Essential Properties Realty Trust, Inc. (EPRT) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to Essential Properties Realty Trust Second Quarter 2026 Earnings Conference Call. This conference call is being recorded, and a replay of the call will be available 3 hours after the completion of the call for the next 2 weeks. The dial-in details for the replay can be found in yesterday's press release. Additionally, there will be an audio webcast available on Essential Properties' website at www.essentialproperties.com, an archive of which will be available for 90 days. On the call this morning are Peter Mavoides, President and Chief Executive Officer; Rob Salisbury, Chief Financial Officer; Max Jenkins, Chief Operating Officer; A.J. Peil, Chief Investment Officer; and Sheryl Kaul, Director of Financial Planning and Data Analytics. It is now my pleasure to turn the call over to Sheryl Kaul.

Thank you, operator. Good morning, everyone and thank you for joining us today for Essential Properties Second Quarter 2026 Earnings Conference Call. During this conference call, we will make certain statements that may be considered forward-looking statements under federal securities dock. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements. and we may not release revisions to those forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in yesterday's earnings press release. In our earnings release last night, for the quarter, we reported GAAP net income of $74.5 million and AFFO of $110.1 million. With that, I'll turn the call over to Pete.

Thanks, Sheryl. Thank you to everyone joining us today for your interest in Essential Properties. In the second quarter, we accretively invested $332 million, reflecting the strength of our deal sourcing engine and the deep relationships we have built with market operators in our targeted industries. As transaction activity accelerated through the quarter, our team effectively converted a strong pipeline of opportunities and to close sale leaseback investments, demonstrating our execution capabilities and the competitive advantage of our relationship-driven origination platform. Cap rates came in slightly better versus prior quarter at an average initial cash yield of 7.8% and at a GAAP yield of 9.1%, preserving a meaningful spread to our cost of capital that is a key driver of our earnings growth. This also reflects our ability to consistently source and close pose attractive opportunities even in a dynamic transaction environment. 84% of our investments were structured as sale leasebacks and sale-leaseback liquidity continues to be a compelling source of growth capital for middle market operators across our targeted industries. Our capital position remains robust with pro forma leverage of 3.5x and $1.7 billion of liquidity. We which was bolstered by our unsecured bond issuance during the quarter with our capital needs largely addressed for the balance of 2026 and well into 2027 and -- we are well funded to continue to execute on our growth strategy and drive durable and compelling earnings growth. investment activity and portfolio operating trends are tracking ahead of budgeted expectations, allowing us to once again increase our 2026 AFFO per share guidance to a new range of $2.01 to $2.05 and our investment volume guidance to a range of $1.2 billion to $1.5 billion. Our revised AFFO per share guidance implies a growth rate of over 7% at the midpoint and over 8% at the high end. Turning to the portfolio. We ended the quarter with investments in 2,493 properties that were leased to over 500 tenants. Our weighted average lease term is over 14 years, our weighted average lease escalations are 1.9% and just 2.3% of our annual base rent is expiring through 2028. With that, I'll turn the call over to A.J. Peil, our Chief Investment Officer who'll provide an update on our portfolio and asset management activities. A.J.?

Thanks, Pete. Overall, our portfolio fundamentals remained healthy during the quarter and continued to perform in line with our expectations. Same-store rent growth improved sequentially to 1.5%. Our occupancy remains strong at 99.6% with only 9 vacant properties. Portfolio rent coverage was stable since last quarter at 3.5x and as the percentage of ABR with rent coverage below 1.5x, declined 50 basis points sequentially, reflecting continued improvement in credit quality. During the quarter, we disposed $54.3 million of assets at a weighted average cap rate of 7.3%. The dispositions were driven by ongoing proactive asset management decisions during the quarter. Going forward, we expect our disposition activity to moderate for our trailing 8-quarter average. Our portfolio benefits from broad diversification as our top 10 tenants represent just 15.2% of ABR at quarter end. Our top 20 accounts for only 25.4%, reflecting our continued focus on partnering with a broad base of middle market operators and limiting concentration risk. We also reduced our top industry exposure by 40 basis points during the quarter to 12.6% of ABR. As a result, our portfolio construction remains healthy with our top 3 industries, car wash, medical dental in early child education, each now representing approximately 12% of ABR. With that, I'll turn the call over to Max Jenkins, our Chief Operating Officer, who will provide update on our investment activities and the current market dynamics.

