Postal Realty Trust, Inc. (PSTL) Earnings Call Transcript & Summary

Good morning, and welcome to the Postal Realty Trust panel at Nareit's REITweek 2022 Investor Conference. I'm Steve Manaker, one of the REIT analysts at Stifel. Today, we are with a senior management team of Postal Realty Trust, a small-cap growth REIT. Postal ticker PSTL has an equity market cap of $350 million and a dividend yield of 5.9% as of yesterday's close. The REIT focuses on owning real estate leased to the United States Postal Service. This is a real estate niche where PSTL is one of the largest, if not the largest owner in the space. The REIT owns both main post offices and distribution facilities. The REIT IPO-ed in May '19 and since then, it has consistently grown earnings and the dividend. Given the nature of the leases, there is modest annual internal growth as old leases are renewed and brought up the current market rates. Additional growth comes from acquisitions. Given Postal size, the timing of acquisitions and capital raises during the quarter can affect that quarter's earnings. To lessen the impact of timing, we believe it's better to look at the run rate on a forward quarter basis so the impact of timing is eliminated. I'll start today's session with some questions directed at the team and then open it up to the audience. With us today, we have Andrew Spodek, CEO; Jeremy Garber, President; and Rob Klein, CFO. Andrew, can you give us a brief overview of Postal Realty Trust?

Sure. So we are the largest owner, second to the Postal Service, with the nation's largest owner of and manager of these postal assets. We have 1,040 buildings throughout 49 states. We own approximately 1,450 buildings in 50 states. We are also the first and only publicly traded REIT in this space. And we have over 30 years in the space really kind of institutionalizing this asset class.

Can you just talk about your background and then Postal's background a little bit? How long you've been in here for 30 years? Can you just talk about how you got involved, how the firm got involved and where you are right now?

Sure. So for those of you that haven't met us before, just a little background. So my father actually started this. He had owned different types of real estate for the majority of his life. He has brought a small portfolio of Postal assets in the early '80s. He bought that portfolio. And what he learned very early on and what we've proven out to be true is that the Postal Service always pays their rent, 100% of the rent, 100% of the time. Doesn't matter the economic cycle. It doesn't matter what's going on in the world, they always pay their rent. What he also discovered is the Postal Service very rarely moves. This is a common misunderstanding in the public. Over the past 10-plus years, we've had a 98-plus percent retention rate, again, through different economic cycles, government shutdowns, through corona, through everything. And number three is, because of the preferential lease structure, we're able to own and operate these properties throughout the country without the need for anybody on site at these particular buildings. And for all those reasons and more, we decided to grow and became the largest owner of postal assets. Around 4 to 5 years ago, I was approached with the opportunity of creating a public company around our portfolio. I contributed the lion's share of my personal assets to this REIT, took back operating partnership units in stock, and we were well on our way. That was in 2019. Since then, we have tripled and quadrupled our portfolio, property count, square footage and rental revenue, and here we are today.

Great. Just a little bit about the market overall and some background. How big is the market? How much do you currently own? And how much do you own and manage? And can you talk about the managed part of the business as well?

Sure. So it's very important to understand what the postal real estate universe looks like. There are 31,000 or so postal properties throughout the country. 23,000 of those are leased. Postal Service pays approximately $1.3 billion to $1.4 billion in rent on those 23,000 buildings. Depending on your underwriting, that's got to be anywhere between a $12 billion to $15 billion market. It's also important to note that, that $1.3 billion or $1.4 billion spent is under 2% of their expenses. So this is the backbone of their entire business, and it's under 2% of their total expenses. We own, as I was saying, over 1,000 properties. We manage 400 properties. The management business as it stands today are properties that we have some ownership in. And when I say we, my family, those properties, the majority of which my family had given a ROFO to the public company to purchase them at some point. We believe at some point, we will be growing that management business, but we haven't actually started doing so yet.

And can you explain the ROFO? What's you're involvement personally? And how does that work with you and the REIT and your family's portfolio?

So I have zero involvement in the ROFO. I have recused myself from that transaction from the outset. Part of the formation of this company and creating the Board that we have was to make it so that I could step out of the whole trade transaction. It's important to note the different people and skills that we have on the board. The Chairman of the Board is the former Postmaster General of the United States Postal Service. We have an accountant on the Board, the former CFO of Mack-Cali, Barry Lefkowitz. We have Anton Feingold, the Associate General Counsel for Ares. And we also have a real estate professional, Jane Gural-Senders. Jeremy, [indiscernible] more to it.

