As filed with the Securities and Exchange Commission on June 11, 2018
Registration Statement No. 333-225215
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1 TO
FORM S-11
FOR REGISTRATION UNDER THE SECURITIES ACT OF 1933
OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES
Essential Properties Realty Trust, Inc.
(Exact name of registrant as specified in its governing instruments)
47 Hulfish Street, Suite 210
Princeton, New Jersey 08542
(609) 436-0619
(Address, including Zip Code and Telephone Number, Including Area Code, of Registrants Principal Executive Offices)
Peter M. Mavoides
President and Chief Executive Officer
47 Hulfish Street, Suite 210
Princeton, New Jersey 08542
(609) 436-0610
(Name, Address, including Zip Code and Telephone Number, Including Area Code, of Agent for Service)
Copies to:
J. Gerard Cummins, Esq. Bartholomew A. Sheehan, Esq. Sidley Austin LLP 787 Seventh Avenue New York, New York 10019 (212) 839-5599 |
Julian T.H. Kleindorfer, Esq. Lewis W. Kneib, Esq. Latham & Watkins LLP 885 Third Avenue New York, New York 10022 (212) 906-1200 |
Approximate date of commencement of proposed sale to the public:
As soon as practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box: ☐
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐
If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. ☐
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. (check one):
Large accelerated filer ☐ | Accelerated filer ☐ | Non-accelerated filer ☒ | Smaller reporting company ☐ | |||
(Do not check if a 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 7(a)(2)(B) of the Securities Act ☒
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Title of Securities to be Registered |
Proposed Maximum Aggregate
Offering Price(1)(2) |
Amount of Registration
Fee(3)(4) |
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Common Stock, $0.01 par value per share |
$635,375,000 | $79,105 | ||
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(1) | Estimated solely for the purpose of determining the registration fee in accordance with Rule 457(o) of the Securities Act of 1933, as amended. |
(2) | Includes the offering price of common stock that may be purchased by the underwriters upon the exercise of their option to purchase additional shares. |
(3) | Calculated in accordance with Rule 457(o) under the Securities Act of 1933, as amended. |
(4) | $12,450.00 previously paid for an initial maximum aggregate offering price of $100,000,000. $66,655 paid herewith for a total proposed maximum aggregate offering price of $635,375,000. |
The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment that specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.
Subject to Completion, dated June 11, 2018
32,500,000 Shares
Common Stock
Essential Properties Realty Trust, Inc.
Essential Properties Realty Trust, Inc., a Maryland corporation, is an internally managed real estate company that acquires, owns and manages primarily single-tenant properties that are net leased on a long-term basis to middle-market companies operating service-oriented or experience-based businesses.
We are offering 32,500,000 shares of our common stock. All of the shares of common stock offered by this prospectus are being sold by us. This is our initial public offering, and no public market currently exists for our common stock. We expect the initial public offering price of our common stock to be between $14.00 and $17.00 per share.
Our common stock has been approved for listing on the New York Stock Exchange, subject to official notice of issuance, under the symbol EPRT.
We intend to elect to qualify as a real estate investment trust, or REIT, for federal income tax purposes commencing with our taxable year ending December 31, 2018. To assist us in complying with certain federal income tax requirements applicable to REITs, among other reasons, our charter contains certain restrictions relating to the ownership and transfer of our capital stock, including an ownership limit of 7.5% in value or in number of shares, whichever is more restrictive, of our outstanding common stock, except for certain designated investment entities that may own up to 9.8% of our outstanding common stock, subject to certain conditions. See Description of Our Capital StockRestrictions on Ownership and Transfer for a detailed description of the ownership and transfer restrictions applicable to our common stock.
We are an emerging growth company under the federal securities laws and, as such, have elected to comply with certain reduced disclosure requirements in this prospectus and in future filings that we make with the Securities and Exchange Commission. See Prospectus SummaryEmerging Growth Company Status.
In connection with the completion of this offering, Eldridge Industries, LLC, which has historically been our principal equity provider, will invest $125 million in a private placement of shares of common stock and, if such investment would represent more than 19.0% of our outstanding shares of common stock, in private placements of shares of common stock and units in our operating partnership, at a price per share and per share and unit, if applicable, equal to the initial public offering price per share of common stock in this offering (without payment of any underwriting discounts).
Investing in our common stock involves risks. See Risk Factors beginning on page 32 for factors you should consider before investing in our common stock.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
Per Share | Total | |||||||
Initial public offering price |
$ | $ | ||||||
Underwriting discounts(1) |
$ | $ | ||||||
Proceeds, before expenses, to us |
$ | $ |
(1) | We refer you to Underwriting beginning on page 246 of this prospectus for additional information regarding underwriting compensation. |
To the extent that the underwriters sell more than 32,500,000 shares of common stock, the underwriters have the option, exercisable within 30 days from the date of this prospectus, to purchase up to an additional 4,875,000 shares from us at the initial public offering price less the underwriting discounts and commissions. The underwriters expect to deliver the shares of common stock to purchasers on our about June , 2018.
Joint Book-Running Managers
Goldman Sachs & Co. LLC |
Citigroup |
Barclays | BofA Merrill Lynch | Credit Suisse |
Co-Managers
RBC Capital Markets |
SunTrust Robinson Humphrey |
Evercore ISI |
Ladenburg Thalmann |
Prospectus dated June , 2018
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SELECTED CONSOLIDATED HISTORICAL AND PRO FORMA FINANCIAL AND OTHER DATA |
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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
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DESCRIPTION OF THE PARTNERSHIP AGREEMENT OF ESSENTIAL PROPERTIES, L.P. |
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CERTAIN PROVISIONS OF MARYLAND LAW AND OF OUR CHARTER AND BYLAWS |
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F-1 |
You should rely only on the information contained in this prospectus or in any free writing prospectus prepared by us. We have not, and the underwriters have not, authorized anyone to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus and any free writing prospectus prepared by us is accurate only as of their respective dates or on the date or dates which are specified in these documents. Our business, financial condition, liquidity, results of operations and prospects may have changed since those dates.
We use market data and industry forecasts and projections throughout this prospectus and, in particular, in the sections entitled Prospectus Summary, Market Opportunity and Business and Properties. We have obtained substantially all of this information from a market study prepared for us in connection with this offering by Rosen Consulting Group, or RCG, a nationally recognized real estate consulting firm. Such information is included in this prospectus in reliance on RCGs authority as an expert on such matters. Any forecasts prepared by RCG are based on data (including third party data), models and experience of various professionals and are based on various assumptions, all of which are subject to change without notice. See Experts. In addition, we have obtained certain
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market and industry data from publicly available industry publications. These sources generally state that the information they provide has been obtained from sources believed to be reliable but that the accuracy and completeness of the information are not guaranteed. The forecasts and projections are based on industry surveys and the preparers experience in the industry, and there is no assurance that any of the projected amounts will be achieved. We have not independently verified this information.
Certain Terms Used in This Prospectus
Unless the context otherwise requires, the following terms and phrases are used throughout this prospectus as described below:
| annualized base rent means annualized contractually specified cash base rent in effect on March 31, 2018 for all of our leases (including those accounted for as direct financing leases) commenced as of that date and $45,000 of interest on a mortgage loan receivable with a principal amount of $0.6 million made to a tenant to finance construction of a property on land leased from us with a maturity that corresponds to the expiration of the tenants lease with us; |
| concurrent Eldridge private placement means Eldridges investment of $125 million in shares of common stock and, if such investment would represent more than 19.0% of our outstanding shares of common stock, in shares of common stock and OP units, at a price per share and per share and unit, if applicable, equal to the initial public offering price per share of common stock in this offering (without payment of any underwriting discounts) that will close concurrently with the completion of this offering (see Pricing Sensitivity Analysis); |
| CPI means the consumer price index for all urban consumers (CPI-U): U.S. city average, all items, which is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services; |
| Eldridge means Eldridge Industries, LLC, a private investment firm specializing in providing both equity and debt capital that has historically provided a substantial portion of our equity funding and will have an ownership interest in our company of approximately 43.9% on a fully diluted basis (based on the mid-point of the price range set forth on the front cover of this prospectus), and its affiliates; |
| fully diluted basis means information is presented assuming all outstanding OP units have been exchanged for shares of common stock on a one-for-one basis and all equity awards to be issued to our management and members of our board of directors in connection with this offering are outstanding (this definition is not the same as the meaning of fully diluted under GAAP); |
| GAAP means generally accepted accounting principles as promulgated by the Financial Accounting Standards Board in the United States of America; |
| NYSE means the New York Stock Exchange; |
| occupancy or a specified percentage of our portfolio that is occupied means the quotient of (1) the total number of our properties minus the number of our properties that are vacant and from which we are not receiving any rental payment, and (2) the total number of our properties as of a specified date; |
| OP units means units of limited partnership interest in the operating partnership, which are redeemable for cash or, at our election, shares of our common stock on a one-for-one basis, beginning one year after the issuance of such units; |
| operating partnership means Essential Properties, L.P., a Delaware limited partnership, through which we will hold substantially all of our assets and conduct our operations; |
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| pro forma basis means information is presented assuming the completion of this offering, the concurrent Eldridge private placement, the formation transactions and the other adjustments described in the unaudited pro forma consolidated financial statements included elsewhere in this prospectus had occurred on March 31, 2018 for purposes of the unaudited pro forma consolidated balance sheet data and on January 1, 2017 for purposes of the unaudited pro forma consolidated statements of operations. |
| property-level expenses mean all maintenance, insurance, utility and tax expense related to a property; |
| rent coverage ratio means the ratio of tenant-reported or, when unavailable, managements estimate, based on tenant-reported financial information, of annual earnings before interest, taxes, depreciation, amortization and cash rent attributable to the leased property (or properties, in the case of a master lease) to the annualized base rental obligation as of a specified date; |
| revolving credit facility means the $300 million unsecured revolving credit facility we expect to enter into upon completion of this offering; and |
| we, our, us and our company mean Essential Properties Realty Trust, Inc., a Maryland corporation, together with its consolidated subsidiaries, including our operating partnership. |
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The following summary highlights information contained elsewhere in this prospectus. This summary is not complete and does not contain all of the information that you should consider before investing in our common stock. You should read the entire prospectus carefully, including the section entitled Risk Factors, as well as the financial statements and related notes included elsewhere in this prospectus, before making an investment decision. Unless otherwise indicated, the information contained in this prospectus assumes (1) that the underwriters option to purchase additional shares is not exercised and (2) that the common stock to be sold in this offering is sold at $15.50 per share, which is the mid-point of the price range set forth on the front cover of this prospectus. While the amount of Eldridges aggregate investment in the concurrent Eldridge private placement will not change, the aggregate number of, and allocation of this amount between, shares of our common stock and OP units, if any, will vary depending on the actual initial public offering price of shares of common stock in this offering as described herein. See Pricing Sensitivity Analysis.
Essential Properties Realty Trust, Inc.
Our Company
We are an internally managed real estate company that acquires, owns and manages primarily single-tenant properties that are net leased on a long-term basis to middle-market companies operating service-oriented or experience-based businesses. We have assembled a diversified portfolio using an investment strategy that focuses on properties leased to tenants in businesses such as restaurants (including quick service and casual and family dining), car washes, automotive services, medical services, convenience stores, entertainment, early childhood education and health and fitness. We believe that properties leased to tenants in these businesses are essential to the generation of the tenants sales and profits and that these businesses exhibit favorable growth characteristics and are generally insulated from e-commerce pressure. As of March 31, 2018, 87.6% of our $75.7 million of annualized base rent was attributable to properties operated by tenants in service-oriented and experience-based businesses.
Our objective is to maximize stockholder value by generating attractive risk-adjusted returns through owning, managing and growing a diversified portfolio of commercially desirable properties. We have grown strategically since commencing investment activities in June 2016. As of March 31, 2018, we had a portfolio of 530 properties (including two undeveloped land parcels and two properties under development) built on the following core attributes:
Diversified Portfolio. Our portfolio was 99.1% occupied by 127 tenants operating 112 different brands, or concepts, in 15 industries across 42 states, with none of our tenants contributing more than 6.8% of our annualized base rent.
Long Remaining Lease Term. Our leases had a weighted average remaining lease term of 13.8 years (based on annualized base rent), with only 4.4% of our annualized base rent attributable to leases expiring prior to January 1, 2023.
Significant Use of Master Leases. 64.8% of our annualized base rent was attributable to master leases.
Healthy Rent Coverage Ratio and Extensive Tenant Financial Reporting. Our portfolios weighted average rent coverage ratio was 2.9x and 97.4% of our leases (based on annualized base rent) obligate the tenant to periodically provide us with specified unit-level financial reporting.
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Contractual Base Rent Escalation. 95.4% of our leases (based on annualized base rent) provided for increases in future base rent at a weighted average rate of 1.5% per year.
Differentiated Investment Approach. Our average investment per property was $1.9 million (which equals our aggregate investment in our properties (including transaction costs, lease incentives and amounts funded for construction in progress) divided by the number of properties owned at March 31, 2018), and we believe investments of similar size allow us to grow our portfolio without concentrating a large amount of capital in individual properties and limit our exposure to events that may adversely affect a particular property.
We intend to continue our disciplined growth strategy, which emphasizes investing in commercially desirable properties with strong unit-level performance and rent coverage, by originating new sale-leaseback transactions and leveraging our tenant relationships to source investment opportunities. During the year ended December 31, 2017, we purchased 212 properties, in 62 separate transactions, with an aggregate purchase price of $534.3 million for an average quarterly investment volume of $133.6 million. During the three months ended March 31, 2018, we purchased 28 properties, in 16 separate transactions, with an aggregate purchase price of $64.1 million. As of March 31, 2018, on a pro forma basis, we had approximately $158.6 of cash and cash equivalents on hand (based on the mid-point of the price range set forth on the front cover of this prospectus) and believe that our capitalization and access to our expected $300 million unsecured revolving credit facility will allow us to significantly grow our portfolio.
Our History
We commenced investment activities on June 16, 2016 when we acquired a portfolio of 262 net leased properties, consisting primarily of restaurants, that were being sold as part of the liquidation of General Electric Capital Corporation for an aggregate purchase price of $279.8 million (including transaction costs), which we refer to as our GE Seed Portfolio. Subsequent to this investment, we have grown through our focused investment strategy, and as of March 31, 2018, we had a portfolio of 530 properties with annualized base rent of $75.7 million.
Our senior management team is comprised of executives with significant net lease, real estate and capital markets experience. Peter M. Mavoides, our President and Chief Executive Officer, has been active in the single-tenant, net lease industry for approximately 20 years, and Gregg A. Seibert, our Executive Vice President and Chief Operating Officer, has been active in the industry for approximately 23 years. Messrs. Mavoides and Seibert have worked together on net lease real estate transactions in various capacities for approximately ten years. Under their leadership, we have rapidly developed and implemented our investment sourcing, underwriting, closing and asset management functions. We have also accumulated a substantial portfolio and maintain a large investment pipeline.
Our Competitive Strengths
We believe the following competitive strengths distinguish us from our competitors and will allow us to compete effectively in the single-tenant, net-lease market:
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Carefully Constructed Portfolio of Recently Acquired Properties Leased to Service-Oriented or Experience-Based Tenants . We have strategically constructed a portfolio that is diversified by tenant, industry and geography and generally avoids exposure to businesses that we believe are subject to pressure from e-commerce. Our properties are subject to newer, long-term net leases that we believe provide us a stable base of revenue from which to grow our portfolio. As of March 31, 2018, we had a portfolio of 530 properties, with annualized base |
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rent of $75.7 million, which was selected by our management team in accordance with our focused investment strategy. Our portfolio is diversified with 127 tenants operating 112 different concepts across 42 states and 15 industries. None of our tenants contributed more than 6.8% of our annualized base rent as of March 31, 2018, and our strategy targets a scaled portfolio that, over time, derives no more than 5% of its annualized base rent from any single tenant or more than 1% from any single property. |
We focus on investing in properties leased to tenants operating in service-oriented or experience-based businesses, such as restaurants (including quick service and casual and family dining), car washes, automotive services, medical services, convenience stores, entertainment, early childhood education and health and fitness, which we believe are generally insulated from e-commerce pressure. As of March 31, 2018, 87.6% of our annualized base rent was attributable to tenants operating service-oriented and experience-based businesses. We believe many of our tenants operate businesses that are performing more favorably than other types of businesses that often occupy net leased real estate, such as big box retailers, specialty apparel retailers and sporting goods outlets.
We believe that our portfolios diversity and recent underwriting decreases the impact on us of an adverse event affecting a specific tenant, industry or region, and our focus on leasing to tenants in industries that we believe are well-positioned to withstand competition from e-commerce increases the stability of our rental revenue.
| Experienced and Proven Net Lease Management Team . Our senior management has significant experience in the net lease industry, a track record of growing net lease businesses to significant scale and was directly responsible for sourcing, financing and acquiring each of the properties in our portfolio. Our President and Chief Executive Officer, Peter M. Mavoides, has been active in the single-tenant, net lease industry for approximately 20 years. During his career, Mr. Mavoides has overseen the acquisition of net leased properties with an aggregate purchase price of $4 billion and has successfully grown net lease businesses to significant scale. Prior to establishing our company, Mr. Mavoides was the President and Chief Operating Officer of Spirit Realty Capital, Inc., or Spirit, an NYSE-listed REIT that invests primarily in single-tenant, net leased real estate, from September 2011 through February 2015. During his tenure at Spirit, Mr. Mavoides was instrumental in transforming the company from a private enterprise, with $3.2 billion of total assets and 37 employees at the time of its September 2012 initial public offering, to a public company with $8.0 billion of total assets and over 70 employees at the time of his departure in February 2015. While at Spirit, Mr. Mavoides chaired the companys investment committee and led the team that acquired over 150 separate investments, with an aggregate purchase price of nearly $2.0 billion and an average investment per property of $2.6 million over a period of approximately three years. In addition to his substantial experience in originating, negotiating and closing sale-leaseback transactions, Mr. Mavoides has experience in large-scale strategic transactions and was a member of Spirits senior management team when it merged with Cole Credit Property Trust II in 2013. |
Our Executive Vice President and Chief Operating Officer, Gregg A. Seibert, has been active in the single-tenant, net lease industry for approximately 23 years, including over 21 years with leadership responsibilities in credit, acquisitions and portfolio management in the net lease industry. From September 2003 through May 2016, Mr. Seibert was employed by Spirit, where he was the companys Executive Vice President and Chief Investment Officer at the time of his departure. While at Spirit, Mr. Seibert was a member of the companys investment committee and its executive management team, and he was instrumental in establishing and implementing that companys business strategy, including investment sourcing, tenant underwriting, asset management and capital markets activities.
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Messrs. Mavoides and Seibert have continued and refined an investment strategy that they jointly pursued at Spirit from 2011 to 2015 and have been primarily responsible for developing and implementing our investment sourcing, underwriting, closing and asset management functions, which we believe can support significant investment growth without a proportionate increase in our operating expenses. As of March 31, 2018, exclusive of our GE Seed Portfolio, 80.6% of our portfolios annualized base rent was attributable to internally originated sale-leaseback transactions and 91.8% was acquired from parties who had previously engaged in one or more transactions that involved a member of our senior management team (including operators and tenants and other participants in the net lease industry, such as brokers, intermediaries and financing sources). The substantial experience, knowledge and relationships of our senior leadership team provide us with an extensive network of contacts that we believe allows us to originate attractive investment opportunities and effectively grow our business.
| Growth Oriented Balance Sheet Supporting Scalable Infrastructure . As of March 31, 2018, on a pro forma basis, we had $510.1 million of total debt outstanding, with a weighted average annual interest rate of 4.35% and a weighted average maturity of 2047, and net debt of $362.2 million. For the year ended December 31, 2017, our pro forma net income was $27.9 million and our pro forma earnings before interest, taxes, depreciation and amortization for real estate, gains (or losses) on the sales of depreciable property and real estate impairment losses, or EBITDAre, was $87.9 million. For the three months ended March 31, 2018, our pro forma net income was $5.7 million, our pro forma EBITDAre was $20.9 million and our pro forma ratio of net debt to annualized EBITDAre was 4.3x. In addition, upon completion of this offering, we expect to have an undrawn $300 million unsecured revolving credit facility with a four year term that will be available for general corporate purposes, including for funding future acquisitions. We will also have 259 unencumbered properties that contribute $43.5 million of annualized base rent as of March 31, 2018 on a pro forma basis. We will seek to manage our balance sheet so that we have access to multiple sources of debt capital in the future, such as term borrowings from insurance companies, banks and other sources, single-asset mortgage financing and CMBS borrowings, that may offer us the opportunity to lower our cost of funding and further diversify our sources of debt capital. |
Our largest borrowing source is our private conduit program, or our Master Trust Funding Program, under which we may, subject to applicable covenants, issue multiple series and classes of notes from time to time to institutional investors in the asset-backed securities market. As of March 31, 2018, on a pro forma basis, we had Class A Notes and Class B Notes outstanding under our Master Trust Funding Program with an aggregate outstanding principal balance of $520.9 million. These notes are secured by a pool of 348 properties and the related leases as of March 31, 2018, however, we have the ability to pre-pay these notes without the payment of a make-whole amount after November 2021, giving us flexibility to unencumber the pledged assets, should we choose to do so as part of a strategy to seek an investment grade credit rating in the future or for other reasons.
Our net debt, our EBITDAre and our ratio of net debt to EBITDAre referenced above are non-GAAP financial measures. For definitions of net debt and EBITDAre, reconciliations of these metrics to total debt and net income, respectively, the most directly comparable GAAP financial measures, and a statement of why our management believes the presentation of these metrics provides useful information to investors and any additional purposes for which management uses these metrics, see Managements Discussion and Analysis of Financial Condition and Results of OperationsNon-GAAP Financial Measures.
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Differentiated Investment Strategy . We seek to acquire and lease freestanding, single-tenant commercial real estate facilities where a tenant services its customers and conducts activities that are essential to the generation of its sales and profits. We primarily seek to invest |
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in properties leased to unrated middle-market companies that we determine have attractive credit characteristics and stable operating histories. We believe middle-market companies are underserved from a capital perspective and that we can offer them attractive real estate financing solutions and enter into lease agreements that provide us with attractive risk-adjusted returns. Furthermore, many net lease transactions with middle-market companies involve properties that are individually relatively small, which allows us to avoid concentrating a large amount of capital in individual properties. We maintain close relationships with our tenants, which we believe allows us to source additional investments and become the capital provider of choice as our tenants businesses grow and their real estate needs increase. |
| Asset Base Allows for Significant Growth . Building on our senior leadership teams experience of more than 20 years in net lease real estate investing, we have developed leading origination, underwriting, financing, documentation and property management capabilities. Our platform is scalable, and we will seek to leverage these capabilities to improve our efficiency and processes to seek attractive risk-adjusted growth. While we expect that our general and administrative expenses will continue to rise in some measure as our portfolio grows, we expect that such expenses as a percentage of our portfolio will decrease over time due to efficiencies and economies of scale. We have grown substantially since we commenced investment activities on June 16, 2016 when we acquired our GE Seed Portfolio for $279.8 million (including transaction costs). During the three months ended March 31, June 30, September 30 and December 31 of 2017, we purchased properties with aggregate purchase prices of $143.8 million, $91.5 million, $138.7 million and $160.4 million, respectively. During the three months ended March 31, 2018, we purchased properties with an aggregate purchase price of $64.1 million, and at March 31, 2018, we owned 530 properties, with annualized base rent of $75.7 million. With our smaller asset base relative to other institutional investors that focus on acquiring net leased real estate, superior growth can be achieved through manageable acquisition volume. Additionally, as of March 31, 2018, our average investment per property was $1.9 million (which equals our aggregate investment in our properties (including transaction costs, lease incentives and amounts funded for construction in progress) divided by the number of properties owned at March 31, 2018), which we believe will allow us to grow our portfolio without concentrating a large amount of capital in individual properties and reduce our exposure to events that may adversely affect a particular property. |
| Disciplined Underwriting Leading to Strong Portfolio Characteristics . We generally seek to execute transactions with an aggregate purchase price of $3 million to $50 million. Our size allows us to focus on investing in a segment of the market that we believe is underserved from a capital perspective and where we can originate or acquire relatively smaller assets on attractive terms that provide meaningful growth to our portfolio. In addition, we seek to invest in commercially desirable properties that are suitable for use by different tenants, offer attractive risk-adjusted returns and possess characteristics that reduce our real estate investment risks. As of March 31, 2018: |
| Our leases had a weighted average remaining lease term (based on annualized base rent) of 13.8 years, with only 4.4% of our annualized base rent attributable to leases expiring prior to January 1, 2023; |
| Master leases contributed 64.8% of our annualized base rent; |
| Our portfolios weighted average rent coverage ratio was 2.9x, with leases contributing 75.3% of our annualized base rent having rent coverage ratios in excess of 2.0x (excluding leases that do not report unit-level financial information); |
| Our portfolio was 99.1% occupied; |
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| Leases contributing 95.4% of our annualized base rent provided for increases in future annual base rent, ranging from 1.0% to 4.0% annually, with a weighted average annual escalation equal to 1.5% of base rent; and |
| Leases contributing 93.8% of annualized base rent were triple-net. |
| Extensive Tenant Financial Reporting Supports Active Asset Management . We seek to enter into lease agreements that obligate our tenants to periodically provide us with corporate and/or unit-level financial reporting, which we believe enhances our ability to actively monitor our investments, negotiate through lease renewals and proactively manage our portfolio to protect stockholder value. As of March 31, 2018, leases contributing 97.4% of our annualized base rent required tenants to provide us with specified unit-level financial information. |
Our Business and Growth Strategies
Our objective is to maximize stockholder value by generating attractive risk-adjusted returns through owning, managing and growing a diversified portfolio of commercially desirable properties. We intend to pursue our objective through the following business and growth strategies.
| Structure and Manage Our Diverse Portfolio With Disciplined Underwriting and Risk Management . We seek to maintain the stability of our rental revenue and maximize the long-term return on our investments while continuing our growth by using our disciplined underwriting and risk management expertise. When underwriting assets, we emphasize commercially desirable properties, with strong operating performance, healthy rent coverage ratios and tenants with attractive credit characteristics. |
Leasing. In general, we seek to enter into leases with (i) relatively long terms (typically with initial terms of 15 years or more and tenant renewal options); (ii) attractive rent escalation provisions; (iii) healthy rent coverage ratios; and (iv) tenant obligations to periodically provide us with financial information, which provides us with information about the operating performance of the leased property and/or tenant and allows us to actively monitor the security of payments under the lease on an ongoing basis. We strongly prefer to use master lease structures, pursuant to which we lease multiple properties to a single tenant on a unitary (i.e., all or none) basis. In addition, in the context of our sale-leaseback investments, we generally seek to establish contract rents that are at prevailing market rents, which we believe enhances tenant retention and reduces our releasing risk in the event that a lease is rejected in a bankruptcy proceeding or expires.
Diversification. We monitor and manage the diversification of our portfolio in order to reduce the risks associated with adverse developments affecting a particular tenant, property, industry or region. Our strategy targets a scaled portfolio that, over time, will (1) derive no more than 5% of its annualized base from any single tenant or more than 1% of its annualized base rent from any single property, (2) be primarily leased to tenants operating in service-oriented or experience-based businesses and (3) avoid significant geographic concentration. While we consider these criteria when making investments, we may be opportunistic in managing our business and make investments that do not meet one or more of these criteria if we believe the opportunity presents an attractive risk-adjusted return. As of March 31, 2018, Captain Ds (Captain Ds, LLC), our largest tenant, contributed 6.8% of our annualized base rent. As of that date, no other tenant contributed more than 5.8% of our annualized base rent, and no single property contributed more than 1.7% of our annualized base rent.
Asset Management. We are an active asset manager and regularly review each of our properties for changes in the business performance at the property, credit of the tenant and
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local real estate market conditions. Among other things, we use Moodys Analytics RiskCalc, which is a model for predicting private company defaults based on Moodys Analytics Credit Research Database, to proactively detect credit deterioration. Additionally, we monitor market rents relative to in-place rents and the amount of tenant capital expenditures in order to refine our tenant retention and alternative use assumptions. Our management team utilizes our internal credit diligence to monitor the credit profile of each of our tenants on an ongoing basis. We believe that this proactive approach enables us to identify and address issues expeditiously and to determine whether there are properties in our portfolio that are appropriate for disposition.
| Focus on Relationship-Based Sourcing to Grow Our Portfolio by Originating Sale-Leaseback Transactions . We plan to continue our disciplined growth by originating sale-leaseback transactions and opportunistically making acquisitions of properties subject to net leases that contribute to our portfolios tenant, industry and geographic diversification. Since we commenced investment activities in June 2016, our senior management team has sourced, underwritten, negotiated and structured 94 investment transactions that have closed. As of March 31, 2018, exclusive of our GE Seed Portfolio, 80.6% of our portfolios annualized base rent was attributable to internally originated sale-leaseback transactions and 91.8% was acquired from parties who had previously engaged in transactions that involved a member of our senior management team (including operators and tenants and other participants in the net lease industry, such as brokers, intermediaries and financing sources). In addition, we seek to leverage our relationships with our tenants to facilitate investment opportunities, including selectively agreeing to reimburse certain of our tenants for development costs at our properties in exchange for contractually specified rent that generally increases proportionally with our funding. As of March 31, 2018, exclusive of our GE Seed Portfolio, approximately 53% of our investments were sourced from operators and tenants who had previously consummated a transaction involving a member of our management team and approximately 39% were sourced from participants in the net lease industry, such as brokers, intermediaries or financing sources, who had previously been involved with a transaction involving a member of our management team. We believe our senior management teams reputation, in-depth market knowledge and extensive network of long-standing relationships in the net lease industry provides us access to an ongoing pipeline of attractive investment opportunities. |
| Focus on Middle-Market Companies in Service-Oriented or Experience-Based Businesses . We primarily focus on investing in properties that we lease on a long-term, triple-net basis to unrated middle-market companies that we determine have attractive credit characteristics and stable operating histories. We generally define middle-market companies as regional and national operators with between 10 and 250 locations and $20 million to $500 million in annual revenue. Properties leased to middle-market companies may offer us the opportunity to achieve superior risk-adjusted returns, as a result of our intensive credit and real estate analysis, lease structuring and portfolio construction. We believe our capital solutions are attractive to middle-market companies due to their more limited financing options, as compared to larger, rated organizations, and, in many cases, smaller transactions with middle-market companies will allow us to maintain and grow our portfolios diversification. Middle-market companies are often willing to enter into leases with structures and terms that we consider attractive (such as master leases and leases that require ongoing tenant financial reporting) and believe contribute to the stability of our rental revenue. |
In addition, we emphasize investment in properties leased to tenants engaged in service-oriented or experience-based businesses, such as restaurants (including quick service and casual and family dining), car washes, automotive services, medical services, convenience
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stores, entertainment, early childhood education, and health and fitness, as we believe these businesses are generally insulated from e-commerce pressure.
| Internal Growth Through Long-Term Triple-Net Leases That Provide For Periodic Rent Escalations . We seek to enter into long-term (typically with initial terms of 15 years or more and tenant renewal options), triple-net leases that provide for periodic contractual rent escalations. As of March 31, 2018, our leases had a weighted average remaining lease term of 13.8 years (based on annualized base rent), with only 4.4% of our annualized base rent attributable to leases expiring prior to January 1, 2023, and 95.4% of our leases (based on annualized base rent) provided for increases in future base rent at a weighted average of 1.5% per year. Additionally, our conservative underwriting and active asset management, which we believe reduces default losses and increases renewal probabilities, is intended to enhance the stability of our rental revenue. |
| Actively Manage Our Balance Sheet to Maximize Capital Efficiency . We seek to maintain a prudent balance between debt and equity financing and to maintain funding sources that lock in long-term investment spreads and limit interest rate sensitivity. We target a level of net debt that, over time, is generally less than six times our EBITDAre. As of March 31, 2018, on a pro forma basis, we had $510.1 million of total debt outstanding and net debt of $362.2 million. Our pro forma net income for the year ended December 31, 2017 was $27.9 million and our pro forma EBITDAre was $87.9 million. Our pro forma net income for the three months ended March 31, 2018 was $5.7 million, our pro forma EBITDAre was $20.9 million and our pro forma ratio of net debt to annualized EBITDAre was 4.3x. We anticipate having access to multiple sources of debt capital, including the investment grade-rated, asset-backed bond market, through our Master Trust Funding Program, and bank debt, through an undrawn unsecured revolving credit facility that we expect to have upon completion of this offering. |
Our net debt, our EBITDAre and our ratio of net debt to EBITDAre referenced above are non-GAAP financial measures. See Managements Discussion and Analysis of Financial Condition and Results of OperationsNon-GAAP Financial Measures.
Our Real Estate Investment Portfolio
As of March 31, 2018, we had a portfolio of 530 properties that was diversified by tenant, industry and geography and had annualized base rent of $75.7 million. Our 127 tenants operate 112 different concepts in 15 industries across 42 states. None of our tenants represented more than 6.8% of our portfolio at March 31, 2018, and our top ten largest tenants represented less than 41.8% of our annualized base rent as of that date.
As of March 31, 2018 our top ten tenants included ten different concepts: Captain Ds, Art Van Furniture, Mister Car Wash, Zips Car Wash, AMC Theaters, Perkins, 84 Lumber, Mirabito, Ruby Tuesday and White Oak Station. Set forth below is information with respect to each concept of our top ten tenants.
Captain Ds (Captain Ds, LLC). Founded in 1969 and headquartered in Nashville, Tennessee, Captain Ds owns, operates and franchises approximately 520 restaurants in 20 states, including 76 operated and two franchised properties leased from us. Captain Ds was acquired in December 2017 by Sentinel Capital Partners, a private equity investment firm.
Art Van Furniture (AVF Parent, LLC). Founded in 1959 and headquartered in Warren, Michigan, Art Van Furniture is the largest independent furniture retailer in the United States and a leading furniture and mattress retailer in the Midwest. The company operates approximately 100 stores
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throughout Michigan, Illinois, Iowa, Ohio and Indiana, including five properties leased from us. Art Van Furniture is owned by affiliates of Thomas H. Lee Partners, a private equity investment firm, that purchased the business in 2017.
Mister Car Wash (Car Wash Partners, Inc.). Headquartered in Tucson, Arizona, Mister Car Wash operates over 240 car washes and over 30 express lube centers in 21 states, including 13 properties leased from us. Mister Car Wash is the largest car wash operator in the United States. Mister Car Wash is owned by affiliates of Leonard Green & Partners, a private equity investment firm.
Zips Car Wash (Zips Car Wash, LLC). Zips Car Wash, based in Jonesboro, Arkansas, was founded in 2004 with two locations in Arkansas. The company currently operates 94 express tunnel wash locations, including 16 properties leased from us, in 11 states, primarily in the southeastern United States.
AMC Theaters (AMC Entertainment Holdings, Inc.). Founded in 1920, AMC Theaters is the largest movie exhibition company in the United States. AMC Theaters operates approximately 1,000 theaters, including four properties leased from us, and 11,000 screens worldwide, and employs approximately 45,000 full and part-time employees. The company serves more than 250 million guests in the United States each year and more than 350 million across the globe. Wanda Group, a multinational conglomerate based in Beijing, is the controlling stockholder of AMC Theaters.