Thanks, A.J. On the investment side, activity picked up over the course of the second quarter, culminating in $332 million of investments at an average initial cash yield of 7.8%. Notably, pricing remained stable with cap rates coming in modestly better than our expectations. Our investments in the quarter had a weighted average initial lease term of 16 years and a weighted average annual rent escalations of 1.9%. And generating a strong average GAAP yield of 9.1%. Our capital deployment during the second quarter was broad-based across most of our top industries as we completed 36 transactions totaling 103 properties with approximately 84% of investment volume sourced through sale-leaseback transactions. One of our sale leaseback transactions this quarter in the early childhood education sector was partially funded in a tax efficient execution through the issuance of operating partnership units. This is the first OP unit transaction for EPRT. And while such deals tend to be episodic, it represents another tool in our toolkit for servicing our valuable relationships. Our average investment size was $3.1 million per property during the quarter, which continues to reflect our focus on acquiring granular highly fungible assets that provide attractive risk-adjusted returns. Pricing in our forward pipeline continues to produce cap rates in the mid- to high 7% range and with over $1 billion of closed plus identified opportunities year-to-date. We are well positioned to execute on our increased full year investment guidance range of $1.2 billion to $1.5 billion. With that, I'd like to turn the call over to Rob Salisbury, our Chief Financial Officer, who will take us through the financials for the second quarter.

Thanks, Max. Overall, we delivered another quarter of strong financial performance. supported by a large diverse portfolio of leased properties, disciplined capital deployment and continued balance sheet strength. Our AFFO per share was $0.50, representing an increase of 9% versus the second quarter of 2025, while nominal AFO increased 18% year-over-year to $110.1 million. This AFFO performance came in modestly ahead of our expectations, driven by stronger than underwritten portfolio performance and better investment volume and pricing. This offsets slightly later timing of closings during the quarter. allowing us to increase both our in guidance and as to per share guidance for the full year. Total G&A in the quarter was $10.9 million. Our cash G&A was $7.2 million which is trending towards the bottom half of our guidance range of $30 million to $34 million for the year and represents just 4.4% of total revenue, down from 5.2% in the same period a year ago. We declared a cash dividend of $0.32 in the second quarter, which represents an AFFO payout ratio of 64%. Our retained free cash flow after dividends totaled $43 million in the quarter. equating to approximately $170 million on an annualized basis, representing a substantial source of internally generated capital to support our future growth. Turning to the balance sheet. Our financial position remains robust. During the quarter, we successfully completed a $400 million 10-year unsecured bond offering with a coupon of 5-3/8. This transaction supports our growth plan for 2020 while further extending our weighted average debt maturity and creating more liquidity in our bond complex. We have been modestly active on the equity side in support of extending our equity runway, raising approximately $85 million of equity during the second quarter and subsequent to grant through the ATM program and the OP unit transactions that Max discussed earlier. Given the excess liquidity generated by our bond offering, we did not settle any forward equity during the quarter, leaving us with approximately $575 million of unsettled forward equity at quarter end. As a result, our pro forma net debt to annualized adjusted EBITDA remained low at 3.5x at quarter end and total available liquidity increased to $1.7 billion. providing us with ample capacity to execute on our investment pipeline well into next year. At quarter end, income-producing gross assets totaled $7.8 billion and the continued growth and diversification of our portfolio further strengthened our credit profile. Our AFO per share guidance continues to incorporate a conservative assumption for treasury stock method dilution on our unsettled forward equity balance. -- totaling approximately underscoring the strength of our operating performance and investment execution year-to-date. As we noted earlier, we increased the low end of our 2026 AFFO per share guidance by $0.01 and to a new range of $2 to $2.05. This reflects a growth rate of over 7% at the midpoint and over 8% at the high end. With that, I'll turn the call back over to Pete.

Thanks, Rob. In summary, we are happy with our second quarter results. The diversified portfolio and ample balance sheet capacity, we remain confident in our long-term growth trajectory and our ability to deliver best-in-class total shareholder return. Operator, please open the call up for questions.