Sure. So to Andrew's comments around the ROFO process, it's being run by special committees. Andrew has no participation. There's an independent trustee that represents the family, so it is a transaction that is really separate from REIT management.

Great. And can you also just talk about the other owners in the postal real estate world? How do they typically purchase these assets? How are they financed? Is there an institutional presence?

Sure. So the 23,000 leased facilities are owned by over 17,000 owners. That's how fragmented this market really is. The average owner owns 1 to 2 properties. The average owner has owned their asset over 40 years, have little or no depreciable basis in their assets. This is not a very heavily financed asset class. There's a significant generational shift going on in these assets as well. All of these things, from my perspective, led to the opportunity sitting in front of us. We are the largest owner of these assets. We own 6% of the market. The next 20 largest owners in total only own 11% of the market. And so you see that 80% of this market is up for grabs, and it's owned by what I refer to as mom-and-pop owners. These are relatively unsophisticated people. They own 1 or 2 assets. This is not their primary business. This is, as I refer to it, this is their nest egg. They live off the cash flow. But because of the age of these owners and the next generation doesn't typically want to own them, I believe that over the next coming years there is going to be a shift in the ownership. And I believe the public platform was the way to do it.

In the market, from the pricing perspective, as rates came down, what happened with cap rates overall for assets that are being sold? And what are you seeing now the rates have kind of come back up?

So as I was saying, this little niche that we play in is not very heavily correlated to financing because most of these assets are not financed. Over the past year or so, I've discussed how there's been a compression in cap rates. We haven't seen cap rates rise. We've seen them stabilize more today. And again, I think that it's just lagging to general real estate, which is typical for us.

And even with that lag and the compression that you saw over the last year, where are spreads overall, from your perspective, in your cost of capital?

So what we've articulated is that we're looking to complete the year and weighted average cap rate range of 6% to 8%, where in prior years we've been able to do 7% to 9%.

And on the acquisition side, are you doing a different mix this year relative to previous years? Are you looking at more -- some larger buildings?

Actually, no, we're not looking at the larger properties. We've seen those cap rates really constrained, I think most people have. And so we're primarily focused on what we refer to as the last mile and flex facilities. And the larger industrial are more opportunistic for us, but the prices got very rich, and we've been kind of staying somewhat clear of them.

So a couple of years ago, you did buy some larger facilities. And then can you talk about that, but also broaden that out into a bigger discussion of what from your perspective is a good postal real estate asset and what's a less good postal real estate asset?

So we buy industrial assets when they make sense, right? We have 2 key underwriting criteria. First and foremost, we have to believe that the asset is important to the Postal Service, either they need to be in the building or want to be in the building. And that's a very broad answer, and we understand that, right? But when you've been in this business as long as we have and you touch the tenant as much as we do and as often as we do, it's easier for us to understand what that means, right? We've also been aggregating a proprietary database over all these years to help us understand which assets are more or less important to them. Once we understand that the Postal Service wants to be in this property, then we underwrite the real estate. On average, we're buying these at or below $150 a foot, which I think most of you will agree is relatively inexpensive. But understanding that the Postal Service is a government agency. And as a result, the cost of them doing things is very expensive. So if you give the Postal Service a vanilla box and have them build it out, they're typically paying somewhere between $170 and $180 put just for the build-out. So for us to pay under $150 a foot for the land, the building and the lease, it tells you the value that we're finding in these assets in addition to the cap rate.

I think -- sorry, but I think that goes to the point of the Post Office not moving very often, right? Given the fact that if they move, they're going to have to put out a fair amount of cash just for the CapEx side of it?

Correct. So again, over the past 10 years, we've had a 98-plus percent retention rate. It's -- the Postal Service has a lot of capital invested in these buildings. They're also very closely tied to the community. And for those reasons and various others, it's very difficult for them to move and very costly for them to move.

Andrew or Jeremy, this is -- either of you can answer this one, if you want. Just, can you talk through your acquisition process and the people involved? So you get a book. You hear about an asset that potentially is being sold. Can you just walk through the process internally of how you decide whether or not to buy it?