Perkins (Perkins & Marie Callenders, LLC). Founded in 1958 and headquartered in Memphis, Tennessee, Perkins operates approximately 400 restaurants in 33 states and five Canadian provinces, including 14 properties in the United States leased from us. Perkins is majority owned by affiliates of Wayzata Investment Partners LLC, a private equity investment firm.
84 Lumber (Magerko Real Estate, LLC). Founded in 1956 and headquartered in Eighty Four, Pennsylvania, 84 Lumber is a building materials supply company that owns and operates over 250 stores in 30 states, including 19 properties leased from us. The company employs approximately 4,900 people.
Mirabito (Mirabito Holdings, Inc.). Mirabito is a private, family-owned company based in Binghamton, New York that, through its predecessors, was founded in 1927. Mirabito owns and operates approximately 75 convenience stores under the Mirabito, Quickway Food Stores, Convenience Express and Manleys Mighty-Mart brands throughout central New York, including 20 properties leased from us.
Ruby Tuesday (Ruby Tuesday, Inc.). The Ruby Tuesday concept has focused on casual American dining since its founding in 1972. There are currently over 500 company-owned and franchised Ruby Tuesday locations throughout the United States and around the world, including 17 properties leased from us. Ruby Tuesday was acquired by NRD Capital, an Atlanta-based private equity firm, in December 2017.
White Oak Station (White Oak Station LLC). Founded in 1983 and headquartered in Harrison, Arkansas, White Oak Station owns and operates convenience stores. White Oak Station owns or manages 82 convenience stores and gas stations primarily in the Ozark Mountain region and in Florida, Texas and Iowa, including 20 properties leased from us.
As of March 31, 2018, 93.8% of our leases (based on annualized base rent) were triple-net, and the tenant is typically responsible for all improvements and is contractually obligated to pay all operating expenses, such as maintenance, insurance, utility and tax expense, related to the leased property. Due to the triple-net structure of our leases, we do not expect to incur significant capital expenditures relating to our triple-net leased properties, and the potential impact of inflation on our operating expenses is reduced.
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The following chart illustrates the percentage of our annualized base rent as of March 31, 2018 attributable to various industries. 87.6% of annualized base rent as of March 31, 2018 related to service-oriented and experience-based businesses.
| Diversification by Tenant . Our 530 properties are operated by our 127 tenants. As of March 31, 2018, our five largest tenants, who contributed 27.2% of our annualized base rent, had a rent coverage ratio of 2.83x, and our ten largest tenants, who contributed 41.8% of our annualized base rent, had a rent coverage ratio of 2.91x. |
| Diversification by Concept . Our tenants operate their businesses across 112 concepts. |
| Diversification by Industry . Our tenants business concepts are diversified across various industries. As of March 31, 2018, our tenants operating service-oriented businesses had a weighted average rent coverage ratio of 2.70x, our tenants operating experience-based businesses had a weighted average rent coverage ratio of 2.40x, our tenants operating retail businesses had a weighted average rent coverage ratio of 3.77x and our tenants operating other types of businesses had a weighted average rent coverage ratio of 5.36x. |
| Diversification by Geography . Our 530 property locations are spread across 42 states. |
As of March 31, 2018, the weighted average remaining term of our leases was 13.8 years (based on annualized base rent), with only 4.4% of our annualized base rent attributable to leases expiring prior to January 1, 2023.
We believe unit-level rent coverage ratios are an important element of evaluating the likelihood that tenants will renew leases upon expiration or exercise renewal options. The following chart illustrates our annualized base rent as of March 31, 2018 attributable to leases expiring during the
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specified periods and provides information about the unit-level rent coverage ratios as of March 31, 2018 for such leases. We believe that our strong rent coverage ratios enhance the likelihood that leases will be renewed or extended and increases the stability of our rental revenue.
(1) | Represents annualized contractually specified cash base rent in effect on March 31, 2018 for all of our leases (including those accounted for as direct financing leases) commenced as of that date. |
We typically lease our properties pursuant to long-term, triple-net leases with initial terms of 15 years or more that often have tenant renewal options. Substantially all of our leases are triple-net, meaning our tenant generally is obligated to pay all operating expenses (such as maintenance, insurance, utility and tax expense) related to the leased property. We strongly prefer to use master lease structures, pursuant to which we lease multiple properties to a single tenant on an all or none basis. In a master lease structure, a tenant is responsible for a single lease payment relating to the entire portfolio of leased properties, as opposed to multiple lease payments relating to individually leased properties. The master lease structure prevents a tenant from cherry picking locations, where it unilaterally gives up underperforming properties while maintaining its leasehold interest in well-performing properties. As of March 31, 2018, master leases contributed 64.8% of our annualized base rent (our largest master lease by annualized base rent related to five properties and contributed 5.8% of our annualized base rent, and our smallest master lease by annualized base rent related to two properties and contributed 0.1% of our annualized base rent). We also seek to invest in properties with healthy rent coverage ratios. Substantially all of our leases also require our tenants to periodically provide us with financial information, which allows us to evaluate the security of payments under the related lease on an ongoing basis.
Substantially all of our leases provide for periodic contractual rent escalations. As of March 31, 2018, leases contributing 95.4% of our annualized base rent provided for increases in future annual base rent, generally ranging from 1.0% to 4.0% annually, with a weighted average annual escalation equal to 1.5% of base rent. Generally, our rent escalators increase rent on specified dates by a fixed
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percentage. Our escalations provide us with a source of internal growth and a measure of inflation protection. Additional information on lease escalation frequency and weighted average annual escalation rates as of March 31, 2018 is displayed below.
Lease Escalation Frequency |
% of Annualized
Base Rent |
Weighted Average
Annual Escalation Rate(1) |
||||||
Annually |
73.7 | % | 1.6 | % | ||||
Every 2 years |
1.2 | % | 1.7 | % | ||||
Every 3 years |
0.2 | % | | |||||
Every 4 years |
1.0 | % | 0.9 | % | ||||
Every 5 years |
15.2 | % | 1.2 | % | ||||
Other escalation frequencies |
4.1 | % | 1.6 | % | ||||
Flat(2) |
4.6 | % | N/A | |||||
|
|
|||||||
Total/Weighted Average(3) |
100.0 | % | 1.5 | % | ||||
|
|
(1) | Represents the weighted average annual escalation rate of the entire portfolio as if all escalations occurred annually. For leases where rent escalates by the greater of a stated fixed percentage or the change in the CPI, we have assumed an escalation equal to the stated fixed percentage in the lease. As of March 31, 2018, leases contributing 10.1% of our annualized base rent provide for rent increases equal to the lesser of a stated fixed percentage or the change in the CPI. As any future increase in CPI is unknowable at this time, we have not included an increase in the rent pursuant to these leases in the weighted average annual escalation rate presented. |
(2) | Approximately 79.6% of the annualized base rent derived from flat leases is attributable to leases that provide for contingent rent based on a percentage of the tenants gross sales at the leased property. |
(3) | Weighted by annualized base rent. |
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Historical Acquisitions and Dispositions
The following chart illustrates our quarterly investment activity since inception, excluding the GE Seed Portfolio:
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The following table sets forth select information about our quarterly investment activity since inception, excluding the GE Seed Portfolio and nine additional properties that we acquired from General Electric Capital Corporation for an aggregate purchase price of $5.7 million (including transaction costs), during the period from June 16, 2016 through December 31, 2016, that we did not acquire on June 16, 2016 when we acquired the GE Seed Portfolio (dollars in thousands):
Three Months Ended | ||||||||||||||||||||||||||||||||
September 30,
2016 |
December 31,
2016 |
March 31,
2017 |
June 30,
2017 |
September 30,
2017 |
December 31,
2017 |
March 31,
2018 |
Total | |||||||||||||||||||||||||
Acquisitions |
||||||||||||||||||||||||||||||||
Volume(1) |
$ | 60,248.9 | $ | 112,513.8 | $ | 143,778.7 | $ | 91,525.8 | $ | 138,653.0 | $ | 160,365.9 | $ | 64,098.4 | $ | 771,184.6 | ||||||||||||||||
Average investment per unit |
$ | 2,151.7 | $ | 1,814.7 | $ | 4,108.0 | $ | 2,473.7 | $ | 2,727.8 | $ | 1,741.7 | $ | 2,195.1 | ||||||||||||||||||
Cash cap rate(2) |
7.3 | % | 7.3 | % | 7.5 | % | 7.6 | % | 7.6 | % | 7.7 | % | 7.8 | % | ||||||||||||||||||
GAAP cap rate(3) |
8.2 | % | 8.3 | % | 8.7 | % | 8.9 | % | 8.9 | % | 8.7 | % | 8.3 | % | ||||||||||||||||||
Property count |
28 | 62 | 35 | 37 | 50 | 90 | 28 | 330 | ||||||||||||||||||||||||
Master lease %(4) |
85.2 | % | 47.3 | % | 83.2 | % | 71.0 | % | 72.9 | % | 64.5 | % | 33.3 | % | ||||||||||||||||||
Sale-leaseback %(4) |
100.0 | % | 65.5 | % | 85.5 | % | 75.9 | % | 94.0 | % | 74.7 | % | 67.5 | % | ||||||||||||||||||
Financial reporting %(5) |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 97.7 | % | 99.8 | % |
|
100.0 |
% |
|||||||||||||||||
Rent coverage ratio |
|
2.92
|
x
|
2.77 | x | 3.14 | x | 3.96 | x | 2.77 | x | 3.05 | x | 2.34x | ||||||||||||||||||
Remaining lease term (years)(4) |
16.8 | 17.3 | 17.0 | 17.3 | 18.4 | 15.5 | 14.1 | |||||||||||||||||||||||||
Number of transactions |
4 | 11 | 12 | 11 | 18 | 21 | 16 | 93 |
(1) | Includes transaction costs, lease incentives and amounts funded for construction in progress. |
(2) | Annualized contractually specified cash base rent for the first full month after the investment divided by the purchase price for the property. |
(3) | GAAP rent for the first twelve months after the investment divided by the purchase price for the property. |
(4) | As a percentage of annualized base rent. |
(5) | Tenants party to leases that obligate them to periodically provide us with corporate and/or unit-level financial reporting, as a percentage of our annualized base rent. |
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We routinely sell properties that we conclude do not offer a return commensurate with the investment risk, contribute to unwanted geographic, industry or tenant concentrations, or may be sold at a price we determine is attractive. The following table sets forth select information about our quarterly disposition activity since inception (dollars in thousands):
Three Months Ended | ||||||||||||||||||||||||||||||||
September 30,
2016 |
December 31,
2016 |
March 31,
2017 |
June 30,
2017 |
September 30,
2017 |
December 31,
2017 |
March 31,
2018 |
Total | |||||||||||||||||||||||||
Dispositions of leased properties |
||||||||||||||||||||||||||||||||
Proceeds(1) |
$ | | $ | 14,884.7 | $ | 4,131.6 | $ | 7,822.5 | $ | 16,614.9 | $ | 14,629.8 | $ | 7,506.0 | $ | 65,589.5 | ||||||||||||||||
Realized gain (loss), net(1) |
$ | | $ | 878.0 | $ | 234.2 | $ | 1,178.2 | $ | 1,537.9 | $ | 3,002.8 | $ | 1,251.3 | $ | 8,082.4 | ||||||||||||||||
Cash cap rate(2) |
$ | | 6.2 | % | 6.5 | % | 6.5 | % | 6.1 | % | 6.4 | % | 6.7 | % | 6.3 | % | ||||||||||||||||
Property count |
| 11 | 3 | 6 | 9 | 8 | 5 | 42 | ||||||||||||||||||||||||
Dispositions of vacant properties |
||||||||||||||||||||||||||||||||
Proceeds(1) |
$ | 628.3 | $ | 962.9 | $ | 925.6 | $ | 3,570.6 | $ | 3,578.3 | $ | 2,352.9 | $ | 215.4 | $ | 12,234.0 | ||||||||||||||||
Realized gain (loss), net(1) |
$ | (13.1 | ) | $ | 6.1 | $ | 60.4 | $ | 288.9 | $ | 436.2 | $ | 9.4 | $ | (19.0) | $ | 768.9 | |||||||||||||||
Property count(3) |
2 | 4 | 4 | 8 | 5 | 4 | 1 | 28 |
(1) | Net of transaction costs. |
(2) | Annualized contractually specified cash base rent at time of sale divided by the gross sale price (excluding transaction costs) for the property. |
(3) | Property count excludes dispositions where only a portion of the owned parcel was sold. |
Market Opportunity
Outlook
According to a market study prepared for us in connection with this offering by RCG, the current outlook for the net lease real estate market is positive for the following reasons:
| net leased properties historically provided owners with relatively stable rent growth across various economic cycles when compared to other types of real estate investments; |
| long-term leases and contractual rent structure can mitigate the risks of economic or real estate market downturns and limit the effects of inflation on operating expenses; and |
| the market is well positioned to accommodate increased investment activity given the $1.5 trillion to more than $2.0 trillion of U.S. real estate estimated to be held by corporate owner-occupiers and favorable industry outlook of our tenants. |
Market Overview
In addition to the relative stability of rental income and inflation mitigation structured into net leases, net leased properties are often purchased through sale-leaseback transactions, which can represent an efficient and economical way for an owner-occupier of real estate to raise capital. Following a sale-leaseback transaction, a former owner-occupier may be better positioned to maximize profitability or growth by allocating capital previously invested in real estate into core business activities.
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The market for net leased properties is fragmented and decentralized, creating significant opportunities for well-capitalized firms with expertise in the market. Furthermore, as many smaller-scale net leased retail and service-oriented properties are valued under $10 million and may be located outside of primary real estate markets, these properties can often fall outside the typical investment criteria of large institutional investors. The lack of strong competition from institutional investors for smaller-scale net leased retail and service properties provides opportunities for firms with expertise in the market that desire to acquire these types of assets.
Given the fragmented ownership and the relatively limited number of potential buyers, RCG believes that well-capitalized firms with expertise in the market may be able to benefit from pricing inefficiencies in terms of the purchase price and lease terms for net leased properties. Furthermore, expertise and access to capital can make it possible for larger firms to better assess risks and more rapidly deploy capital in order to acquire new properties.
Service-Oriented and Internet-Resilient Industries
As a percentage of personal consumption expenditures, consumer spending on services has outpaced spending on goods for a number of years. From the end of 2010 through March 2018, the most recent data available, spending on services increased by 35.4%, compared with an increase of 26.7% in spending on goods, according to the Bureau of Economic Analysis (BEA). The BEA defines services as commodities that cannot be stored or inventoried and that are usually consumed at the place and time of purchase. Examples include education, health care, transportation services, recreation services, restaurants and financial services. As of March 2018, more than two-thirds of consumer spending was on services. In addition, in recent years e-commerce pressured bricks-and-mortar retailers that sell goods that are easily accessible online, but service-oriented and experienced-based businesses have generally provided greater internet-resiliency.
| Restaurants . Dining in a restaurant provides consumers with a culinary experience that cannot be directly replicated by cooking at home or through a food delivery service. Spending on food away from home grew to 43.8% of total food expenditures in 2016, compared with 40.9% in 2010, according to the Bureau of Labor Statistics (BLS). Both the experiential nature of restaurants and evolving residential preferences should support the restaurant industry and provide some resiliency to competition from internet-based grocery and food delivery services. |
| Car Washes and Automotive Services . The reliance of most U.S. households on cars as a primary mode of transportation underscores the potential demand for auto-related products and services. As of 2016, more than 91% of households had at least one vehicle, according to the U.S. Census Bureau (USCB). In addition, the total number of vehicle miles traveled per year also increased by 6.1% between December 2007 and February 2018, the most recent data available, to more than 3.2 trillion miles, according to the U.S. Federal Highway Administration. Rising demand for auto-related products and services is further supported by the increasing age of vehicles. The average age of all light vehicles in operation in the U.S. increased from 9.9 years in 2006 to 11.6 years in 2016, according to the U.S. Department of Transportation. While consumer behavior may evolve as new technologies influence the automotive industry, households are expected to continue to utilize car washes and automotive services. |
|
Convenience Stores and Gas Stations . From December 2010 to April 2018, the most recent data available, U.S. gasoline consumption increased by 4.6% to nearly 9.3 million barrels per day. When purchasing fuel, consumers often make additional purchases from attached convenience stores. Convenience store purchases are also typically comprised of purchases intended for immediate consumption. As of 2017, approximately 83% of |
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convenience store purchases are consumed within one hour of purchase, according to the NACS. In aggregate, U.S. convenience store sales increased by 11.5% from 2012 through 2016, according to NACS. The advantages of highly accessible locations, extended hours of operation and products that satisfy impulse and necessity purchases should continue to sustain consumer demand for convenience store products. |
| Early Childhood Education . Demand for early childhood education services is expected to grow as a result of an increasing population of young children, proliferation of single-parent and dual-income households and an emphasis on early childhood education, beyond traditional daycare. As millennials enter their thirties and begin to start families, the number of young children in the U.S. is expected to grow substantially. According to the USCB, as of 2017, there were nearly 20 million children under the age of five in the Unites States, all of whom require some form of child care. By 2025, this segment is expected to grow approximately 3.9% to 20.8 million. Many of these families with young children are expected to be dual-income households. The labor force participation rate among women with preschool-aged children (ages three to five years) increased from 45% in 1975 to 67.3% in 2015, according to the BLS. Furthermore, there is increased demand for curriculum-based, child-centered learning, which promotes academic development beyond providing only for a childs physical needs. Looking ahead, demographic and lifestyle patterns should lead to more births and a growing number of families seeking childcare services, supporting demand for the early childhood education industry. |
| Movie Theaters and Entertainment . The growing consumer preference for experiences, particularly among millennials, is supporting growth in the arts, entertainment and recreation industry. According to the BEA, industry output increased from $0.9 trillion in 2006 to over $1.4 trillion in 2017, and industry output as a percentage of total U.S. GDP increased from approximately 3.6% to approximately 4.1% during the same time period. Consumer spending on entertainment fees and admissions also increased, rising by 17.2% from an average per-consumer annual expenditure of $581 in 2010 to $681 in 2016, according to the BLS. Growth in consumer spending on arts, entertainment and recreation should continue to support the movie theater and entertainment industry in the coming years. |
| Health and Fitness. |
Health . Aging of the U.S. population and increased healthcare utilization should support increased demand for a wide range of healthcare services. In particular, the baby boomer generation is expected to utilize significantly more healthcare products and services in the coming years. The population aged 65 years or older is expected increase to 56.1 million people by 2020 and 73.1 million by 2030, according to the USCB. The aging population and rising healthcare utilization, combined with the need for physical care and treatment, should sustain demand for healthcare services, including urgent care centers, doctor offices, outpatient care facilities, and other health-related centers.
Fitness . In recent years, the number of gym memberships and spending on fitness-related activities increased. As of 2017, nearly 61 million Americans belonged to a fitness club. The number of adults aged 20 to 64 years old, the group most likely to hold a fitness center membership, according to the National Association for Health and Fitness, increased by more than 7 million people from 2010 to 2017, according to the USCB. As of 2017, the number of fitness club memberships in the United States increased to 60.9 million, an increase of 33.6% since 2008, according to the International Health, Racquet and Sportsclub Association (IHRSA). Moreover, the average member visited their club 104 times in 2017. Reflecting sustained fitness center utilization, health clubs generated
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$27.6 billion in revenue in 2016, compared with $25.8 billion in 2015, an increase of 7.2%, according to IHRSA. Considering the experiential nature of fitness centers (and the expanding diversity of industry offerings), the fitness industry should continue to attract a wide range of consumers.
Recent Developments
Completed and Pending Acquisitions
During the period from April 1, 2018 through June 1, 2018, we completed 35 property acquisitions with an aggregate purchase price of $79.7 million (including transaction costs). In connection with these acquisitions, we entered into leases with annualized base rent of $6.1 million. As of June 1, 2018, we were party to purchase and sale agreements relating to the acquisition of 51 properties with an aggregate purchase price of $127.4 million (not including transaction costs). In connection with these acquisitions, we expect to enter into leases with annualized base rent of $9.7 million. While we regard the completion of these pending acquisitions to be probable, these transactions are subject to customary closing conditions, including the completion of due diligence, and there can be no assurance that these acquisitions will be completed on the terms described above or at all.
Completed and Pending Dispositions
During the period from April 1, 2018 through June 1, 2018, we completed property dispositions with an aggregate sale price, net of disposition costs, of $9.4 million. As of June 1, 2018, we had also agreed to sell two properties with an aggregate sales price of $2.7 million (excluding estimated transaction costs) that we believe are probable of closing. While we regard the completion of these pending dispositions to be probable, these transactions are subject to customary closing conditions, including the completion of due diligence, and there can be no assurance that these dispositions will be completed on the terms described above or at all.
Funded and Pending Tenant Construction Reimbursement Obligations and Tenant Loan
During the period from April 1, 2018 through June 1, 2018, we provided $1.3 million to three of our tenants for construction costs that they incurred in connection with construction at three of our properties in exchange for contractually specified rent that generally increases proportionally with our funding. As of June 1, 2018, we had agreed to fund four of our tenants in an aggregate amount of $13.3 million for construction costs that they expect to incur in connection with construction at four of our properties in exchange for contractually specified rent that generally increases proportionally with our funding. During the period April 1, 2018 through June 1, 2018, we also funded $0.3 million of a tenant mortgage loan to finance construction at a property leased from us with a remaining unfunded loan commitment at June 1, 2018 of $2.7 million.
Summary Risk Factors
You should carefully consider the matters discussed in the Risk Factors section beginning on page 32 of this prospectus for factors you should consider before investing in our common stock. Some of these risks include:
| We are subject to risks related to commercial real estate ownership that could reduce the value of our properties. |
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| Global market and economic conditions may materially and adversely affect us and the ability of our tenants to make rental payments to us pursuant to our leases. |
| Our business is dependent upon our tenants successfully operating their businesses and their failure to do so could materially and adversely affect us. |
| Our assessment that certain businesses are insulated from e-commerce pressure may prove to be incorrect, and changes in macroeconomic trends may adversely affect our tenants, either of which could impair our tenants ability to make rental payments to us and materially and adversely affect us. |
| Loss of our key personnel with long-standing business relationships could materially impair our ability to operate successfully. |
| As of March 31, 2018, on a pro forma basis, we had approximately $520.9 million principal balance of indebtedness outstanding, which may expose us to the risk of default under our debt obligations. |
| Market conditions could adversely affect our ability to refinance existing indebtedness or obtain additional financing for growth on acceptable terms or at all, which could materially and adversely affect us. |
| Failure to qualify, or maintain our qualification, as a REIT would materially and adversely affect us and the value of our common stock. |
| There can be no assurance that we will be able to make or maintain cash distributions, and certain agreements relating to our indebtedness may, under certain circumstances, limit or eliminate our ability to make distributions to our common stockholders. |
| Eldridge will have substantial influence over our business, and its interests, and the interests of certain members of our management team, may differ from our interests or those of our other stockholders. |
Structure and Formation of Our Company
Our Operating Partnership
Following the completion of this offering, the concurrent Eldridge private placement and the formation transactions, our wholly-owned subsidiary, Essential Properties OP G.P., LLC, will be the sole general partner of our operating partnership. Substantially all of our assets will be held by, and our operations will be conducted through, our operating partnership. We will contribute the net proceeds received by us from this offering and the concurrent private placement of common stock to Eldridge to our operating partnership in exchange for OP units. Our interest in our operating partnership will generally entitle us to share in cash distributions from, and in the profits and losses of, our operating partnership in proportion to our percentage ownership. Through our wholly-owned subsidiary, Essential Properties OP G.P., LLC, the sole general partner of our operating partnership, we will generally have the exclusive power under the partnership agreement to manage and conduct its business and affairs, subject to certain approval and voting rights of the limited partners, which are described more fully below in Description of the Partnership Agreement of Essential Properties, L.P. Our board of directors will manage our business and affairs.
Beginning on and after the date that is 12 months after the issuance of the OP units, each limited partner of our operating partnership will have the right to require our operating partnership to redeem part or all of its OP units for cash, based upon the value of an equivalent number of shares of our common stock at the time of the redemption, or, at our election, shares of our common stock on a
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one-for-one basis, subject to certain adjustments and the restrictions on ownership and transfer of our stock set forth in our charter and described under the section entitled Description of Our Capital StockRestrictions on Ownership and Transfer. Each redemption of OP units will increase our percentage ownership interest in our operating partnership and our share of its cash distributions and profits and losses. See Description of the Partnership Agreement of Essential Properties, L.P.
Concurrent Eldridge Private Placement
Concurrently with the completion of this offering, Eldridge will invest $125 million in shares of common stock in a transaction exempt from the registration requirement of the Securities Act of 1933, as amended, or the Securities Act; provided that, if such investment would result in Eldridge holding more than 19.0% of the common stock to be outstanding immediately after completion of this offering and the concurrent Eldridge private placement, Eldridge will invest the portion of such investment that would result in Eldridge holding more than 19.0% of the outstanding common stock in OP units in a transaction exempt from the registration requirement of the Securities Act. The concurrent Eldridge private placement will be made at a price per share and per share and unit, if applicable, equal to the initial public offering price per share of common stock in this offering (without payment of any underwriting discount). Assuming an initial public offering price of $15.50 per share, which is the mid-point of the price range set forth on the front cover of this prospectus, Eldridge will purchase 7,785,611 shares of our common stock and 278,905 OP units in the concurrent Eldridge private placement. See Pricing Sensitivity Analysis.
Formation Transactions
Prior to completion of this offering, the concurrent Eldridge private placement and the formation transactions our business was owned by and conducted directly and indirectly through Essential Properties Realty Trust LLC, or EPRT LLC. EPRT LLC is principally owned indirectly by, and is controlled by, Eldridge. Certain members of our senior management team also hold interests in EPRT LLC. On December 31, 2017, the owners of EPRT LLC contributed all of their interests in EPRT LLC to a newly formed Delaware limited liability company, EPRT Holdings, LLC, in exchange for interests in EPRT Holdings, LLC with the same rights as the interests they held in EPRT LLC.
Through the formation transactions, the following have occurred or will occur prior to or concurrently with the completion of this offering.
| Essential Properties Realty Trust, Inc. was formed by EPRT Holdings, LLC as a Maryland corporation on January 12, 2018. In connection with our formation, EPRT Holdings, LLC made an initial investment in us of $100 in exchange for 100 shares of our common stock. Such shares will be repurchased by us at or prior to the closing of the offering for $100. |
| Essential Properties OP G.P., LLC was formed by Essential Properties Realty Trust, Inc. as a Delaware limited liability company on March 16, 2018. |
| Prior to the completion of this offering, EPRT LLC will convert from a Delaware limited liability company into a Delaware limited partnership, change its name to Essential Properties, L.P. and adopt the Agreement of Limited Partnership pursuant to which, among other things, our wholly-owned subsidiary, Essential Properties OP G.P., LLC, will become Essential Properties, L.P.s sole general partner. |
| In connection with EPRT LLCs conversion into a Delaware limited partnership, EPRT Holdings, LLCs interest in EPRT LLC will be converted into 17,913,592 OP units. |
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| We will contribute the net proceeds from this offering and the concurrent private placement of common stock to Eldridge in exchange for 40,976,901 OP units (or 45,851,901 OP units if the underwriters exercise their option to purchase up to an additional 4,875,000 shares of our common stock in full), representing a 69.3% ownership interest in the operating partnership (71.6% if the underwriters exercise their option to purchase up to an additional 4,875,000 shares of our common stock in full), with EPRT Holdings, LLC and Eldridge holding 30.2% and 0.5% ownership interests in the operating partnership, respectively (28.0% and 0.4% if the underwriters exercise their option to purchase up to an additional 4,875,000 shares of our common stock in full) (in each case, based on the mid-point of the price range set forth on the front cover of this prospectus). |
Our Structure
The following chart sets forth information about our company, the operating partnership, certain related parties and the ownership interests therein on a pro forma basis. Ownership percentages in the company and the operating partnership are presented assuming that the underwriters option to purchase additional shares is not exercised and an initial public offering price of $15.50 per share, which is the mid-point of the price range set forth on the front cover of this prospectus; however, these ownership percentages will vary depending on the actual initial public offering price of shares of common stock in this offering as described herein. See Pricing Sensitivity Analysis.
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(1) | Messrs. Mavoides and Seibert own a 1.6% interest in the aggregate in EPRT Holdings, LLC. See Certain Relationships and Related Party TransactionsLong-Term Incentives with EPRT Holdings, LLC. |
(2) | Eldridge owns a (a) 98.4% interest in EPRT Holdings, LLC; (b) 0.5% limited partner interest in the operating partnership; and (c) 7,785,611 shares of our common stock (representing a 19.0% ownership interest in Essential Properties Realty Trust, Inc.). |
(3) | Purchasers of common stock in this offering own 32,500,000 shares of our common stock (representing a 79.3% ownership interest in Essential Properties Realty Trust, Inc.). |
(4) | Essential Properties Realty Trust, Inc. will directly own a 68.3% limited partner interest in the operating partnership and will indirectly own a 1.0% general partner interest in the operating partnership through its ownership of 100% of the interests in Essential Properties OP G.P., LLC. |
Benefits to Related Parties
Upon completion of this offering, the concurrent Eldridge private placement, the use of the net proceeds therefrom and the formation transactions, EPRT Holdings, LLC, an affiliate of Eldridge and our directors and executive officers will receive material benefits, including the following:
| EPRT Holdings, LLC will own 17,913,592 OP units having an aggregate value of $277.7 million, based on the mid-point of the price range set forth on the front cover of this prospectus. |
| Eldridge will have invested through the concurrent Eldridge private placement an aggregate of $125 million to purchase 7,785,611 shares of our common stock and 278,905 OP units (in each case, based on the mid-point of the price range set forth on the front cover of this prospectus) at a price per share and per OP unit equal to the initial public offering price per share of our common stock sold in this offering (without payment of any underwriting discounts). While the amount of Eldridges aggregate investment in the concurrent Eldridge private placement will not change, the aggregate number of, and the allocation of this amount between, shares of our common stock and OP units will vary depending on the actual initial public offering price of shares of common stock in this offering as described herein. See Pricing Sensitivity Analysis. |
| An affiliate of Eldridge will have received approximately $288.0 million of the net proceeds from this offering to repay certain of our outstanding indebtedness. See Structure and Formation of Our CompanyBenefits to Related Parties. |
| We will have entered into a stockholders agreement with Eldridge. See Certain Relationships and Related Party TransactionsStockholders Agreement. |
| We will have entered into indemnification agreements with each of our directors and executive officers providing for the indemnification by us for certain liabilities and expenses incurred as a result of actions brought, or threatened to be brought, against our directors and executive officers in their capacities as such. |
| We will have entered into a registration rights agreement with EPRT Holdings, LLC with respect to resales of shares of our common stock that may be received upon exchange of OP units. |
| We will have entered into a registration rights agreement with Eldridge with respect to resales of (i) shares of our common stock that it purchased in the concurrent private placement of common stock; and (ii) shares of our common stock that may be received upon exchange of any OP units that it purchased in a concurrent private placement of OP units. |
| In connection with the concurrent private placement of common stock, we will grant a waiver from the ownership limit contained in our charter to Eldridge to own up to 19.0% of the outstanding shares of our common stock in the aggregate. |
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| Upon completion of this offering, we will enter into new employment agreements with each of Messrs. Mavoides and Seibert and with Hillary P. Hai, our Chief Financial Officer. For a description of the terms of these employment agreements, see Executive CompensationNarrative Disclosure Regarding Employment Agreements and Post-Termination ArrangementsEmployment Agreements. |
| We will have adopted the Essential Properties Realty Trust, Inc. and Essential Properties, L.P. 2018 Incentive Award Plan, or the Equity Incentive Plan, to provide equity incentive opportunities to our officers, employees, non-employee directors, consultants, independent contractors and agents, and will have issued, in the aggregate, thereunder 691,290 shares of restricted common stock to our directors, executive officers and other employees upon completion of this offering. See Executive CompensationNarrative Disclosure Regarding Employment Agreements and Post-Termination ArrangementsEquity Incentive Plan for further details. |
Distribution Policy
We intend to pay cash distributions to our common stockholders out of assets legally available for distribution. We intend to make a pro rata distribution with respect to the period commencing upon the completion of this offering and ending on September 30, 2018 based on a distribution rate of $0.21 per share of common stock for a full quarter. On an annualized basis, this would be $0.84 per share of common stock, or an annualized distribution rate of approximately 5.42% based on the mid-point of the price range set forth on the front cover of this prospectus. We intend to maintain our initial distribution rate for the 12 months following the completion of this offering unless our results of operations, funds from operations, or FFO, adjusted FFO, or AFFO, liquidity, cash flows, financial condition, or prospects, economic conditions or other factors differ materially from the assumptions used in projecting our initial distribution rate. We intend to make distributions that will enable us to meet the distribution requirements applicable to REITs and to eliminate or minimize our obligation to pay corporate-level federal income and excise taxes. We do not intend to reduce the expected distribution per share if the underwriters option to purchase additional shares is exercised.
Any distributions will be at the sole discretion of our board of directors, and their form, timing and amount, if any, will depend upon a number of factors, including our actual and projected results of operations, FFO, AFFO, liquidity, cash flows and financial condition, the revenue we actually receive from our properties, our operating expenses, our debt service requirements, our capital expenditures, prohibitions and other limitations under our financing arrangements, our REIT taxable income, the annual REIT distribution requirements, applicable law and such other factors as our board of directors deems relevant.
Restrictions on Ownership and Transfer of Our Common Stock
Our charter, subject to certain exceptions, authorizes our board of directors to take such actions as are necessary or appropriate to allow us to qualify and to preserve our status as a REIT. Furthermore, our charter prohibits any person from actually or constructively owning more than 7.5% in value or in number, whichever is more restrictive, of the outstanding shares of our common stock or 7.5% in value of the aggregate of the outstanding shares of all classes and series of our stock, except for certain designated investment entities that may own up to 9.8% of our outstanding common stock, subject to certain conditions. Our board of directors, in its sole discretion, may exempt a person, prospectively or retroactively, and subject to such conditions and limitations as our board of directors may deem appropriate, from these ownership limits if certain conditions are satisfied. However, our
24
board of directors may not grant an exemption from these ownership limits if such exemption would cause us to fail to qualify as a REIT. In connection with the concurrent private placement of common stock, we will grant a waiver from the ownership limit contained in our charter to Eldridge to own up to 19.0% of the outstanding shares of our common stock in the aggregate. We will also agree to provide transferees of Eldridge, subject to the satisfaction of certain conditions, with any necessary waivers from our ownership limits provided that any such waivers are consistent with our compliance with the ownership requirements for qualification as a REIT under the Internal Revenue Code of 1986, or the Code. Pursuant to the stockholders agreement, we have agreed, upon Eldridges request, subject to the delivery by Eldridge of any additional information requested by our board of directors, to increase the percentage of our outstanding common stock that may be owned by Eldridge, unless our board concludes that any such increase could jeopardize our ability to qualify for taxation as a REIT.
Our charter contains additional restrictions on ownership and transfer of our stock intended to, among other purposes, assist us to qualify as a REIT. The restrictions on ownership and transfer of our stock contained in our charter will not apply if our board of directors (with the consent of Eldridge for so long as Eldridge owns shares representing at least 5% of the voting power of our common stock) determines that it is no longer in our best interests to attempt to, or continue to, qualify as a REIT or if our board of directors determines that compliance with any such restriction is no longer required in order for us to qualify as a REIT. The ownership limits may delay or impede a transaction or a change of control that might be in your best interest. See Description of Our Capital StockRestrictions on Ownership and Transfer.
