|TEV||11,996||TEV/EBIT||30||TTM 2019-09-30, in MM, except price, ratios|
|Item 1. Business|
|Item 1A. Risk Factors|
|Item 1B. Unresolved Staff Comments|
|Item 2. Properties|
|Item 3. Legal Proceedings|
|Item 4. Mine Safety Disclosures|
|Item 5. Market for Registrant's Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities|
|Item 6. Selected Financial Data|
|Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations|
|Item 7A. Quantitative and Qualitative Disclosures About Market Risk|
|Item 8. Financial Statements and Supplementary Data|
|Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure|
|Item 9A. Controls and Procedures|
|Item 9B. Other Information|
|Item 10. Directors, Executive Officers and Corporate Governance|
|Item 11. Executive Compensation|
|Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters|
|Item 13. Certain Relationships and Related Transactions, and Director Independence|
|Item 14. Principal Accountant Fees and Services|
|Item 15. Exhibits and Financial Statement Schedules|
|Item 16. Form 10 - K Summary|
|Balance Sheet||Income Statement||Cash Flow|
Rev, G Profit, Net Income
Ops, Inv, Fin
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number:
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. Yes
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
As of June 30, 2020 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of the registrant’s shares of common stock, $0.01 par value, held by non-affiliates of the registrant, was $
As of February 24, 2021, there were
Documents Incorporated by Reference
Portions of Part III of this Form 10-K are incorporated by reference from the registrant’s definitive proxy statement for its 2021 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission no later than 120 days after the end of the registrant’s fiscal year.
TABLE OF CONTENTS
In this Annual Report on Form 10-K, or this Annual Report, we refer to STORE Capital Corporation, a Maryland corporation, as “we,” “us,” “our,” “the Company,” “S|T|O|R|E” or “STORE Capital,” unless we specifically state otherwise or the context indicates otherwise.
This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Such forward-looking statements include, without limitation, statements concerning our business and growth strategies, investment, financing and leasing activities and trends in our business, including trends in the market for long-term, triple-net leases of freestanding, single-tenant properties, and expected liquidity needs and sources (including the ability to obtain financing or raise capital). Words such as “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. Currently, one of the most significant factors that could cause actual outcomes to differ materially from our forward-looking statements is the potential adverse effects of the COVID-19 pandemic, and federal, state and/or local regulatory guidelines and private business actions to control it, on our financial condition, operating results and cash flows, our customers, the real estate market in which we operate, the global economy and the financial markets. The extent to which the COVID-19 pandemic will continue to impact us and our customers will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration of the pandemic, and the resulting economic impacts and potential changes in customer behavior, among others. The following risks, among others, which may be further heightened by the COVID-19 pandemic, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:
|●||actual or perceived threats associated with epidemics, pandemics, including COVID-19, or public health crises;|
|●||the performance and financial condition of our customers;|
|●||our ability to raise debt and equity capital on attractive terms;|
|●||the competitive environment in which we operate;|
|●||real estate risks, including fluctuations in real estate values and the general economic climate in local markets and competition for customers in such markets;|
|●||decreased rental rates or increased vacancy rates;|
|●||potential defaults (including bankruptcy or insolvency) on, or non-renewal of, leases by customers;|
|●||real estate acquisition risks, including our ability to identify and complete acquisitions and/or failure of such acquisitions to perform in accordance with projections;|
|●||potential natural disasters and other liabilities and costs associated with the impact of climate change;|
|●||litigation, including costs associated with defending claims against us as a result of incidents on our properties, and any adverse outcomes;|
|●||potential changes in the law or governmental regulations that affect us and interpretations of those laws and regulations, including changes in real estate and zoning or real estate investment trust tax laws;|
|●||the impact of changes in the tax code as a result of federal tax legislation and uncertainty as to how such changes may be applied;|
|●||financing risks, including the risks that our cash flows from operations may be insufficient to meet required payments of principal and interest and that we may be unable to refinance our existing debt upon maturity or obtain new financing on attractive terms at all;|
|●||lack of or insufficient amounts of insurance;|
|●||our ability to maintain our qualification as a real estate investment trust;|
|●||our ability to retain key personnel;|
|●||possible environmental liabilities, including costs, fines or penalties that may be incurred due to necessary remediation of contamination of properties presently owned or previously owned by us; and|
|●||the factors included in this report, including those set forth under the headings “Business,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.|
You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of the document in which they are contained. 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 any forward-looking statement that may be made to reflect events or circumstances after the date as of which that forward-looking statement speaks or to reflect the occurrence of unanticipated events, except as required by law.