[Operator Instructions] We'll take our first question from Greg McGinniss with Scotiabank.

Certainly, we -- sorry about that I was hoping you could touch on the utilization of OP units in Q2, whether you plan on doing more of those, whether that's a type of tenant you're trying to bring into the portfolio, more so? Any details would be appreciated.

Sure. It was a traditional sale leaseback with an operator who had owned real estate on balance sheet that they were looking to monetize and there was not a cash out or a business need for the cash. And it was tax efficient for them to take OP units and participate in OP and have ownership in EPRT going forward, and it was a valuable currency in the transaction. It differentiated us from competitors. And and it was an efficient way for us to close that transaction with tax leakage for the seller. There's not a lot of situations where that comes to play. There's certainly they come in from time to time, and we like to utilize that currency and the tax efficiency of it. And so to the extent that there is further opportunities great, but I'm not optimistic that there are -- it takes pretty unique selling.

Okay. And then just looking at the category exposure. Early childhood education ticked up this last quarter. Is that an area where you see you're having more increased focus? Or was it a single onetime kind of transaction that looked attractive? Obviously, you've done a good job in terms of diversification of the top 3, but just curious if we're seeing the best opportunities for investment right now.

Yes, I wouldn't read too much into that, Greg. We maintain and seek investments across all our industries and obviously, as you've seen, they have a flow. There was a larger opportunity in the child care space during the quarter, but we'll see contain that diversity going forward.

Our next question will come from Caitlin Burrows with Goldman Sachs.

I was wondering if you could first talk a bit about your acquisition process from the standpoint of what was the industry mix of deals in 2Q? And what drove that? Does it end up being yield-driven, portfolio construction, like why that mix in 2Q?

Yes, in the second quarter it was $36 million. individual transactions. The vast majority of those, 72% were existing relationships. We maintain relationships and seek to build relationships in all our industry vials. -- and grow our portfolio radically. Each industry has different risk return parameters, different competitive parameters, and we price deals in each industry in part based upon our credit performance and recovery experience within those industries. And so as investing as granular as we do and $3.1 million assets and transactions in the quarter, it's going to be broad-based across all our industries, and we're pricing each deal based upon that individual risk profile of that opportunity. So we're agnostic as to which industries we invest in. We want to service profitable relationships and ultimately maintain a diverse portfolio.

Okay. Got it. And then maybe from a coverage perspective, I think last quarter, you mentioned that perhaps we could see some headwinds on the restaurant side. Wondering, a, if you've seen that play out? And then, b, it looks like our exposure to the under onetime bucket ticked up a bit. So wondering if you could comment on that?

Sure. generally, what we've seen in the restaurant space is the restaurant operators are flat and same-store flat margins resulting in pretty flat coverage. So I haven't really seen a material drop-off in the coverage within that cohort. As it pertains to the under 1 bucket as is the case most times, it tends to be pretty idiosyncratic and not industry related. And that's just normal ebbs and flows within that bucket. Overall, the under 1.5x bucket came down 50 basis points. So we think the portfolio is sitting in a good spot.

Our next question will come from Haendel St. Juste with Mizuho.

So just looking at the volume you've accomplished in the first half of the year on acquisitions and what your updated guidance suggests a pretty meaningful cell or a slowdown in volume in the back half of the year. I'm curious if that's conservatism? Is it something maybe that we're missing? And maybe can you shed some light on the pipeline, your expectations for cap rates to mid the geopolitical macro volatility, and that's impacting your conversations with counterparties at all?

Yes, Haendel. The cap rates, as Max in his comments remain in kind of the mid- to high 7s. Overall, the capital markets volatility that we're seeing helps our negotiating leverage relative to our other parties and allows us to keep rates higher. I think you see that in the second quarter print. As it pertains to volume, Max had some commentary around that. In general, we bumped our investment guidance for the year and the pipeline is in a really good spot.

Okay. Fair enough. So maybe there's a little bit of upside to how the year plays out. And then secondly, I was hoping you could share some color on treasury stock method kind of what's embedded in the updated guide versus prior quarter?