Our Tax Status
We intend to elect to qualify as a REIT for federal income tax purposes commencing with our taxable year ending December 31, 2018. We believe that our organization and operations will allow us to qualify as a REIT for federal income tax purposes commencing with such taxable year, and we intend to continue operating in such a manner. To maintain REIT status, we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and excluding any net capital gains. See Federal Income Tax Considerations.
Emerging Growth Company Status
We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other publicly-traded companies that are not emerging growth companies, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. We have not yet made a decision as to whether we will take advantage of any or all of these exemptions.
In addition, the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we have chosen to opt out of this extended transition period, and, as a result, we will comply with new or revised accounting standards on or prior to the relevant dates on which adoption of such standards is required for all public companies that are not emerging growth companies. Our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.
We will remain an emerging growth company until the earliest to occur of (i) the last day of the fiscal year during which our total annual revenue equals or exceeds $1.07 billion (subject to adjustment for inflation), (ii) the last day of the fiscal year following the fifth anniversary of this offering, (iii) the date
25
on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt or (iv) the date on which we are deemed to be a large accelerated filer under the Securities Exchange Act of 1934, as amended, or the Exchange Act.
Corporate Information
We were formed in March 2016. Our principal executive office is located at 47 Hulfish Street, Suite 210, Princeton, New Jersey 08542. Our telephone number is (609) 436-0619.
The Offering
Common stock offered by us |
32,500,000 shares (plus up to an additional 4,875,000 shares of our common stock that we may issue and sell upon the exercise in full of the underwriters option to purchase additional shares). |
Common stock to be outstanding after this offering and the concurrent Eldridge private placement |
40,976,901 shares(1) |
Common stock and OP units to be outstanding after this offering (excluding OP units held directly or indirectly by us), the concurrent Eldridge private placement and the formation transactions |
59,169,398 shares of common stock and OP units(1)(2) |
Use of proceeds |
We estimate that the net proceeds to us from this offering and the concurrent Eldridge private placement will be approximately $588.5 million, or $659.6 million if the underwriters exercise in full their option to purchase additional shares, after deducting underwriting discounts and commissions and other estimated expenses, in each case, based on an assumed initial public offering price of $15.50 per share, which is the mid-point of the price range set forth on the front cover of this prospectus. We intend to use the net proceeds from these offerings to repay indebtedness to an affiliate of Eldridge and for general corporate purposes, including potential future investments. See Use of Proceeds. |
Risk factors |
Investing in our common stock involves risks. You should carefully read and consider the information set forth under the heading Risk Factors beginning on page 32 and other information included in this prospectus before investing in our common stock. |
NYSE symbol |
EPRT |
(1) |
Includes (a) 32,500,000 shares of our common stock to be issued in this offering, (b) 7,785,611 shares of our common stock to be issued to Eldridge in the concurrent private |
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placement of common stock, (based on the mid-point of the price range set forth on the front cover of this prospectus) and (c) 691,290 shares of restricted common stock to be granted to our directors, executive officers and other employees in connection with the completion of this offering pursuant to the Equity Incentive Plan. Excludes (i) 4,875,000 shares of our common stock issuable upon the exercise in full of the underwriters option to purchase additional shares and (ii) 2,858,710 shares of our common stock issuable in the future under the Equity Incentive Plan, as more fully described in Executive CompensationNarrative Disclosure Regarding Employment Agreements and Post-Termination ArrangementsEquity Incentive Plan. Also excludes 100 shares of our common stock that were issued to EPRT Holdings for $100 in connection with our formation and will be repurchased by us at or prior to the closing of this offering for $100. |
(2) | Includes (a) 17,913,592 OP units to be issued to EPRT Holdings, LLC in the formation transactions and (b) 278,905 OP units to be issued to Eldridge in the concurrent private placement of OP units (based on the mid-point of the price range set forth on the front cover of this prospectus). While the amount of Eldridges aggregate investment in the concurrent Eldridge private placement will not change, the aggregate number of, and allocation of this amount between, shares of common stock and, if applicable, OP units to be issued to Eldridge in the concurrent private placement will vary depending on the actual initial public offering price of shares of common stock in this offering. See Pricing Sensitivity Analysis. OP units are redeemable for cash or, at our election, shares of our common stock on a one-for-one basis, subject to adjustment in certain circumstances, beginning one year after the issuance of such units. |
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Summary Selected Consolidated Historical and Pro Forma Financial and Other Data
Set forth below is summary selected financial and other data presented on (i) a historical basis for Essential Properties Realty Trust LLC, which, through the formation transactions, will become our operating partnership and (ii) a pro forma basis for our company after giving effect to the completion of this offering, the concurrent Eldridge private placement, the formation transactions and the other adjustments described in the unaudited pro forma consolidated financial statements beginning on page F-73 of this prospectus. We have not presented historical data for Essential Properties Realty Trust, Inc. because we have not had any corporate activity since our formation other than the issuance of common stock in connection with our initial capitalization and activity in connection with this offering and the formation transactions. Accordingly, we do not believe that a presentation of the historical results of Essential Properties Realty Trust, Inc. would be meaningful. Prior to or concurrently with the completion of this offering, we will consummate the formation transactions pursuant to which, among other things, Essential Properties Realty Trust LLC will be converted into a Delaware limited partnership and become our operating partnership, and Essential Properties OP G.P., LLC, a wholly-owned subsidiary, will become the sole general partner of our operating partnership. Upon completion of the formation transactions, substantially all of our assets will be held by, and substantially all of our operations will be conducted through, our operating partnership. We will contribute the net proceeds received by us from this offering and the concurrent private placement of common stock to Eldridge to our operating partnership in exchange for OP units. For more information regarding the formation transactions, please see Structure and Formation of Our Company.
Essential Properties Realty Trust LLCs historical consolidated balance sheet data as of December 31, 2017 and 2016 and consolidated operating data for the year ended December 31, 2017 and the period from March 30, 2016 (commencement of operations) to December 31, 2016 have been derived from Essential Properties Realty Trust LLCs audited historical consolidated financial statements included elsewhere in this prospectus. Essential Properties Realty Trust LLCs historical consolidated balance sheet data as of March 31, 2018 and consolidated operating data for the three months ended March 31, 2018 and 2017 have been derived from Essential Properties Realty Trust LLCs unaudited historical consolidated financial statements included elsewhere in this prospectus. Essential Properties Realty Trust LLCs unaudited interim financial and operating data, in managements opinion, has been prepared in accordance with U.S. GAAP on the same basis as its audited financial statements and related notes included elsewhere in this prospectus and, in the opinion of management, reflects all adjustments consisting only of normal recurring adjustments that management considers necessary to state fairly the financial information as of and for the periods presented. The historical consolidated financial data included below and set forth elsewhere in this prospectus are not necessarily indicative of our future performance, and results for any interim period are not necessarily indicative of the results for any full year.
Our unaudited summary selected pro forma consolidated financial and operating data as of March 31, 2018 and for the three months ended March 31, 2018 and the year ended December 31, 2017 assume the completion of this offering, the concurrent Eldridge private placement, the formation transactions and the other adjustments described in the unaudited pro forma consolidated financial statements had occurred on March 31, 2018 for purposes of the unaudited pro forma consolidated balance sheet data and on January 1, 2017 for purposes of the unaudited pro forma consolidated statements of operations data. Our pro forma financial information is not necessarily indicative of what our actual financial position and results of operations would have been as of the date and for the period indicated, nor does it purport to represent our future financial position or results of operations.
You should read the following summary selected financial and other data together with Managements Discussion and Analysis of Financial Condition and Results of Operations, Business
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and Properties and our consolidated financial statements and related notes appearing elsewhere in this prospectus.
Operating Data:
Three Months Ended March 31, |
Year Ended December 31, |
Period from
March 30, 2016 (Commencement of Operations) to December 31, 2016 (Historical) |
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(In thousands, except share and
|
2018
(Pro forma) (Unaudited) |
2018
(Historical) (Unaudited) |
2017
(Historical) (Unaudited) |
2017
(Pro forma) (Unaudited) |
2017
(Historical) |
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Revenues: |
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Rental revenue(1) |
$ | 25,540 | $ | 20,075 | $ | 10,008 | $ | 101,190 | $ | 53,373 | $ | 15,271 | ||||||||||||
Interest income on direct financing lease receivables |
62 | 62 | 83 | 290 | 293 | 161 | ||||||||||||||||||
Other revenue |
130 | 66 | 5 | 1,117 | 832 | 91 | ||||||||||||||||||
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Total revenues |
25,732 | 20,203 | 10,096 | 102,597 | 54,498 | 15,523 | ||||||||||||||||||
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Expenses: |
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Interest |
6,619 | 8,276 | 3,715 | 26,361 | 22,574 | 987 | ||||||||||||||||||
General and administrative |
4,545 | 3,386 | 1,951 | 13,573 | 8,936 | 4,398 | ||||||||||||||||||
Property expenses |
307 | 347 | 209 | 1,239 | 1,547 | 533 | ||||||||||||||||||
Depreciation and amortization |
7,936 | 6,468 | 3,782 | 32,523 | 19,516 | 5,428 | ||||||||||||||||||
Provision for impairment of real estate |
664 | 1,849 | 151 | 961 | 2,377 | 1,298 | ||||||||||||||||||
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Total expenses |
20,071 | 20,326 | 9,808 | 74,657 | 54,950 | 12,644 | ||||||||||||||||||
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Income (loss) before gain on dispositions of real estate |
5,661 | (123 | ) | 288 | 27,940 | (452 | ) | 2,879 | ||||||||||||||||
Gain on dispositions of real estate, net |
| 1,232 | 295 | | 6,748 | 871 | ||||||||||||||||||
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Net income |
5,661 | $ | 1,109 | $ | 583 | 27,940 | $ | 6,296 | $ | 3,750 | ||||||||||||||
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Less: net income attributable to non-controlling interests |
(1,741 | ) | (8,590 | ) | ||||||||||||||||||||
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Net income attributable to stockholders |
$ | 3,920 | $ | 19,350 | ||||||||||||||||||||
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Pro forma weighted average common shares outstanding basic |
40,976,901 | 40,976,901 | ||||||||||||||||||||||
Pro forma weighted average common shares outstanding diluted |
59,169,398 | 56,169,398 | ||||||||||||||||||||||
Pro forma basic earnings per share |
$ | 0.10 | $ | 0.47 | ||||||||||||||||||||
Pro forma diluted earnings per share |
$ | 0.10 | $ | 0.47 |
(1) |
Includes $0.5 million, $0.2 million, $1.1 million and $0.4 million of contingent rent (based on a percentage of the tenants gross sales at the leased property) during the three months ended |
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March 31, 2018 and 2017, the year ended December 31, 2017 and the period from March 30, 2016 (commencement of operations) to December 31, 2016. |
Balance Sheet Data (end of period):
As of March 31, | As of December 31, | |||||||||||||||
(In thousands) |
2018
(Pro forma) (Unaudited) |
2018
(Historical) (Unaudited) |
2017
(Historical) |
2016
(Historical) |
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Real estate investments, at cost |
$ | 1,203,348 | $ | 985,548 | $ | 932,174 | $ | 455,008 | ||||||||
Total real estate investments, net |
1,172,298 | 954,238 | 907,349 | 448,887 | ||||||||||||
Cash and cash equivalents |
158,646 | 1,842 | 7,250 | 1,825 | ||||||||||||
Total assets |
1,352,631 | 986,593 | 942,220 | 466,288 | ||||||||||||
Secured borrowings, net of deferred financing costs |
510,138 | 510,138 | 511,646 | 272,823 | ||||||||||||
Notes payable to related party |
| 225,000 | 230,000 | | ||||||||||||
Intangible lease liabilities, net |
12,848 | 12,425 | 12,321 | 16,385 | ||||||||||||
Total liabilities |
529,263 | 753,840 | 760,818 | 291,638 | ||||||||||||
Members equity |
| 232,753 | 181,402 | 174,650 | ||||||||||||
Total equity |
823,368 | | | |
Other Data:
Three Months Ended March 31, |
Year Ended December 31, |
Period from
March 30, 2016 (Commencement of Operations) to December 31, 2016 (Historical) |
||||||||||||||||||||||
(In thousands) |
2018
(Pro forma) (Unaudited) |
2018
(Historical) (Unaudited) |
2017
(Historical) (Unaudited) |
2017
(Pro forma) (Unaudited) |
2017
(Historical) |
|||||||||||||||||||
FFO(1) |
$ | 14,260 | $ | 8,193 | $ | 4,221 | $ | 61,421 | $ | 21,438 | $ | 9,605 | ||||||||||||
AFFO(1) |
$ | 13,864 | $ | 7,428 | $ | 3,836 | $ | 58,561 | $ | 20,337 | $ | 8,579 | ||||||||||||
EBITDA(2) |
$ | 20,246 | $ | 15,883 | $ | 8,087 | $ | 86,985 | $ | 48,547 | $ | 10,242 | ||||||||||||
EBITDAre(2) |
$ | 20,910 | $ | 16,500 | $ | 7,943 | $ | 87,946 | $ | 44,176 | $ | 10,669 |
As of March 31, | As of December 31, | |||||||||||||||
($ In thousands) |
2018
(Pro forma) (Unaudited) |
2018
(Historical) (Unaudited) |
2017
(Historical) |
2016
(Historical) |
||||||||||||
Net debt(3) |
$ | 362,224 | $ | 744,028 | $ | 745,686 | $ | 278,609 | ||||||||
Number of properties in investment portfolio |
607 | 530 | 508 | 344 | ||||||||||||
Occupancy at period end |
99.5 | % | 99.1 | % | 98.8 | % | 96.8 | % |
(1) | FFO and AFFO are non-GAAP financial measures. For definitions of FFO and AFFO, and reconciliations of these metrics to net income, the most directly comparable GAAP financial measure, and a statement of why our management believes the presentation of these metrics provides useful information to investors and any additional purposes for which management uses these metrics, see Managements Discussion and Analysis of Financial Condition and Results of OperationsNon-GAAP Financial Measures. |
(2) | Earnings before interest, taxes, depreciation and amortization, or EBITDA, and EBITDAre are non-GAAP financial measures. For definitions of EBITDA and EBITDAre, and reconciliations of these metrics to net income, the most directly comparable GAAP financial measure, and a statement of why our management believes the presentation of these metrics provides useful information to investors and any additional purposes for which management uses these metrics, see Managements Discussion and Analysis of Financial Condition and Results of OperationsNon-GAAP Financial Measures. |
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(3) | Net debt is a non-GAAP financial measure. For a definition of net debt and a reconciliation of this metric to total debt, the most directly comparable GAAP financial measure, and a statement of why our management believes the presentation of this metric provides useful information to investors and any additional purposes for which management uses this metric, see Managements Discussion and Analysis of Financial Condition and Results of OperationsNon-GAAP Financial Measures. |
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Investing in our common stock involves risks. Before you invest in our common stock, you should carefully consider the risk factors below together with all of the other information included in this prospectus. If any of the risks discussed in this prospectus were to occur, our business, financial condition, liquidity, results of operations and prospects and our ability to service our debt and make distributions to our stockholders could be materially and adversely affected (which we refer to collectively as materially and adversely affecting us or having a material adverse effect on us and comparable phrases), the market price of our common stock could decline significantly and you could lose all or part of your investment in our common stock. Some statements in this prospectus, including statements in the following risk factors, constitute forward-looking statements. Please refer to the section in this prospectus entitled Special Note Regarding Forward-Looking Statements.
Risks Related to Our Business and Properties
We are subject to risks related to commercial real estate ownership that could reduce the value of our properties.
Our core business is the ownership of real estate that is net leased on a long-term basis to middle-market companies operating service-oriented or experience-based businesses. Accordingly, our performance is subject to risks incident to the ownership of commercial real estate, including:
| inability to collect rents from tenants due to financial hardship, including bankruptcy; |
| changes in local real estate conditions in the markets in which we operate, including the availability and demand for single-tenant restaurant and retail space; |
| changes in consumer trends and preferences that affect the demand for products and services offered by our tenants; |
| inability to lease or sell properties upon expiration or termination of existing leases; |
| environmental risks related to matters, including the presence of hazardous or toxic substances on our properties; |
| the subjectivity of real estate valuations and changes in such valuations over time; |
| the illiquid nature of real estate compared to most other financial assets; |
| changes in laws and governmental regulations, including those governing real estate usage and zoning; |
| changes in interest rates and the availability of financing; and |
| changes in the general economic and business climate. |
The occurrence of any of the risks described above may cause the value of our real estate to decline, which could materially and adversely affect us.
Global market and economic conditions may materially and adversely affect us and the ability of our tenants to make rental payments to us pursuant to our leases.
Our results of operations are sensitive to changes in the overall economic conditions that impact our tenants financial condition and leasing practices. Adverse economic conditions such as high unemployment levels, interest rates, tax rates and fuel and energy costs may have an impact on the results of operations and financial conditions of our tenants. During periods of economic slowdown, rising interest rates and declining demand for real estate may result in a general decline in rents or an
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increased incidence of defaults under existing leases. A lack of demand for rental space could adversely affect our ability to maintain our current tenants and gain new tenants, which may affect our growth and profitability. Accordingly, a decline in economic conditions could materially and adversely affect us.
Our business is dependent upon our tenants successfully operating their businesses and their failure to do so could materially and adversely affect us.
Generally, each of our properties is operated and occupied by a single tenant. Therefore, we believe that the success of our investments is materially dependent on the financial stability of our tenants. The success of any one of our tenants is dependent on its individual business and its industry, which could be adversely affected by poor management, economic conditions in general, changes in consumer trends and preferences that decrease demand for a tenants products or services or other factors over which neither they nor we have control. Our portfolio consists primarily of properties leased to single tenants that operate in multiple locations, which means we own numerous properties operated by the same tenant. To the extent we finance numerous properties operated by one company, the general failure of that single tenant or a loss or significant decline in its business could materially and adversely affect us.
At any given time, any tenant may experience a downturn in its business that may weaken its operating results or the overall financial condition of individual properties or its business as whole. As a result, a tenant may delay lease commencement, fail to make rental payments when due, decline to extend a lease upon its expiration, become insolvent or declare bankruptcy. We depend on our tenants to operate the properties we own in a manner which generates revenues sufficient to allow them to meet their obligations to us, including their obligations to pay rent, maintain certain insurance coverage, pay real estate taxes and maintain the properties in a manner so as not to jeopardize their operating licenses or regulatory status. The ability of our tenants to fulfill their obligations under our leases may depend, in part, upon the overall profitability of their operations. Cash flow generated by certain tenant businesses may not be sufficient for a tenant to meet its obligations to us. We could be materially and adversely affected if a number of our tenants were unable to meet their obligations to us.
Our assessment that certain businesses are insulated from e-commerce pressure may prove to be incorrect, and changes in macroeconomic trends may adversely affect our tenants, either of which could impair our tenants ability to make rental payments to us and materially and adversely affect us.
We primarily invest in properties leased to tenants engaged in a targeted set of service-oriented or experience-based businesses, and we believe these businesses are generally insulated from e-commerce pressure. While we believe this to be the case, businesses previously thought to be internet resistant, such as the retail grocery industry, have proven to be susceptible to competition from e-commerce. Technology and business conditions, particularly in the retail industry, are rapidly changing, and our tenants may be adversely affected by technological innovation, changing consumer preferences and competition from non-traditional sources. To the extent our tenants face increased competition from non-traditional competitors, such as internet vendors, some of which may have different business models and larger profit margins, their businesses could suffer. There can be no assurance that our tenants will be successful in meeting any new competition, and a deterioration in our tenants businesses could impair their ability to meet their lease obligations to us and materially and adversely affect us.
Additionally, we believe that many of the businesses operated by our tenants are favorably impacted by current macroeconomic trends that support consumer spending, such as generally
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declining unemployment and positive consumer sentiment. Economic conditions are cyclical, and developments that discourage consumer spending, such as increasing unemployment, wage stagnation, decreases in the value of real estate and/or financial assets, inflation or increasing interest rates, could adversely affect our tenants, impair their ability to meet their lease obligations to us and materially and adversely affect us.
Single-tenant leases involve significant risks of tenant default.
Our strategy focuses primarily on investing in single-tenant triple-net leased properties throughout the United States. The financial failure of, or default in payment by, a single tenant under its lease is likely to cause a significant or complete reduction in our rental revenue from that property and a reduction in the value of the property. We may also experience difficulty or a significant delay in re-leasing or selling such property. This risk is magnified in situations where we lease multiple properties to a single tenant under a master lease. A tenant failure or default under a master lease could reduce or eliminate rental revenue from multiple properties and reduce the value of such properties. Although the master lease structure may be beneficial to us because it restricts the ability of tenants to remove individual underperforming assets, there is no guarantee that a tenant will not default in its obligations to us or decline to renew its master lease upon expiration. The default of a tenant that leases multiple properties from us or its decision not to renew its master lease upon expiration could materially and adversely affect us.
Our portfolio has geographic market concentrations that make us especially susceptible to adverse developments in those geographic markets.
In addition to general, regional, national and international economic conditions, our operating performance is impacted by the economic conditions of the specific geographic markets in which we have concentrations of properties. Our business includes substantial holdings in the following states as of March 31, 2018 (based on annualized base rent): Texas (12.8%), Georgia (11.3%), Michigan (8.3%) and Florida (7.8%). In addition, a significant portion of our holdings as of that date (based on annualized rent) were located in the South (57.6%) and Midwest (26.9%) regions of the United States (as defined by the U.S. Census Bureau). This geographic concentration could adversely affect our operating performance if conditions become less favorable in any of the states or markets within such states in which we have a concentration of properties. We cannot assure you that any of our markets will grow, not experience adverse developments or that underlying real estate fundamentals will be favorable to owners and operators of service-oriented or experience-based properties. Our operations may also be affected if competing properties are built in our markets. A downturn in the economy in the states or regions in which we have a concentration of properties, or markets within such states or regions, could adversely affect our tenants operating businesses in those states, impair their ability to pay rent to us and materially and adversely affect us.
We are subject to risks related to tenant concentration, and an adverse development with respect to a large tenant could materially and adversely affect us.
As of March 31, 2018, Captain Ds (Captain Ds, LLC), our largest tenant, contributed 6.8% of our annualized base rent. Additionally, we derived 5.8%, 5.4% and 5.4% of our annualized base rent as of March 31, 2018 from Art Van Furniture (AVF Parent, LLC), Mister Car Wash (Car Wash Partners, Inc.), and Zips Car Wash (Zips Car Wash, LLC), respectively. As a result, our financial performance depends significantly on the revenues generated from these tenants and, in turn, the financial condition of these tenants. Although our strategy targets a scaled portfolio that, over time, derives no more than 5% of its annualized base from any single tenant or more than 1% from any single property, as of March 31, 2018, we had four tenants that individually contributed more than 5% of our annualized base rent and three properties that contributed more than 1% of our annualized base rent. In the future, we may
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experience additional tenant and property concentrations. In the event that one of these tenants, or another tenant that occupies a significant portion of our properties or whose lease payments represent a significant portion of our rental revenue, were to experience financial weakness or file for bankruptcy, it could have a material adverse effect on us.
The vast majority of our properties are leased to unrated tenants whom we determine are creditworthy via our internal underwriting and credit analysis procedures. However, the tools we use to measure credit quality, such as property-level rent coverage ratio, may not be accurate.
The vast majority of our properties are leased to unrated tenants whom we determine, through our internal underwriting and credit analysis, to be creditworthy. Substantially all of our tenants are required to provide corporate-level financial information to us periodically or, in some instances, at our request. This financial information generally includes balance sheet, income statement and cash flow statement data, or other financial and operating data, on an annual basis. Additionally, as of March 31, 2018, leases contributing 97.4% of our annualized base rent required tenants to provide us with specified unit-level financial information. To assist in our determination of a tenants credit quality, we utilize a third-party model, Moodys Analytics RiskCalc. RiskCalc is a model for predicting private company defaults, based on Moodys Analytics Credit Research Database, that provides an estimated default frequency, or EDF, and a shadow rating, and we evaluate a leases property-level rent coverage ratio.
Our methods may not adequately assess the risk of an investment. An EDF score and shadow rating from Moodys Analytics RiskCalc is not the same as a published credit rating and lacks the extensive company participation that is typically involved when a rating agency publishes a rating; accordingly, an EDF score or a shadow rating may not be as indicative of creditworthiness as a rating published by Moodys Investment Services, Inc., or Moodys, Standard & Poors, or S&P, or another nationally recognized statistical rating organization. An EDF is only an estimate of default probability based, in part, on assumptions incorporated into the product. Our calculations of EDFs, shadow ratings and rent coverage ratios are unaudited and are based on financial information provided to us by our tenants and prospective tenants without independent verification on our part, and we must assume the appropriateness of estimates and judgments that were made by the party preparing the financial information. If our assessment of credit quality proves to be inaccurate, we may be subject to defaults, and investors may view our cash flows as less stable. The ability of an unrated tenant to meet its obligations to us may not be considered as well assured as that of rated tenant.
The decrease in demand for restaurant and retail space may materially and adversely affect us.
As of March 31, 2018, leases representing approximately 33.0% and 8.9% of our annual rent were with tenants in the restaurant and retail industries, respectively. In the future we may acquire additional restaurant and retail properties. Accordingly, decreases in the demand for restaurant and/or retail spaces may have a greater adverse effect on us than if we had fewer investments in these industries. The market for restaurant and retail space has been, and could continue to be, adversely affected by weakness in the national, regional and local economies, the adverse financial condition of some large restaurant and retail companies, the ongoing consolidation in the restaurant and retail industries, the excess amount of restaurant and retail space in a number of markets and, in the case of the retail industry, increasing consumer purchases through catalogues or the internet. To the extent that these conditions continue, they are likely to negatively affect market rents for restaurant and retail space and could materially and adversely affect us.
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We may be unable to renew leases, lease vacant space or re-lease space as leases expire on favorable terms or at all.
Our results of operations depend on our ability to continue to strategically lease space in our properties, including renewing expiring leases, leasing vacant space and re-leasing space in properties where leases are expiring, optimizing our tenant mix or leasing properties on more economically favorable terms. As of March 31, 2018, leases representing approximately 0.6% of our annualized base rent will expire during the remainder of 2018. As of March 31, 2018, exclusive of two vacant land parcels that we own, five of our properties, representing approximately 0.9% of our total number of properties, were vacant. Current tenants may decline, or may not have the financial resources available, to renew current leases and we cannot assure you that leases that are renewed will have terms that are as economically favorable to us as the expiring lease terms. If tenants do not renew the leases as they expire, we will have to find new tenants to lease our properties and there is no guarantee that we will be able to find new tenants or that our properties will be re-leased at rental rates equal to or above the current average rental rates or that substantial rent abatements, tenant improvement allowances, early termination rights or below-market renewal options will not be offered to attract new tenants. We may experience significant costs in connection with re-leasing a significant number of our properties, which could materially and adversely affect us.
As we continue to acquire properties, we may decrease or fail to increase the diversity of our portfolio.
While we will seek to maintain or increase our portfolios tenant, geographic and industry diversification with future acquisitions, it is possible that we may determine to consummate one or more acquisitions that actually decrease our portfolios diversity. If our portfolio becomes less diverse, the trading price our common stock may fall, as our business will be more sensitive to the bankruptcy or insolvency of fewer tenants, to changes in consumer trends of a particular industry and to a general economic downturn in a particular geographic area.
We have investments in industries that depend upon discretionary spending by consumers. A reduction in the willingness or ability of consumers to use their discretionary income in the businesses of our tenants and potential tenants could reduce the demand for our properties.
Most of our portfolio is leased to tenants operating service-oriented or experience-based businesses at our properties. Restaurants (including quick service and casual and family dining), car washes, medical services, home furnishings, convenience stores, automotive services, entertainment (including movie theaters), early childhood education and health and fitness represent the largest industries in our portfolio. Captain Ds, Art Van Furniture, Mister Car Wash, Zips Car Wash, Applebees, AMC Theaters, Perkins, 84 Lumber, Mirabito and Ashley Homestore represent the largest concepts in our portfolio. The success of most of these businesses depends on the willingness of consumers to use discretionary income to purchase their products or services. A downturn in the economy could cause consumers to reduce their discretionary spending, which may have a material adverse effect on us.
Our ability to realize future rent increases on some of our leases may vary depending on changes in the CPI.
Our leases often provide for periodic contractual rent escalations. As of March 31, 2018, leases contributing 95.4% of our annualized base rent provided for increases in future annual base rent, generally ranging from 1.0% to 4.0% annually, with a weighted average annual escalation equal to 1.5% of base rent. Although many of our rent escalators increase rent at a fixed amount on fixed dates, approximately 13.4% of our rent escalators relate to any increase in the CPI over a specified period.
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Therefore, during periods of low inflation or deflation, small increases or decreases in the CPI will subject us to the risk of receiving lower rental revenue than we otherwise would have been entitled to receive if our rent escalators were based on higher fixed percentages or amounts.
Some of our customers operate under franchise or license agreements, which, if terminated or not renewed prior to the expiration of their leases with us, would likely impair their ability to pay us rent.
As of March 31, 2018, 21.7% of our customers operated under franchise or license agreements. Generally, franchise agreements have terms that end earlier than the respective expiration dates of the related leases. In addition, a tenants rights as a franchisee or licensee typically may be terminated and the tenant may be precluded from competing with the franchisor or licensor upon termination. Usually, we have no notice or cure rights with respect to such a termination and have no rights to assignment of any such franchise agreement. This may have an adverse effect on our ability to mitigate losses arising from a default on any of our leases. A franchisors or licensors termination or refusal to renew a franchise or license agreement would likely have a material adverse effect on the ability of the tenant to make payments under its lease, which could materially and adversely affect us.
The bankruptcy or insolvency of any of our tenants could result in the termination of such tenants lease and material losses to us.
The occurrence of a tenant bankruptcy or insolvency could diminish the income we receive from that tenants lease or leases or force us to take back a property as a result of a default or a rejection of a lease by a tenant in bankruptcy. If a tenant becomes bankrupt or insolvent, federal law may prohibit us from evicting such tenant based solely upon such bankruptcy or insolvency. In addition, a bankrupt or insolvent tenant may be authorized to reject and terminate its lease or leases with us. Any claims against such bankrupt tenant for unpaid future rent would be subject to statutory limitations that would likely result in our receipt of rental revenues that are substantially less than the contractually specified rent we are owed under the lease or leases. In addition, any claim we have for unpaid past rent, if any, may not be paid in full. We may also be unable to re-lease a terminated or rejected space or to re-lease it on comparable or more favorable terms. As a result, tenant bankruptcies may materially and adversely affect us.
Tenants who are considering filing for bankruptcy protection may request that we agree to amendments of their master leases to remove certain of the properties they lease from us under such master leases. We cannot guarantee that we will be able to sell or re-lease properties that we agree to release from tenants leases in the future or that lease termination fees, if any, will be sufficient to make up for the rental revenues lost as a result of lease amendments.
Property vacancies could result in significant capital expenditures.
The loss of a tenant, either through lease expiration or tenant bankruptcy or insolvency, may require us to spend significant amounts of capital to renovate the property before it is suitable for a new tenant and cause us to incur significant costs. Many of the leases we enter into or acquire are for properties that are specially suited to the particular business of our tenants. Because these properties have been designed or physically modified for a particular tenant, if the current lease is terminated or not renewed, we may be required to renovate the property at substantial costs, decrease the rent we charge or provide other concessions in order to lease the property to another tenant. In addition, in the event we are required to sell the property, we may have difficulty selling it to a party other than the tenant due to the special purpose for which the property may have been designed or modified. This potential illiquidity may limit our ability to quickly modify our portfolio in response to changes in economic or other conditions, including tenant demand. These limitations may materially and adversely affect us.
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We may be unable to identify and complete acquisitions of suitable properties, which may impede our growth, and our future acquisitions may not yield the returns we expect.
Our ability to expand through acquisitions requires us to identify and complete acquisitions or investment opportunities that are compatible with our growth strategy and to successfully integrate newly acquired properties into our portfolio. We continually evaluate investment opportunities and may acquire properties when strategic opportunities exist. Our ability to acquire properties on favorable terms and successfully operate them may be constrained by the following significant risks:
| we face competition from other real estate investors with significant capital, including REITs and institutional investment funds, which may be able to accept more risk than we can prudently manage, including risks associated with paying higher acquisition prices; |
| we face competition from other potential acquirers which may significantly increase the purchase price for a property we acquire, which could reduce our growth prospects; |
| we may incur significant costs and divert management attention in connection with evaluating and negotiating potential acquisitions, including ones that we are subsequently unable to complete; |
| we may acquire properties that are not accretive to our results upon acquisition, and we may be unsuccessful in managing and leasing such properties in accordance with our expectations; |
| our cash flow from an acquired property may be insufficient to meet our required principal and interest payments with respect to debt used to finance the acquisition of such property; |
| we may discover unexpected items, such as unknown liabilities, during our due diligence investigation of a potential acquisition or other customary closing conditions may not be satisfied, causing us to abandon an investment opportunity after incurring expenses related thereto; |
| we may fail to obtain financing for an acquisition on favorable terms or at all; |
| we may spend more than budgeted amounts to make necessary improvements or renovations to acquired properties; |
| market conditions may result in higher than expected vacancy rates and lower than expected rental rates; or |
| we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities such as liabilities for clean-up of undisclosed environmental contamination not revealed in Phase I environmental reports or otherwise through due diligence, claims by tenants, vendors or other persons dealing with the former owners of the properties, liabilities incurred in the ordinary course of business and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties. |
If any of these risks are realized, we may be materially and adversely affected.
We may not acquire the properties that we evaluate in our pipeline.
Throughout this prospectus, we refer to our pipeline of potential investment opportunities. In addition to properties that are subject to purchase agreements, we are often party to non-binding letters of intent. Additionally, we actively seek to identify and negotiate with respect to potential properties that we may consider purchasing in the future. Generally, our purchase agreements contain several closing conditions. Transactions may fail to close for a variety of reasons, including the discovery of previously unknown liabilities or other items uncovered during our diligence process.
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Similarly, we may never execute binding purchase agreements with respect to properties that are currently subject to non-binding letters of intent, and properties with respect to which we are negotiating may never lead to the execution of any letter of intent. For many other reasons, we may not ultimately acquire the properties currently in our pipeline. Accordingly, you should not place undue reliance on the concept of a pipeline as we have discussed in this prospectus.
The past performance of Spirit is not an indicator of our future performance.