Sure. So we have both an internal and external sourcing effort. Last year, we did probably 75% of our acquisitions through in-house, so sourced internally off market. We have a pretty robust process and efficient and repeatable process. As Andrew described, we've been doing this for many, many years. So on average, we close an asset a day. We went public in '19 with 271 assets. So in 3 years, we've acquired over 700 assets. And again, a team that is efficient and has the ability to underwrite these assets because we know these assets, we manage these assets. We understand what the Postal Service is looking for in management and operations. So again, we're pretty set up right now to continue to attack the opportunity with limited expansion in really infrastructure.

And just to add to that, so it's a deal of business day, just to be clear. And these owners are typically the original owners of the asset, the original builder of the asset or purchased it from the original owner. A lot of these assets are very similar. Different vintages have different building structures. And so we're able to utilize and leverage our network of contractors and vendors throughout the country to visit, and the people in the office are very clearly able to underwrite and close these more efficiently than anybody else out there.

Jeremy, there have been some modest changes in the leases the USPS is assigning now. Can you explain those changes and what it means for the REIT?

Sure. So we describe our lease as a modified double net lease. We're responsible for roof structure insurance. Taxes are a pass-through. So we pay the taxes and we're reimbursed. As Andrew described, this is a very fragmented ownership base. So the Postal Service in the past few years attempted to sort of unify their lease structure and put out a lease form that was standardized. Historically, leases were negotiated by Postal representatives across the country, and we would come across leases that were just different. Every USPS representative across the country had the opportunity to face off with an owner and negotiate a different type of lease structure. That's all really changed over the past 10 years. Leasing is now outsourced to Jones Lang LaSalle. And as you're describing, Steve, in the past few years, they've rolled out a pretty standard lease form, a lease form that we have negotiated a proprietary addendum. And as leases roll, they roll into this new lease form.

Great. Thanks. Andrew, can you talk about the current pipeline, give us a sense of the size? And any changes that you're seeing in selling motivations or expectations?

Sure. So the pipeline is thankfully, very robust. We -- currently, I want to say it's north of $100 million. As of our last earnings call, we had closed approximately $34 million in deals and had another $40 million in definitive contracts. We're seeing a significant amount of inbound calls from sellers that are motivated to sell, whether that's the volatility of the market or the world or whatever it is, we're seeing a lot of inbound interest to sell assets.

Do you think that's part of a reaction to rising rates? Or what do you attribute that strong demand-pull?

I don't believe it's rates. I think that my perception of this is that -- I think that a lot of these mom-and-pop sellers are going to be selling at some point anyway, right? This shift that Jeremy was speaking about, the way that we would look at it as an internally managed real estate organization to externally, blends itself to a lot of the difficulties that these owners have today that they didn't have before. The generational shift, the age, all of this is leading towards the same place, which is it's a very inefficient market. It doesn't make any sense for the Postal Service to be negotiating 17,000 leases with 17,000 people, right? The whole thing is not set up properly. And those inefficiencies are what we're trying to take advantage of.

That's kind of a frightening picture actually, if you think about it, 17,000 leases. Are you seeing more competition from other buyers? Are there other entrants coming into the market? And are you seeing more of an institutional presence?

We haven't really seen a significant change. We've seen people looking at postal assets in a way that they haven't before. Some of that has to do with the light that we've shined on this. Some of this has to do with the fact that the compression of the other double and triple net assets that have come to market. But in general, as Jeremy spoke to, we did 75% of our deals off-market last year, which speaks to who we are in the space and our ability to source and close these deals.

Rob, can you discuss your balance sheet philosophy, what debt levels you're comfortable with and how you fund acquisitions near-term and long-term?

Sure. So we pride ourselves on having a very flexible balance sheet, a very conservative balance sheet. As of our last reported earnings, we sat at 23% net debt to enterprise value and 3.9x net debt to annualized adjusted EBITDA. Our targets are staying below 40% and below 7x on both those metrics. So a lot of runway. Our debt, majority of it is unsecured. So our credit facility is an unsecured credit facility. It has the ability for a revolver underneath it as well as we now have 2 term loans. Most of our debt is fixed, except for what's outstanding on our revolver. And we intend to use whatever the markets will allow for either using operating partnership units, our ATM, regular-way common offerings. And in addition to that, on the debt side, we have plenty of room on our revolver and then on our term loans as well. So we feel like we've got a very ample runway to attack our entire pipeline and then some and still remain conservatively leveraged.