Yes, so we traditionally have incorporated very conservative assumptions around the treasury stock method dilution just so that we can put ourselves in a good position for conservatism on guidance. That has changed this quarter. As we updated our modeling, the stock has moved up recently, which creates a little bit of incremental dilution. As we mentioned in my prepared remarks today, we see $0.01 to $0.02 of headwind to AFFO per share this year from the treasury stock method dilution. I'd say we're probably trending closer to the high end of that range currently whereas we're close to the low end of that range last quarter when we gave you an update. And so -- we'll see how the rest of the year progresses on that front, not a massive headwind, but relative to our guidance range, we would have been able to hike by more, but for a slight amount of headwind incrementally from that.

Our next question will come from Michael Goldsmith with UBS.

First question is, as of the rate, the acquisition volumes were pretty muted through the quarter, but they clearly picked up through the back half of June. So can you just talk a little bit about just the cadence of acquisitions and closings through the quarter? Is that typical of what you see? Did you did you push hard to get this volume to get this volume in the period? Just trying to get a sense of what has changed through the quarter and to achieve this high volume of acquisitions.

Yes. And I would say it's certainly not out of the norm. The total volume in the quarter is relatively consistent with past quarters, albeit the timing may have been slightly delayed. When you're thinking about 36 transactions with counterparties that we don't always control, it just we drive the process and try to make it as efficient as possible. But ultimately, we don't control the closing. And then you layer in a chunky $50 million to $100 million deal that's really going to affect your weighted average close date. So nothing abnormal during the quarter. Generally, our closing team strives to be as efficient as possible and close deals as quickly as possible, but we're often subject to the timing of the counterparty that we don't control. So nothing unusual. We'll continue to close deals as quickly as possible and be as efficient as possible.

Got it. And then as a follow-up, continue to push further into the health and fitness space. I think with fitness ventures kind of moving their way up into the top 10 tenants, and then you also have undefeated tribe maybe with a little bit of a logo change in your deck. But can you just talk a little bit about that category, the opportunities there? And where you ultimately would like to get that as it got within the mix?

Sure. I mean those 2 tenants are both tenants operating within the Crunch Fitness franchise system. They're both great operators. We really like the crunch model kind of a high volume, low price point, high-quality service, coupled with a an investment that is not astronomically large on average, anywhere between $7 million to $12 million for a gym compared to some of the higher-end models, which can range up to $60 million and so we really like crunch. We like that system. We particularly like these operators. It provides us an opportunity. We generally invest through new development which is typically repositioning of all boxes with a nice mark-to-market on those boxes and attractive yield for construction financing. And ultimately, coverages that work and make a lot of sense for us. So we like the space. We don't see a ton of opportunity within this space. So I would not expect it to grow distally, but it should continue to grow ratably.

Our next question will come from Eric Gordon with BMO Capital Markets.

Good morning, everyone. -- understanding that you don't guide to bad debt, but just thinking about the return any in the first quarter, and then maybe come with an increase in the sub times 1x coverage in the second quarter. Do you expect that debt expense to remain near our long-term average of roughly 28 basis points? Or is there a risk it trends modestly above that level?

And that really isn't necessarily bad debt, and it's really just lost credit loss lost ABR. We generally take a more conservative estimate relative to our historical average, as you would expect, and we would expect the portfolio to perform relatively consistently. And -- but I would suggest there's probably a more conservative sumo supporting guidance, but we do not see anything out of the normal in the credit performance of the portfolio that would suggest outsized credit performance.

And then my follow-up question is around the loan book. Just with loan repayments occurring at 9.3% yield, how attractive does that lending opportunity set of today? Can you replace those repayments with similar yielding loans? Or would you rather redeploy that capital into traditional net lease acquisitions?

Generally, we do loans truly as an accommodation to the counterparty. Our preference is to do a sale -- we structured the loans with similar economics to our sale-leaseback transactions. And so any cash flow from loan repayments will generally be redeployed into our investment pipeline, which generally has a percentage alone consistent with the overall portfolio, which is right around 5%. So not a meaningful driver or a mover of the needle but -- we'll continue to do loans as they come available. And when we can't get true ownership of the real estate. But our focus will be continuing to build our own real estate portfolio.