In this prospectus, we present the total return information of Spirit, a NYSE-listed equity REIT that invests primarily in single-tenant, net leased real estate, during the period that Messrs. Mavoides and Seibert, our President and Chief Executive Officer, and Executive Vice President and Chief Operating Officer, respectively, were members of Spirits executive management team, compared against total returns on the S&P 500, the MSCI US REIT Index and a peer group of publicly-traded REITs that invest in net lease real estate. This performance data includes periods with economic characteristics and interest rate environments that are significantly different from those we face today and may face in the future. Information regarding Spirit reflects past performance and may have been due in part to external factors beyond the control of the management of Spirit, including superior general economic conditions than those existing now, and is not a guarantee or prediction of our future operating results or the returns that our stockholders should expect to achieve in the future. In addition, Spirit faced various adverse business developments during the tenure of Messrs. Mavoides and Seibert. For example, after the Federal Reserve announced in May 2013 that it would begin tapering the size of its bond-buying program, known as quantitative easing, the company experienced a general downturn in its stock price. Spirit, and the net lease real estate market more generally, underperformed the S&P 500, reflecting a weakened demand for real estate investments as investors focused on shorter-duration investment strategies. In addition, from time to time, in the ordinary course of business, Spirit had properties that underperformed or failed to meet operational or financial expectations. For the years ended December 31, 2014 and 2012, Spirit reported total revenues of $602.9 million and $273.1 million and net losses attributable to common stockholders of $33.8 million and $76.3 million, respectively. For the year ended December 31, 2013, Spirit reported total revenues of $419.5 million and net income attributable to common stockholders of $1.7 million. For the years ended December 31, 2014, 2013 and 2012, Spirit reported losses from continuing operations of $50.9 million, $33.2 million and $72.5 million, respectively. Spirit reported depreciation and amortization expense for the years ended December 31, 2014, 2013 and 2012 of $248 million, $164.1 million and $105 million, or 42.2%, 36.5% and 33.6% of total expenses, respectively. Spirit also reported impairments of $36 million and $8.9 million for the years ended December 31, 2014 and 2012, respectively. Spirits results for 2013 and 2014 were significantly impacted by its July 2013 acquisition of Cole Credit Property Trust II, Inc., which significantly increased its size and involved significant costs. If our management team is unable to anticipate or effectively adapt to future economic downturns or other adverse business developments, our business may also experience declines. This past performance data is not an indicator of our future performance, and our total returns may be significantly less than those reflected in this data. In addition, our future performance may not outpace, and may be significantly outpaced by, the S&P 500, the MSCI US REIT Index and our peer group. Accordingly, you should not place undue reliance on the past performance data we have presented in this prospectus.
Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition.
The real estate investments made, and expected to be made, by us are relatively difficult to sell quickly. As a result, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial or investment conditions is limited. Return of capital and realization of gains, if any, from an investment generally will occur upon disposition or refinancing of the underlying
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property. We may be unable to realize our investment objective by sale, other disposition or refinancing at attractive prices within any given period of time or may otherwise be unable to complete any exit strategy. In particular, these risks could arise from weakness in or even the lack of an established market for a property, changes in the financial condition or prospects of prospective purchasers, changes in national or international economic conditions and changes in laws, regulations or fiscal policies of the jurisdiction in which the property is located.
In addition, the Code imposes restrictions on a REITs ability to dispose of properties that are not applicable to other types of real estate companies. In particular, the tax laws applicable to REITs effectively require that we hold our properties for investment, rather than primarily for sale in the ordinary course of business, which may cause us to forgo or defer sales of properties that otherwise would be in our best interest. Therefore, we may not be able to vary our portfolio in response to economic or other conditions promptly or on favorable terms, which may materially and adversely affect us.
We face significant competition for tenants, which may decrease or prevent increases of the occupancy and rental rates of our properties, and competition for acquisitions may reduce the number of acquisitions we are able to complete and increase the costs of these acquisitions.
We compete with numerous developers, owners and operators of properties, many of which own properties similar to ours in the same markets in which our properties are located. If our competitors offer space at rental rates below current market rates or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates or to offer more substantial rent abatements, tenant improvements, early termination rights or below-market renewal options in order to retain tenants when our leases expire. Competition for tenants could decrease or prevent increases of the occupancy and rental rates of our properties, which could materially and adversely affect us.
We also face competition for acquisitions of real property from investors, including traded and non-traded public REITs, private equity investors and institutional investment funds, some of which have greater financial resources than we do, a greater ability to borrow funds to acquire properties and the ability to accept more risk than we can prudently manage. This competition may increase the demand for the types of properties in which we typically invest and, therefore, reduce the number of suitable investment opportunities available to us and increase the prices paid for such acquisition properties. This competition will increase if investments in real estate become more attractive relative to other types of investment. Accordingly, competition for the acquisition of real property could materially and adversely affect us.
Inflation may materially and adversely affect us and our tenants.
Increased inflation could have a negative impact on variable rate debt we currently have or that we may incur in the future. During times when inflation is greater than the increases in rent provided by many of our leases, rent increases will not keep up with the rate of inflation. Increased costs may have an adverse impact on our tenants if increases in their operating expenses exceed increases in revenue, which may adversely affect the tenants ability to pay rent owed to us.
Our growth depends on external sources of capital that are outside of our control and may not be available to us on commercially reasonable terms or at all.
In order to qualify as a REIT, we are required under the Code, among other things, to distribute annually at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and excluding any net capital gain. In addition, we will be subject to income tax at the
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corporate rate to the extent that we distribute less than 100% of our REIT taxable income, determined without regard to the dividends paid deduction and including any net capital gain. Because of these distribution requirements, we may not be able to fund future capital needs, including any necessary acquisition financing, from operating cash flow. Consequently, we may rely on third-party sources to fund our capital needs. We may not be able to obtain the financing on favorable terms or at all. Any additional debt we incur will increase our leverage and likelihood of default. Our access to third-party sources of capital depends, in part, on:
| general market conditions; |
| the markets perception of our growth potential; |
| our current debt levels; |
| our current and expected future earnings; |
| our cash flow and cash distributions; and |
| the market price per share of our common stock. |
If we cannot obtain capital from third-party sources, we may not be able to acquire properties when strategic opportunities exist, meet the capital and operating needs of our existing properties, satisfy our debt service obligations or make the cash distributions to our stockholders necessary to qualify as a REIT.
Failure to hedge effectively against interest rate changes may materially and adversely affect us.
While we have not hedged our exposure to interest rate volatility, we may choose to do so in the future. Should we seek to hedge our interest rate exposure, we may choose to use interest rate swaps, caps or derivative instruments. However, these arrangements involve risks and may not be effective in reducing our exposure to interest rate changes. In addition, the counterparties to any hedging arrangements we enter into in the future may not honor their obligations. Failure to hedge effectively against changes in interest rates relating to the interest expense of our future floating-rate borrowings may materially and adversely affect us.
A significant portion of our assets have been pledged to secure the borrowings of our subsidiaries.
A significant portion of our investment portfolio consists of assets owned by our consolidated, bankruptcy remote, special purpose entity subsidiaries that have been pledged to secure the long-term borrowings of those subsidiaries. As of March 31, 2018, on a pro forma basis, we had properties with a gross investment amount of $620.6 million pledged as collateral under our Master Trust Funding Program. We or our other consolidated subsidiaries are the equity owners of these special purpose entities, meaning we are entitled to the excess cash flows after debt service and all other required payments are made on the debt of these entities. If our subsidiaries fail to make the required payments on this indebtedness, distributions of excess cash flow to us may be reduced or eliminated and the indebtedness may become immediately due and payable. If the subsidiaries are unable to pay the accelerated indebtedness, the pledged assets could be foreclosed upon and distributions of excess cash flow to us may be suspended or terminated. In this case, our ability to make distributions to our stockholders could be materially and adversely affected.
Loss of our key personnel with long-standing business relationships could materially impair our ability to operate successfully.
Our continued success and our ability to manage anticipated future growth depend, in large part, upon the efforts of key personnel, particularly our President and Chief Executive Officer, Peter M. Mavoides, and Gregg A. Seibert, our Executive Vice President and Chief Operating Officer, who
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have extensive market knowledge and relationships and exercise substantial influence over our operational, financing, acquisition and disposition activity. Among the reasons that they are important to our success is that each has a national or regional industry reputation that attracts business and investment opportunities and assists us in negotiations with lenders, existing and potential tenants and industry personnel.
Many of our other key executive personnel, particularly our senior managers, also have extensive experience and strong reputations in the real estate industry and have been instrumental in setting our strategic direction, operating our business, identifying, recruiting and training key personnel and arranging necessary financing. In particular, the extent and nature of the relationships that these individuals have developed with financial institutions and existing and prospective tenants is critically important to the success of our business. We cannot guarantee the continued employment of any of our senior management team, who may choose to leave our company for any number of reasons, such as other business opportunities, differing views on our strategic direction or other personal reasons. The loss of services of one or more members of our senior management team, or our inability to attract and retain highly qualified personnel, could adversely affect our business, diminish our investment opportunities and weaken our relationships with lenders, business partners, existing and prospective tenants and industry personnel, which could materially and adversely affect us.
Any material failure, weakness, interruption or breach in security of our information systems could prevent us from effectively operating our business.
We rely on information systems across our operations and corporate functions, including finance and accounting, and depend on such systems to ensure payment of obligations, collection of cash, data warehousing to support analytics, and other various processes and procedures. Our ability to efficiently manage our business depends significantly on the reliability and capacity of these systems. The failure of these systems to operate effectively, maintenance problems, upgrading or transitioning to new platforms, or a breach in security of these systems, such as in the event of cyber-attacks, could result in the theft of intellectual property, personal information or personal property, damage to our reputation and third-party claims, as well as reduced efficiency in our operations and in the accuracy in our internal and external financial reporting. A failure or weakness in our information systems could materially and adversely affect us, and the remediation of any such problems could result in significant unplanned expenditures.
We have a limited operating history and our past experience may not be sufficient to allow us to successfully operate as a public company going forward.
We commenced business operations in March 2016. We cannot assure you that our past experience will be sufficient to successfully operate our company as a publicly traded company, including the requirements to timely meet disclosure requirements of the Securities and Exchange Commission, or SEC, and comply with the Sarbanes-Oxley Act. Upon the completion of this offering, we will be required to develop and implement control systems and procedures in order to satisfy our periodic and current reporting requirements under applicable SEC regulations and comply with the NYSE listing standards, and this transition could place a significant strain on our management systems, infrastructure and other resources. Failure to operate successfully as a public company could materially and adversely affect us.
We may become subject to litigation, which could materially and adversely affect us.
In the future we may become subject to litigation, including claims relating to our operations, security offerings and otherwise in the ordinary course of business. Some of these claims may result in
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significant defense costs and potentially significant judgments against us, some of which are not, or cannot be, insured against. We generally intend to vigorously defend ourselves. However, we cannot be certain of the ultimate outcomes of any claims that may arise in the future. Resolution of these types of matters against us may result in our having to pay significant fines, judgments, or settlements, which, if uninsured, or if the fines, judgments, and settlements exceed insured levels, could adversely impact our earnings and cash flows, thereby materially and adversely affecting us. Certain litigation or the resolution of certain litigation may affect the availability or cost of some of our insurance coverage, which could materially and adversely impact us, expose us to increased risks that would be uninsured, and materially and adversely impact our ability to attract directors and officers.
In connection with its audit of the consolidated financial statements of Essential Properties Realty Trust LLC, which will become our operating partnership in the formation transactions, for the period from March 30, 2016 (commencement of operations) to December 31, 2016, Ernst & Young LLP identified a material weakness in internal control over financial reporting. Material weaknesses or a failure to maintain an effective system of internal control over financial reporting could prevent us from accurately reporting our financial results in a timely manner, which could materially and adversely affect us.
In connection with its audit of the consolidated financial statements of Essential Properties Realty Trust LLC, which will become our operating partnership in the formation transactions, for the period from March 30, 2016 (commencement of operations) to December 31, 2016, Ernst & Young LLP, our independent registered public accounting firm, identified a material weakness in internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. The identified material weakness involved a lack of formally designed processes and controls relating to non-routine and estimation processes to prevent or mitigate the risk of material errors from occurring within the financial statements. During the audit, Ernst & Young LLP identified material audit differences individually and in the aggregate that required adjusting journal entries to be made to the consolidated financial statements. Ernst & Young LLP indicated that formally implementing accounting processes, written job descriptions and responsibilities, and designing and implementing controls over non-routine and estimation processes would reduce the risk that material misstatements may not be prevented or detected on a timely basis. Though we remediated this material weakness and no material weaknesses were identified in connection with the audit of our financial statements for the year ended December 31, 2017, there can be no guarantee that we will not identify material weaknesses in the future.
As a publicly-traded company, we will be required to report annual audited financial statements and quarterly unaudited interim financial statements prepared in accordance with GAAP. We will rely on our internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. More broadly, effective internal control over financial reporting is a necessary component of our program to seek to prevent, and to detect any, fraud and to operate successfully as a public company. Though we remediated the material weakness described above that was identified in connection with the audit of our financial statements for the period from March 30, 2016 (commencement of operations) to December 31, 2016 and no material weaknesses were identified in connection with the audit of our financial statements for the year ended December 31, 2017, there can be no guarantee that we will not identify material weaknesses in the future or that our internal control over financial reporting will be effective in accomplishing all of its objectives. Furthermore, as we grow, our business, and hence our internal control over financial reporting, will likely become more complex, and we may require significantly more resources to develop and maintain effective controls. Designing and implementing an effective system of internal control over financial reporting is a continuous effort
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that requires significant resources, including the expenditure of a significant amount of time by senior members of our management team.
Additionally, while Section 404 of the Sarbanes-Oxley Act will require us to assess the effectiveness of our internal control structure and procedures for financial reporting on an annual basis, for as long as we are an emerging growth company under the JOBS Act (which we may be until the last day of the fiscal year following the fifth anniversary of this offering), the registered public accounting firm that issues an audit report on our financial statements will not be required to attest to or report on the effectiveness of our internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act. An independent assessment of the effectiveness of our internal controls could detect problems that our managements assessment might not.
In connection with our ongoing monitoring of our internal control over financial reporting or audits of our financial statements, we or our auditors may identify additional deficiencies in our internal control over financial reporting that may be significant or rise to the level of material weaknesses. Any failure to maintain effective internal control over financial reporting or to timely effect any necessary improvements to such controls could harm our operating results or cause us to fail to meet our reporting obligations (which could affect the listing of our common stock on the NYSE). Additionally, ineffective internal control over financial reporting could also adversely affect our ability to prevent or detect fraud, harm our reputation and cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our common stock.
If we fail to implement and maintain effective disclosure controls and procedures, we may not be able to meet applicable reporting requirements, which could materially and adversely affect us.
Upon completion of this offering, we will become subject to the informational requirements of the Exchange Act and will be required to file reports and other information with the SEC. As a publicly-traded company, we will be required to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file with, or submit to, the SEC is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms. They include controls and procedures designed to ensure that information required to be disclosed in reports filed with, or submitted to, the SEC is accumulated and communicated to management, including our principal executive and principal financial officers, to allow timely decisions regarding required disclosure. Effective disclosure controls and procedures are necessary for us to provide reliable reports, effectively prevent and detect fraud, and to operate successfully as a public company. Designing and implementing effective disclosure controls and procedures is a continuous effort that requires significant resources and devotion of time. We may discover deficiencies in our disclosure controls and procedures that may be difficult or time consuming to remediate in a timely manner. Any failure to maintain effective disclosure controls and procedures or to timely effect any necessary improvements thereto could cause us to fail to meet our reporting obligations (which could affect the listing of our common stock on the NYSE). Additionally, ineffective disclosure controls and procedures could also adversely affect our ability to prevent or detect fraud, harm our reputation and cause investors to lose confidence in our reports filed with, or submitted to, the SEC, which would likely have a negative effect on the trading price of our common stock.
We will incur significant expenses as a result of being a public company, which will negatively impact our financial performance.
We will incur significant legal, accounting, insurance and other expenses as a result of being a public company. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, and the Sarbanes-Oxley Act, as well as related rules implemented by the SEC and
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the NYSE, have required changes in corporate governance practices of public companies. Although the JOBS Act may for a limited period of time lessen the cost of complying with some of these additional regulatory and other requirements, we nonetheless expect a substantial increase in legal, accounting, insurance and certain other expenses in the future, which will negatively impact our results of operations and financial condition. In addition, rules that the SEC is implementing or is required to implement pursuant to the Dodd-Frank Act are expected to require additional changes. We expect that compliance with these and other similar laws, rules and regulations, including compliance with Section 404 of the Sarbanes-Oxley Act, will substantially increase our expenses, including our legal and accounting costs, and make some activities more time-consuming and costly. We also expect these laws, rules and regulations to make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage, which may make it more difficult for us to attract and retain qualified persons to serve on our board of directors or as officers.
The costs of compliance with or liabilities related to environmental laws may materially and adversely affect us.
The properties we own or have owned in the past may subject us to known and unknown environmental liabilities. Under various federal, state and local laws and regulations relating to the environment, as a current or former owner or operator of real property, we may be liable for costs and damages resulting from environmental matters, including the presence or discharge of hazardous or toxic substances, waste or petroleum products at, on, in, under or migrating from such property, including costs to investigate or clean up such contamination and liability for personal injury, property damage or harm to natural resources. We may face liability regardless of:
| our knowledge of the contamination; |
| the timing of the contamination; |
| the cause of the contamination; or |
| the party responsible for the contamination of the property. |
There may be environmental liabilities associated with our properties of which we are unaware. We obtain Phase I environmental site assessments on all properties we finance or acquire. The Phase I environmental site assessments are limited in scope and therefore may not reveal all environmental conditions affecting a property. Therefore, there could be undiscovered environmental liabilities on the properties we own. Some of our properties use, or may have used in the past, underground tanks for the storage of petroleum-based products or waste products that could create a potential for release of hazardous substances or penalties if tanks do not comply with legal standards. If environmental contamination exists on our properties, we could be subject to strict, joint and/or several liability for the contamination by virtue of our ownership interest. Some of our properties may contain asbestos-containing materials, or ACM. Environmental laws govern the presence, maintenance and removal of ACM and such laws may impose fines, penalties, or other obligations for failure to comply with these requirements or expose us to third-party liability (e.g., liability for personal injury associated with exposure to asbestos). Environmental laws also apply to other activities that can occur on a property, such as storage of petroleum products or other hazardous toxic substances, air emissions, water discharges and exposure to lead-based paint. Such laws may impose fines and penalties for violations, and may require permits or other governmental approvals to be obtained for the operation of a business involving such activities.
The known or potential presence of hazardous substances on a property may adversely affect our ability to sell, lease or improve the property or to borrow using the property as collateral. In addition, environmental laws may create liens on contaminated properties in favor of the government
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for damages and costs it incurs to address such contamination. Moreover, if contamination is discovered on our properties, environmental laws may impose restrictions on the manner in which they may be used or businesses may be operated, and these restrictions may require substantial expenditures.
In addition, although our leases generally require our tenants to operate in compliance with all applicable laws and to indemnify us against any environmental liabilities arising from a tenants activities on the property, we could be subject to strict liability by virtue of our ownership interest. We cannot be sure that our tenants will, or will be able to, satisfy their indemnification obligations, if any, under our leases. Furthermore, the discovery of environmental liabilities on any of our properties could lead to significant remediation costs or to other liabilities or obligations attributable to the tenant of that property, or could result in material interference with the ability of our tenants to operate their businesses as currently operated. Noncompliance with environmental laws or discovery of environmental liabilities could each individually or collectively affect such tenants ability to make payments to us, including rental payments and, where applicable, indemnification payments.
Our environmental liabilities may include property and natural resources damage, personal injury, investigation and clean-up costs, among other potential environmental liabilities. These costs could be substantial. Although we may obtain insurance for environmental liability for certain properties that are deemed to warrant coverage, our insurance may be insufficient to address any particular environmental situation and we may be unable to continue to obtain insurance for environmental matters, at a reasonable cost or at all, in the future. If our environmental liability insurance is inadequate, we may become subject to material losses for environmental liabilities. Our ability to receive the benefits of any environmental liability insurance policy will depend on the financial stability of our insurance company and the position it takes with respect to our insurance policies. If we were to become subject to significant environmental liabilities, we could be materially and adversely affected.
Our properties may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediation.
When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing, as exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, should our tenants or their employees or customers be exposed to mold at any of our properties we could be required to undertake a costly remediation program to contain or remove the mold from the affected property. In addition, exposure to mold by our tenants or others could subject us to liability if property damage or health concerns arise. If we were to become subject to significant mold-related liabilities, we could be materially and adversely affected.
Natural disasters, terrorist attacks, other acts of violence or war, or other unexpected events could materially and adversely impact us.
Natural disasters, terrorist attacks, other acts of violence or war or other unexpected events could materially interrupt our business operations (or those of our tenants), cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and worldwide financial markets and economy. They also could result in or prolong an economic recession in the United States. Any of these occurrences could materially and adversely affect us.
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Insurance on our properties may not adequately cover all losses and uninsured losses could materially and adversely affect us.
Our tenants are required to maintain liability and property insurance coverage for the properties they lease from us pursuant to triple-net leases. Pursuant to such leases, our tenants are required to name us (and any of our lenders that have a mortgage on the property leased by the tenant) as additional insureds on their liability policies and additional named insured and/or loss payee (or mortgagee, in the case of our lenders) on their property policies. All tenants are required to maintain casualty coverage and most carry limits at 100% of replacement cost. Depending on the location of the property, losses of a catastrophic nature, such as those caused by earthquakes and floods, may be covered by insurance policies that are held by our tenant with limitations such as large deductibles or co-payments that a tenant may not be able to meet. In addition, losses of a catastrophic nature, such as those caused by wind/hail, hurricanes, terrorism or acts of war, may be uninsurable or not economically insurable. In the event there is damage to our properties that is not covered by insurance and such properties are subject to recourse indebtedness, we will continue to be liable for the indebtedness, even if these properties are irreparably damaged.
Inflation, changes in building codes and ordinances, environmental considerations, and other factors, including terrorism or acts of war, may make any insurance proceeds we receive insufficient to repair or replace a property if it is damaged or destroyed. In that situation, the insurance proceeds received may not be adequate to restore our economic position with respect to the affected real property. Furthermore, in the event we experience a substantial or comprehensive loss of one of our properties, we may not be able to rebuild such property to its existing specifications without significant capital expenditures which may exceed any amounts received pursuant to insurance policies, as reconstruction or improvement of such a property would likely require significant upgrades to meet zoning and building code requirements. The loss of our capital investment in or anticipated future returns from our properties due to material uninsured losses could materially and adversely affect us.
Compliance with the Americans with Disabilities Act and fire, safety and other regulations may require us to make unanticipated expenditures that materially and adversely affect us.
Our properties are subject to the Americans with Disabilities Act, or ADA. Under the ADA, all public accommodations must meet federal requirements related to access and use by disabled persons. Compliance with the ADA requirements could require removal of access barriers and non-compliance could result in imposition of fines by the U.S. government or an award of damages to private litigants, or both. While our tenants are obligated by law to comply with the ADA and typically obligated under our leases to cover costs associated with compliance, if required changes involve greater expenditures than anticipated or if the changes must be made on a more accelerated basis than anticipated, the ability of our tenants to cover costs could be adversely affected. We could be required to expend our own funds to comply with the provisions of the ADA, which could materially and adversely affect us.
In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental agencies and bodies and become applicable to our properties. We may be required to make substantial capital expenditures to comply with those requirements and may be required to obtain approvals from various authorities with respect to our properties, including prior to acquiring a property or when undertaking renovations of any of our existing properties. There can be no assurance that existing laws and regulatory policies will not adversely affect us or the timing or cost of any future acquisitions or renovations, or that additional regulations will not be adopted that increase such delays or result in additional costs. Additionally, failure to comply with any of these requirements could result in the imposition of fines by governmental authorities or awards of damages to private litigants. While
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we intend to only acquire properties that we believe are currently in substantial compliance with all regulatory requirements, these requirements may change and new requirements may be imposed which would require significant unanticipated expenditures by us and could materially and adversely affect us.
Changes in accounting standards may materially and adversely affect us.
From time to time the Financial Accounting Standards Board, or FASB, and the SEC, who create and interpret appropriate accounting standards, may change the financial accounting and reporting standards or their interpretation and application of these standards that will govern the preparation of our financial statements. These changes could materially and adversely affect our reported financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in restating prior period financial statements. Similarly, these changes could materially and adversely affect our tenants reported financial condition or results of operations and affect their preferences regarding leasing real estate.
In the future, we may choose to acquire properties or portfolios of properties through tax deferred contribution transactions, which could result in stockholder dilution and limit our ability to sell such assets.
In the future we may acquire properties or portfolios of properties through tax deferred contribution transactions in exchange for partnership interests in our operating partnership, which may result in stockholder dilution. This acquisition structure may have the effect of, among other things, reducing the amount of tax depreciation we could deduct over the tax life of the acquired properties, and may require that we agree to protect the contributors ability to defer recognition of taxable gain through restrictions on our ability to dispose of the acquired properties and/or the allocation of partnership debt to the contributors to maintain their tax bases. These restrictions could limit our ability to sell an asset at a time, or on terms, that would be favorable absent such restrictions.
Risks Related to Our Indebtedness
As of March 31, 2018, on a pro forma basis, we had approximately $520.9 million principal balance of indebtedness outstanding, which may expose us to the risk of default under our debt obligations.
As of March 31, 2018, on a pro forma basis, we had approximately $520.9 million principal balance of indebtedness outstanding. As of March 31, 2018, on a pro forma basis, all of this indebtedness was issued in two series, each consisting of Class A Notes and Class B Notes, under our Master Trust Funding Program, which allows us to issue multiple series of rated notes from time to time to institutional investors in the asset-backed securities market. In addition, upon the completion of this offering, we expect to have an unsecured revolving credit facility. Payments of principal and interest on borrowings may leave us with insufficient cash resources to meet our cash needs or make the distributions to our common stockholders currently contemplated or necessary to qualify as a REIT qualification. Our level of debt and the limitations imposed on us by our debt agreements could have significant adverse consequences, including the following:
| our cash flow may be insufficient to meet our required principal and interest payments; |
| cash interest expense and financial covenants relating to our indebtedness may limit or eliminate our ability to make distributions to our common stockholders; |
| we may be unable to borrow additional funds as needed or on favorable terms, which could, among other things, adversely affect our ability to capitalize upon investment opportunities or meet operational needs; |
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| we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness; |
| because a portion of our debt bears interest at variable rates, increases in interest rates could increase our interest expense; |
| we may be unable to hedge floating rate debt, counterparties may fail to honor their obligations under any hedge agreements we enter into, such agreements may not effectively hedge interest rate fluctuation risk, and, upon the expiration of any hedge agreements we enter into, we would be exposed to then-existing market rates of interest and future interest rate volatility; |
| we may be forced to dispose of properties, possibly on unfavorable terms or in violation of certain covenants to which we may be subject; |
| we may default on our obligations and the lenders or mortgagees may foreclose on our properties or our interests in the entities that own the properties that secure their loans and receive an assignment of rents and leases; |
| we may be restricted from accessing some of our excess cash flow after debt service if certain of our tenants fail to meet certain financial performance metric thresholds; |
| we may violate restrictive covenants in our loan documents, which would entitle the lenders to accelerate our debt obligations; and |
| our default under any loan with cross default provisions could result in a default on other indebtedness. |
The occurrence of any of these events could materially and adversely affect us. Furthermore, foreclosures could create taxable income without accompanying cash proceeds, which could hinder our ability to meet the REIT distribution requirements imposed by the Code.
Market conditions could adversely affect our ability to refinance existing indebtedness or obtain additional financing for growth on acceptable terms or at all, which could materially and adversely affect us.
Credit markets may experience significant price volatility, displacement and liquidity disruptions, including the bankruptcy, insolvency or restructuring of certain financial institutions. Such circumstances could materially impact liquidity in the financial markets, making financing terms for borrowers less attractive, and potentially result in the unavailability of various types of debt financing. As a result, we may be unable to obtain debt financing on favorable terms or at all or fully refinance maturing indebtedness with new indebtedness. Reductions in our available borrowing capacity or inability to obtain credit, including the revolving credit facility that we expect to have upon the completion of this offering, when required or when business conditions warrant could materially and adversely affect us.
Furthermore, if prevailing interest rates or other factors at the time of refinancing result in higher interest rates upon refinancing, then the interest expense relating to that refinanced indebtedness would increase. Higher interest rates on newly incurred debt may negatively impact us as well. If interest rates increase, our interest costs and overall costs of capital will increase, which could materially and adversely affect us and our ability to make distributions to our stockholders.
Total debt payments for the remainder of 2018 are $185.7 million (including $5.7 million of scheduled amortization). We expect to meet these repayment requirements primarily through financing activity or net cash from operating activities.
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Our debt financing agreements, including the Master Trust Funding Program and revolving credit facility that we expect to have upon completion of this offering, contain or will contain restrictions and covenants which may limit our ability to enter into or obtain funding for certain transactions, operate our business or make distributions to our common stockholders.
The agreements governing our borrowings, including the Master Trust Funding Program and the revolving credit facility that we expect to have upon the completion of this offering, contain or will contain financial and other covenants with which we are or will be required to comply and that limit or will limit our ability to operate our business. These covenants, as well as any additional covenants to which we may be subject in the future because of additional borrowings, could cause us to have to forego investment opportunities, reduce or eliminate distributions to our common stockholders or obtain financing that is more expensive than financing we could obtain if we were not subject to the covenants. In addition, the agreements governing our borrowing may have cross default provisions, which provide that a default under one of our debt financing agreements would lead to a default on all of our debt financing agreements.
The covenants and other restrictions under our debt agreements may affect, among other things, our ability to:
| incur indebtedness; |
| create liens on assets; |
| cause our subsidiaries to distribute cash to us to fund distributions to stockholders or to otherwise use in our business; |
| sell or substitute assets; |
| modify certain terms of our leases; |
| manage our cash flows; and |
| make distributions to equity holders, including our common stockholders. |
Additionally, these restrictions may adversely affect our operating and financial flexibility and may limit our ability to respond to changes in our business or competitive environment, all of which may materially and adversely affect us.
Under certain circumstances, the subsidiaries included in our Master Trust Funding Program would be prohibited from distributing excess cash flow to us and the assets of such subsidiaries could be foreclosed upon.
Through our Master Trust Funding Program, certain of our operating partnerships indirect wholly-owned subsidiaries have issued net-lease mortgage notes payable with an aggregate outstanding principal balance as of March 31, 2018 of $520.9 million. As of March 31, 2018, we had pledged 348 properties, with a net investment amount of $620.6 million, as collateral under this program. As the equity owner of the subsidiaries included in our Master Trust Funding Program, we are only entitled to the excess cash flows from such subsidiaries after debt service and all other required payments are made on the notes. If at any time the monthly debt service coverage ratio (as defined) generated by the collateral pool is less than or equal to 1.25 to 1, excess cash flow (as defined) from the subsidiaries included in our Master Trust Funding Program will be deposited into a reserve account to be used for payments to be made on the net-lease mortgage notes, to the extent there is a shortfall. Additionally, if at any time the three month average debt service coverage ratio generated by the collateral pool is less than or equal to 1.15 to 1, excess cash flow from the subsidiaries included in our Master Trust Funding Program will be applied to an early amortization of the notes. For the year ended March 31, 2018, the debt service coverage ratio was approximately 1.47 to 1. If we fail to maintain the required
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debt service coverage ratios, the excess cash flows we receive from these subsidiaries would be reduced or eliminated. This could materially and adversely affect us, including by reducing our ability to pay cash distributions on our common stock and possibly prevent us from qualifying or maintaining our qualification for taxation as a REIT. In addition, if the subsidiaries included in our Master Trust Funding Program are unable to repay the notes, including in connection with any acceleration of maturity, the pledged assets could be foreclosed upon and our equity in such assets eliminated.
Risks Related to Our Organizational Structure
Eldridge will have substantial influence over our business, and its interests, and the interests of certain members of our management, may differ from our interests or those of our other stockholders.
Immediately after this offering and the concurrent Eldridge private placement, Eldridge will beneficially own approximately 19.0% of our outstanding common stock (based on the mid-point of the price range set forth on the front cover of this prospectus and subject to adjustment as described under Pricing Sensitivity Analysis). As a result, Eldridge will have significant influence in the election of our directors who will elect our executive officers, set our management policies and exercise overall supervision and control over us and our subsidiaries. In addition, pursuant to our charter, our bylaws and a stockholders agreement that we intend to enter into with Eldridge prior to the consummation of this offering, Eldridge, subject to certain limitations, will have the right to designate nominees for election to our board of directors, designate a member of certain board committees and approve certain actions, such as the removal of directors designated by Eldridge and amendments to certain provisions of our charter and bylaws. In addition to the waiver from our ownership limit that we will grant to Eldridge in connection with the concurrent private placement of our common stock, allowing Eldridge to own up to 19.0% of our outstanding common stock, we will agree in the stockholders agreement to, upon Eldridges request, subject to the delivery by Eldridge of any additional information requested by our board of directors, increase the percentage of our outstanding common stock that may be owned by Eldridge, unless our board concludes that any such increase could jeopardize our ability to qualify for taxation as a REIT. See Certain Relationships and Related Party TransactionsStockholders Agreement and ManagementStockholders Agreement. Additionally, for so long as Eldridge owns at least 10% of the OP units, we will be prohibited from undertaking certain actions, including, without limitation, consummating fundamental transactions, without first gaining the approval of the partners as specified in the partnership agreement. See Description of the Partnership Agreement of Essential Properties, L.P.Purpose, Business and Management. Certain potential transactions may affect Eldridge differently than other stockholders and it is possible that Eldridge may have different interests than stockholders with respect to such transactions.
The interests of Eldridge may differ from the interests of our other stockholders, and Eldridges significant stockholdings and rights described above may limit other stockholders ability to influence corporate matters. In this regard, sales or other dispositions of our properties may have adverse tax implications for Eldridge. In addition, certain members of our management have certain equity interests in the holding company through which Eldridge owns some of its interest in our business, which may cause them to have interests that differ from our other stockholders. The concentration of ownership and voting power of Eldridge and Eldridges rights described above may also delay, defer or even prevent an acquisition by a third party or other change of control of our company and may make some transactions more difficult or impossible without the support of Eldridge, even if such events are in the best interests of our other stockholders. The concentration of voting power in Eldridge may have an adverse effect on the price of our common stock. As a result of Eldridges influence, we may take actions that our other stockholders do not view as beneficial, which may adversely affect our results of operations and financial condition and cause the value of your investment in us to decline.
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Eldridge and its affiliates engage in a broad spectrum of activities, including investments in real estate. In the ordinary course of their business activities, Eldridge and its affiliates may engage in activities where their interests conflict with our interests or those of our stockholders. Our charter will provide that, to the maximum extent permitted by Maryland law, none of Eldridge, its affiliates, each of their representatives, and each of our directors or officers that is an employee, affiliate or designee for nomination as a director of Eldridge will have any duty to refrain from engaging, directly or indirectly, in the same business activities or similar business activities or lines of business in which we operate or directly or indirectly doing business with any of our clients, customers or suppliers. Eldridge and its affiliates also may pursue acquisition opportunities that may be complementary to our business (provided, however, that any corporate opportunity presented to a person solely in his or her capacity as a director or officer of us must be presented to us), and, as a result, those acquisition opportunities may not be available to us. See Certain Provisions of Maryland Law and of Our Charter and BylawsCorporate Opportunities.
Our charter and bylaws and Maryland law contain provisions that may delay, defer or prevent a change of control transaction, even if such a change in control may be in your interest, and as a result may depress the market price of our common stock. Our charter contains certain restrictions on ownership and transfer of our stock.