Item 1. BUSINESS
General. S|T|O|R|E is an internally managed net-lease real estate investment trust, or REIT, that is the leader in the acquisition, investment and management of Single Tenant Operational Real Estate, or STORE Properties, which is our target market and the inspiration for our name. A STORE Property is a real property location at which a company operates its business and generates sales and profits, which makes the location a profit center and, therefore, fundamentally important to that business.
S|T|O|R|E is one of the largest and fastest-growing net-lease REITs and our portfolio is highly diversified. As of December 31, 2020, our 2,634 property locations were operated by 519 customers across the United States. Our customers operate across a wide variety of industries within the service, retail and manufacturing sectors of the U.S. economy, with restaurants, early childhood education, health clubs, metal fabrication and automotive repair and maintenance representing the top industries in our portfolio.
The following table depicts the growth in our investment portfolio since our inception in 2011.
Our Total Investment Portfolio at Period End
Taxation as a Real Estate Investment Trust. We have elected to be taxed as a real estate investment trust, or a REIT, under the Internal Revenue Code of 1986, as amended, or the Code, commencing with our initial taxable year ended December 31, 2011. To continue to qualify as a REIT, we must continue to meet certain tests which, among other things, require that our assets consist primarily of real estate assets, our income be derived primarily from real estate assets, and that we distribute at least 90% of our REIT taxable income (other than our net capital gains) to our stockholders annually.
The Net-Lease Model and Sustainability. S|T|O|R|E is a net-lease REIT. Accordingly, we acquire STORE Properties from business owners, and then lease the properties back to the business owners under net-leases, substantially all of which are triple-net. Under a triple-net lease, our customer (the tenant) is solely responsible for operating the business conducted at the property subject to the lease, keeping property and improvements in good order and repair, remodeling and updating the building as it deems appropriate to maximize business value, and paying the insurance, property taxes and other property-related expenses. Under the triple-net lease model, therefore, S|T|O|R|E is not a real estate operator; rather, we provide real estate financing solutions to customers seeking a long-term, lower-cost alternative to real estate ownership. Following our acquisition of a property, it is our customer, and not S|T|O|R|E, that controls the property, including with respect to decisions as to when and how to implement environmentally sustainable practices at a given property. However, as the property owner, we nevertheless recognize that the operation of commercial real estate assets can have a meaningful impact on the environment, particularly with respect to resource consumption and waste generation, and on the health of building occupants. Accordingly, at S|T|O|R|E, we believe that being conscious of, and seeking to address, environmental impacts within our control, and supporting our tenant customers to do the same in their businesses, plays a role in building and sustaining successful enterprises and, thus, is material to the success of our own business.
Our Corporate Responsibility. We define success by our ability to make a positive difference for all of our many stakeholders. S|T|O|R|E’s beginning was inspired by our belief that we could make a positive difference for real estate intensive businesses across the U.S. by delivering innovative and superior real estate capital solutions. That belief has guided our efforts to bring much needed capital and liquidity opportunities to middle market businesses which, in turn, have brought value creation and growth to our most integral stakeholders: our customers, stockholders and employees. For our many customers, STORE’s real estate lease solutions have contributed to their prospects for wealth creation and to their ability to grow, create jobs and contribute to many communities across the country. In turn, meeting the needs of our customers provides an extraordinary investment opportunity that we believe holds the promise of sustainable long-term wealth creation for our many stockholders. We are committed to operating our business responsibly, guarding our valuable reputation and creating long-term and sustainable value for our company through a robust business model and attentiveness
to our many stakeholders. S|T|O|R|E is committed to playing an important role for middle market and larger companies across the U.S. in order to help them succeed, while making a positive impact on our collective communities, both today and for future generations.
