense, net | 1,169 | 905 | |||||||||
| Income tax expense | 91 | 50 | |||||||||
| Amortization of loan origination costs | 13 | — | |||||||||
| EBITDA | 14,053 | 7,435 | |||||||||
| Adjustments: | |||||||||||
| Provision for impairments | — | 69 | |||||||||
| Gain on sales of real estate, net | (161) | — | |||||||||
EBITDAre | 13,892 | 7,504 | |||||||||
| Adjustments: | |||||||||||
| Straight-line rent adjustments | (526) | (240) | |||||||||
| Non-cash compensation expense | 1,045 | 557 | |||||||||
Adjusted EBITDAre | $ | 14,411 | $ | 7,821 | |||||||
NOI and Cash NOI
NOI and Cash NOI are non-GAAP financial measures which we use to assess our operating results. We compute NOI as net income (computed in accordance with GAAP), excluding general and administrative expenses, interest expense (or income), income tax expense, depreciation and amortization, gains (or losses) from the sales of depreciable property, impairment charges on depreciable real property, transaction costs, and other income (or expense). We further adjust NOI for non-cash components of straight-line rent and amortization of lease intangibles and lease incentives to derive Cash NOI. We believe NOI and Cash NOI provide useful and relevant information because they reflect only those income and expense items that are incurred at the property level and present such items on an unlevered basis.
NOI and Cash NOI are not measurements of financial performance under GAAP, and our NOI and Cash NOI may not be comparable to similarly titled measures of other companies. You should not consider our NOI and Cash NOI as alternatives to net income or cash flows from operating activities determined in accordance with GAAP.
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The following table sets forth a reconciliation of NOI and Cash NOI for the periods presented (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (Unaudited) | |||||||||||
| Net income | $ | 1,966 | $ | 741 | |||||||
| General and administrative | 4,190 | 3,137 | |||||||||
| Depreciation and amortization | 10,980 | 5,929 | |||||||||
| Provisions for impairment | — | 69 | |||||||||
| Transaction costs | 165 | 151 | |||||||||
| Interest expense, net | 1,169 | 905 | |||||||||
| Gain on sales of real estate, net | (161) | — | |||||||||
| Income tax expense | 91 | 50 | |||||||||
| Interest income on mortgage loan receivable | (411) | — | |||||||||
| NOI | 17,989 | 10,982 | |||||||||
| Straight-line rent adjustments | (526) | (240) | |||||||||
| Amortization of above/below market lease intangibles | (283) | (190) | |||||||||
| Amortization of lease incentives | 118 | — | |||||||||
| Cash NOI | $ | 17,298 | $ | 10,552 | |||||||
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our future income, cash flows and fair value relevant to our financial instruments depends upon prevailing market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. Based upon the nature of our operations, the principal market risk to which we are exposed is the risk related to interest rate fluctuations. As of March 31, 2022, we had total indebtedness of $175.0 million under the Term Loan and $120.0 million of borrowings under the Revolver, both of which are floating rate debt with a variable interest rate. For the three months ended March 31, 2022, we had average daily outstanding borrowings on our Revolver of $118.8 million.
On September 28, 2020 and effective through the maturity date of December 23, 2024, the Company entered into an interest rate derivative in order to hedge its market interest risk associated with the Term Loan. The interest rate derivative converts the variable rate debt on the Term Loan to a fixed interest rate of 0.21%, plus a margin of 1.15%. Additionally, we occasionally fund acquisitions through the use of our Revolver which bears an interest rate determined by either (i) LIBOR, plus a margin ranging from 1.20% to 1.80%, based on the Company’s consolidated total leverage ratio, or (ii) a Base Rate (as defined in the Credit Facility), plus a margin ranging from 0.20% to 0.80%, based on the Company’s consolidated total leverage ratio. Many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control contribute to our interest rate risk. Based on the results of our sensitivity analysis and daily outstanding borrowings on the Revolver during 2022, which assumes a 1% adverse change in the interest rate as of March 31, 2022, the estimated market risk exposure for the Revolver was less than $1.2 million.
On March 5, 2021, the Financial Conduct Authority (“FCA”) announced that USD LIBOR will no longer be published after June 30, 2023. This announcement has several implications, including setting the spread that may be used to automatically convert contracts from LIBOR to the Secured Overnight Financing Rate (“SOFR”). Additionally, banking regulators have encouraged banks to discontinue new LIBOR debt issuances prior to December 31, 2021.
The Company anticipates that LIBOR will continue to be available at least until June 30, 2023. Any changes adopted by the FCA or other governing bodies in the method used for determining LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR. If that were to occur, our interest payments could change. In addition, uncertainty about the extent and manner of future changes may result in interest rates and/or payments that are higher or lower than if LIBOR were to remain available in its current form.