Our charter contains various provisions that are intended to assist us to qualify as a REIT, among other reasons, and, subject to certain exceptions, authorizes our directors to take such actions as are necessary or appropriate to qualify as a REIT. For example, our charter prohibits the actual, beneficial or constructive ownership by any person of more than 7.5% in value or in number of shares, whichever is more restrictive, of the outstanding shares of our common stock or more than 7.5% in value of the aggregate of the outstanding shares of all classes and series of our stock. However, certain entities that are defined as designated investment entities in our charter, which generally includes pension funds, mutual funds and certain investment management companies, are permitted to own up to 9.8% (in value or in number of shares) of our outstanding common stock, or 9.8% in value of the aggregate of the outstanding shares of all classes and series of stock, so long as each beneficial owner of the shares owned by such designated investment entity would satisfy the ownership limits if those beneficial owners owned directly their pro rata share of the common stock owned by the designated investment entity. We refer to this restriction as the designated investment entity limit.
Our board of directors, in its sole and absolute discretion, may exempt a person, prospectively or retroactively, from these ownership limits if certain conditions are satisfied. See Description of Our Capital StockRestrictions on Ownership and Transfer. The restrictions on ownership and transfer of our stock may, among other things:
| discourage a tender offer or other transactions or a change in management or of control that might involve a premium price for our common stock or that our stockholders otherwise believe to be in their best interests; or |
| result in the transfer of shares acquired in excess of the restrictions to a trust for the benefit of one or more charitable beneficiaries and, as a result, the forfeiture by the acquirer of the benefits of owning the additional shares. |
We could increase or decrease the number of authorized shares of stock, classify and reclassify unissued stock and issue stock without stockholder approval.
Our board of directors, without stockholder approval, has the power under our charter to amend our charter to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we are authorized to issue, to authorize us to issue authorized but unissued shares of our common stock or preferred stock and to classify or reclassify any unissued
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shares of our common stock or preferred stock into one or more classes or series of stock and to set the terms of such newly classified or reclassified shares. See Description of Our Capital StockCommon Stock and Preferred Stock. As a result, we may issue one or more classes or series of common stock or preferred stock with preferences, conversion or other rights, voting powers or rights, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption that are senior to, or otherwise conflict with, the rights of our common stockholders. Although our board of directors has no such intention at the present time, it could establish a class or series of common stock or preferred stock that could, depending on the terms of such class or series, delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Termination of the employment agreements with certain members of our senior management team could be costly and prevent a change in control of our company.
The employment agreements with certain members of our senior management team provide that if their employment with us terminates under certain circumstances (including in connection with a change in control of our company), we may be required to pay them significant amounts of severance compensation, thereby making it costly to terminate their employment. Furthermore, these provisions could delay or prevent a transaction or a change in control of our company that might involve a premium paid for shares of our common stock or otherwise be in the best interests of our stockholders.
Our board of directors may change our investment and financing policies without stockholder approval and we may become more highly leveraged, which may increase our risk of default under our debt obligations.
Our investment and financing policies are exclusively determined by our board of directors. Accordingly, our stockholders do not control these policies. Further, our organizational documents do not limit the amount or percentage of indebtedness, funded or otherwise, that we may incur. Although we are not required to maintain a particular leverage ratio, we generally intend to target a level of net debt (which includes recourse and non-recourse borrowings and any outstanding preferred stock issuance less unrestricted cash and cash equivalents) that, over time, is less than six times our EBITDAre. However, from time to time, our ratio of net debt to our EBITDAre may exceed six times. Our board of directors may alter or eliminate our current policy on borrowing at any time without stockholder approval. If this policy changed, we could become more highly leveraged, which could result in an increase in our debt service. Higher leverage also increases the risk of default on our obligations. In addition, a change in our investment policies, including the manner in which we allocate our resources across our portfolio or the types of assets in which we seek to invest, may increase our exposure to interest rate risk, real estate market fluctuations and liquidity risk. Changes to our policies with regards to the foregoing could materially and adversely affect us.
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
Upon the completion of this offering, as permitted by Maryland law, our charter will limit the liability of our directors and officers to us and our stockholders for money damages to the maximum extent permitted by Maryland law. Therefore, our directors and officers will be subject to monetary liability resulting only from:
| actual receipt of an improper benefit or profit in money, property or services; or |
| active and deliberate dishonesty by the director or officer that was established by a final judgment as being material to the cause of action adjudicated. |
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As a result, we and our stockholders have rights against our directors and officers that are more limited than might otherwise exist. Accordingly, in the event that actions taken by any of our directors or officers impede the performance of our company, your and our ability to recover damages from such director or officer will be limited. In addition, our charter and our bylaws will require us to indemnify our directors and officers for actions taken by them in those and certain other capacities to the maximum extent permitted by Maryland law.
Upon the completion of this offering and the formation transactions, we will be a holding company with no direct operations and will rely on funds received from our operating partnership to pay liabilities.
Upon the completion of this offering and the formation transactions, we will be a holding company and will conduct substantially all of our operations through our operating partnership. We will not have, apart from an interest in our operating partnership, any independent operations. As a result, we will rely on distributions from our operating partnership to pay any distributions we might declare on shares of our common stock. We will also rely on distributions from our operating partnership to meet any of our obligations, including any tax liability on taxable income allocated to us from our operating partnership. In addition, because we will be a holding company, your claims as stockholders will be structurally subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of our operating partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets and those of our operating partnership and its subsidiaries will be able to satisfy the claims of our stockholders only after all of our and our operating partnerships and its subsidiaries liabilities and obligations have been paid in full.
In connection with our future acquisition of properties or otherwise, we may issue units of our operating partnership to third parties. Such issuances would reduce our ownership in our operating partnership. Because you will not directly own units of our operating partnership, you will not have any voting rights with respect to any such issuances or other partnership level activities of our operating partnership.
Conflicts of interest could arise in the future between the interests of our stockholders and the interests of holders of units in our operating partnership, which may impede business decisions that could benefit our stockholders.
Conflicts of interest could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any future partner thereof, on the other. Our directors and officers have duties to our company under applicable Maryland law in connection with the management of our company. At the same time, one of our wholly-owned subsidiaries, Essential Properties General OP Holdings, LLC, as the general partner of our operating partnership, will have fiduciary duties and obligations to our operating partnership and its limited partners under Delaware law and the partnership agreement of our operating partnership in connection with the management of our operating partnership. The fiduciary duties and obligations of Essential Properties General OP Holdings, LLC, as general partner of our operating partnership, and its limited partners may come into conflict with the duties of our directors and officers to our company.
Under the terms of the partnership agreement of our operating partnership, if there is a conflict between the interests of our stockholders on one hand and any limited partners on the other, we will endeavor in good faith to resolve the conflict in a manner not adverse to either our stockholders or any limited partners; provided, however, that at such time as we own a controlling economic interest in our operating partnership, any conflict that cannot be resolved in a manner not adverse to either our stockholders or any limited partners shall be resolved in favor of our stockholders.
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The partnership agreement requires the general partner or us, as the parent of the general partner, to obtain the approval of a majority in interest of the outside limited partners in our operating partnership (which excludes us and our subsidiaries) in connection with certain mergers, consolidations or other combinations of us, or a sale of all or substantially all of our assets. In addition, for so long as Eldridge owns at least 10% of the OP units, the Operating Partnership will be prohibited from undertaking certain actions (including, without limitation, consummating fundamental transactions) without first gaining the approval of in excess of 50% of (i) the units owned by us or our subsidiaries (voted in the same proportion as the vote of holders of our shares of common stock) plus (ii) the units issued to Eldridge and EPRT Holdings, LLC in the formation transactions. See Description of the Partnership Agreement of Essential Properties, L.P.Transferability of Operating Partnership Units; Extraordinary Transactions. This approval right could prevent a transaction that might be in the best interests of our stockholders.
The partnership agreement will also provide that the general partner will not be liable to our operating partnership, its partners or any other person bound by the partnership agreement for monetary damages for losses sustained, liabilities incurred or benefits not derived by our operating partnership or any limited partner, except for liability for the general partners intentional harm or gross negligence. Moreover, the partnership agreement will provide that our operating partnership is required to indemnify the general partner and its members, managers, managing members, officers, employees, agents and designees from and against any and all claims that relate to the operations of our operating partnership, except (1) if the act or omission of the person was material to the matter giving rise to the action and either was committed in bad faith or was the result of active or deliberate dishonesty, (2) for any transaction for which the indemnified party received an improper personal benefit, in money, property or services or otherwise in violation or breach of any provision of the partnership agreement or (3) in the case of a criminal proceeding, if the indemnified person had reasonable cause to believe that the act or omission was unlawful.
We are an emerging growth company, and we cannot be certain if the reduced SEC reporting requirements applicable to emerging growth companies will make our common stock less attractive to investors, which could make the market price and trading volume of our common stock be more volatile and decline significantly.
We are an emerging growth company as defined in the JOBS Act. We will remain an emerging growth company until the earliest to occur of (i) the last day of the fiscal year during which our total annual revenue equals or exceeds $1.07 billion (subject to adjustment for inflation), (ii) the last day of the fiscal year following the fifth anniversary of this offering, (iii) the date on which we have, during the previous three-year period, issued more than $1 billion in non-convertible debt securities or (iv) the date on which we are deemed to be a large accelerated filer under the Exchange Act. We intend to take advantage of exemptions from various reporting requirements that are applicable to most other public companies, whether or not they are classified as emerging growth companies, including, but not limited to, an exemption from the provisions of Section 404(b) of the Sarbanes-Oxley Act requiring that our independent registered public accounting firm provide an attestation report on the effectiveness of our internal control over financial reporting. An attestation report by our auditor would require additional procedures by them that could detect problems with our internal control over financial reporting that are not detected by management. If our system of internal control over financial reporting is not determined to be appropriately designed or operating effectively, it could require us to restate financial statements, cause us to fail to meet reporting obligations and cause investors to lose confidence in our reported financial information, all of which could lead to a significant decline in the market price of our common stock. The JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in the Securities Act for complying with new or revised accounting standards. However, we have chosen to opt out of this extended transition period and, as a result, we will comply with new or revised accounting standards on or prior to the
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relevant dates on which adoption of such standards is required for all public companies that are not emerging growth companies. Our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable. We cannot predict if investors will find our common stock less attractive because we intend to rely on certain of these exemptions and benefits under the JOBS Act. If some investors find our common stock less attractive as a result, there may be a less active, liquid and/or orderly trading market for our common stock and the market price and trading volume of our common stock may be more volatile and decline significantly.
Risks Related to Our Status as a REIT
Failure to qualify as a REIT would materially and adversely affect us and the value of our common stock.
We believe that we have been organized and have operated in a manner that will allow us to qualify as a REIT for federal income tax purposes commencing with our taxable year ending December 31, 2018, and we intend to continue operating in such a manner. We have not requested and do not plan to request a ruling from the Internal Revenue Service, or IRS, that we qualify as a REIT, and the statements in this prospectus are not binding on the IRS or any court. Therefore, we cannot assure you that we will qualify as a REIT, or that we will remain qualified as such in the future. If we lose our REIT status, we will face significant tax consequences that would substantially reduce our cash available for distribution to you for each of the years involved because:
| we would not be allowed a deduction for distributions to stockholders in computing our taxable income and would be subject to federal income tax at the corporate rate; |
| we also could be subject to increased state and local taxes; and |
| unless we are entitled to relief under applicable statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year during which we were disqualified. |
Any such corporate tax liability could be substantial and would reduce our cash available for, among other things, our operations and distributions to stockholders. In addition, if we fail to qualify as a REIT, we will not be required to make distributions to our stockholders. As a result of all these factors, our failure to qualify as a REIT also could impair our ability to expand our business and raise capital, and could materially and adversely affect the trading price of our common stock.
Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The determination of various factual matters and circumstances not entirely within our control may affect our ability to qualify as a REIT. In order to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the ownership of our stock, requirements regarding the composition of our assets and a requirement that at least 95% of our gross income in any year must be derived from qualifying sources, such as rents from real property. Also, we must make distributions to stockholders aggregating annually at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and excluding any net capital gains. In addition, legislation, new regulations, administrative interpretations or court decisions may materially and adversely affect our investors, our ability to qualify as a REIT for federal income tax purposes or the desirability of an investment in a REIT relative to other investments.
Even if we qualify as a REIT for federal income tax purposes, we may be subject to some federal, state and local income, property and excise taxes on our income or property and, in certain cases, a 100% penalty tax, in the event we sell property as a dealer. In addition, any taxable REIT subsidiaries will be subject to tax as regular corporations in the jurisdictions in which they operate.
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If our operating partnership fails to qualify as a partnership for federal income tax purposes, we would cease to qualify as a REIT and suffer other adverse consequences.
We believe that our operating partnership will be treated as a partnership for federal income tax purposes. As a partnership, our operating partnership would generally not be subject to federal income tax on its income. Instead, for federal income tax purposes, if our operating partnership is treated as a partnership, each of its partners, including us, would be allocated, and may be required to pay tax with respect to, such partners share of its income. Our operating partnership will generally be required to determine and pay an imputed underpayment of tax (plus interest and penalties) resulting from an adjustment of the operating partnerships items of income, gain, loss, deduction or credit at the partnership level. We cannot assure you that the IRS will not challenge the status of our operating partnership or any other subsidiary partnership in which we own an interest as a disregarded entity or partnership for federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating our operating partnership or any such other subsidiary partnership as an entity taxable as a corporation for federal income tax purposes, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, we would likely cease to qualify as a REIT. Also, the failure of our operating partnership or any subsidiary partnerships to qualify as a disregarded entity or partnership could cause it to become subject to federal and state corporate income tax, which would reduce significantly the amount of cash available for debt service and for distribution to its partners, including us.
To maintain our REIT status, we may be forced to borrow funds during unfavorable market conditions, and the unavailability of such capital on favorable terms at the desired times, or at all, may cause us to curtail our investment activities and/or to dispose of assets at inopportune times, which could materially and adversely affect us and the per share trading price of our common stock.
To qualify as a REIT, we generally must distribute to our stockholders at least 90% of our REIT taxable income each year, determined without regard to the dividends-paid deduction and excluding any net capital gains, and we will be subject to corporate income tax on our undistributed taxable income to the extent that we distribute less than 100% of our REIT taxable income, determined without regard to the dividends-paid deduction and including any net capital gains, each year. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. In order to maintain our REIT status and avoid the payment of income and excise taxes, we may need to borrow funds to meet the REIT distribution requirements even if the then prevailing market conditions are not favorable for these borrowings. These borrowing needs could result from, among other things, differences in timing between the actual receipt of cash and recognition of income for federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of reserves or required debt or amortization payments. These sources, however, may not be available on favorable terms or at all. Our access to third-party sources of capital depends on a number of factors, including the markets perception of our growth potential, our current debt levels, the market price of our common stock, and our current and potential future earnings. We cannot assure you that we will have access to such capital on favorable terms at the desired times, or at all, which may cause us to curtail our investment activities and/or to dispose of assets at inopportune times, and could materially and adversely affect us and the per share trading price of our common stock.
The IRS may treat sale-leaseback transactions as loans, which could jeopardize our REIT status or require us to make an unexpected distribution.
The IRS may take the position that specific sale-leaseback transactions that we treat as leases are not true leases for federal income tax purposes but are, instead, financing arrangements or loans.
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If a sale-leaseback transaction were so re-characterized, we might fail to satisfy the REIT asset tests, the income tests or distribution requirements and consequently lose our REIT status effective with the year of re-characterization unless we elect to make an additional distribution to maintain our REIT status. The primary risk relates to our loss of previously incurred depreciation expenses, which could affect the calculation of our REIT taxable income and could cause us to fail the REIT distribution test that requires a REIT to distribute at least 90% of its REIT taxable income, determined without regard to the dividends-paid deduction and excluding any net capital gain. In this circumstance, we may elect to distribute an additional dividend of the increased taxable income so as not to fail the REIT distribution test. This distribution would be paid to all stockholders at the time of declaration rather than the stockholders existing in the taxable year affected by the re-characterization.
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
The maximum tax rate applicable to income from qualified dividends payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs, however, generally are not eligible for the 20% rate applicable to qualified dividends except to the extent the REIT dividends are attributable to qualified dividends received by the REIT itself. However, for non-corporate U.S. stockholders, dividends payable by REITs that are not designated as capital gain dividends or otherwise treated as qualified dividends generally are eligible for a deduction of 20% of the amount of such dividends, for taxable years beginning before January 1, 2026. More favorable rates will nevertheless continue to apply for regular corporate qualified dividends. Although these rules do not adversely affect the taxation of REITs or dividends payable by REITs, to the extent that the 20% rate continues to apply to regular corporate qualified dividends, investors who are individuals, trusts and estates may regard investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations.
The tax imposed on REITs engaging in prohibited transactions may limit our ability to engage in transactions which would be treated as sales for federal income tax purposes.
A REITs net income from prohibited transactions is subject to a 100% penalty tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, held primarily for sale to customers in the ordinary course of business. Although we do not intend to hold any properties that would be characterized as held for sale to customers in the ordinary course of our business, unless a sale or disposition qualifies under certain statutory safe harbors, such characterization is a factual determination and no guarantee can be given that the IRS would agree with our characterization of our properties or that we will always be able to make use of the available safe harbors.
Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code substantially limit our ability to hedge our assets and liabilities. Any income from a hedging transaction that we enter into to manage the risk of interest rate changes with respect to borrowings made or to be made to acquire or carry real estate assets, or from certain terminations of such hedging positions, does not constitute gross income for purposes of the 75% or 95% gross income tests that apply to REITs, provided that certain identification requirements are met. To the extent that we enter into other types of hedging transactions or fail to properly identify such transaction as a hedge, the income is likely to be treated as non-qualifying income for purposes of both of the gross income tests. See Federal Income Tax Considerations. As a result of these rules, we may be required to limit our use of advantageous hedging techniques or implement those hedges through a taxable REIT subsidiary, or TRS. This could increase the cost of our hedging activities
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because any TRS in which we own an interest may be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in any TRS in which we own an interest will generally not provide any tax benefit, except that such losses could theoretically be carried forward against future taxable income in such TRS.
Complying with REIT requirements may affect our profitability and may force us to liquidate or forgo otherwise attractive investments.
To qualify as a REIT, we must continually satisfy tests concerning, among other things, the nature and diversification of our assets, the sources of our income and the amounts we distribute to our stockholders. We may be required to liquidate or forgo otherwise attractive investments in order to satisfy the asset and income tests or to qualify under certain statutory relief provisions. We also may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. As a result, having to comply with the distribution requirement could cause us to: (1) sell assets in adverse market conditions; (2) borrow on unfavorable terms; or (3) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt. Accordingly, satisfying the REIT requirements could materially and adversely affect us. Moreover, if we are compelled to liquidate our investments to meet any of these asset, income or distribution tests, or to repay obligations to our lenders, we may be unable to comply with one or more of the requirements applicable to REITs or may be subject to a 100% tax on any resulting gain if such sales constitute prohibited transactions.
Changes to the U.S. federal income tax laws, including the recent enactment of certain tax reform measures, could have a material and adverse effect on us.
Changes to the U.S. federal income tax laws are proposed regularly. Additionally, the REIT rules are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury, which may result in revisions to regulations and interpretations in addition to statutory changes. If enacted, certain such changes could have an adverse impact on our business and financial results.
In particular, recently enacted legislation known as the Tax Cuts and Jobs Act makes wholesale changes to the Code. The effect of the many changes made in this legislation is highly uncertain, both in terms of direct effect on the taxation of an investment in our common stock and their indirect effect on our business generally. It appears as of the date of this prospectus that the principal direct tax effect of the legislation on U.S. stockholders of Essential Properties Realty Trust, Inc. is to allow, subject to certain exceptions, the deduction of an amount equal to 20% of any dividends that are not designated as capital gain dividends or otherwise treated as qualified dividends received by non-corporate U.S. stockholders for taxable years beginning before January 1, 2026. The complicated statutes, regulations, rulings and other administrative positions relating to the qualification of REITs and the taxation of them and their stockholders are subject to revision at any time. That is particularly the case following the enactment of statutory amendments as extensive as those made by the Tax Cuts and Jobs Act. It is likely that there will be technical corrections legislation with respect to the Tax Cuts and Jobs Act, the effect of which cannot be predicted and may be adverse. In addition, many of the amendments will require guidance through the issuance of Treasury Regulations in order to assess their effect. There may be substantial delay before such regulations are promulgated, increasing the uncertainty as to the ultimate effect of the statutory amendments on us.
There may also be future changes in federal tax laws, regulations, rules, and judicial and administrative interpretations applicable to us and our business, the effect of which cannot be predicted. Prospective investors are urged to consult with their tax advisors regarding the possible effect of the Tax Cuts and Jobs Act on us, our business, and our stockholders.
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Risks Related to this Offering and Ownership of Our Common Stock
There has been no public market for our common stock prior to this offering and an active trading market for our common stock may not develop following this offering.
Prior to this offering, there has been no public market for our common stock, and there can be no assurance that an active trading market will develop or be sustained or that shares of our common stock will be resold at or above the initial public offering price. Our common stock has been approved for listing on the NYSE, subject to official notice of issuance. The initial public offering price of our common stock will be determined by agreement among us and the underwriters, but there can be no assurance that our common stock will not trade below the initial public offering price following the completion of this offering. See Underwriting. The market value of our common stock could be substantially affected by general market conditions, including the extent to which a secondary market develops for our common stock following the completion of this offering, the extent of institutional investor interest in us, the general reputation of REITs and the attractiveness of their equity securities in comparison to other equity securities (including securities issued by other real estate-based companies), our financial performance and general stock and bond market conditions.
The market price and trading volume of shares of our common stock may be volatile following this offering.
The market price of shares of our common stock may fluctuate. In addition, the trading volume in shares of our common stock may fluctuate and cause significant price variations to occur. If the market price of shares of our common stock declines significantly, you may be unable to resell your shares of our common stock at or above the public offering price. We cannot assure you that the market price of shares of our common stock will not fluctuate or decline significantly, including a decline below the public offering price, in the future.
Some of the factors that could negatively affect our share price or result in fluctuations in the market price or trading volume of shares of our common stock include:
| actual or anticipated declines in our quarterly operating results or distributions; |
| changes in government regulations; |
| changes in laws affecting REITs and related tax matters; |
| the announcement of new contracts by us or our competitors; |
| reductions in our FFO, AFFO or earnings estimates; |
| publication of research reports about us or the real estate industry; |
| increases in market interest rates that lead purchasers of shares of our common stock to demand a higher yield; |
| future equity issuances, or the perception that they may occur, including issuances of common stock upon exercise or vesting of equity awards or redemption of OP units; |
| changes in market valuations of similar companies; |
| adverse market reaction to any increased indebtedness we incur in the future; |
| additions or departures of key management personnel; |
| actions by institutional stockholders; |
| differences between our actual financial and operating results and those expected by investors and analysts; |
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| changes in analysts recommendations or projections; |
| speculation in the press or investment community; and |
| the realization of any of the other risk factors presented in this prospectus. |
There can be no assurance that we will be able to make or maintain cash distributions, and certain agreements relating to our indebtedness may, under certain circumstances, limit or eliminate our ability to make distributions to our common stockholders.
We intend to make cash distributions to our stockholders in amounts such that all or substantially all of our taxable income in each year, subject to adjustments, is distributed. Our ability to continue to make distributions in the future may be adversely affected by the risk factors described in this prospectus. We can give no assurance that we will be able to make or maintain distributions and certain agreements relating to our indebtedness may, under certain circumstances, limit or eliminate our ability to make distributions to our common stockholders. We can give no assurance that rents from our properties will increase, or that future acquisitions of real properties or other investments will increase our cash available for distributions to stockholders. In addition, any distributions will be authorized at the sole discretion of our board of directors, and their form, timing and amount, if any, will depend upon a number of factors, including our actual and projected results of operations, FFO, AFFO, liquidity, cash flows and financial condition, the revenue we actually receive from our properties, our operating expenses, our debt service requirements, our capital expenditures, prohibitions and other limitations under our financing arrangements, our REIT taxable income, the annual REIT distribution requirements, applicable law and such other factors as our board of directors deems relevant.
Distributions are expected to be based upon our FFO, AFFO, financial condition, cash flows and liquidity, debt service requirements and capital expenditure requirements for our properties. If we do not have sufficient cash available for distributions, we may need to fund the shortage out of working capital or borrow to provide funds for such distributions, which would reduce the amount of proceeds available for real estate investments and increase our future interest costs. Our inability to make distributions, or to make distributions at expected levels, could result in a decrease in per share trading price of our common stock.
We may use a portion of the net proceeds from this offering and the concurrent Eldridge private placement to make distributions to our stockholders, which would, among other things, reduce our cash available to acquire properties and may reduce the returns on your investment in our common stock.
Prior to the time we have fully invested the net proceeds from this offering and the concurrent Eldridge private placement, we may fund distributions to our stockholders out of the net proceeds, which would reduce the amount of cash we have available to acquire properties and may reduce the returns on your investment in our common stock. The use of these net proceeds for distributions to stockholders could materially and adversely affect us. In addition, funding distributions from the net proceeds from this offering and the concurrent Eldridge private placement may constitute a return of capital to our stockholders, which would have the effect of reducing each stockholders tax basis in our common stock.
Increases in market interest rates may result in a decrease in the value of shares of our common stock.
One of the factors that will influence the price of shares of our common stock will be the distribution yield on shares of our common stock (as a percentage of the price of shares of our common stock) relative to market interest rates. An increase in market interest rates, which are
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currently at low levels relative to historical rates, may lead prospective purchasers of shares of our common stock to expect a higher distribution yield and higher interest rates would likely increase our borrowing costs and potentially decrease funds available for distribution. Thus, higher market interest rates could cause the per share trading price of our common stock to decrease.
Broad market fluctuations could negatively impact the market price of shares of our common stock.
The stock market may experience extreme price and volume fluctuations that have affected the market price of many companies in industries similar or related to ours and that have been unrelated to these companies operating performances. The changes frequently appear to occur without regard to the operating performance of the affected companies. Hence, the price of our common stock could fluctuate based upon factors that have little or nothing to do with us in particular. These broad market fluctuations could reduce the market price of shares of our common stock. Furthermore, our operating results and prospects may be below the expectations of public market analysts and investors or may be lower than those of companies with comparable market capitalizations. Either of these factors could lead to a material decline in the per share trading price of our common stock.
This offering is expected to be dilutive to earnings, and there may be future dilution to earnings related to shares of our common stock.
On a pro forma basis, we expect that this offering and the concurrent Eldridge private placement will have a dilutive effect on our expected earnings per share and FFO per share. The actual amount of dilution cannot be determined at this time and will be based upon numerous factors. The market price of shares of our common stock could decline as a result of issuances or sales of a large number of shares of our common stock in the market after this offering or the perception that such issuances or sales could occur. Additionally, future issuances or sales of substantial amounts of shares of our common stock may be at prices below the initial public offering price of the shares of our common stock offered by this prospectus and may result in further dilution in our earnings and FFO per share and/or materially and adversely impact the per share trading price of our common stock. See Dilution.
Future offerings of debt, which would be senior to shares of our common stock upon liquidation, and/or preferred equity securities that may be senior to shares of our common stock for purposes of distributions or upon liquidation, may materially and adversely affect the market price of shares of our common stock.
In the future, we may attempt to increase our capital resources by making additional offerings of debt or preferred equity securities (or causing our operating partnership to issue debt securities). Upon liquidation, holders of our debt securities and preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to our stockholders. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock and may result in dilution to owners of our common stock. Our stockholders are not entitled to preemptive rights or other protections against dilution. Our preferred stock, if issued, could have a preference on liquidating distributions or a preference on distribution payments that could limit our right to make distributions to our stockholders. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Our stockholders bear the risk of our future offerings reducing per share trading price of our common stock.
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Sales of substantial amounts of our common stock in the public markets, or the perception that they might occur, could reduce the price of our common stock and may dilute your voting power and your ownership interest in us.
Sales of substantial amounts of our common stock in the public market following our initial public offering, or the perception that such sales could occur, could adversely affect the market price of our common stock and may make it more difficult for you to sell your common stock at a time and price that you deem appropriate. Assuming an initial public offering price of $15.50 per share, which is the mid-point of the price range set forth on the front cover of this prospectus, upon the completion of this offering and the concurrent Eldridge private placement, we expect to have outstanding 40,976,901 shares of our common stock (or 45,851,901 shares of our common stock if the underwriters exercise in full their option to purchase additional shares) (in each case, based on the mid-point of the price range set forth on the front cover of this prospectus).
The shares of our common stock that we are selling in this offering may be resold immediately in the public market unless they are held by affiliates, as that term is defined in Rule 144 of the Securities Act. The common stock and, if applicable, OP units to be purchased by Eldridge in the concurrent Eldridge private placement and the OP units to be held by EPRT Holdings, LLC, an affiliate of Eldridge, will be restricted securities within the meaning of Rule 144 under the Securities Act and may not be sold in the absence of registration under the Securities Act unless an exemption from registration is available, including the exemptions contained in Rule 144. Eldridge and EPRT Holdings, LLC (as well as our directors, director nominees and officers) have agreed, subject to certain exceptions, not to sell or otherwise dispose of any of their common stock or OP units (which may be exchanged for common stock) from the date of this prospectus continuing through the date 180 days (or 365 days, in the case of Eldridge) after the date of this prospectus, except with the underwriters prior written consent. As a result of the registration rights agreement, however, all of these shares of our common stock, including common stock that may be issued in exchange for OP units, may be eligible for future sale without restriction, subject to applicable lock-up arrangements. See Shares Eligible for Future SaleRegistration Rights and Certain Relationships and Related TransactionsRegistration Rights Agreement. Sales of a substantial number of such shares upon expiration of the lock-up agreements, the perception that such sales may occur, or early release of these agreements, could cause the market price of our common stock to fall or make it more difficult for you to sell your common stock at a time and price that you deem appropriate.
In addition, upon completion of this offering, our charter will provide that we may issue up to 500,000,000 shares of common stock and 150,000,000 shares of preferred stock, $0.01 par value per share. Moreover, under Maryland law and as will be provided in our charter, a majority of our entire board of directors will have the power to amend our charter to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we are authorized to issue without stockholder approval. Future issuances of shares of our common stock or securities convertible or exchangeable into common stock may dilute the ownership interest of our common stockholders. Because our decision to issue additional equity or convertible or exchangeable securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future issuances. In addition, we are not required to offer any such securities to existing stockholders on a preemptive basis. Therefore, it may not be possible for existing stockholders to participate in such future issuances, which may dilute the existing stockholders interests in us.
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A lack of research analyst coverage or restrictions on the ability of analysts associated with the co-managers of this offering to publish during certain time periods, including when we report our results of operations, could materially and adversely affect the trading price and liquidity of our common stock.
We cannot assure you that research analysts, including those associated with the underwriters of this offering, will initiate or maintain research coverage of us or our common stock. In addition, regulatory rules prohibit research analysts associated with the co-managers of this offering from publishing or otherwise distributing a research report or from making a public appearance regarding us for 15 days prior to and after the expiration, waiver or termination of any lock-up agreement that we or certain of our stockholders have entered into with the underwriters of this offering. Accordingly, it could be the case that research concerning our results of operations or the possible effects on us of significant news or a significant event will not be published or will be published on a delayed basis. A lack of research or the inability of certain research analysts to publish research relating to our results of operations or significant news or a significant event in a timely manner could materially and adversely affect the trading price and liquidity of our common stock.
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements within the meaning of the federal securities laws. In particular, statements pertaining to our business and growth strategies, investment and leasing activities and trends in our business, including trends in the market for long-term, net leases of freestanding, single-tenant properties, contain forward-looking statements. When used in this prospectus, the words estimate, anticipate, expect, believe, intend, may, will, should, seek, approximately or plan, or the negative of these words and phrases or similar words or phrases that are predictions of or indicate future events or trends and that do not relate solely to historical matters are intended to identify forward-looking statements. You can also identify forward-looking statements by discussions of strategy, plans or intentions of management.
Forward-looking statements involve numerous risks and uncertainties and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods that may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:
| general business and economic conditions; |
| continued volatility and uncertainty in the credit markets and broader financial markets, including potential fluctuations in the CPI; |
| other risks inherent in the real estate business, including tenant defaults, potential liability relating to environmental matters, illiquidity of real estate investments, and potential damages from natural disasters; |
| availability of suitable properties to acquire and our ability to acquire and lease those properties on favorable terms; |
| ability to renew leases, lease vacant space or re-lease space as existing leases expire or are terminated; |
| the degree and nature of our competition; |
| our failure to generate sufficient cash flows to service our outstanding indebtedness; |
| access to debt and equity capital markets; |
| fluctuating interest rates; |
| availability of qualified personnel and our ability to retain our key management personnel; |
| changes in, or the failure or inability to comply with, government regulation, including Maryland laws; |
| failure to qualify for taxation as a REIT; |
| changes in the U.S. tax law and other U.S. laws, whether or not specific to REITs; and |
| additional factors discussed in the sections entitled Business and Properties, Risk Factors and Managements Discussion and Analysis of Financial Condition and Results of Operations in this prospectus. |
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You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this prospectus. While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date of this prospectus or to reflect the occurrence of unanticipated events, except as required by law. In light of these risks and uncertainties, the forward-looking events discussed in this prospectus might not occur as described, or at all.
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We estimate that the net proceeds to us from this offering and the concurrent Eldridge private placement will be approximately $588.5 million, or $659.6 million if the underwriters exercise in full their option to purchase additional shares, after deducting underwriting discounts and commissions and other estimated expenses, in each case, based on an assumed initial public offering price of $15.50 per share, which is the mid-point of the price range set forth on the front cover of this prospectus. We will contribute the net proceeds from this offering and the concurrent private placement of common stock to our operating partnership in exchange for OP units.
We expect our operating partnership to use the net proceeds received from us and in the concurrent private placement of OP units (if any) (i) to repay short-term notes, with an aggregate principal balance of approximately $288.0 million as of June 1, 2018, issued to an affiliate of Eldridge and (ii) for general corporate purposes, including potential future investments. The indebtedness to be repaid to an affiliate of Eldridge was incurred to acquire properties. These short-term notes accrue interest at an annual rate equal to LIBOR plus a spread of between 2.14% and 2.55% (with a weighted average annual interest rate of 3.83% as of March 31, 2018) and mature on various dates throughout 2018 and 2019 (with a weighted average maturity of 245 days, as of March 31, 2018).
Pending the permanent use of the net proceeds from these offerings, we intend to invest the net proceeds in interest-bearing, short-term investment-grade securities, money-market accounts or other investments that are consistent with our intention to qualify for taxation as a REIT for federal income tax purposes.
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We intend to make a pro rata distribution with respect to the period commencing upon the completion of this offering and ending on September 30, 2018, based on a distribution rate of $0.21 per share of common stock for a full quarter. On an annualized basis, this would be $0.84 per share of common stock, or an annualized distribution rate of approximately 5.42% based on the mid-point of the price range set forth on the front cover of this prospectus. We estimate that this initial annual distribution rate will represent approximately 97.2% of our estimated cash available for distribution to stockholders for the twelve months ending March 31, 2019, based on the mid-point of the price range set forth on the front cover of this prospectus. We do not intend to reduce the annualized distribution per share of common stock if the underwriters exercise their option to purchase additional shares. Our intended initial annual distribution rate has been established based on our estimate of cash available for distribution for the twelve months ending March 31, 2019, which we have calculated based on adjustments to our pro forma net income for the twelve months ended March 31, 2018. This estimate was based on our pro forma operating results and does not take into account our long-term business and growth strategies, nor does it take into account any unanticipated expenditures we may have to make or any financings for such expenditures. In estimating our cash available for distribution for the twelve months ending March 31, 2019, we have made certain assumptions as reflected in the table and footnotes below.