|●||During the year ended December 31, 2020, we invested approximately $1.1 billion in 214 property locations.|
|●||As of December 31, 2020, our total gross investment in real estate had reached approximately $9.6 billion, of which $6.1 billion was unencumbered. Our long-term outstanding debt totaled $3.8 billion at December 31, 2020, and, at that date, approximately $2.2 billion of our total long-term debt was secured debt and approximately $3.5 billion of our investment portfolio served as collateral for these outstanding borrowings.|
|●||For the year ended December 31, 2020, we declared dividends totaling $1.42 per share of common stock to our stockholders. In the third quarter of 2020 we raised our quarterly dividend 2.9% from our previous quarterly dividend amount.|
|●||During 2020, we raised aggregate net proceeds of $686.4 million from sales of shares under our “at the market”, or ATM, equity offering program. As of December 31, 2020, we had the ability to offer and sell up to an additional $787.0 million of our shares of common stock under our $900.0 million ATM authorization established in November 2020.|
|●||In November 2020, we completed our third public debt offering, issuing $350.0 million in aggregate principal amount of unsecured, investment-grade rated 2.75% Senior Notes, due in November 2030.|
|●||In the fourth quarter of 2020, in conjunction with the $350.0 million public debt offering, we prepaid, without penalty, one of our $100.0 million bank term loans and STORE Master Funding notes with a balance of approximately $92.3 million at the time of prepayment; the STORE Master Funding notes were scheduled to mature in 2022 and bore a coupon rate of 3.75%.|
Our Target Market
We are the leader in providing real estate financing solutions principally to middle-market and larger businesses that own STORE Properties and operate within the broad-based service, retail and manufacturing sectors of the U.S. economy. We have designed our net-lease solutions to provide a long-term, lower-cost way to improve our customers’ capital structures and, thus, be a preferred alternative to real estate ownership. We estimate the market for STORE Properties to approximate $3.9 trillion in market value and to include more than 2.0 million properties.
We define middle-market companies as those having approximate annual gross revenues of between $10 million and $1.0 billion, although approximately 18% of our customers have annual revenues in excess of $1.0 billion. The median annual revenues of our 519 customers was approximately $50 million and, on a weighted average basis, our average customer had revenues of approximately $800 million. Most of our customers do not have credit ratings, although some have ratings from rating agencies that service insurance companies or fixed-income investors. Most of these non-rated companies either prefer to be unrated or are simply too small to issue debt rated by a nationally recognized rating agency in a cost-efficient manner.
The financing marketplace for STORE Properties is highly fragmented, with few participants addressing the long-term capital needs of middle-market and larger non-rated companies. While we believe our net-lease financing solutions can add value to a wide variety of companies, we believe the largest underserved market and, therefore, our greatest opportunity, is non-rated, bank-dependent, middle-market and larger companies that generally have less access to efficient sources of long-term capital.
Our customers typically have the choice either to own or to lease the real estate they use in their daily businesses. They choose to lease for various reasons, including the potential to lower their cost of capital, as leasing supplants traditional financing options that tie up the equity in their real estate. Leasing is also viewed as an attractive alternative to our customers because it generally locks in scheduled payments, at lower levels and for longer periods, than traditional financing options; these factors are viewed favorably relative to the amounts funded.
Whether companies elect to rent or own the real estate they use in their businesses is most often a financial decision. For the few highly capitalized large companies that possess investment-grade credit ratings, real estate leasing tends to be viewed as a substitute for corporate borrowings that they could otherwise access (so long as they remain highly rated and equitized). With real estate leases often bearing rental costs that exceed corporate term borrowing costs, such companies elect to rent for strategic reasons. Such reasons may include the long-term flexibility to vacate properties that are no longer strategic, the permanence of lease capital which lessens potential refinancing risk should corporate credit ratings deteriorate, the lack of corporate financial covenants associated with leasing and the ability to harness developers to effectively outsource their real estate development needs. The primary motivations for S|T|O|R|E’s middle market and larger customers tend to be different. For such companies, real estate leasing solutions offer the potential to lower their cost of capital. In addition to this primary economic motivation, our tenants also seek lease assignability, property substitution rights, property closure rights and S|T|O|R|E’s assistance with property expansion and lease contract modification. Our real estate leasing solutions offer tenants such flexibility, which, in turn, offers the potential for further tenant wealth creation. We believe that our customers select us as their landlord of choice principally as a result of our service, comparative business flexibility and the tailored net-lease solutions we provide.