And on the operating partnership units, are -- can you just explain that a little bit more? Are you seeing more demand from that from potential sellers? And are there any other entities in this space that can offer OPUs or something similar?

So we are seeing demand for that. We haven't been issuing at the stock price, just we think that the stock is too undervalued, but we are seeing a significant demand for it. And we believe that, that currency is very critical to this company, right? So what -- I guess, pre IPO, this is all a thesis, right? We're the only public postal REIT out there. And I personally believe that the operating partnership currency was going to be a big driver of deal flow. Most investors we met with told me that a lot of people say it and very little people actually do it. We've done it. We've done 10% to 15% of our deal flow using that currency, but there's a lot of other deal flow that we closed with cash that generated because we had that currency to offer. We convert deals to cash and close them for cash on a regular basis. But what we found is that people that weren't interested in selling, I've offered to buy, it was never about cap rate or price per square foot. Having that currency has motivated people, having that flexibility that the currency offers them to estate plan their assets, to divide partnerships or family partnerships has been a very big driver of deal flow. And I believe that, as time goes on, as interest rate goes up and as the volatility of the world continues to be that a lot of people will be interested in that currency.

And Rob, as you've grown over the last few years, how is your ability to access capital and the cost of that capital changed? And where do you see your cost of capital right now?

Yes. So I think we've got a very good access to capital. We did a common offering in November. That was successful, which allowed us to significantly delever our balance sheet. Our access to capital on the debt side is also really good. We just completed in May, adding another $75 million delayed draw term loan, which we accessed $50 million of that day 1, which was used primarily to reduce our revolver balance. So we feel like we're in a very good spot with that with access to capital. And as I mentioned before, several different ways to do it on the equity side as the markets allow it and as we find that to be the appropriate methodology for capitalizing ourselves, through our ATM, through operating partnership units and common offerings. We don't really disclose our methodology for cost of capital, but it's safe to assume that there is a significant spread between that and where the acquisition environment is today, even where our stock trades today, which we do believe is undervalued, but I will always say it's undervalued.

And Rob, can you also discuss the dividend policy as well?

Yes. So we don't have a formally announced dividend policy, but I think the pattern -- there's been a pattern established that everyone can see, that we've increased our dividend each quarter since going public. We intend to continue to do so and have it covered by AFFO as we grow.

Great. So is the way to think about the dividend growth over time basically as you grow the asset base, you'll grow the dividends?

Yes. Absolutely.

Okay. Great. I'll open it up to any questions. If you have any questions, I think the best way is to...

Yes. Two questions. First is easy. What's your normal length of lease? Do they have any escalation clause, et cetera? The second question is [indiscernible] your tenants always pay. They rarely vacate. It's an inefficient market, and you know what you're doing, but there's no [indiscernible] business. What could go wrong? What are you making sure or what's out of your control that could go wrong?

Thank you. I appreciate the questions. So first and foremost, the lease structure. So most common is a 5-year lease structure, and the Postal Service straight-lines their rent. So the way I describe it is, if you want to start your rent at 8 and into 10, they're going to pay you 9 for the duration. There are no escalations. But because of the shorter duration, you're able to mark your leases to market on an annual basis. We have anywhere between 6% and 11% of our leases rolling every year for the next couple of years. On a 5-year lease roll, we're typically getting 10% to 15% NOI increases on that lease roll. So that's 2% to 3% NOI increases on a year-over-year basis. The second question is a good one. I'm inherently biased. I've been in this my whole life. I haven't seen it break since I was a child doing this. It's a very rare, rare opportunity, right? And it's what compelled me to take this public. It's what I believe compelled my father to start buying these assets, right? Finding a credit-backed asset in this capitalization rate range is difficult to find. Finding that with the full backing of the U.S. government is even more difficult. But finding an entire industry that's fragmented is, I don't know, I've never found another one. And so when I was approached about this opportunity, I knew I was the largest owner. I was just kind of working and didn't really answer to anybody, didn't have investors. Just buying and operating postal assets, and it was working great. But when I spent about a year or so really researching what it meant to be a public company and what the opportunity set was, I realized how fragmented it was. I realized that it didn't have to be me, but someone was going to do this. It needed to be done. I just happened to be sitting in the right seat at the right time and, truthfully, at the right age. I know these assets. I know the tenants. I know their use of the properties. It's inefficient, and it needs to be consolidated. And it's a benefit not just to the shareholders and myself, but it's a benefit to the Postal Service as well. They need an institutional owner. They need less people to face off against when they're negotiating their leases. They need a partner that has the capital to put money into their buildings. They need a company that can respond to their request that's set up for it. This is not the way that these assets were run when my father started. The demand requires a different type of owner. And all of that leads to the opportunity and leads to the fact that these owners are going to end up selling their assets.