Our estimate of cash available for distribution does not include the effect of any changes in our working capital resulting from changes in our working capital accounts. In addition, our estimate of cash available for distribution does not include the approximately $1.2 million to $1.5 million of incremental general and administrative expenses expected to be incurred subsequent to the completion of this offering in order to operate as a public company but that are not reflected in our pro forma net income for the twelve months ended March 31, 2018. It also does not reflect the amount of cash estimated to be used for investing activities, financing activities or other activities, other than reductions in interest expense associated with loan amortization. Any such investing and/or financing activities may have a material and adverse effect on our estimate of cash available for distribution. Because we have made the assumptions described herein in estimating cash available for distribution, we do not intend this estimate to be a projection or forecast of our actual results of operations, FFO, AFFO, liquidity or financial condition, and we have estimated cash available for distribution for the sole purpose of determining our estimated initial annual distribution amount. Our estimate of cash available for distribution should not be considered as an alternative to cash flow from operating activities (computed in accordance with GAAP) or as an indicator of our liquidity or our ability to make distributions. In addition, the methodology upon which we made the adjustments described herein is not necessarily intended to be a basis for determining future distributions.
We intend to maintain our initial distribution rate for the 12 months following the completion of this offering unless our results of operations, FFO, AFFO, liquidity, cash flows, financial condition, prospects, economic conditions or other factors differ materially from the assumptions used in projecting our initial distribution rate. We believe that our estimate of cash available for distribution constitutes a reasonable basis for setting the initial distribution rate. However, we cannot assure you that our estimate will prove accurate, and actual distributions may therefore be significantly below the expected distributions. Our actual results of operations will be affected by a number of factors, including the revenue received from our properties, our operating expenses, interest expense and unanticipated capital expenditures. We may, from time to time, be required, or elect, to borrow under our revolving credit facility or otherwise to pay distributions.
We cannot assure you that our estimated distributions will be made or sustained or that our board of directors will not change our distribution policy in the future. Any distributions will be at the sole discretion of our board of directors, and their form, timing and amount, if any, will depend upon a number of factors, including our actual and projected results of operations, FFO, AFFO, liquidity, cash flows and financial condition, the revenue we actually receive from our properties, our operating
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expenses, our debt service requirements, our capital expenditures, prohibitions and other limitations under our financing arrangements, our REIT taxable income, the annual REIT distribution requirements, applicable law, including restrictions on distributions under Maryland law, and such other factors as our board of directors deems relevant. For more information regarding risk factors that could materially and adversely affect us and our ability to make cash distributions, see Risk Factors. If our operations do not generate sufficient cash flow to enable us to pay our intended or required distributions, we may be required either to fund distributions from working capital, borrow or raise equity or to reduce such distributions. In addition, our charter allows us to issue preferred stock that could have a preference on distributions and could limit our ability to make distributions to our stockholders. Additionally, under certain circumstances, agreements relating to our indebtedness could limit our ability to make distributions to our stockholders.
Federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income, determined without regard to the dividends paid deduction and excluding any net capital gains, and that it pay tax at the corporate rate to the extent that it annually distributes less than 100% of its REIT taxable income, determined without regard to the dividends paid deduction and including any net capital gains. In addition, a REIT will be required to pay a 4% nondeductible excise tax on the amount, if any, by which the distributions it makes in a calendar year are less than the sum of 85% of its ordinary income, 95% of its capital gain net income and 100% of its undistributed income from prior years. For more information, see Federal Income Tax Considerations. We anticipate that our estimated cash available for distribution will be sufficient to enable us to meet the annual distribution requirements applicable to REITs and to avoid or minimize the imposition of corporate and excise taxes. However, under some circumstances, we may be required to make distributions in excess of cash available for distribution in order to meet these distribution requirements or to avoid or minimize the imposition of tax and we may need to borrow funds to make certain distributions.
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The following table sets forth calculations relating to the estimated initial distribution based on our pro forma net income for the twelve months ended March 31, 2018 and is provided solely for the purpose of illustrating the estimated initial distribution and is not intended to be a basis for determining future distributions. Dollar amounts are in thousands except per share amounts.
Pro forma net income for the year ended December 31, 2017 |
$ | 27,940 | ||
Less: pro forma net income for the three months ended March 31, 2017 |
(7,384 | ) | ||
Add: pro forma net income for the three months ended March 31, 2018 |
5,661 | |||
|
|
|||
Pro forma net income for the twelve months ended March 31, 2018 |
26,217 | |||
Add: estimated net increases in contractual rental revenue(1) |
17,639 | |||
Less: net decreases in contractual rental revenue due to tenant lease expirations and other vacancies(2) |
(297 | ) | ||
Less: estimated recurring capital expenditures(3) |
(25 | ) | ||
Less: estimated leasing and brokerage costs(4) |
(242 | ) | ||
Add: real estate depreciation and amortization |
32,324 | |||
Add: other depreciation and amortization |
4 | |||
Less: net accretion of market ground lease intangibles included in property expenses |
(379 | ) | ||
Add: non-cash impairment charges(5) |
1,526 | |||
Add: non-cash interest expense(6) |
2,715 | |||
Less: net effect of non-cash rental revenue(7) |
(9,425 | ) | ||
Add: net reduction to interest expense associated with the amortization of indebtedness(8) |
233 | |||
Add: non-cash compensation expense(9) |
4,540 | |||
|
|
|||
Estimated cash flows from operating activities for the twelve months ending March 31, 2019 |
$ | 74,830 | ||
Less: estimated amount of tenant construction reimbursement obligations and tenant loan commitment(10) |
(15,965 | ) | ||
Less: scheduled principal payments on indebtedness(11) |
(7,715 | ) | ||
|
|
|||
Estimated cash available for distribution for the twelve months ending March 31, 2019 |
$ | 51,150 | ||
Our stockholders share of estimated cash available for distribution(12) |
$ | 35,423 | ||
Non-controlling interests share of estimated cash available for distribution(13) |
$ | 15,727 | ||
Estimated initial annual distribution per share of common stock and per OP Unit |
$ | 0.84 | ||
Total estimated initial annual distribution to stockholders(14) |
$ | 34,421 | ||
Total estimated initial annual distribution to non-controlling interests(15) |
$ | 15,282 | ||
Total estimated initial annual distribution to stockholders and non-controlling interests |
$ | 49,703 | ||
Payout ratio(16) |
97.2 | % |
(1) | Represents contractual increases in rental revenue from: |
| scheduled fixed rent increases; |
| contractual increases based on changes in the CPI (including (a) increases that have already occurred but were not in effect for the entire twelve months ended March 31, 2018 and (b) actual increases that have occurred from April 1, 2018 through June 1, 2018; and |
| net increases from new leases or renewals that were not in effect for the entire twelve months ended March 31, 2018 or that will go into effect during the twelve months ending March 31, 2019 based upon leases entered into through June 1, 2018. |
(2) |
Represents decreases in rental revenue due to leases that (a) expired or were terminated during the twelve months ended March 31, 2018 or the period from April 1, 2018 through June 1, 2018, in each case that were not re-leased as of June 1, 2018 or (b) will expire during the twelve months ending March 31, 2019; provided, that, we have assumed lease renewals at current rates for three |
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leases expiring during the twelve months ending March 31, 2019 where we have no knowledge of an intent not to renew the lease and the rent coverage ratio is 1.5x or greater. Assuming these three leases were not renewed, contractual rental revenue (and therefore our estimated cash available for distribution) for the twelve months ending March 31, 2019 would be $0.1 million less. |
(3) | Represents estimated recurring capital expenditures to be made during the twelve months ending March 31, 2019. Substantially all of our properties are triple-net leased to tenants who are required to pay all property-level operating expenses; accordingly, we have historically had limited capital expenditure requirements. For the period from March 30, 2016 (commencement of operations) to December 31, 2016 and the three months ended March 31, 2018, we had no capital expenditures. For the year ended December 31, 2017, we had non-recurring capital expenditures of $48,000. |
(4) | Represents the estimated amount of leasing commissions and brokerage costs for the twelve months ending March 31, 2019 for closed or probable acquisitions and properties where we do not expect the tenants to renew their leases upon expiration. |
(5) | Represents non-cash impairment charges recognized on real estate investments during the twelve months ended March 31, 2018 on a pro forma basis. |
(6) | Represents non-cash interest expense associated with: |
| the amortization of deferred financing costs related to our outstanding indebtedness; and |
| the amortization of deferred financing costs related to the upfront fees and other costs incurred in connection with the new revolving credit facility and included in our pro forma net income for the twelve months ended March 31, 2018. |
(7) | Represents net non-cash rental revenues associated with the net straight-line adjustment to rental revenue, the amortization of above- and below-market lease intangibles and capitalized lease incentives. |
(8) | Represents net reductions in pro forma contractual interest expense for the twelve months ending March 31, 2019 due to reductions in outstanding principal amount of indebtedness arising from principal amortization payments on our pro forma indebtedness as of March 31, 2018. |
(9) | Represents non-cash stock-based compensation expense related to equity based awards granted to certain members of our management, directors and employees and included in our pro forma net income for the twelve months ended March 31, 2018. |
(10) | Represents estimated amount of tenant construction reimbursement obligations and a tenant loan commitment to be funded during the twelve months ending March 31, 2019. |
(11) | Represents scheduled principal amortization during the twelve months ending March 31, 2019 for indebtedness outstanding as of March 31, 2018 on a pro forma basis. |
(12) | Based on an estimated ownership by our company of approximately 69.3% of the general and limited partner interests in our operating partnership, based on the mid-point of the price range set forth on the front cover of this prospectus. |
(13) | Represents the share of our estimated cash available for distribution for the twelve months ending March 31, 2019 that is attributable to the holders of limited partner interests in our operating partnership other than us, based on the mid-point of the price range set forth on the front cover of this prospectus. |
(14) | Based on a total of 40,976,901 shares of our common stock expected to be outstanding upon completion of this offering and the concurrent private placement of common stock, based on the mid-point of the price range set forth on the front cover of this prospectus and subject to adjustment as provided under Pricing Sensitivity Analysis. |
(15) | Based on a total of 18,192,497 OP units expected to be outstanding upon completion of this offering and the concurrent private placement (excluding OP units held by us), based on the mid-point of the price range set forth on the front cover of this prospectus and subject to adjustment as provided under Pricing Sensitivity Analysis. |
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(16) | Calculated as total estimated initial annual distribution to stockholders divided by our stockholders share of estimated cash available for distribution for the twelve months ending March 31, 2019. If the underwriters exercise in full their option to purchase additional shares, our total estimated initial annual distribution to stockholders would be $38.5 million and our payout ratio would be 105.2%. |
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The following table sets forth our historical capitalization as of March 31, 2018 and our pro forma capitalization as of March 31, 2018 to give effect to this offering, the concurrent Eldridge private placement, the formation transactions and the other adjustments described in the unaudited pro forma consolidated financial statements included elsewhere in this prospectus, based on the mid-point of the price range set forth on the front cover of this prospectus. This table should be read in conjunction with the sections entitled Use of Proceeds, Selected Consolidated Historical and Pro Forma Financial and Other Data, Managements Discussion and Analysis of Financial Condition and Results of Operations, Pricing Sensitivity Analysis and our historical and pro forma financial statements and related notes included elsewhere in this prospectus.
As of March 31, 2018 | ||||||||
Historical | Pro Forma | |||||||
(In thousands, except share and per share amounts) |
||||||||
Debt: |
||||||||
New revolving credit facility(1) |
$ | | $ | | ||||
Secured borrowings, net of deferred financing costs |
510,138 | 510,138 | ||||||
Notes payable to related party(2) |
225,000 | | ||||||
Members/Stockholders Equity: |
||||||||
Preferred stock, $0.01 par value per share; no shares authorized, no shares issued and outstanding, actual; 150,000,000 shares authorized, no shares issued and outstanding, pro forma |
| | ||||||
Common stock, $0.01 par value per share; no shares authorized, no shares issued and outstanding, actual; 500,000,000 shares authorized and 40,976,901 shares issued and outstanding, pro forma(3) |
| 410 | ||||||
Additional paid in capital |
| 583,792 | ||||||
|
|
|
|
|||||
Total stockholders equity |
| 584,202 | ||||||
|
|
|
|
|||||
Members equity |
232,753 | | ||||||
|
|
|
|
|||||
Noncontrolling interest |
| 239,166 | ||||||
|
|
|
|
|||||
Total Capitalization |
$ | 967,891 | $ | 1,333,506 | ||||
|
|
|
|
(1) | We expect to have a $300 million unsecured revolving credit facility upon completion of this offering. |
(2) | As of June 1, 2018, we had approximately $288.0 million aggregate principal amount of short-term notes payable to a related party outstanding. See Use of Proceeds. |
(3) | Pro forma common stock outstanding includes (a) 32,500,000 shares of our common stock to be issued in this offering, (b) 7,785,611 shares of our common stock to be issued to Eldridge in the concurrent private placement of common stock (based on the mid-point of the price range set forth on the front cover of this prospectus, subject to adjustment as provided in Pricing Sensitivity Analysis) and (c) 691,290 shares of restricted common stock to be granted to our directors, executive officers and other employees in connection with the completion of this offering pursuant to the Equity Incentive Plan. Excludes (i) 4,875,000 shares of our common stock issuable upon the exercise in full of the underwriters option to purchase additional shares and (ii) 2,858,710 shares of our common stock issuable in the future under the Equity Incentive Plan, as more fully described in Executive CompensationNarrative Disclosure Regarding Employment Agreements and Post-Termination Arrangements2018 Equity Incentive Plan. In connection with our formation, EPRT Holdings, LLC made an initial investment in us of $100 in exchange for 100 shares of our common stock. Such shares will be repurchased by us at or prior to the closing of the offering for $100. |
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Dilution After This Offering
Purchasers of our common stock offered by this prospectus will experience an immediate and substantial dilution of the net tangible book value per share of our common stock from the initial public offering price. Net tangible book value per share represents the amount of total tangible assets less total tangible liabilities, divided by the number of outstanding shares of common stock, assuming the exchange of OP units for shares of our common stock on a one-for-one basis. As of March 31, 2018, we had a net tangible book value of approximately $189.9 million, or $10.60 per share. After giving effect to the sale of our common stock by us in this offering, the concurrent Eldridge private placement, the application of the aggregate net proceeds received by us from these offerings, completion of the formation transactions and the other adjustments described in the unaudited pro forma consolidated financial statements included elsewhere in this prospectus, our pro forma net tangible book value as of March 31, 2018 would have been $778.9 million, or $13.16 per share of common stock (assuming the exchange of OP units for shares of common stock on a one-for-one basis). This amount represents an immediate increase in net tangible book value of $2.56 per share to our continuing investors and an immediate dilution in pro forma net tangible book value of $2.34 per share from the public offering price of $15.50 per share of common stock to our new investors. The following table illustrates this per share dilution.
Initial public offering price per share |
$ | 15.50 | ||||||
Net tangible book value per share as of March 31, 2018(1) |
$ | 10.60 | ||||||
Net increase in net tangible book value per share attributable to the formation transactions, this offering, the concurrent Eldridge private placement and other pro forma adjustments |
$ | 2.56 | ||||||
|
|
|||||||
Pro forma net tangible book value per share after the formation transactions, this offering, the concurrent Eldridge private placement and other pro forma adjustments(2) |
$ | 13.16 | ||||||
|
|
|||||||
Dilution in pro forma net tangible book value per share to new investors(3) |
$ | 2.34 | ||||||
|
|
(1) | Net tangible book value per share as of March 31, 2018 was determined by dividing the net tangible book value as of March 31, 2018 of $189.9 million by the 17,913,592 OP units to be received by continuing investors in the formation transactions, assuming the exchange of OP units for shares of common stock on a one-for-one basis. |
(2) | The pro forma net tangible book value per share after the formation transactions, this offering, the concurrent Eldridge private placement and other pro forma adjustments was determined by dividing net tangible book value of approximately $778.9 million by 59,169,398 shares of common stock and OP units to be outstanding after the formation transactions, this offering, the concurrent Eldridge private placement and other pro forma adjustments, assuming the exchange of OP units for shares of common stock on a one-for-one basis. This excludes the shares that may be issued by us upon exercise of the underwriters option to purchase additional shares, the related proceeds and additional common stock reserved for future issuance under the Equity Incentive Plan. |
(3) | The dilution in pro forma net tangible book value per share to new investors was determined by subtracting pro forma net tangible book value per share after the formation transactions, this offering, the concurrent Eldridge private placement and other pro forma adjustments from the assumed initial public offering price paid by a new investor for our common stock. |
Assuming the underwriters exercise their option to purchase additional shares of common stock in full, our pro forma net tangible book value as of March 31, 2018 would have been $854.4 million, or $13.34 per share of common stock (assuming the exchange of OP units for shares of common stock on a one-for-one basis). This represents an immediate dilution in pro forma net tangible book value of $2.16 per share of common stock to new investors.
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Differences Between New Investors and Continuing Investors
The table below summarizes, as of March 31, 2018, on a pro forma basis after giving effect to the formation transactions, this offering and the concurrent Eldridge private placement, the differences between the number of shares of common stock and OP units to be received by the continuing investors in connection with the formation transactions and the new investors purchasing shares in this offering and the concurrent Eldridge private placement, the total consideration paid and the average price per share of common stock or OP unit paid by the continuing investors in connection with the formation transactions and paid in cash by the new investors purchasing shares in this offering and the concurrent Eldridge private placement (based on the net tangible book value attributable to the existing investors in the formation transactions).
Common Stock/OP units
Issued/Granted |
Pro Forma Net Tangible
Book Value of Contribution/Cash(1) |
Average
Price Per Share |
||||||||||||||||||
Number | Percentage | Amount | Percentage | |||||||||||||||||
($ in thousands, except per share amounts) | ||||||||||||||||||||
Continuing investors(2) |
17,913,592 | 30.2 | % | $ | 190,341 | 23.2 | % | $ | 10.63 | |||||||||||
New investors and restricted share grants(3) |
41,255,806 | 69.8 | % | 628,750 | 76.8 | % | $ | 15.24 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||||||
Total |
59,169,398 | 100.0 | % | $ | 819,091 | 100.0 | % | |||||||||||||
|
|
|
|
|
|
|
|
(1) | Represents pro forma net tangible book value as of March 31, 2018 after giving effect to the formation transactions, this offering and the concurrent Eldridge private placement. |
(2) | Includes 17,913,592 OP units to be issued in connection with the formation transactions. |
(3) | Includes 32,500,000 shares of common stock to be sold in this offering, 7,785,611 shares of common stock and 278,905 OP units to be sold in the concurrent Eldridge private placement of common stock and an aggregate of 691,290 restricted shares of common stock to be granted to certain of our directors, executive officers and other employees concurrently with the completion of this offering (the common stock and OP units to be sold in the concurrent Eldridge private placement are subject to adjustment as provided in Pricing Sensitivity Analysis). In connection with our formation, EPRT Holdings, LLC made an initial investment in us of $100 in exchange for 100 shares of our common stock. Such shares will be repurchased by us at or prior to the closing of the offering for $100. |
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SELECTED CONSOLIDATED HISTORICAL AND PRO FORMA FINANCIAL AND OTHER DATA
Set forth below is selected financial and other data presented on (i) a historical basis for Essential Properties Realty Trust LLC, which, through the formation transactions, will become our operating partnership and (ii) a pro forma basis for our company after giving effect to the completion of this offering, the concurrent Eldridge private placement, the formation transactions and the other adjustments described in the unaudited pro forma consolidated financial statements beginning on page F-73 of this prospectus. We have not presented historical data for Essential Properties Realty Trust, Inc. because we have not had any corporate activity since our formation other than the issuance of common stock in connection with our initial capitalization and activity in connection with this offering and the formation transactions. Accordingly, we do not believe that a presentation of the historical results of Essential Properties Realty Trust, Inc. would be meaningful. Prior to or concurrently with the completion of this offering, we will consummate the formation transactions pursuant to which, among other things, Essential Properties Realty Trust LLC will be converted into a Delaware limited partnership and become our operating partnership, and Essential Properties OP G.P., LLC, a wholly-owned subsidiary, will become the sole general partner of our operating partnership. Upon completion of the formation transactions, substantially all of our assets will be held by, and substantially all of our operations will be conducted through, our operating partnership. We will contribute the net proceeds received by us from this offering and the concurrent private placement of common stock to Eldridge to our operating partnership in exchange for OP units. For more information regarding the formation transactions, please see Structure and Formation of Our Company.
Essential Properties Realty Trust LLCs historical consolidated balance sheet data as of December 31, 2017 and 2016 and consolidated operating data for the year ended December 31, 2017 and the period from March 30, 2016 (commencement of operations) to December 31, 2016 have been derived from Essential Properties Realty Trust LLCs audited historical consolidated financial statements included elsewhere in this prospectus. Essential Properties Realty Trust LLCs historical consolidated balance sheet data as of March 31, 2018 and consolidated operating data for the three months ended March 31, 2018 and 2017 have been derived from Essential Properties Realty Trust LLCs unaudited historical consolidated financial statements included elsewhere in this prospectus. Essential Properties Realty Trust LLCs unaudited interim financial and operating data, in managements opinion, has been prepared in accordance with U.S. GAAP on the same basis as its audited financial statements and related notes included elsewhere in this prospectus and, in the opinion of management, reflects all adjustments consisting only of normal recurring adjustments that management considers necessary to state fairly the financial information as of and for the periods presented. The historical consolidated financial data included below and set forth elsewhere in this prospectus are not necessarily indicative of our future performance, and results for any interim period are not necessarily indicative of the results for any full year.
Our unaudited selected pro forma consolidated financial and operating data as of March 31, 2018 and for the three months ended March 31, 2018 and the year ended December 31, 2017 assume the completion of this offering, the concurrent Eldridge private placement, the formation transactions and the other adjustments described in the unaudited pro forma consolidated financial statements had occurred on March 31, 2018 for purposes of the unaudited pro forma consolidated balance sheet data and on January 1, 2017 for purposes of the unaudited pro forma consolidated statements of operations data. Our pro forma financial information is not necessarily indicative of what our actual financial position and results of operations would have been as of the date and for the period indicated, nor does it purport to represent our future financial position or results of operations.
You should read the following summary selected financial and other data together with Managements Discussion and Analysis of Financial Condition and Results of Operations, Business and Properties and our consolidated financial statements and related notes appearing elsewhere in this prospectus.
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Operating Data:
Three Months Ended March 31, |
Year Ended December 31, |
Period from
March 30, 2016 (Commencement of Operations) to December 31, 2016 (Historical) |
||||||||||||||||||||||
(In thousands, except share and
|
2018
(Pro forma) (Unaudited) |
2018
(Historical) (Unaudited) |
2017
(Historical) (Unaudited) |
2017
(Pro forma) (Unaudited) |
2017
(Historical) |
|||||||||||||||||||
Revenues: |
||||||||||||||||||||||||
Rental revenue(1) |
$ | 25,540 | $ | 20,075 | $ | 10,008 | $ | 101,190 | $ | 53,373 | $ | 15,271 | ||||||||||||
Interest income on direct financing lease receivables |
62 | 62 | 83 | 290 | 293 | 161 | ||||||||||||||||||
Other revenue |
130 | 66 | 5 | 1,117 | 832 | 91 | ||||||||||||||||||
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|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total revenues |
25,732 | 20,203 | 10,096 | 102,597 | 54,498 | 15,523 | ||||||||||||||||||
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|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Expenses: |
||||||||||||||||||||||||
Interest |
6,619 | 8,276 | 3,715 | 26,361 | 22,574 | 987 | ||||||||||||||||||
General and administrative |
4,545 | 3,386 | 1,951 | 13,573 | 8,936 | 4,398 | ||||||||||||||||||
Property expenses |
307 | 347 | 209 | 1,239 | 1,547 | 533 | ||||||||||||||||||
Depreciation and amortization |
7,936 | 6,468 | 3,782 | 32,523 | 19,516 | 5,428 | ||||||||||||||||||
Provision for impairment of real estate |
664 | 1,849 | 151 | 961 | 2,377 | 1,298 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total expenses |
20,071 | 20,326 | 9,808 | 74,657 | 54,950 | 12,644 | ||||||||||||||||||
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|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Income (loss) before gain on dispositions of real estate |
5,661 | (123 | ) | 288 | 27,940 | (452 | ) | 2,879 | ||||||||||||||||
Gain on dispositions of real estate, net |
| 1,232 | 295 | | 6,748 | 871 | ||||||||||||||||||
|
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|
|
|
|
|
|
|
|
|
|
|||||||||||||
Net income |
5,661 | $ | 1,109 | $ | 583 | 27,940 | $ | 6,296 | $ | 3,750 | ||||||||||||||
|
|
|
|
|
|
|
|
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Less: net income attributable to non-controlling interests |
(1,741 | ) | (8,590 | ) | ||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Net income attributable to stockholders |
$ | 3,920 | $ | 19,350 | ||||||||||||||||||||
|
|
|
|
|||||||||||||||||||||
Pro forma weighted average common shares outstanding basic |
40,976,901 | 40,976,901 | ||||||||||||||||||||||
Pro forma weighted average common shares outstanding diluted |
59,169,398 | 56,169,398 | ||||||||||||||||||||||
Pro forma basic earnings per share |
$ | 0.10 | $ | 0.47 | ||||||||||||||||||||
Pro forma diluted earnings per share |
$ | 0.10 | $ | 0.47 |
(1) | Includes $0.5 million, $0.2 million, $1.1 million and $0.4 million of contingent rent (based on a percentage of the tenants gross sales at the leased property) during the three months ended March 31, 2018 and 2017, the year ended December 31, 2017 and the period from March 30, 2016 (commencement of operations) to December 31, 2016. |
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Balance Sheet Data:
As of March 31, | As of December 31, | |||||||||||||||
(In thousands) |
2018
(Pro forma) (Unaudited) |
2018
(Historical) (Unaudited) |
2017
(Historical) |
2016
(Historical) |
||||||||||||
Real estate investments, at cost |
$ | 1,203,348 | $ | 985,548 | $ | 932,174 | $ | 455,008 | ||||||||
Total real estate investments, net |
1,172,298 | 954,238 | 907,349 | 448,887 | ||||||||||||
Net investments |
1,175,005 | 962,830 | 914,247 | 452,546 | ||||||||||||
Cash and cash equivalents |
158,646 | 1,842 | 7,250 | 1,825 | ||||||||||||
Restricted cash |
559 | 9,329 | 12,180 | 10,097 | ||||||||||||
Total assets |
1,352,631 | 986,593 | 942,220 | 466,288 | ||||||||||||
Secured borrowings, net of deferred financing costs |
510,138 | 510,138 | 511,646 | 272,823 | ||||||||||||
Notes payable to related party |
| 225,000 | 230,000 | | ||||||||||||
Intangible lease liabilities, net |
12,848 | 12,425 | 12,321 | 16,385 | ||||||||||||
Total liabilities |
529,263 | 753,840 | 760,818 | 291,638 | ||||||||||||
Members equity |
| 232,753 | 181,402 | 174,650 | ||||||||||||
Total equity |
823,368 | | | |
Other Data:
Three Months Ended March 31, |
Year Ended December 31, |
Period from
March 30, 2016 (Commencement of Operations) to December 31, 2016 (Historical ) |
||||||||||||||||||||||
(In thousands) |
2018
(Pro forma) (Unaudited) |
2018
(Historical) (Unaudited) |
2017
(Historical) (Unaudited) |
2017
(Pro forma) (Unaudited) |
2017
(Historical) |
|||||||||||||||||||
FFO(1) |
$ | 14,260 | $ | 8,193 | $ | 4,221 | $ | 61,421 | $ | 21,438 | $ | 9,605 | ||||||||||||
AFFO(1) |
$ | 13,864 | $ | 7,428 | $ | 3,836 | $ | 58,561 | $ | 20,337 | $ | 8,579 | ||||||||||||
EBITDA(2) |
$ | 20,246 | $ | 15,883 | $ | 8,087 | $ | 86,985 | $ | 48,547 | $ | 10,242 | ||||||||||||
EBITDAre(2) |
$ | 20,910 | $ | 16,500 | $ | 7,943 | $ | 87,796 | $ | 44,176 | $ | 10,669 |
As of March 31, | As of December 31, | |||||||||||||||
($ In thousands) |
2018
(Pro forma) (Unaudited) |
2018
(Actual) (Unaudited) |
2017
(Historical) |
2016
(Historical) |
||||||||||||
Net debt(3) |
$ | 362,224 | $ | 744,028 | $ | 745,686 | $ | 278,609 | ||||||||
Number of properties in investment portfolio |
607 | 530 | 508 | 344 | ||||||||||||
Occupancy at period end |
99.5 | % | 99.1 | % | 98.8 | % | 96.8 | % |
(1) | FFO and AFFO are non-GAAP financial measures. For definitions of FFO and AFFO, and reconciliations of these metrics to net income, the most directly comparable GAAP financial measure, and a statement of why our management believes the presentation of these metrics provides useful information to investors and any additional purposes for which management uses these metrics, see Managements Discussion and Analysis of Financial Condition and Results of OperationsNon-GAAP Financial Measures. |
(2) | EBITDA and EBITDAre are non-GAAP financial measures. For definitions of EBITDA and EBITDAre, and reconciliations of these metrics to net income, the most directly comparable GAAP financial measure, and a statement of why our management believes the presentation of these metrics provides useful information to investors and any additional purposes for which management uses these metrics, see Managements Discussion and Analysis of Financial Condition and Results of OperationsNon-GAAP Financial Measures. |
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(3) | Net debt is a non-GAAP financial measure. For a definition of net debt and a reconciliation of this metric to total debt, the most directly comparable GAAP financial measure, and a statement of why our management believes the presentation of this metric provides useful information to investors and any additional purposes for which management uses this metric, see Managements Discussion and Analysis of Financial Condition and Results of OperationsNon-GAAP Financial Measures. |
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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read together with the Selected Consolidated Historical and Pro Forma Financial and Other Data, Business and Properties and consolidated financial statements and related notes that are included elsewhere in this prospectus. Where appropriate, the following discussion includes the effects of the completion of the formation transactions, this offering, the concurrent Eldridge private placement and the use of the net proceeds therefrom on a pro forma basis. These effects are reflected in our pro forma consolidated financial statements included elsewhere in this prospectus. This discussion contains forward-looking statements based upon our current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Risk Factors, Special Note Regarding Forward-Looking Statements or in other parts of this prospectus.
Overview
We are an internally managed real estate company that acquires, owns and manages primarily single-tenant properties that are net leased on a long-term basis to middle-market companies operating service-oriented or experience-based businesses. We have a diversified portfolio that focuses on properties leased to tenants in businesses such as restaurants (including quick service and casual and family dining), car washes, automotive services, medical services, convenience stores, entertainment, early childhood education and health and fitness. We seek to acquire and lease freestanding, single-tenant commercial real estate facilities where a tenant services its customers and conducts activities that are essential to the generation of its sales and profits.
Upon completion of the formation transactions, this offering and the concurrent Eldridge private placement, we expect our operations to be carried out through our operating partnership, Essential Properties, L.P., a Delaware limited partnership and our operating partnership. Essential Properties OP G.P., LLC, one of our wholly-owned subsidiaries, will be the sole general partner and own a 1.0% general partner interest in our operating partnership. We will hold a 68.3% limited partnership interest in the operating partnership, EPRT Holdings, LLC, which is principally owned by Eldridge and certain members of our management team, will hold a 30.2% limited partnership interest in the operating partnership and Eldridge will hold a 0.5% limited partnership interest in the operating partnership (based on the mid-point of the price range set forth on the front cover of this prospectus). See Pricing Sensitivity Analysis. In general, OP units are exchangeable for cash or, at our election, shares of our common stock at a one-to-one ratio. See Description of the Partnership Agreement of Essential Properties, L.P. Substantially all of our real estate is held by our wholly-owned subsidiaries, many of which are special purpose bankruptcy remote entities formed to facilitate the financing of our real estate.
We generally lease our properties to a single tenant on a triple-net long-term basis, and we generate our cash from operations primarily through the monthly lease payments, or base rent, we receive from the tenants that occupy our properties. As of March 31, 2018, we had a portfolio of 530 properties that was diversified by tenant, industry and geography, had annualized base rent of $75.7 million and was 99.1% occupied.
Substantially all of our leases provide for periodic contractual rent escalations. As of March 31, 2018, leases contributing 95.4% of our annualized base rent provided for increases in future annual base rent, generally ranging from 1.0% to 4.0% annually, with a weighted average annual escalation equal to 1.5% of base rent. As of March 31, 2018, leases contributing 93.8% of annualized base rent were triple-net, which means that our tenant is responsible for all operating expenses, such as
80
maintenance, insurance, utility and tax expense, related to the leased property (including any increases in those costs that may occur as a result of inflation). Our remaining leases were double-net, where the tenant is responsible for certain expenses, such as taxes and insurance, but we retain responsibility for other expenses, generally related to maintenance and structural component replacement that may be required on such leased properties in the future. Also, we will incur property-level expenses associated with our vacant properties and we occasionally incur nominal property-level expenses that are not paid by our tenants, such as the costs of periodically making site inspections of our properties. We do not currently anticipate incurring significant capital expenditures or property costs. Since our properties are single-tenant properties, all of which are under long-term leases, it is not necessary for us to perform any significant ongoing leasing activities on our properties. As of March 31, 2018, the weighted average remaining term of our leases was 13.8 years (based on annualized base rent), with only 4.4% of our annualized base rent attributable to leases expiring prior to January 1, 2023.
As of March 31, 2018, 64.8% of our annualized base rent was attributable to master leases, where we have acquired multiple properties from a seller and leased them back to the seller under a master lease. Since properties are generally leased under a master lease on an all or none basis, the structure prevents a tenant from cherry picking locations, where it unilaterally gives up underperforming properties while maintaining its leasehold interest in well-performing properties.
As of March 31, 2018, our leases had a weighted average remaining lease term of 13.8 years (based on annualized base rent), excluding renewal options that have not been exercised, which are exercisable at the option of our tenants upon expiration of their base lease term. Our leases providing for tenant renewal options generally provide for periodic contractual rent escalations during any renewed term that are similar to those applicable during the initial term of the lease.
As more fully described herein, as of March 31, 2018, on a pro forma basis, we had approximately $520.9 million principal balance of outstanding indebtedness. Based upon the mid-point of the price range set forth on the front cover of this prospectus, as of March 31, 2018, on a pro forma basis, we also had approximately $158.6 million of cash and cash equivalents on hand. Additionally, upon completion of this offering, we expect to have a $300 million revolving credit facility. The purchasers of common stock in this offering, EPRT Holdings, LLC, Eldridge and our directors, executive officers and other employees as a group (assuming vesting of all equity awards and the exchange by EPRT Holdings, LLC of its OP units for shares of common stock on a one-for-one basis) will own approximately 55.2%, 30.4%, 13.2% and 1.7%, respectively, of our outstanding shares of common stock on a pro forma basis (in each case, based on the mid-point of the price range set forth on the front cover of this prospectus). See Pricing Sensitivity Analysis.