We believe the demand for our net-lease solutions has grown as a result of the current bank regulatory environment. In our view, the increased scrutiny and regulation of the banking industry in response to the collapse of the housing and mortgage industries from 2007 to 2009, particularly the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, and the Basel Accords issued by the Basel Committee on Banking Supervision, have constrained real estate lending practices and limited desirable term debt real estate borrowing options. Real estate leasing today represents a highly desirable component of corporate capitalization strategies due, in part, to the unavailability of long-term, fixed rate commercial real estate mortgage financing with important features such as affordable prepayment and modification options or loan assignability.
S|T|O|R|E was formed to capitalize on a large market opportunity resulting from the widespread need amongst middle market and larger companies for efficient corporate real estate capital solutions. We believe our opportunities include both gaining market share from the fragmented network of net-lease capital providers and growing the market by creating demand for our net-lease solutions that meet the long-term real estate capital needs of these companies.
The estimated $3.9 trillion market of STORE Properties is divided into three primary industry sectors and various industry sub-sectors. The primary sectors and their proportion of this market are service at 47%, retail at 42% and manufacturing at 11%. The sub-sectors included within each primary sector are summarized in the table below.
Big box retail
Automotive (new and used)
Within the sub-sectors, the market for STORE Properties is further subdivided into a wide variety of industries within the service, retail and manufacturing sectors, such as:
Automotive parts stores
Cold storage facilities
Office supplies retailers
Pet care facilities
Early childhood education
Family entertainment facilities
Fast food restaurants
Full service restaurants
Although many of these industries are represented within our diverse property portfolio, S|T|O|R|E primarily targets service sector properties that represent a broad array of everyday services (such as restaurants and early childhood education facilities) that are not readily available online and that are located near customers targeted by the business operating on the property. Although not our primary focus, the retail sector assets we target are primarily located in retail corridors, also tend to be internet resistant and include a high experiential component, such as furniture and hunting and fishing stores. In the manufacturing sector, we typically target properties that represent a broad array of industries, are located in industrial parks near customers and suppliers, and are operated by businesses that produce everyday necessities. As of December 31, 2020, our portfolio of investments in STORE Properties was diversified across more than 110 industries, of which 64% was in the service sector, 18% was in the retail sector and 18% was in the manufacturing sector, based on revenue.
Our Asset Class: STORE Properties
STORE Properties are a unique asset class that inspired the formation of S|T|O|R|E and our company name. STORE (Single Tenant Operational Real Estate) Properties are profit-center real estate locations on which our customers conduct their businesses and generate revenues and profits. Along with obtaining properties at yields exceeding the auction marketplace, we describe the ongoing receipt of unit-level profit and loss statements from our tenants, using master leases wherever possible and investing in real estate below its replacement cost, as our four “Tables Stakes” when investing in STORE Properties. The defining characteristic of STORE Properties is the number of sources that support the payment of our rent: STORE Properties have the following three sources, whereas all other commercial real estate assets have just two.
|●||Unit-Level Profitability. STORE Properties are distinguished by the primary source that supports the payment of rent, which is the profits produced by the business operations at the real estate locations we own, which we refer to as unit-level profitability. While it is a common perception that the tenant under a lease is the primary source of the rent payment (as distinguished from the business unit operating at the leased site), we have observed a historic pattern in which tenants in corporate insolvencies seek to vacate unprofitable locations while retaining profitable ones, which indicates that the profitability of a property location is the main indicator of a tenant’s long-term ability to pay the rent on that property. Because insolvent tenants historically retain profitable locations while seeking to vacate unprofitable ones, a key component of our business includes requiring our customers to produce and submit to us unit-level financial statements of the businesses they operate at our properties. As of December 31, 2020, approximately 98% of the properties in our portfolio are subject to unit-level financial reporting requirements. Without access to these unit-level financial reports, it is difficult to accurately assess our customer’s business and, thus, the quality of the most important, and primary, source for our rent payments.|