Yes.

[indiscernible] mail volume trends [indiscernible].

So there are a couple of questions there. So I don't typically opine on the Postal Service operating business. Mail volumes in general have been declining and will continue to decline. But what has come is in its replacement is package volume, right? What everybody in this room as well as in the country, if not the world, recognizes that e-commerce is the new retail, right? And everybody wants to be selling online and wants to be buying online. And the Postal Service controls the largest and most intricate logistics network in this country, if not in the world. They touch 163 million delivery points every day, 6 days a week. That is the competitive advantage of the Postal Service. It is how everybody in the delivery business, DHL, FedEx, UPS, everybody, Amazon, everybody. They can't get to the American people without the Postal Service. And that network is irreplaceable, and that network is what we're buying. These properties in general are zoned general commercial. I've seen them and had them repurposed to all different types of uses, from medical office to bank branches to hardware stores and a lot of them to apartment buildings. These buildings are typically located either [indiscernible]. There is a very good land-to-building ratio because it has to provide for customer parking, employee parking and parking for Postal vehicles. It's important to understand that the Postal Service doesn't pick a building. They pick a parcel, and they choose it specifically because of its access to highways, ingress and egress within that town and county. And so the buildings are very simple. They have a retail area, an office component and a warehouse component with loading docks. And so you can literally repurpose these buildings to pretty much anything. I think I got all your answers, but if I missed something, please tell me.

[indiscernible].

We haven't had any real experience with [indiscernible].

Andrew, can you just delve into a little bit more, how does FedEx, how does UPS, how does Amazon utilize the Postal Service?

Of course. So Amazon told me directly. Prime would not exist without the Postal Service. It's an important statement, right? And the reason is because Prime, the ability to touch the American people in 1 to 2 days, could not happen without leveraging that last-mile network. It just wouldn't exist, right? That's how everybody is utilizing the Postal Service. When Trump started tweeting about Amazon paying less money, what he didn't recognize and what he didn't focus on was the fact that they were only using a very small component of their network, right? So if we in Manhattan go to mail a package and we go down to our local post office and give it to a mailman and we want to send it to Texas or wherever it is, it has to touch a lot of places along the way. The Postal Service has a product called Parcel Select. And Parcel Select is you presort your package and you drop it at the facility by a certain time in the morning. I think it's prior to 5:30 to 6:00 in the morning, and you drop off pallets of them at the back of the building. It's then the Postal Service's job to deliver it to whoever the people are on that day, right? The most efficient way to get to a person is to give it to the person seeing them every day anyway, which is the Postal Service. And so everybody out there that is trying to leverage their network and try to get to the American people faster is that it's about putting warehousing close to where the Postal Service's concentration and networks are. That's what it is. And that's how Amazon has done it, and that's how everybody else is trying to do it also.

Do you all develop any buildings either on spec or with high confidence [indiscernible]?

We don't. We're not developers. I'm not averse to developing, but in general, the Postal Service hasn't really built and has no real plans on building new buildings on a general rule, right? There are exceptions to that. But as I was saying before, the Postal Service doesn't come to the owner. The Postal Service goes to the parcel. And so typically, the right of development carries with the landowner. We've had conversations with the landowner. You build it. We'll buy it from you. we can partner with that landowner, but it's not a very large portion of this industry.

Just a quick question on your underwriting. How do you identify assets that are an important part of the logistics for the Post Office?

It's a complicated answer. Every property is underwritten on its own merits, not just in the market, but also for their use by the Postal Service. And that could be number of routes, number of carriers, the PO boxes, the number of hours they're operating. And it could be as simple as the demographics in that particular area. We factor all of it in, and we have a database that we've been building over all the years of doing this that help us do that.

Andrew, Rob, Jeremy, thank you very much.

No. Thank you, Steve. Appreciate it.