We intend to elect to qualify as a REIT for federal income tax purposes commencing with our taxable year ending December 31, 2018. We believe that our organization and operations will allow us to qualify as a REIT for federal income tax purposes commencing with such taxable year, and we intend to continue operating in such a manner.
Critical Accounting Policies and Estimates
Our accounting policies are determined in accordance with GAAP. The preparation of our financial statements requires us to make estimates and assumptions that are subjective in nature and, as a result, our actual results could differ materially from our estimates. Estimates and assumptions include, among other things, subjective judgments regarding the fair values and useful lives of our properties for depreciation and lease classification purposes, the collectability of receivables and asset impairment analysis. Set forth below are the more critical accounting policies that require management judgment and estimates in the preparation of our consolidated financial statements.
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Real Estate Investments
Investments in real estate are carried at cost less accumulated depreciation and impairment losses, if any. The cost of investments in real estate reflects their purchase price or development cost. We evaluate each acquisition transaction to determine whether the acquired assets meet the definition of a business. Under ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business , an acquisition does not qualify as a business when there is no substantive process acquired or 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 are 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. Improvements and replacements are capitalized when they extend the useful life or improve the productive capacity of the asset. Costs of repairs and maintenance 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, site improvements and buildings. Intangible assets may include the value of in-place leases and above- and below-market leases and other identifiable intangible assets or liabilities based on lease or property specific characteristics.
We may incur various costs in the leasing and development of our properties. Amounts paid to tenants that incentivize them to extend or otherwise amend an existing lease or to sign a new lease agreement are capitalized to lease incentive on our consolidated balance sheets. Tenant improvements are capitalized to building and improvements within our consolidated balance sheets. Costs incurred which are directly related to properties under development, which include preconstruction costs essential to the development of the property, development costs, construction costs, interest costs and real estate taxes and insurance, are capitalized during the period of development as construction in progress. After the determination is made to capitalize a cost, it is allocated to the specific component of a project that benefited. Determination of when a development project commences and capitalization begins, and when a development project has reached substantial completion and is available for occupancy and capitalization must cease, involves a degree of judgment.
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 tenants 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. Factors we consider in this analysis include an estimate of the carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses, and estimates of lost rentals at market rates during the expected lease-up periods, which primarily range from six to 12 months. The fair value of above- 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.
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In making estimates of fair values for purposes of allocating purchase price, we utilize a number of sources, including real estate valuations prepared by independent valuation firms. We also consider 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 tenants business. We also 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 acquired. We use the information obtained as a result of its pre-acquisition due diligence as part of its consideration of the accounting standard governing asset retirement obligations and, when necessary, will record an asset retirement obligation as part of the purchase price allocation.
Real estate investments that are intended to be sold are designated as held for sale on the consolidated balance sheets at the lesser of carrying amount or fair value less estimated selling costs when they meet specific criteria to be presented as held for sale. Real estate investments are no longer depreciated when they are classified as held for sale. If the disposal, or intended disposal, of certain real estate investments represents a strategic shift that has had or will have a major effect on our operations and financial results, the operations of such real estate investments would be presented as discontinued operations in the consolidated statements of operations and comprehensive income for all applicable periods.
Depreciation and Amortization
Depreciation is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings and 15 years for site improvements.
Lease incentives are amortized on a straight-line basis as a reduction of rental income over the remaining non-cancellable terms of the respective leases. In the event that a tenant terminates its lease, the unamortized portion of the lease incentive is charged to rental revenue.
Construction in progress is not depreciated until the development has reached substantial completion. Tenant improvements are depreciated over the non-cancellable term of the related lease or their estimated useful life, whichever is shorter.
Capitalized above-market lease values are amortized on a straight-line basis as a reduction of rental revenue over the remaining non-cancellable terms of the respective leases. Capitalized below-market lease values are accreted on a straight-line basis as an increase to rental revenue over the remaining non-cancellable terms of the respective leases including any below-market fixed-rate renewal option periods.
Capitalized above-market ground lease values are accreted as a reduction of property expenses over the remaining terms of the respective leases. Capitalized below-market ground lease values are amortized as an increase to property expenses over the remaining terms of the respective leases and any expected below-market renewal option periods where renewal is considered probable.
The value of in-place leases, exclusive of the value of above-market and below-market lease intangibles, is amortized to depreciation and amortization expense on a straight-line basis expense over the remaining periods of the respective leases.
In the event that a tenant terminates its lease, the unamortized portion of each intangible, including in-place lease values, is charged to depreciation and amortization expense, while above- and below-market lease adjustments are recorded within rental revenue in the consolidated statement of operations and comprehensive income.
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Direct Financing Lease Receivables
Certain of our real estate investment transactions are accounted for as direct financing leases. We record the direct financing lease receivables at their net investment, determined as the aggregate minimum lease payments and the estimated non-guaranteed residual value of the leased property less unearned income. The unearned income is recognized over the life of the related lease contracts so as to produce a constant rate of return on the net investment in the asset. Our investment in direct financing lease receivables is reduced over the applicable lease term to its non-guaranteed residual value by the portion of rent allocated to the direct financing lease receivables.
If and when an investment in direct financing lease receivables is identified for impairment evaluation, we will apply the guidance in both FASB Accounting Standards Codification (ASC) 310, Receivables (ASC 310), and ASC 840, Leases (ASC 840). Under ASC 310, the lease receivable portion of the net investment in a direct financing lease receivable is evaluated for impairment when it becomes probable we, as the lessor, will be unable to collect all rental payments associated with our investment in the direct financing lease receivable. Under ASC 840, we review the estimated non-guaranteed residual value of a leased property at least annually. If the review results in a lower estimate than had been previously established, we determine whether the decline in estimated non-guaranteed residual value is other than temporary. If a decline is judged to be other than temporary, the accounting for the transaction is revised using the changed estimate and the resulting reduction in the net investment in direct financing lease receivables is recognized by us as a loss in the period in which the estimate is changed.
Impairment of Long Lived Assets
If circumstances indicate that the carrying value of a property may not be recoverable, we review the asset for impairment. This review is based on an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the propertys use and eventual disposition. These estimates consider factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a property, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property for properties to be held and used. For properties held for sale, the impairment loss is the adjustment to fair value less estimated cost to dispose of the asset. Impairment assessments have a direct impact on net income because recording an impairment loss results in an immediate negative adjustment to our consolidated statements of operations and comprehensive income.
Allowance for Doubtful Accounts
We continually review receivables related to rent and unbilled rent receivables and determine collectability by taking into consideration the tenants payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectability of a receivable is in doubt, the accounts receivable and straight-line rent receivable balances are reduced by an allowance for uncollectible accounts on the consolidated balance sheets or a direct write-off of the receivable is recorded in the consolidated statements of operations. The provision for doubtful accounts is included in property expenses in our consolidated statements of operations and comprehensive income. If the accounts receivable balance or straight-line rent receivable balance is subsequently deemed to be uncollectible, such receivable amounts are written-off to the allowance for doubtful accounts.
Revenue Recognition
Our rental revenue is primarily related to rent received from tenants. Rent from tenants is recorded in accordance with the terms of each lease on a straight-line basis over the non-cancellable
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initial term of the lease from the later of the date of the commencement of the lease or the date of acquisition of the property subject to the lease. Rental revenue recognition begins when the tenant controls the space through the term of the related lease. Because substantially all of the leases provide for rental increases at specified intervals, we record a straight-line rent receivable and recognize revenue on a straight-line basis over the expiration of the non-cancellable term of the lease. We take into account whether the collectability of rents is reasonably assured in determining the amount of straight-line rent to record. Rental revenue from leases with contingent rentals is recognized when changes in the factors on which the contingent payments are based actually occur.
We defer rental revenue related to lease payments received from tenants in advance of their due dates. These amounts are presented within accrued liabilities and other payables on our consolidated balance sheets.
Certain properties in our investment portfolio are subject to leases that provide for contingent rent based on a percentage of the tenants gross sales. For these leases, we recognize contingent rental revenue when the threshold upon which the contingent lease payment is based is actually reached.
Income Taxes
During the period presented, we and our subsidiaries included in the consolidated financial statements were treated as disregarded entities for U.S. federal and state income tax purposes, and accordingly, we were not subject to entity-level tax. Therefore, until our issuance of Class A and Class C units in January 2017, our net income flowed through to SCF Funding LLC, our initial sole member, for federal income tax purposes. Following the issuance of Class A and C units, our net income flowed through to Class A and Class C unitholders for federal income tax purposes. Accordingly, no provision or liability for U.S. federal income taxes has been included in the accompanying consolidated financial statements. With regard to state income taxes, we are a taxable entity only in certain states that tax all entities, including partnerships.
We analyze our tax filing positions in all of the U.S. federal, state and local tax jurisdictions where we are required to file income tax returns, as well as for all open tax years in such jurisdictions. We follow a two step process to evaluate uncertain tax positions. Step one, recognition, occurs when an entity concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Step two, measurement, determines the amount of benefit that is more-likely-than-not to be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when the company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. The use of a valuation allowance as a substitute for derecognition of tax positions is prohibited. Our policy is to classify interest in interest expense and penalties in general and administrative expense in the consolidated statements of operations and comprehensive income.
Unit Based Compensation
In 2017, the Company granted unit awards to certain of its employees and managers, as well as non-employees, consisting of units that vest over a multi-year period, subject to the recipients continued service. The Company accounts for unit-based compensation in accordance with ASC 718, Compensation Stock Compensation, which requires that compensation related to all unit-based awards, including restricted member units, be recognized in the financial statements based on their estimated grant-date fair value. The value of unit-based awards is recognized as compensation expense in general and administrative expenses in the accompanying consolidated statements of operations over the requisite service periods, with subsequent remeasurement for any unvested units granted to non-employees. See Note 7. Unit Based Compensation to the Essential Properties Realty
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Trust, Inc. Predecessor Historical Consolidated Financial Statements included elsewhere in this prospectus.
The Company recognizes unit-based compensation using the straight-line method based on the terms of the individual grant.
Variable Interest Entities
The FASB provides guidance for determining whether an entity is a variable interest entity (VIE). VIEs are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. A VIE is required to be consolidated by its primary beneficiary, which is the party that (i) has the power to control the activities that most significantly impact the VIEs economic performance and (ii) has the obligation to absorb losses, or the right to receive benefits, of the VIE that could potentially be significant to the VIE.
We use VIEs for its secured borrowings. We transfer real estate investments and their related leases into a trust and the assets held in the trusts can only be used to settle obligations of the trust. We serve as the servicer for these secured borrowings. The creditors of these trusts have no recourse to us. We issued one secured borrowing during the period from March 30, 2016 (commencement of operations) to December 31, 2016, which is reported as secured borrowings on our consolidated balance sheets and the assets included in the trust are consolidated into our real estate investments as of December 31, 2016. We consolidate the VIEs as we are the primary beneficiary and have power to direct the activities that most significantly impact the economic performance of the VIE.
Recently Issued Accounting Pronouncements
In May 2014, with subsequent updates in 2015, 2016 and 2017, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which establishes a principles-based approach for accounting for revenue from contracts with customers. The standard does not apply to revenue recognition for lease contracts or to the interest income recognized from direct financing receivables, which together represent over 98% of our 2017 revenue. ASU 2014-09 was effective for us on January 1, 2018 with early adoption permitted and allows for full retrospective or modified retrospective methods of adoption. In accordance with our implementation plan for adoption, we have evaluated our revenue streams and identified the very few that fall within the scope of this new accounting standard including any impact to the accounting for sales of real estate assets. We adopted the standard effective January 1, 2018 using the modified retrospective method for transition and did not recognize a cumulative effect adjustment. This new revenue guidance included changes to the accounting for sales of real estate properties; however, based on our analysis, the new standard is not expected to have a material impact on our recognition of real estate sales and resulting recognition of a gain or loss.
In February 2016, the FASB issued Accounting Standards Update 2016-02, Leases (Topic 842), (ASU 2016-02), which amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU 2016-02 requires lessees (applicable to our ground lease and corporate office lease obligations) to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of
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their classification. Leases with a term of 12 months or less may be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. Additionally, the new standard and the new revenue recognition guidance (discussed above) will impact how lessors account for lease executory costs (such as property taxes, common area maintenance and utilities). Under the current lease accounting guidance, these payments made by its tenants to third parties are excluded from lease payments and rental revenue. Upon adoption of the new lease accounting standard in 2019, these lease executory cost payments will be accounted for as activities or costs that are not components of the lease contract. As a result, we may be required to show these payments made by our tenants on a gross basis (for example, both as property tax expense and as corresponding revenue from the tenant who makes the payment directly to the third party) in our consolidated statements of operations and comprehensive income. Although there is not expected to be any impact to net income or cash flows as a result of a gross presentation, such presentation would have the impact of increasing both reported revenues and property expenses. We are continuing to quantify the impact of this potential gross up and will evaluate any ongoing implementation guidance available on this topic. The standard also will require new disclosures within the notes accompanying the consolidated financial statements. ASU 2016-02 supersedes the previous lease standard, Leases (Topic 840). The new guidance requires modified retrospective transition, which requires application of the new guidance at the beginning of the earliest comparative period presented in the year of adoption. The standard will be effective for us on January 1, 2019. We have commenced the process of implementing the new leasing standard and have completed an initial inventory and evaluation of our lease contracts as both a lessee and lessor. Future steps to be completed in 2018 include the identification of changes needed to our processes and systems impacted by the new standard, the implementation of updates and enhancements to our internal control framework, accounting systems and related documentation surrounding our lease accounting processes and the preparation of any additional disclosures that will be required.
In August 2016 and November 2016, the FASB issued ASU 2016-15, Statement of Cash FlowsClassification of Certain Cash Receipts and Cash Payments (ASU 2016-15), and ASU 2016-18, Statement of Cash FlowsRestricted Cash (ASU 2016-18), which addresses classification of certain cash receipts and cash payments, including changes in restricted cash, in the statement of cash flows. The new guidance is effective for reporting periods beginning after December 15, 2017 on a retrospective basis, with early adoption permitted. We have chosen to early adopt this guidance effective March 30, 2016 (commencement of operations).
In October 2016, the FASB issued ASU 2016-17, ConsolidationInterests Held through Related Parties That Are under Common Control (ASU 2016-17), which addresses when a reporting entity will need to evaluate if it should consolidate a VIE. The amendments change the evaluation of whether a reporting entity is the primary beneficiary of a VIE by changing how a single decision maker of a VIE treats indirect interests in the entity held through related parties that are under common control with the reporting entity. The new guidance is effective for reporting periods beginning after December 15, 2016, with early adoption permitted. We have adopted this new guidance and this adoption had no material impact to our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, Business CombinationsClarifying the Definition of a Business (ASU 2017-01), which provides new guidance on the evaluation of acquisitions as a business combination or asset acquisition. The update requires entities to evaluate whether all of the fair value of the gross asset acquired is concentrated into a single identifiable asset, which would indicate that the set is not a business. This guidance is effective prospectively for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted for transactions that occurred before the issuance date or effective date of the standard if the transactions were not reported in financial statements that have been issued or made
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available for issuance. The adoption of ASU 2017-01 will result in less real estate acquisitions qualifying as business acquisitions and, accordingly, acquisition costs for those acquisitions that are not businesses will be capitalized rather than expensed. We have early adopted this guidance.
Factors that May Influence Our Operating Results
Rental Revenue
Our revenues are generated predominantly from receipt of rental revenue. Our ability to grow rental revenue will depend primarily on our ability to acquire additional properties and realize the rental escalations built into our leases. As of March 31, 2018, leases contributing 95.4% of our annualized base rent provided for increases in future annual base rent, ranging from 1.0% to 4.0% annually, with a weighted average annual escalation equal to 1.5% of base rent. Generally, our rent escalators increase rent at specified dates by a fixed percentage, typically 1.0% to 4.0% per year. Although many of our rent escalators increase rent at a fixed amount on fixed dates, approximately 13.4% of our rent escalators are based on an increase in the CPI over a specified period. Therefore, during periods of low inflation, small increases in the CPI will result in limited increases in rental revenue from such leases. When the CPI decreases or does not change over the relevant period, our rental revenue from such leases is not reduced and will remain the same.
Without giving effect to the exercise of tenant renewal options, the weighted average remaining term of our leases as of March 31, 2018 was 13.8 years (based on annualized base rent). Approximately 4.4% of our leases (based on annualized base rent) as of March 31, 2018 will expire prior to January 1, 2023. See Business and PropertiesOur Real Estate Investment PortfolioLease Expirations. The stability of the rental revenue generated by our properties depends principally on our tenants ability to pay rent and our ability to collect rents, renew expiring leases or re-lease space upon the expiration or other termination of leases, lease currently vacant properties and maintain or increase rental rates at our leased properties. Adverse economic conditions, particularly those that affect the markets in which our properties are located, or downturns in our tenants industries could impair our tenants ability to meet their lease obligations to us and our ability to renew expiring leases or re-lease space. In particular, the bankruptcy of one or more of our tenants could adversely affect our ability to collect rents from such tenant and maintain our portfolios occupancy.
Our ability to grow revenue will depend, to a significant degree, on our ability to acquire additional properties. We primarily focus on opportunities to provide capital to middle-market companies that we determine have attractive credit characteristics and stable operating histories, but lack the access to capital that larger companies often have. We believe our senior management teams reputation, in-depth market knowledge and extensive network of long-standing relationships in the net lease industry provides us access to an ongoing pipeline of attractive investment opportunities.
Our Triple-Net Leases
We generally lease our properties to tenants pursuant to long-term, triple-net leases that require the tenant to pay all operating expenses, such as maintenance, insurance, utility and tax expense, related to the leased property. As of March 31, 2018, leases contributing 93.8% of our annualized base rent were triple-net. Occasionally, we have entered into a lease pursuant to which we retain responsibility for the costs of structural repairs and maintenance. Although these instances are infrequent and have not historically resulted in significant costs to us, an increase in costs related to these responsibilities could negatively influence our operating results. Similarly, an increase in the vacancy rate of our portfolio would increase our costs, as we would be responsible for costs that our tenants are currently required to pay. As of March 31, 2018, master leases, where multiple properties
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are leased to a single tenant on an all or none basis and which contain cross-default provisions, contributed 64.8% of our annualized base rent. We strongly prefer master leases, and we seek to enter into master leases whenever appropriate to prevent a tenant from unilaterally giving up underperforming properties while maintaining well performing properties.
Interest Expense
As of March 31, 2018, on a pro forma basis, we had approximately $510.1 million of indebtedness, with a weighted average annual interest rate of 4.35% and a weighted average maturity of 2047, consisting principally of amounts outstanding under our Master Trust Funding Program. Our initial fixed-rate debt structure will provide us with a stable and predictable cash requirement related to our debt service. We amortize on a non-cash basis the deferred financing costs associated with our fixed-rate debt to interest expense using the effective interest rate method over the terms of the related notes. For the year ended December 31, 2017, non-cash interest expense recognized on our fixed rate debt to be outstanding on a pro forma basis totaled $2.6 million. For the three months ended March 31, 2018, non-cash interest expense recognized on our fixed rate debt to be outstanding on a pro forma basis totaled $0.8 million. Any changes to our debt structure, including borrowings under the revolving credit facility that we expect to have on a pro forma basis or debt financing associated with property acquisitions, could materially influence our operating results depending on the terms of any such indebtedness. Our Master Trust Funding Program (which constituted 100% of our outstanding indebtedness as of March 31, 2018 on a pro forma basis) is partially amortizing and provides for scheduled principal payments.
General and Administrative Expenses
General and administrative expenses include employee compensation costs, professional fees, consulting, portfolio servicing costs and other general and administrative expenses. As a public company, we estimate our annual general and administrative expenses will increase by approximately $5.8 million to $6.1 million, which amounts include, among other things, non-cash compensation expense and $1.2 million to $1.5 million due to increased legal, insurance, accounting and other expenses related to corporate governance, SEC reporting and other compliance matters. In addition, while we expect that our general and administrative expenses will continue to rise in some measure as our portfolio grows, we expect that such expenses as a percentage of our portfolio will decrease over time due to efficiencies and economies of scale.
Impact of Inflation
Our leases typically contain provisions designed to mitigate the adverse impact of inflation on our results of operations. Since tenants are typically required to pay all property operating expenses, increases in property-level expenses at our leased properties generally do not adversely affect us. However, increased operating expenses at vacant properties and the limited number of properties that are not subject to full triple-net leases could cause us to incur additional operating expense. Additionally, our leases generally provide for rent escalators (see Rental Revenue above) designed to mitigate the effects of inflation over a leases term. However, since some of our leases do not contain rent escalators and many that do limit the amount by which rent may increase, any increase in our rental revenue may not keep up with the rate of inflation.
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Results of Operations
Comparison of the Three Months Ended March 31, 2018 and the Three Months Ended March 31, 2017
The following discussion includes the results of our operations as summarized in the table below:
(Dollar amounts in thousands) |
Three Months Ended
March 31, 2018 |
Three Months Ended
March 31, 2017 |
Change | % | ||||||||||||
Revenues: |
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Rental revenue |
$ | 20,075 | $ | 10,008 | $ | 10,067 | 100.6 | % | ||||||||
Interest income on direct financing lease receivables |
62 | 83 | (21 | ) | (25.3 | )% | ||||||||||
Other revenue |
66 | 5 | 61 | 1,220.0 | % | |||||||||||
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Total revenues |
20,203 | 10,096 | 10,107 | 100.1 | % | |||||||||||
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Expenses: |
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Interest |
8,276 | 3,715 | 4,561 | 122.8 | % | |||||||||||
General and administrative |
3,386 | 1,951 | 1,435 | 73.6 | % | |||||||||||
Property expenses |
347 | 209 | 138 | 66.0 | % | |||||||||||
Depreciation and amortization |
6,468 | 3,782 | 2,686 | 71.0 | % | |||||||||||
Provision for impairment of real estate |
1,849 | 151 | 1,698 | 1,124.5 | % | |||||||||||
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Total expenses |
20,326 | 9,808 | 10,518 | 107.2 | % | |||||||||||
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Income (loss) before gain on dispositions of real estate |
(123 | ) | 288 | (411 | ) | (142.7 | )% | |||||||||
Gains on dispositions of real estate, net |
1,232 | 295 | 937 | 317.6 | % | |||||||||||
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Net income and comprehensive income |
$ | 1,109 | $ | 583 | $ | 526 | 90.2. | % | ||||||||
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Revenues
Rental revenue . Rental revenue increased by $10.1 million to $20.1 million for the three months ended March 31, 2018 as compared to $10.0 million for the three months ended March 31, 2017. The increase in rental revenue was primarily due to our acquisition of 177 properties during the period from April 1, 2017 to December 31, 2017, which provided $8.6 million of additional rental revenue between the comparison periods. Additionally, our acquisition of 28 and 35 properties during the three months ended March 31, 2018 and March 31, 2017, respectively, provided an additional $0.6 million and $1.8 million of rental revenue, respectively, between the comparison periods. These increases in rental revenue were partially offset by a $0.7 million, $0.4 million and approximately $48,000 reduction in rental revenue between comparison periods due to the sale of 40, six and seven properties during the period from April 1, 2017 to December 31, 2017 and the three months ended March 31, 2018 and 2017, respectively.
As of March 31, 2018, 99.1% of our properties were occupied. We regularly review and analyze the operational and financial condition of our tenants and the industries in which they operate in order to identify underperforming properties that we may seek to dispose of in an effort to mitigate risks in our portfolio. As of March 31, 2018, exclusive of two vacant land parcels that we own, five of our properties, representing 0.9% of our portfolio, were vacant and not generating rent, compared to seven vacant properties, representing 1.9% of our portfolio, as of March 31, 2017.
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Interest income on direct financing receivables . Interest income on direct financing receivables decreased by approximately $21,000 to approximately $0.1 million for the three months ended March 31, 2018, primarily due to the termination of two direct financing leases during the period from April 1, 2017 to December 31, 2017.
Other revenue . Other revenue increased by approximately $61,000 to approximately $0.1 million for the three months ended March 31, 2018. The increase in other revenue was primarily due to an increase in interest income related to a higher average daily balance in interest bearing bank accounts and new expense reimbursement income on two properties that were acquired in September 2017.
Expenses
Interest . Interest expense increased by $4.6 million to $8.3 million for the three months ended March 31, 2018 as compared to $3.7 million for the three months ended March 31, 2017. The increase in interest expense was primarily due to $2.5 million of additional interest expense from having $248.1 million of notes issued under our Master Trust Funding Program in July 2017 outstanding during the three months ended March 31, 2018, $1.8 million of additional interest expense on $98.0 million of additional related party debt issued to finance acquisitions and $0.2 million of additional non-cash interest expense from the amortization of deferred financing costs.
General and administrative. General and administrative expenses increased $1.4 million to $3.4 million for the three months ended March 31, 2018 as compared to $2.0 million for the three months ended March 31, 2017. This increase in general and administrative expenses was primarily due to the increased costs required to support our larger real estate investment portfolio during the three months ended March 31, 2018.
Property expenses . Our leases are generally triple-net and provide that the tenant is responsible for the payment of all property-level expenses, such as maintenance, insurance, utility and tax expense, related to the leased property. Therefore, we are generally not responsible for operating costs related to the properties, unless a property is not subject to a triple-net lease or is vacant. Property expenses increased by $0.1 million to $0.3 million for the three months ended March 31, 2018 as compared to $0.2 million for the three months ended March 31, 2017. The increase in property costs was primarily due to an increase in loss on uncollectible accounts of approximately $52,000, reimbursable property expenses of $18,000 on two properties that were acquired during September 2017 and insurance expense for our vacant properties of approximately $9,000.
Depreciation and amortization . Depreciation and amortization expense relates primarily to depreciation on the properties and improvements we own and to amortization of the related lease intangibles. Depreciation and amortization expense increased by $2.7 million to $6.5 million for the three months ended March 31, 2018 as compared to $3.8 million for the three months ended March 31, 2017. The increase during the three months ended March 31, 2018 was due to the inclusion of three months of depreciation and amortization expense for properties acquired during the period from April 1, 2017 to December 31, 2017, which added $2.4 million of additional depreciation and amortization expense, $0.6 million of additional depreciation and amortization expense recorded during the three months ended March 31, 2018 on properties that were acquired during the three months ended March 31, 2017 and $0.2 million of additional depreciation recorded on properties that were acquired during the three months ended March 31, 2018. These increases were partially offset by a reduction of $0.5 million of depreciation and amortization expense on 46 properties that we disposed during the period from April 1, 2017 to March 31, 2018.
Provision for impairment of real estate . Impairment charges on real estate investments were $1.8 million and $0.2 million for the three months ended March 31, 2018 and 2017, respectively.
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During the three months ended March 31, 2018, we recorded a provision for impairment of real estate at seven of our real estate investments compared to two real estate investments during the three months ended March 31, 2017. We strategically seek to identify non-performing properties that we may re-lease or dispose of in an effort to improve our returns and manage risk exposure. An increase in vacancy associated with our disposition or re-leasing strategies may trigger impairment charges when the expected future cash flows from the properties from sale or re-lease are less than their net book value.
Gain on dispositions of real estate, net. Gain on dispositions of real estate, net, increased by $0.9 million to $1.2 million for the three months ended March 31, 2018 as compared to $0.3 million for the three months ended March 31, 2017. The increase in gain on dispositions of real estate was primarily due to our disposition of six real estate properties at more favorable prices during the three months ended March 31, 2018 compared to our disposition of seven real estate properties during the three months ended March 31, 2017.
Comparison of the Year Ended December 31, 2017 and the Period From March 30, 2016 (Commencement of Operations) to December 31, 2016
The following discussion includes the results of our operations as summarized in the table below:
(Dollar amounts in thousands) |
Year Ended
December 31, 2017 |
Period from
March 30, 2016 (Commencement of Operations) to December 31, 2016 |
Change | % | ||||||||||||
Revenues: |
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Rental revenue |
$ | 53,373 | $ | 15,271 | $ | 38,102 | 249.5 | % | ||||||||
Interest income on direct financing lease receivables |
293 | 161 | 132 | 82.0 | % | |||||||||||
Other revenue |
832 | 91 | 741 | 814.3 | % | |||||||||||
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Total revenues |
54,498 | 15,523 | 38,975 | 251.1 | % | |||||||||||
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Expenses: |
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Interest |
22,574 | 987 | 21,587 | 2,187.1 | % | |||||||||||
General and administrative |
8,936 | 4,398 | 4,538 | 103.2 | % | |||||||||||
Property expenses |
1,547 | 533 | 1,014 | 190.2 | % | |||||||||||
Depreciation and amortization |
19,516 | 5,428 | 14,088 | 259.5 | % | |||||||||||
Provision for impairment of real estate |
2,377 | 1,298 | 1,079 | 83.1 | % | |||||||||||
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Total expenses |
54,950 | 12,644 | 42,306 | 334.6 | % | |||||||||||
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Income (loss) before gain on dispositions of real estate |
(452 | ) | 2,879 | (3,331 | ) | (115.7 | )% | |||||||||
Gain on dispositions of real estate, net |
6,748 | 871 | 5,877 | 674.7 | % | |||||||||||
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Net income and comprehensive income |
$ | 6,296 | $ | 3,750 | $ | 2,546 | 67.9 | % | ||||||||
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Revenues
For the year ended December 31, 2017, approximately 98.5% of our revenues were attributable to long-term leases. Total revenues increased by $39.0 million to $54.5 million for the year ended December 31, 2017 as compared to $15.5 million for the period from March 30, 2016 (commencement of operations) to December 31, 2016. The increase in total revenues was due to the changes in the individual components of total revenues described below.
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Rental revenue. Rental revenue increased by $38.1 million to $53.4 million for the year ended December 31, 2017 as compared to $15.3 million for the period from March 30, 2016 (commencement of operations) to December 31, 2016. The increase in rental revenue was primarily due to our acquisition of 212 properties for $534.8 million during the year ended December 31, 2017, which provided $17.6 million of additional rental revenue between the comparison periods, contractual rent escalations and the inclusion of a full year of operations from properties acquired during the period from March 30, 2016 (commencement of operations) to December 31, 2016, which contributed $20.5 million of additional rental revenue between the comparison periods.
As of December 31, 2017, 98.8% of our properties were occupied. We regularly review and analyze the operational and financial condition of our tenants and the industries in which they operate in order to identify underperforming properties that we may seek to dispose of in an effort to mitigate risks in our portfolio. As of December 31, 2017, exclusive of two vacant land parcels that we own, six of our properties, representing 1.2% of our portfolio, were vacant and not generating rent, compared to 11 vacant properties, representing 3.2% of our portfolio, as of December 31, 2016.
Interest income on direct financing receivables . Interest income on direct financing receivables increased by $0.1 million to $0.3 million for the year ended December 31, 2017, as compared to $0.2 million for the period from March 30, 2016 (commencement of operations) to December 31, 2016. The increase in interest income on direct financing receivables was due to the inclusion of a full year of operations from our eight investments in direct financing receivables acquired during the period from March 30, 2016 (commencement of operations) to December 31, 2016 (net of disposition or termination of two direct financing leases during the year ended December 31, 2017).
Other revenue . Other revenue increased by $0.7 million to $0.8 million for the year ended December 31, 2017, as compared to $0.1 million for the period from March 30, 2016 (commencement of operations) to December 31, 2016. The increase in other revenue was primarily due to the receipt of $0.7 million of lease termination fees from former tenants during the year ended December 31, 2017.
Expenses
Interest . Interest expense increased by $21.6 million to $22.6 million for the year ended December 31, 2017 as compared to $1.0 million for the period from March 30, 2016 (commencement of operations) to December 31, 2016. The increase in interest expense was primarily due to $11.8 million of additional interest expense from having $280.8 million of notes issued under our Master Trust Funding Program in December 2016 outstanding for a full year, $8.0 million of additional interest expense on debt issued to finance acquisitions during the year ended December 31, 2017 and $1.8 million of additional non-cash interest expense from the amortization of deferred financing costs. During the year ended December 31, 2017, we issued an additional $248.1 million of notes under our Master Trust Funding Program and had net borrowings of $230.0 million through short-term notes with related parties.
General and administrative. General and administrative expenses increased $4.5 million to $8.9 million for the year ended December 31, 2017 as compared to $4.4 million for the period from March 30, 2016 (commencement of operations) to December 31, 2016. This increase in general and administrative expenses was primarily due to the inclusion of a full year of operations and increased costs required to support our larger real estate investment portfolio during the year ended December 31, 2017.
Property expenses . Property expenses increased by $1.0 million to $1.5 million for the year ended December 31, 2017 as compared to $0.5 million for the period from March 30, 2016 (commencement of operations) to December 31, 2016. The increase in property costs was due to the
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inclusion of a full year of operations and related property expenses for our vacant properties during the year ended December 31, 2017, partially offset by reduced property expenses due to a net four property decrease in our total number of vacant properties during the year ended December 31, 2017.
Depreciation and amortization . Depreciation and amortization expense increased by $14.1 million to $19.5 million for the year ended December 31, 2017 as compared to $5.4 million for the period from March 30, 2016 (commencement of operations) to December 31, 2016. The increase during the year ended December 31, 2017 was due to the inclusion of a full year of operations and related depreciation and amortization expense from properties acquired during the period from March 30, 2016 (commencement of operations) to December 31, 2016, which added $8.6 million of additional depreciation and amortization expense, and $5.5 million of additional depreciation and amortization expense recorded on the 212 properties that we acquired during the year ended December 31, 2017.
Provision for impairment of real estate . Impairment charges on real estate investments were $2.4 million and $1.3 million for the year ended December 31, 2017 and the period from March 30, 2016 (commencement of operations) to December 31, 2016, respectively. During the year ended December 31, 2017, we recorded a provision for impairment of real estate at nine of our real estate investments, compared to seven real estate investments during the period from March 30, 2016 (commencement of operations) to December 31, 2016.
Gain on dispositions of real estate, net. Gain on dispositions of real estate, net, increased by $5.9 million to $6.7 million for the year ended December 31, 2017 as compared to $0.9 million for the period from March 30, 2016 (commencement of operations) to December 31, 2016. The increase in gain on dispositions of real estate was primarily due to our disposition of 47 real estate properties during the year ended December 31, 2017 compared to our disposition of 17 properties during the period from March 30, 2016 (commencement of operations) to December 31, 2016.