|●||Customer Credit Quality. In addition to the unit-level profitability of the businesses operated on the real estate we own, our customers’ overall financial health, or credit quality, serves as a secondary source supporting rent payments. Our customer’s credit can become the primary source if our unit is not profitable and our customer is required to divert cash flows from its other profitable locations or utilize other resources to pay our rents. However, we have seen that customer credit quality tends to be subject to greater volatility over time than unit-level profitability, because customer credit quality is not only a function of the unit-level profitability of the operations at our locations, but of the profitability of potentially many other properties owned by our customer or other third parties. Corporate financial health is also a function of many other decisions, such as optional changes in capital structure or growth strategies, as well as conditions in the marketplace for our customers’ products and services, that can change over time and that may have profound impacts on customer creditworthiness.|
|●||Real Estate Residual Value. The final source supporting the payment of rent, common to all real estate investments, is the residual value of the underlying real estate, which gives us the opportunity to receive rents from substitute tenants in the event our property becomes vacant. For S|T|O|R|E, this means more than just looking at comparable lease rates and transactions. Studies we have completed underscore the importance of investing in properties at or below their as-new replacement costs. We also review the local markets in which our properties are located and seek to have rents that are at or below prevailing market rents on a per square foot basis for comparable properties. Taking these steps protects S|T|O|R|E and our customers by making it|
|easier for us to assign, sell or sublease properties that our customers may want to sell, reposition or vacate as part of their capital efficiency strategies.|
Creating Investment-Grade Contracts
From our inception in 2011, we have emphasized and uniquely disclosed information regarding the net-lease contracts we create with our tenants. We believe that our net-lease contracts, and not simply tenant or real estate quality, are central to our potential to deliver superior long-term risk-adjusted rates of return to our stockholders. Contract quality embodies tenant and real estate characteristics, together with other investment attributes we believe are highly material. Contract attributes include the prices we pay for the real estate we own, inclusive of the prices relative to new construction cost. As of December 31, 2020, our average investment approximated 80% of replacement cost, a statistic that has been relatively stable since 2015. Other important contract attributes include the ability to receive unit-level financial statements, which allows us to evaluate unit-level cash flows relative to the rents we receive. As of December 31, 2020, the median ability of the properties we own to cover our rents, inclusive of an allowance for indirect costs, approximated 2.1:1, which has also held fairly stable since 2015. Likewise, over many years of providing real estate net-lease capital, we have determined that tenant alignments of interest are highly important. Such alignments of interest can include full parent company recourse, credit enhancements in the form of guarantees, cross default provisions and the use of master leases. Master leases are individual lease contracts that bind multiple properties and offer landlords greater security in the event of tenant insolvency and bankruptcy. Whereas individual property leases provide tenants with the opportunity to evaluate the desirability and viability of each individual property they rent in the event of a bankruptcy, master leases bind multiple properties, permitting landlords to benefit from aggregate property performance and limiting tenants’ ability to pick and choose which leases to retain. As of December 31, 2020, 94% of our multi-property net-lease contracts were in the form of master leases. Contract economic terms are also highly important because they can enhance margins of safety. During 2020, our weighted average initial lease rate was 8.1%, with annual contractual lease escalations averaging an added 1.9% of contract rents. We believe that our initial yields, on average, range from 10% to 15% above those expected by investors seeking real estate investment opportunities through the broker auction market, which provides us greater flexibility to preserve and enhance returns. Other important tenant contract considerations include indemnification provisions, lease renewal rights, and the ability to sublease and assign leases, as well as qualitative considerations, such as alternative real estate use assessment and the composition of a tenant’s capitalization structure.
Since our November 2014 initial public offering, S|T|O|R|E’s extensive contract attribute disclosure has uniquely included a tenant credit quality distribution chart, employing computed implied credit ratings applied to regularly received tenant financial statements using Moody’s Analytics RiskCalc. Since tenant credit ratings are merely one component of contract risk, we developed a means to deliver a base quantitative contract quality estimate. Our approach was to modify risk of tenant insolvency, as estimated by the Moody’s algorithm, by our own estimate of the likelihood of property closure, based on the regularly monitored profitability of the properties bound by each lease contract we create. To accomplish this, we established a simple range of property closure likelihood ranging from 10% to 100% based upon property profitability ranges from breakeven to a computed ability to cover our rents twice over. Multiplying tenant estimated insolvency probability (Moody’s Analytics RiskCalc) by our estimate of the probability of property closure results in a contract risk measurement that we call the STORE Score and which we regularly and uniquely disclose.