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The Company’s Term Loan and Revolver, which mature on December 23, 2024 and December 23, 2023, respectively, are indexed to LIBOR, and provide for procedures for determining an alternative base rate. The Company continues to monitor and evaluate the related risks, including future negotiations with lenders and other counterparties. These risks arise in connection with transitioning contracts to an alternative rate, including any resulting value transfer that may occur, and are likely to vary by contract. The value of loans, securities, or derivative instruments tied to LIBOR, as well as interest rates on our current or future indebtedness, may also be impacted if LIBOR is limited or discontinued. For some instruments the method of transitioning to an alternative reference rate may be challenging, especially if we cannot agree with the respective counterparty about how to make the transition.
While we expect LIBOR to be available in substantially its current form until at least the end of June 30, 2023, it is possible that LIBOR will become unavailable prior to that point. This could result, for example, if sufficient banks decline to make submissions to the LIBOR administrator. In that case, the risks associated with the transition to an alternative reference rate will be accelerated and magnified.
Alternative rates and other market changes related to the replacement of LIBOR, including the introduction of financial products and changes in market practices, may lead to risk modeling and valuation challenges, such as adjusting interest rate accrual calculations and building a term structure for an alternative rate.
The introduction of an alternative rate also may create additional basis risk and increased volatility as alternative rates are phased in and utilized in parallel with LIBOR.
Adjustments to systems and mathematical models to properly process and account for alternative rates will be required, which may strain the model risk management and information technology functions and result in substantial incremental costs for the company.
Off-Balance Sheet Arrangements
As of March 31, 2022 and December 31, 2021, we did not have any off-balance sheet arrangements that have had or are reasonably likely to have a material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital resources or capital expenditures.
Item 4. Controls and Procedures
Disclosure Controls and Procedures.
At the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of its principal executive officer and principal financial officer, of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that its disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
Changes in Internal Control over Financial Reporting.
During the period covered by this report, there have been no changes in our internal control over financial reporting identified in connection with the evaluation described above that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II — OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may be party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of our business. We are not currently subject to any lawsuits, claims, or other legal proceedings.
Item 1A. Risk Factors
For a discussion of the most significant factors that may adversely affect us, see the information under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021, which is accessible on the SEC’s website at www.sec.gov. There have been no material changes to the risk factors disclosed in the Annual Report. These risk factors may not describe every risk facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sales of Equity Securities and Use of Proceeds
None.
Company Stock Repurchases
None.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
Not applicable.
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Item 6. Exhibits
| Exhibit No. | Description | |||||||
| 3.1 | ||||||||
| 3.2 | ||||||||
| 3.3 | ||||||||
| 10.1*† | ||||||||
| 10.2*† | ||||||||
| 31.1* | ||||||||
| 31.2* | ||||||||
| 32.1* | ||||||||
| 32.2* | ||||||||
| 101.INS** | XBRL Instance Document. | |||||||
| 101.SCH*** | XBRL Taxonomy Extension Schema Document. | |||||||
| 101.CAL*** | XBRL Taxonomy Extension Calculation Linkbase Document. | |||||||
| 101.LAB*** | XBRL Taxonomy Extension Label Linkbase Document. | |||||||
| 101.PRE*** | XBRL Taxonomy Extension Presentation Linkbase Document. | |||||||
| 101.DEF*** | XBRL Taxonomy Extension Definition Linkbase Document. | |||||||
| 104** | Cover Page Interactive Data File. | |||||||
* | Filed herewith. | |||||||
** | The XBRL Instance Document and Cover Page Interactive Data File do not appear in the Interactive Data File because their XBRL tags are embedded within the Inline XBRL document. | |||||||
| *** | Submitted electronically with the report. | |||||||
| † | Management contract or compensatory plan or arrangement. | |||||||
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| NETSTREIT Corp. | ||||||||||||||
| April 28, 2022 | /s/ MARK MANHEIMER | |||||||||||||
| Date | Mark Manheimer | |||||||||||||
| President, Chief Executive Officer and Director | ||||||||||||||
| (Principal Executive Officer) | ||||||||||||||
| April 28, 2022 | /s/ ANDREW BLOCHER | |||||||||||||
| Date | Andrew Blocher | |||||||||||||
| Chief Financial Officer, Treasurer and Secretary | ||||||||||||||
| (Principal Financial Officer) | ||||||||||||||
| April 28, 2022 | /s/ PATRICIA MCBRATNEY | |||||||||||||
| Date | Patricia McBratney | |||||||||||||
| Senior Vice President and Chief Accounting Officer | ||||||||||||||
| (Principal Accounting Officer) | ||||||||||||||
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