Indebtedness to be Outstanding after this Offering
As of March 31, 2018, on a pro forma basis, we had an approximately $520.9 million principal balance outstanding of long-term debt. The following table sets forth as of March 31, 2018 our long-term indebtedness outstanding on a pro forma basis:
Pro Forma
Amount Outstanding (in thousands) |
Annual
Interest Rate |
Maturity |
Balloon
Payment due prior to Maturity (in thousands) |
|||||||||||||
$300 million unsecured revolving credit facility(1) |
$ | | Variable | June 2022 | $ | | ||||||||||
Master Trust Funding Program(2) amortizing mortgage notes: |
||||||||||||||||
Series 2016-1 Class A |
258,175 | 4.51% | Nov 2046 | |||||||||||||
Series 2016-1 Class B |
17,244 | 4.51% | Nov 2046 | |||||||||||||
Series 2017-1 Class A |
229,782 | 4.16% | June 2047 | |||||||||||||
Series 2017-1 Class B |
15,669 | 4.16% | June 2047 | |||||||||||||
|
|
|||||||||||||||
Total principal outstanding |
520,870 | |||||||||||||||
Less: unamortized deferred financing costs |
(10,732 | ) | ||||||||||||||
|
|
|||||||||||||||
Total |
$ | 510,138 | ||||||||||||||
|
|
(1) | Upon the completion of this offering, we expect to have a $300 million unsecured revolving credit facility. |
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(2) | Our Master Trust Funding Program subjects us to various covenants. See Description of Certain DebtMaster Trust Funding Program. As of March 31, 2018, we were in material compliance with the covenants contained in our Master Trust Funding Program. |
We primarily use long-term, fixed-rate debt to finance our properties on a match-funded basis. In general, the obligor of our property-level debt is a special purpose entity that holds the real estate and other collateral securing the indebtedness. We seek to use property-level financing that bears interest at an annual rate less than the annual rent on the related lease(s) and that matures prior to the expiration of such lease(s). As of March 31, 2018, on a pro forma basis, we had approximately $520.9 million principal balance of outstanding indebtedness with a weighted average annual interest rate of 4.35% and a weighted average maturity of 2047. Most of this debt is partially amortizing and requires a balloon payment at maturity. We can provide no assurance that we will be able to refinance our indebtedness as it matures with replacement debt financing on similar terms or at all, should we choose to do so, or that we will be able to otherwise repay indebtedness at maturity. Our ability to refinance debt will depend upon many factors, including the then current value of the property securing the indebtedness to be refinanced and the amount of debt financing lenders are willing to provide, expressed as a percentage of the securing propertys value.
Scheduled debt payments as of March 31, 2018 (on a pro forma basis) are as follows:
Year |
Scheduled
Principal Amortization |
Scheduled
Balloon Payments |
Total | |||||||||
(in thousands) | ||||||||||||
2018 (remainder of year) |
5,750 | | 5,750 | |||||||||
2019 |
8,009 | | 8,009 | |||||||||
2020 |
8,419 | | 8,419 | |||||||||
2021 |
8,039 | 259,519 | 267,558 | |||||||||
2022 |
4,292 | | 4,292 | |||||||||
Thereafter |
6,459 | 220,383 | 226,842 | |||||||||
|
|
|
|
|
|
|||||||
Total |
$ | 40,968 | $ | 479,902 | $ | 520,870 | ||||||
|
|
|
|
|
|
We have $180.0 million of debt maturing in 2018 as of March 31, 2018. We expect to fund interest and amortization payments with cash and cash equivalents or net cash from operating activities.
For additional information about our indebtedness see Liquidity and Capital ResourcesDescription of Certain Debt below.
GE Seed Portfolio Same Store Information
On June 16, 2016, we acquired our GE Seed Portfolio, consisting of 262 net leased properties for an aggregate purchase price of $279.8 million (including transaction costs). As of March 31, 2018, our total portfolio consisted of 530 properties with an aggregate purchase price of $981.9 million. After giving effect to the disposition of some assets we acquired in the GE Seed Portfolio, the remaining assets that we acquired in the GE Seed Portfolio constituted approximately 22.8% of the aggregate purchase price of our total portfolio as of March 31, 2018. We generally lease our properties to tenants on a net lease basis, meaning our tenants are responsible for paying property-level expenses. While we are responsible for property-level expenses for our vacant properties, historically these expenses have been immaterial, as the occupancy of our portfolio has been high throughout the period of our ownership.
Although we do not have data for GAAP revenues and property-level expenses of the GE Seed Portfolio for periods prior to our ownership, we present same store information below as to the GE
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Portfolios contractual base rent, occupancy and weighted average lease term. In the absence of GAAP revenues and property-level expenses, we believe this information may be useful to investors by illustrating the consistent nature of the GE Portfolios contractual base rent, occupancy and weighted average lease term, both prior and subsequent to our ownership on a same store basis. Contractual base rent refers to contractually specified cash base rent payable during each of the periods presented. Neither we nor, to our knowledge, the prior owner of the GE Seed Portfolio provided tenants with free rent or any other material tenant inducements during any of the periods presented.
Contractual Base Rent . The following tables set forth information about the contractual base rent due pursuant to leases relating to the properties included in the GE Seed Portfolio that we continued to own on December 31, 2017 and March 31, 2018, respectively.
Contractual Base Rent Due For the Year Ended December 31, | ||||||||||||||||||||
2016 | 2016 (total) | 2017 | Change | |||||||||||||||||
(Dollar amounts in thousands) |
January 1
to June 15 |
June 16
to December 31 |
||||||||||||||||||
GE Seed Portfolio Same Stores (209 properties) |
$ | 8,341 | $ | 9,913 | $ | 18,253 | $ | 18,413 | 0.8 | % |
Contractual Base Rent Due For the Three Months
Ended March 31, |
||||||||||||
(Dollar amounts in thousands) |
2017 | 2018 | Change | |||||||||
GE Seed Portfolio Same Stores (203 properties) |
$ | 4,496 | $ | 4,505 | 0.2 | % |
Contractual base rent does not represent rental revenue computed in accordance with GAAP, and it does not include any participating rent payable (i.e., additional rent payable based upon a tenants gross sales) pursuant to the leases. Contractual base rent does not present actual cash collected by us, nor does it include the impact of any tenant payment defaults. Contractual base rent presented in the tables above equals base rent payable pursuant to leases relating to the properties included in the GE Seed Portfolio that we continued to own on December 31, 2017 and March 31, 2018, and it includes rent payable pursuant to such leases for the portion of 2016 preceding our acquisition of such properties.
GE Seed Portfolio Occupancy . The following table sets forth information about the occupancy of the GE Seed Portfolio as of the dates indicated.
Occupancy | ||||||
June 16, 2016 (Date of
Acquisition) |
December 31,
|
December 31, 2017 |
March 31, 2018 |
|||
94.7% | 96.3% | 97.1% | 97.5% |
The occupancy of our entire portfolio as of June 16, 2016, December 31, 2016, December 31, 2017 and March 31, 2018 was 94.7%, 96.8%, 98.8% and 99.1%, respectively.
GE Seed Portfolio Weighted Average Remaining Lease Term . The following table sets forth information about the weighted average remaining lease term (based on annualized base rent) of the GE Seed Portfolio as of the dates indicated.
Weighted Average Remaining Lease Term
(based on annualized base rent) |
||||||
June 16, 2016 (Date of
Acquisition) |
December 31,
|
December 31, 2017 |
March 31, 2018 |
|||
7.8 years | 7.3 years | 7.3 years | 7.1 years |
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The weighted average remaining lease term of our entire portfolio as of June 16, 2016, December 31, 2016, December 31, 2017 and March 31, 2018 was 7.8 years,10.6 years, 14.0 years and 13.8 years, respectively.
Liquidity and Capital Resources
We will seek to acquire real estate with a combination of debt and equity capital and with cash from operations that is not otherwise distributed to our stockholders. To date our equity capital needed for our real estate investments has been provided to us by Eldridge, our primary institutional capital provider. Through this offering, we intend to add public equity capital to our initial private institutional equity capital to facilitate our growth and provide potential liquidity for our current capital provider. Our debt capital has principally been provided through promissory notes issued to an affiliate of Eldridge. Historically, upon accumulating a sufficiently large and diverse pool of real estate we have generally refinanced this debt through the issuance of long-term, fixed-rate debt through our Master Trust Funding Program. Upon completion of this offering, the concurrent Eldridge private placement and the use of the net proceeds therefrom, we anticipate that we will have repaid all promissory notes due to the Eldridge affiliate, and we expect to have a revolving credit facility that will be available to fund our short-term debt capital requirements. Over time, we may access additional long-term debt capital with future debt issuances through our Master Trust Funding Program. Additionally, future sources of debt capital may include term borrowings from insurance companies, banks and other sources, single-asset mortgage financing and CMBS borrowings, and may offer us the opportunity to lower our cost of funding and further diversify our sources of debt capital. Over time, we may choose to issue preferred equity as a part of our overall funding strategy.
By matching the expected cash inflows from our long-term real estate leases with the expected cash outflows of our long-term fixed-rate debt, we seek to lock in, for as long as is economically feasible, the expected positive difference between our scheduled cash inflows on the leases and the cash outflows on our debt payments. In this way, we seek to reduce the risk that increases in interest rates would adversely impact our results of operations. Although we are not required to maintain a particular leverage ratio, we generally intend to target, over time, a level of net debt (which includes recourse and non-recourse borrowings and any outstanding preferred stock issuance less unrestricted cash) that is less than six times our EBITDAre.
As we grow our real estate portfolio, we intend to manage our long-term debt maturities to reduce the risk that a significant amount of our debt will mature in any single year in the future. As of March 31, 2018, our nearest significant debt maturity was $49.0 million of promissory notes maturing in September 2018. These notes were issued to an affiliate of Eldridge to provide debt capital to fund a portion of our historical acquisition activity. As noted above, upon completion of this offering, the concurrent Eldridge private placement and the use of the net proceeds therefrom, we anticipate that we will have repaid all promissory notes due to the Eldridge affiliate, and we expect to meet our future short-term debt capital requirements with borrowings under the revolving credit facility that we expect to enter into in connection with the completion of this offering. Over time, we may access additional long-term debt capital with future debt issuances. As our outstanding debt matures, we may refinance it as it comes due or choose to repay it using cash and cash equivalents or our revolving credit facility. Management believes that the cash generated by our operations, together with our cash and cash equivalents at March 31, 2018, the revolving credit facility that we expect to enter into in connection with the completion of this offering, and our access to long-term debt capital, will be sufficient to fund our operations for the foreseeable future and allow us to acquire the real estate for which we currently have made commitments.
Our short-term liquidity requirements consist primarily of funds necessary to pay for our operating expenses, including principal and interest payments on our outstanding indebtedness, and the general
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and administrative expenses of servicing our portfolio and operating our business. Since our occupancy level is high and substantially all of our leases are triple-net, we do not currently anticipate making significant capital expenditures or incurring other significant property costs. However, our short-term liquidity requirements include the funding needs associated with three of our properties where we have agreed to reimburse the tenant for certain development costs in exchange for contractually specified rent that generally increases proportionally with our funding. As of March 31, 2018, we had agreed to reimburse development costs in an aggregate amount of approximately $19.2 million. As of March 31, 2018, we had funded approximately $6.9 million of this commitment, and we expect to fund the balance of such commitment by December 31, 2018. In addition, as of June 1, 2018 we had agreed to acquire 51 properties with an aggregate purchase price of $127.4 million. We expect to meet our short-term liquidity requirements primarily from cash and cash equivalents, net cash from operating activities and borrowings under the undrawn revolving credit facility that we expect to have upon the completion of this offering.
Our long-term liquidity requirements consist primarily of funds necessary to acquire additional properties and repay indebtedness. We expect to meet our long-term liquidity requirements through various sources of capital, including borrowings under the undrawn revolving credit facility that we expect to have upon the completion of this offering, net cash from operating activities, future financings, working capital, proceeds from select sales of our properties and other secured and unsecured borrowings (including potential issuances under our Master Trust Funding Program). However, at any point in time, there may be a number of factors that could have a material and adverse effect on our ability to access these capital sources, including unfavorable conditions in the overall equity and credit markets, our degree of leverage, our unencumbered asset base, borrowing restrictions imposed by our lenders, general market conditions for REITs, our operating performance, liquidity and market perceptions about us. The success of our business strategy will depend, to a significant degree, on our ability to access these various capital sources.
To maintain our qualification as a REIT, we must make distributions to our stockholders aggregating annually at least 90% of our REIT taxable income excluding capital gains. See Federal Income Tax ConsiderationsTaxation of Our CompanyAnnual Distribution Requirements. As a result of this requirement, we cannot rely on retained earnings to fund our business needs to the same extent as other entities that are not REITs. If we do not have sufficient funds available to us from our operations to fund our business needs, we will need to find alternative ways to fund those needs. Such alternatives may include, among other things, divesting ourselves of properties (whether or not the sales price is optimal or otherwise meets our strategic long-term objectives), incurring additional indebtedness or issuing equity securities in public or private transactions, the availability and attractiveness of the terms of which cannot be assured.
As of March 31, 2018 and December 31, 2017, we had $1.8 million and $7.3 million, respectively, of cash and cash equivalents. This decrease resulted primarily from our use of cash to fund acquisitions of real estate. We believe that following the completion of this offering and the concurrent Eldridge private placement, we will have access to sufficient capital to meet our capital needs for the foreseeable future.
Description of Certain Debt
Master Trust Funding Program
General Overview . SCF RC Funding I LLC, SCF RC Funding II LLC and SCF RC Funding III LLC, or, collectively, the Master Trust Issuers, all of which are indirect wholly-owned subsidiaries of our operating partnership, have issued net-lease mortgage notes payable, or the Notes, with an aggregate outstanding principal balance of $522.9 million as of December 31, 2017 and $520.9 million as of March 31, 2018. As of December 31, 2017 and March 31, 2018, an affiliate of Eldridge owned
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$366.7 million and $365.3 million, respectively, of these Notes. The Notes are secured by all assets owned by the Master Trust Issuers. Pursuant to an amended and restated property management and servicing agreement, dated as of July 11, 2017, among the Master Trust Issuers, SCF Realty Capital LLC (as property manager and as special servicer), Midland Loan Services, a division of PNC Bank, National Association, (as back-up manager) and Citibank, N.A. (as indenture trustee), we provide property management services with respect to the mortgaged properties and service the related leases.
Starting in 2016, two series of Notes were issued under the program: (1) Notes originally issued by SCF RC Funding I LLC and SCF RC Funding II LLC, which we refer to as the Series 2016-1 Notes, with an aggregate outstanding principal balance of $276.5 million as of December 31, 2017 and $275.4 million as of March 31, 2018 and (2) Notes originally issued by SCF RC Funding I LLC, SCF RC Funding II LLC and SCF RC Funding III LLC, which we refer to as the Series 2017-1 Notes, with an aggregate outstanding principal balance of $246.4 million as of December 31, 2017 and $245.5 million as of March 31, 2018. All asset-backed net-lease mortgage notes, or ABS notes, are the joint obligations of all Master Trust Issuers. The proceeds from the sale of the Notes were generally used to distribute amounts previously contributed as equity for use in connection with the acquisition of properties.
Notes issued under our Master Trust Funding Program are secured by a lien on all of the property owned by the Master Trust Issuers and the related leases. A substantial portion of our real estate investment portfolio serves as collateral for borrowings outstanding under our Master Trust Funding Program. The Master Trust Issuers have issued Notes with an aggregate outstanding principal balance of $522.9 million as of December 31, 2017 and $520.9 million as of March 31, 2018. As of December 31, 2017 and March 31, 2018, we had pledged 348 properties, with a net investment amount of $620.0 million as of December 31, 2017 and $620.6 million as of March 31, 2018, as collateral under our Master Trust Funding Program. The collateral pool is pledged to an indenture trustee who holds fee title to the properties and an assignment of the leases pursuant to a security interest granted to the indenture trustee in favor of the holders of the notes. The properties within the collateral pool compose a representative sample of our portfolio, are diversified by tenant, industry and geography and have annualized base rent of $47.9 million as of March 31, 2018, representing 63.3% of the annualized base rent of our entire portfolio as of that date. We own 99.4% (based on annualized base rent) of these pledged properties in fee simple and 0.6% of these pledged properties are leasehold properties where we are the lessee under a ground lease. The pledged properties had a weighted average rent coverage ratio of 3.04x. The related leases on the pledged properties had a weighted average remaining lease term of 13.0 years (based on annualized base rent). The agreement governing our Master Trust Funding Program permits substitution of real estate collateral from time to time, subject to certain conditions.
Through the Master Trust Funding Program, we arrange for bankruptcy remote, special purpose entity subsidiaries to issue multiple series of investment-grade ABS notes from time to time as additional collateral is added to the collateral pool. The ABS notes are generally issued to institutional investors through the asset-backed securities market. The ABS notes issued prior to the date hereof were issued in two classes, Class A and Class B Notes. The Class A Notes, which represent approximately 93.7% of the appraised value of the underlying real estate collateral, have been rated A by each of S&P Global, Inc. and Kroll Bond Rating Agency, Inc. for structured finance products. The Class B Notes, which represent approximately 3.3% of the appraised value of the underlying real estate collateral, have been rated BBB by each of S&P Global, Inc. and Kroll Bond Rating Agency, Inc. for structured finance products. To the extent we choose to raise additional debt financing under our Master Trust Funding Program in the future through the issuance of ABS notes, the cost of such financing would be influenced by any ratings assigned to such notes, and we cannot assure you that we will be able to achieve similar ratings in the future. We have not obtained a corporate credit rating,
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and the ratings of the Class A Notes and Class B Notes are not indicative of any corporate rating our company may obtain (or the rating of any securities our company may issue) in the future.
When we wish to issue additional long-term debt under the Master Trust Funding Program, our special purpose entity subsidiaries acquire real estate assets to increase the size of the existing collateral pool sufficiently to support the additional debt. We may also add an additional special purpose subsidiary and its assets as a new Master Trust Issuer in which case such entitys assets will be added to the collateral pool and such entity will be a joint issuer of all the ABS Notes. Upon issuance of a new series of debt under this program, the entire collateral pool (including the newly added real estate) will be pledged to secure all of the notes, both the existing and the new series, on a pro rata basis. The amount of debt that can be issued in any new series is determined by the structure of the transaction and the amount of collateral that has been added to the pool. In addition, the issuance of each new series of notes is subject to the satisfaction of several conditions, including that there is no event of default on the existing note series and that the issuance will not result in an event of default on, or the downgrade, qualification or withdrawal of the credit rating of, the existing note series.
Absent a plan to issue additional long-term debt through the Master Trust Funding Program, we are not required to add assets to, or substitute collateral in, the existing collateral pool. We can voluntarily elect to substitute assets in the collateral pool, subject to meeting prescribed conditions that are designed to protect the collateral pool by requiring the substitute assets to be of equal or greater measure in attributes such as: the assets fair value, monthly rent payments, remaining lease term and weighted average coverage ratios. In addition, we can sell underperforming assets and reinvest the proceeds in better performing properties. Any substitutions and sales are subject to an overall limitation of 35% of the collateral pool which is typically reset at each new issuance unless the substitution or sale is credit- or risk-based, in which case there are no limitations.
A significant portion of our cash flows are generated by the special purpose entities comprising our Master Trust Funding Program. For the three months ended March 31, 2018, excess cash flow from the Master Trust Funding Program, after payment of debt service and servicing and trustee expenses, totaled $4.9 million on cash collections of $14.5 million, which represents an overall ratio of cash collections to debt service of approximately 1.47 to 1. If at any time the monthly debt service coverage ratio (as defined in the program documents) generated by the collateral pool is less than or equal to 1.25 to 1, excess cash flow from the Master Trust Funding Program entities will be deposited into a reserve account to be used for payments to be made on the net-lease mortgage notes, to the extent there is a shortfall; if at any time the three month average debt service coverage ratio generated by the collateral pool is less than or equal to 1.15 to 1, excess cash flow from the Master Trust Funding Program entities will be applied to an early amortization of the notes.
Maturity and Interest . The ABS notes require monthly payments of principal and interest. The payment of principal and interest on any Class B Notes is subordinate to the payment of principal and interest on any Class A Notes. The Series 2016-1 Notes mature in November 2046 and have a weighted average annual interest rate of 4.51%. However, the anticipated repayment date for the 2016-1 Notes is November 2021, and if the notes are not repaid in full on or before such anticipated repayment date, additional interest will begin to accrue on the notes. The Series 2017-1 Notes mature in June 2047 and have a weighted average interest rate of 4.16%. However, the anticipated repayment date for the 2017-1 Notes is June 2024, and if the notes are not repaid in full on or before such anticipated repayment date, additional interest will begin to accrue on the notes. Throughout this prospectus, when we disclose weighted average debt maturities, we have assumed the maturity date for the Series 2016-1 Notes and the 2017-1 Notes is their respective anticipated repayment date (which precedes the relevant maturity date), as we expect to repay such indebtedness on the relevant anticipated repayment date and we do not expect such indebtedness to remain outstanding until stated maturity.
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Prepayment . The Series 2016-1 Notes may be voluntarily prepaid, in whole or in part, at any time on or after the date that is 24 months prior to the anticipated repayment date in November 2021 without the payment of a make whole amount. Voluntary prepayments may be made before 24 months prior to the anticipated repayment date, but will be subject to the payment of a make whole amount.
The Series 2017-1 Notes may be voluntarily prepaid, in whole or in part, at any time on or after the date that is 31 months prior to the anticipated repayment date in June 2024 without the payment of a make whole amount. Voluntary prepayments may be made before 31 months prior to the anticipated repayment date, but will be subject to the payment of a make whole amount.
Security . The Notes are secured by a lien on all of the property owned by the Master Trust Issuers and the related leases. As of March 31, 2018, there are 348 properties pledged to secure the Notes. The agreement permits substitution of real estate collateral from time to time subject to certain conditions.
Events of Default . An event of default will occur if, among other things, the Master Trust Issuers fail to pay interest or principal on the Notes when due, materially default in compliance with the material covenants contained in the documents evidencing the Notes or the mortgages on the mortgaged property collateral or if a bankruptcy or other insolvency event occurs. Under the master trust indenture, we have a number of Master Trust Issuer covenants including requirements to pay any taxes and other charges levied or imposed upon the Master Trust Issuers and to comply with specified insurance requirements. We are also required to ensure that all uses and operations on or of our properties comply in all material respects with all applicable environmental laws. As of March 31, 2018, we were in material compliance with all such covenants.
For additional information about our Master Trust Funding Program see Note 4. Secured Borrowings to the Historical Consolidated Financial Statements of Essential Properties Realty Trust, Inc. Predecessor included elsewhere in this prospectus.
Unsecured Revolving Credit Facility
Prior to the completion of this offering, we expect to enter into an agreement with a group of lenders for a senior unsecured revolving credit facility in the maximum aggregate initial original principal amount of up to $300 million. We expect that Barclays Bank PLC, Citigroup Global Markets Inc. and Goldman Sachs Bank USA, each an affiliate of an underwriter in this offering, will act as joint lead arrangers, with Barclays Bank PLC acting as administrative agent.
We expect that the new revolving credit facility will have a term of four years with an extension option of up to 12-months exercisable by us, subject to certain conditions, and will initially bear interest at an annual rate of applicable LIBOR plus the applicable margin. The applicable LIBOR will be the rate with a term equivalent to the interest period applicable to the relevant borrowing. The applicable margin will initially be a spread set according to a leverage-based pricing grid. At our election, on and after receipt of an investment grade corporate credit rating from S&P or Moodys, the applicable margin will be a spread set according to our corporate credit ratings by S&P and/or Moodys. The facility will be freely prepayable at any time and will be mandatorily prepayable by us if borrowings exceed the borrowing base or the facility limit. We will be able to re-borrow amounts paid down, subject to customary borrowing conditions. We will be required to pay revolving credit fees throughout the term of the facility based upon our usage of the facility, at a rate which depends on our usage of the facility during the period before we receive an investment grade corporate credit rating from S&P or Moodys, and which rate shall be based on the corporate credit rating from S&P and/or Moodys after the time, if applicable, we receive such a rating. However, there can be no assurance that we will receive an
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investment grade corporate rating from S&P and/or Moodys. The facility will provide an accordion feature to increase, subject to certain conditions, the maximum availability of the facility by up to $200 million.
Our operating partnership will be the borrower under the facility, and we and each of our subsidiaries that owns a direct or indirect interest in an eligible real property asset will be guarantors under the facility. We will be subject to financial covenants under the facility, including maintaining: a limitation on total consolidated leverage of not more than 60% of our total consolidated assets with a step up on two non-consecutive occasions to 65%, at our election, for two consecutive quarters each following a material acquisition; a consolidated fixed charge coverage ratio of at least 1.50x; a consolidated tangible net worth of at least 75% of our tangible net worth at the date of the facility plus 75% of future net equity proceeds; a consolidated secured leverage ratio of not more than 50% of our total consolidated assets; a secured recourse debt ratio of not more than 10% of our total consolidated assets; an unencumbered leverage ratio of not more than 60% of our consolidated unencumbered assets with a step up on two non-consecutive occasions to 65%, at our election, for two consecutive quarters each following a material acquisition; and an unencumbered interest coverage ratio of at least 1.75x. Additionally, the revolving credit facility will restrict our ability to pay distributions to our stockholders under certain circumstances. However, we may make distributions to the extent necessary to qualify or maintain our qualification as a REIT. The revolving credit facility will contain certain covenants that, subject to exceptions, limit or restrict our incurrence of indebtedness and liens, disposition of assets, transactions with affiliates, mergers and fundamental changes, modification of organizational documents, changes to fiscal periods, making of investments, negative pledge clauses and lines of business and REIT qualification.
Closing of the facility is conditioned on our satisfaction of certain customary conditions, including the consummation of this offering.
Promissory Notes
As of March 31, 2018, we had issued promissory notes to an affiliate of Eldridge with an aggregate outstanding principal balance of $225.0 million. These notes are secured by pledges of equity in subsidiaries holding assets with a net investment amount of $342.2 million, generally mature 360 days following issuance and bear interest at LIBOR plus a spread of between 2.14% and 2.55%. Upon completion of this offering, the concurrent Eldridge private placement and the use of the net proceeds therefrom, we anticipate that we will have repaid these promissory notes in full and the equity pledge will be released.
Off-Balance Sheet Arrangements
As of March 31, 2018 and December 31, 2017, we did not have any off-balance sheet arrangements.
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Contractual Obligations
The following table provides information with respect to our commitments as of December 31, 2017.
Payment due by period
(in thousands) |
||||||||||||||||||||
Contractual Obligations |
Total |
Less than
1 year |
1 - 3 years | 3 - 5 years |
More
than 5 years |
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Secured BorrowingsPrincipal(1) |
$ | 752,936 | $ | 237,619 | $ | 16,428 | $ | 271,954 | $ | 226,935 | ||||||||||
Secured BorrowingsFixed Interest(2) |
110,854 | 22,587 | 44,154 | 30,115 | 13,998 | |||||||||||||||
Tenant Construction Reimbursement Obligations(3). |
6,205 | 6,205 | | | | |||||||||||||||
Operating Lease Obligations(4) |
3,314 | 1,134 | 1,279 | 792 | 109 | |||||||||||||||
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|
|
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Total |
$ | 873,309 | $ | 267,545 | $ | 61,861 | $ | 302,861 | $ | 241,042 | ||||||||||
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(1) | Includes an aggregate of $522.9 million of outstanding indebtedness issued under our Master Trust Funding Program and $230.0 million of promissory notes issued to an affiliate of Eldridge. |
(2) | Includes interest payments on outstanding indebtedness issued under our Master Trust Funding Program through the anticipated repayment dates. |
(3) | Includes obligations to reimburse certain of our tenants for construction costs that they incur in connection with construction at our properties in exchange for contractually specified rent that generally increases proportionally with our funding. |
(4) | Includes $1.8 million of rental payments due under ground lease arrangements where our tenants are directly responsible for payment. |
The following table provides information with respect to our commitments as of March 31, 2018.
Payment due by period
(in thousands) |
||||||||||||||||||||
Contractual Obligations |
Total |
April 1 -
December 31, 2018 |
2019 - 2020 | 2021 - 2022 | Thereafter | |||||||||||||||
Secured BorrowingsPrincipal(1) |
$ | 745,870 | $ | 185,750 | $ | 61,428 | $ | 271,850 | $ | 226,842 | ||||||||||
Secured BorrowingsFixed Interest(2) |
105,136 | 16,904 | 44,137 | 30,103 | 13,992 | |||||||||||||||
Total Construction Reimbursement Obligations(3) |
11,107 | 11,107 | | | | |||||||||||||||
Operating Lease Obligations(4) |
7,105 | 854 | 2,468 | 2,008 | 1,775 | |||||||||||||||
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Total |
$ | 869,218 | $ | 214,615 | $ | 108,033 | $ | 303,961 | $ | 242,609 | ||||||||||
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(1) | Includes an aggregate of $520.9 million of outstanding indebtedness issued under our Master Trust Funding Program and $225.0 million of promissory notes issued to an affiliate of Eldridge. |
(2) | Includes interest payments on outstanding indebtedness issued under our Master Trust Funding Program through the anticipated repayment dates. |
(3) | Includes obligations to reimburse certain of our tenants for construction costs that they incur in connection with construction at our properties in exchange for contractually specified rent that generally increases proportionally with our funding. |
(4) | Includes $1.7 million of rental payments due under ground lease arrangements where our tenants are directly responsible for payment. |
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The following table provides information with respect to our commitments as of March 31, 2018, on a pro forma basis.
Payment due by period
(in thousands) |
||||||||||||||||||||
Contractual Obligations |
Total |
April 1 -
December 31, 2018 |
2019 - 2020 | 2021 - 2022 | Thereafter | |||||||||||||||
Secured BorrowingsPrincipal(1) |
$ | 520,870 | $ | 5,750 | $ | 16,428 | $ | 271,850 | $ | 226,842 | ||||||||||
Secured BorrowingsFixed Interest(2) |
105,136 | 16,904 | 44,137 | 30,103 | 13,992 | |||||||||||||||
Operating Lease Obligations(3) |
7,105 | 854 | 2,468 | 2,008 | 1,775 | |||||||||||||||
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|
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Total |
$ | 633,111 | $ | 23,508 | $ | 63,033 | $ | 303,961 | $ | 242,609 | ||||||||||
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(1) | Includes an aggregate of $520.9 million of outstanding indebtedness issued under our Master Trust Funding Program. |
(2) | Includes interest payments on outstanding indebtedness issued under our Master Trust Funding Program through the anticipated repayment dates. |
(3) | Includes $1.7 million of rental payments due under ground lease arrangements where our tenants are directly responsible for payment. |
Additionally, we may enter into commitments to purchase goods and services in connection with the operation of our business. Those commitments generally have terms of one-year or less and reflect expenditure levels comparable to our historical expenditures.
We intend to elect to qualify as a REIT for federal income tax purposes commencing with our taxable year ending December 31, 2018; accordingly, we generally will not be subject to federal income tax, provided we distribute all of our REIT taxable income, determined without regard to the dividends paid deduction, to our stockholders.
Cash Flows
Comparison of the Three Months Ended March 31, 2018 and the Three Months Ended March 31, 2017
As of March 31, 2018, we had $1.8 million of cash and cash equivalents and $9.3 million of restricted cash as compared to $3.0 million and $2.6 million, respectively, as of March 31, 2017.
Cash Flows for the Three Months Ended March 31, 2018
During the three months ended March 31, 2018, net cash provided by operating activities was $5.2 million. Our cash flows from operating activities are primarily dependent upon the occupancy level of our portfolio, the rental rates specified in our leases, the collectability of rent and the level of our operating expenses and other general and administrative costs. Cash inflows related to a net income adjusted for non-cash items of $7.5 million (net income of $1.1 million adjusted for non-cash items, including depreciation and amortization of tangible and intangible real estate assets, amortization of deferred financing costs, provision for impairment of real estate, gains on dispositions of investments, net, straight-line rent receivable, unit based compensation and allowance for doubtful accounts of $6.4 million). These cash inflows were partially offset by a net increase in prepaid expenses and other assets of $1.9 million and a decrease in accrued liabilities and other payables of 0.4 million.
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Net cash used in investing activities during the three months ended March 31, 2018 was $56.4 million. Our net cash used in investing activities is generally used to fund property acquisitions, the development of our construction in progress, investments in loans receivable and, to a limited extent, capital expenditures, offset by cash provided from the disposition of real estate and principal collections on our direct financing receivables. The cash used in investing activities included $59.1 million to acquire investments in real estate and $5.1 million to fund construction in progress and other. These cash outflows were partially offset by $7.7 million of proceeds from sales of investments, net of disposition costs, approximately $18,000 of principal collections on our direct financing receivables and a decrease of approximately $36,000 in deposits on prospective real estate investments.
Net cash provided by financing activities of $42.9 million during the three months ended March 31, 2018 related to cash inflows of $45.0 million from the issuance of notes payable to related parties and $50.0 million of capital contributions. These cash inflows were partially offset by $50.0 million of payments of principal on notes payable to related parties, $2.1 million of repayments of secured borrowing principal and the payment of approximately $18,000 of deferred financing costs.
Cash Flows for the Three Months Ended March 31, 2017
During the three months ended March 31, 2017, net cash provided by operating activities was $3.7 million. Cash inflows related to a net income adjusted for non-cash items of $3.9 million (net income of $0.6 million adjusted for non-cash items, including depreciation and amortization of tangible and intangible real estate assets, amortization of deferred financing costs, provision for impairment of real estate, gains on dispositions of investments, net, straight-line rent receivable and unit based compensation of $3.3 million) and a net increase in prepaid expenses and other assets of approximately $11,000. These cash inflows were partially offset by a $0.2 million decrease in accrued liabilities and other payables.
Net cash used in investing activities during the three months ended March 31, 2017 was $123.6 million. The cash used in investing activities included $126.5 million to acquire investments in real estate, an increase of $2.1 million paid for deposits on prospective real estate investments and approximately $28,000 to fund construction in progress. These cash outflows were partially offset by $5.0 million of proceeds from sales of investments, net of disposition costs, and approximately $22,000 of principal collections on our direct financing lease receivables.
Net cash provided by financing activities of $113.5 million during the three months ended March 31, 2017 related to cash inflows of $215.0 million from the issuance of notes payable to related parties and $83.7 million of capital contributions. These cash inflows were partially offset by $83.0 million of payments of principal on notes payable to related parties, $101.2 million of equity distributions and $0.9 million of repayments of secured borrowing principal.
Comparison of the Year Ended December 31, 2017 and the Period From March 30, 2016 (commencement of operations) to December 31, 2016
As of December 31, 2017, we had $7.3 million of cash and cash equivalents and $12.2 million of restricted cash as compared to $1.8 million and $10.1 million, respectively, as of December 31, 2016.
Cash Flows for the Year Ended December 31, 2017
During the year ended December 31, 2017, net cash provided by operating activities was $22.5 million. Cash inflows related to a net income adjusted for non-cash items of $20.7 million (net income of $6.3 million adjusted for non-cash items, including depreciation and amortization of tangible and intangible real estate assets, amortization of deferred financing costs, provision for impairment of real
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estate, gains on dispositions of investments, net, straight-line rent receivable, unit based compensation and allowance for doubtful accounts of $14.4 million) and a $4.1 million increase in accrued liabilities and other payables. These cash inflows were partially offset by a net increase in prepaid expenses and other assets of $2.3 million.
Net cash used in investing activities during the year ended December 31, 2017 was $464.4 million. The cash used in investing activities included $509.8 million to acquire investments in real estate, $7.7 million to fund construction in progress, $0.3 million paid to tenants as lease incentives, $0.3 million paid for deposits on prospective real estate investments and approximately $0.05 million for capital expenditures. These cash outflows were partially offset by $53.6 million of proceeds from sales of investments, net of disposition costs, and $0.1 million of principal collections on our direct financing receivables.
Net cash provided by financing activities of $449.4 million during the year ended December 31, 2017 related to cash inflows of $543.0 million from the issuance of notes payable to related parties, $248.1 million of proceeds from secured borrowings under our Master Trust Funding Program and $83.7 million of capital contributions. These cash inflows were partially offset by $313.0 million of payments of principal on notes payable to related parties, $101.2 million of equity distributions, $5.6 million of repayments of secured borrowing principal and $5.6 million of deferred financing costs.