Our Competitive Strengths
We have a market-leading platform for the acquisition, investment in and management of STORE Properties that simultaneously creates value for stockholders and customers through our five corporate competencies.
|●||Investment Origination. We founded S|T|O|R|E to fill a need for efficient long-term real estate capital for middle-market and larger customers. We do this principally through a solutions-oriented approach that includes the use of lease contracts that address our customers’ needs and that strive to provide superior value for our customers over other financial options they may have to capitalize their businesses. A S|T|O|R|E hallmark is our ability to directly market our real estate lease solutions to middle market and larger companies nation-wide, harnessing a geographically focused team of experienced relationship managers at our home office. Approximately 80% of our investments, by dollar volume, have been originated by our internal origination team through direct new customer solicitations and a strong level of repeat business from existing customers. By creating demand for our services, we maintain a large pipeline of investment opportunities, which we estimate to be $12.4 billion as of December 31, 2020. Our objectives are to be highly selective and to achieve higher rates of return than our stockholders could achieve if they sought to acquire profit-center real estate on their own.|
|●||Investment Underwriting. Our investment underwriting approach centers on evaluations of unit-level and corporate-level financial performance, together with detailed real estate valuation assessments, which is reflective of the characteristics of the STORE Property asset class. We have combined our underwriting approach with our portfolio management systems to capture and track computed customer credit ratings as well as the performance of the businesses conducted at the properties we own (unit-level performance). Our focus on STORE Properties, which are profit-centers for our tenants, enables us to create lease contracts having payment performance characteristics that are generally materially superior to the implied credit ratings of our diverse tenant base. Through our underwriting and portfolio management approach, we track, measure and report investment performance, with the investment underwriting goal to create a diverse portfolio centered on investment-grade quality contracts. As of December 31, 2020, we estimate that the net portfolio losses we have experienced due to credit events experienced by our customers have averaged 0.3% per year of the total investments we have made since we began in 2011 based on average annual credit events of 1.3% and average annual net credit losses of 0.4% offset by average annual gains on property sales of 0.1%, which is reflective of our underwriting and portfolio management guidelines.|
|●||Investment Documentation. Because we believe purchase and lease contracts are the principal determinants of investment risk, we have always emphasized the importance of our investment documentation. The purchase documentation process includes the validation of investment underwriting through our due diligence|
|process, which includes our initiation and receipt of third-party real estate valuations, title insurance, property condition assessments and environmental reports. When we are satisfied with the results and outcome of our pre-acquisition due diligence process, we purchase the property under a purchase agreement and enter into a lease with the seller. Our lease documents incorporate lessons learned over decades to forge balanced contracts characterized by important alignments of interest, including strong enforcement provisions. Altogether, our documentation process, like our approach to investment underwriting, is integral to investment quality and designed to offer our investors a value that most could not create for themselves.|
|●||Portfolio Management. Net-lease real estate investment portfolios require active management to realize superior risk-adjusted rates of return. S|T|O|R|E is virtually paperless and we can access detailed information on our large diversified portfolio from practically anywhere and at any time, allowing us to monitor unit-level profit and loss statements, customer corporate financial statements and the timely payment of property taxes and insurance in order to gauge portfolio quality. Having such systems is central to our ability to effectively monitor and reduce customer credit risk at the property level, which, in turn, allows us to place greater focus on effectively managing the minority of investments that may have higher risks. We believe these systems, when combined with our high degree of financial and operating flexibility, allow us to realize better stockholder risk-adjusted rates of return on our invested capital.|
|●||Financial Reporting and Treasury. We consider and evaluate our corporate financing strategies with the same emphasis as our real estate investment strategies. Under our financing strategy, borrowings must: prudently improve stockholder returns; be structured to provide portfolio flexibility and minimize our exposure to changes in long-term interest rates; be structured to optimize our cost of financing in a way that will enhance investor rates of return; and contribute to corporate governance by enhancing corporate flexibility. Our senior leadership team has extensive experience with diverse liability strategies. Today, we are one of the few REITs able to employ our own AAA rated borrowing source, while simultaneously maintaining investment-grade corporate credit ratings. We have designed and implemented strategies that add value to our investors by offering a more efficient means to finance real estate than they could otherwise do on their own. At the same time, the flexibility we derive from our liability strategies can also result in important flexibility for our customers.|
Our Business and Growth Strategies
Our objective is to continue to create stockholder value through sustained investment and management activities designed to increase distributable cash flows and deliver attractive risk-adjusted rates of return from a growing, diverse portfolio of STORE Properties. To accomplish this, our principal business and growth strategies are as follows:
|●||Focus on Middle-Market and Larger Companies Operating STORE Properties. We believe we have selected the most attractive investment opportunity within the net-lease market, STORE Properties, and targeted the most attractive customer type within that market, middle-market and larger non-investment-grade-rated companies. We focus on this market given its strong fundamentals and the limited long-term financing solutions available to the companies in it. Within the net-lease market for STORE Properties, our value proposition is most compelling to middle-market and larger, bank-dependent companies, most of which are not rated by any nationally recognized rating agency due to their size or capital markets preferences, but who have strong credit metrics and operate within broad-based industries having the potential for sustained relevance.|
|●||Realize Stable Income and Internal Growth. We seek to make investments that generate strong and stable current income as a result of the difference, or spread, between the rate we earn on our assets (primarily our lease revenues) and the rate we pay on our liabilities (primarily our long-term debt). We augment that income with internal growth. We seek to realize superior internal growth through a combination of (1) a target dividend payout ratio that permits a meaningful level of free cash flow reinvestment and (2) cash generated from the estimated 1.9% weighted average annual escalation of base rent and interest in our portfolio (as of December 31, 2020, as if the escalations in all of our leases were expressed on an annual basis). We benefit from contractual rent escalations, as approximately 98% of our leases and loans (as of December 31, 2020, by base rent and interest) have escalations that are either fixed (13% of our leases and loans) or based on the|
|Consumer Price Index, or CPI (85% of our leases and loans). A final means of internal growth is the accretive redeployment of cash realized from the occasional sale of real estate. During 2020, we divested real estate which had an initial cost of $236.4 million and collected $215.3 million in proceeds on these sales which we were able to redeploy. We believe these three means of internal growth will enable strong cash flow growth without relying exclusively on future common stock issuances to fund new portfolio investments.|
|●||Capitalize on Direct Origination Capabilities for External Growth. As the market leader in STORE Property investment originations, we plan to complement our internal growth with external growth driven by continued new investments funded through future equity issuances and borrowings to expand our platform and raise investor cash flows.|
|●||Actively Manage our Balance Sheet to Maximize Capital Efficiency. We seek funding sources that enable us to lock in long-term investment spreads and limit interest rate sensitivity. We also seek to maintain a prudent balance between the use of debt (which includes our own STORE Master Funding program, unsecured term notes, commercial mortgage-backed securities borrowings, insurance borrowings, bank borrowings and possibly preferred stock issuances) and equity financing. We are currently rated Baa2, BBB and BBB rating by Moody’s Investors Service, S&P Global Ratings and Fitch Ratings, respectively. As of December 31, 2020, our secured and unsecured long-term debt had an aggregate outstanding principal balance of $3.8 billion, a weighted average maturity of approximately seven years and a weighted average interest rate of 4.2%.|
|●||Increase our portfolio diversity. As of December 31, 2020, we had invested approximately $9.6 billion in 2,634 property locations, substantially all of which are profit centers for our customers. Our portfolio is highly diversified; built on an average transaction size of just over $9.0 million, we now have over 500 customers (having added an average of approximately 14 net new customers quarterly since inception) operating across more than 750 different brand names, or business concepts, across 49 states and over 110 industry groups. Our largest customer represented 3.1% of our portfolio as of December 31, 2020, based on base rent and interest. Our portfolio’s diversity decreases the impact on us of an adverse event affecting a specific customer, industry or region, thereby increasing the stability of our cash flows. We expect that additional acquisitions in the future will further increase the diversity of our portfolio and, from time to time, we may sell properties in our portfolio to improve overall portfolio credit quality or diversity.|
|●||Engage with our tenants. Our experienced relationship managers provide tailored lease solutions to our customers that address our customers’ needs and that strive to provide superior value for our customers over other financial options they may have to capitalize their businesses. The direct relationships we develop with our customers give us greater insights into their businesses and allow us to proactively help them grow their businesses or work with them to help solve problems that may arise from time to time. For example, during 2020 and in connection with the shutdowns and other disruptions resulting from the COVID-19 pandemic, we have worked with a number of our tenants on short-term rent deferral arrangements, including through a structured rent relief program under which we allowed such tenants to defer a portion of their rent, with repayment primarily structured through short-term, interest-bearing notes. These efforts allowed our customers to avoid lease defaults while giving their businesses time to recover and gave us the ability to continue to receive our contractual rent.|
Beyond our regular engagement with our customers on business matters, in 2019, we initiated a tenant outreach program designed to gauge our tenants’ current sustainability practices, provide them with sustainability education and support resources, and encourage them to engage in sustainable practices, including reducing power usage, saving water, assessing building equipment, and implementing other energy-efficiency upgrades. We believe that effective encouragement of sustainability initiatives, particularly related to energy, water and indoor environmental quality, can lead to the adoption of practices that can drive business and real estate value appreciation, decrease operating costs and mitigate regulatory risks.
We are committed to environmental sustainability and the mitigation of environmental risks in connection with
the development of our property portfolio. This commitment reflects the fact that the properties we acquire are subject to both state and federal environmental regulations, but, more importantly, it aligns with our belief that being conscious of, and seeking to address and manage environmental risks within our control, and supporting our customers to do the same in their businesses, plays a role in building and sustaining successful enterprises; and, thus, is material to the success of our own business.
As part of our attentiveness to environmental concerns, we:
|●||Continuously seek to understand the environmental risks and opportunities associated with our business practices;|
|●||Undertake initiatives to promote greater environmental awareness among our employees and evaluate opportunities to enhance our processes; and|
|●||Promote awareness and engage with our tenants regarding sustainability practices and solutions.|
Acquisition Process. Our commitment to environmental sustainability begins before we acquire a real estate asset and involves, among other factors, a consideration of the environmental risk associated with our tenants and with prior users of the real estate asset. We then analyze environmental matters in each step of our three-phase property acquisition process:
|●||When assessing a target company, we engage a nationally recognized and insured environmental engineer to perform a Phase I environmental site assessment against current industry standards and evaluate any recognized environmental conditions (RECs) identified in the assessment. We also conduct separate, property-level condition and sustainable practices assessments through an independent third party.|
|●||When we identify a REC, we take appropriate mitigating action, which may include conducting a Phase II environmental assessment, submitting the property into a voluntary clean-up program, purchasing an environmental insurance policy, and remediating the REC in accordance with regulatory requirements,|
|●||When we are satisfied with the results and outcome of our pre-acquisition due diligence process, we purchase the property and enter into a lease with the seller pursuant to which the seller agrees to certain covenants and indemnities that typically require the seller to comply with applicable environmental laws and remediate or take other corrective action should any environmental issues arise.|
We may take additional actions in situations where a target property may be subject to risks associated with climate change, particularly as a result of being located in a geographic area susceptible to floods, hurricanes, tornados, earthquakes or other climate-related occurrences. These additional steps and actions may include: maintaining comprehensive environmental insurance coverage for specified properties in our portfolio to ensure that there are financial resources available to conduct safe and timely remediation in the event of an unforeseen environmental issue; and preparing for climate-related natural disasters by requiring our tenants to carry insurance, including fire, wind/hail, earthquake, flood and other extended coverage where appropriate given the relative risk of loss, geographic location and industry best practices.
Building Sustainable Tenant Relationships. Despite owning our properties subject to triple-net leases, under which our tenants control all business operations at the properties, we strive to positively influence the sustainability practices of our tenants. We expect that such efforts will foster relationships with our tenants that effectively encourage sustainability initiatives, particularly related to energy, water and indoor environmental quality, which can lead to the adoption of practices that should drive business and real estate value appreciation, decrease operating costs and mitigate regulatory risks.
To advance this effort, we conduct inspections of up to 20% of our properties annually to collect data on types and prevalence of sustainability features implemented at the properties, such as programmable thermostats, LED lighting, energy efficient windows, air filtration, and energy efficient water heaters, in order to gauge our performance relative to long-term sustainability initiatives. We initiated our annual property inspection process to aid our portfolio managers and developers in evaluating the sustainability features of existing properties and informing the acquisition analysis process for
target properties. We believe our innovative investment analysis process is responsive to increasing market demands for sustainable features in our portfolio properties. We expect that this survey data will provide a baseline framework in which we can develop and improve on the sustainability features already implemented at such properties.
We supplement our annual property inspections with an annual tenant outreach survey from which we collect further data on sustainability features implemented by our participating tenants at their leased properties. The data collected from our survey is broken down into our three primary tenant industry sectors: manufacturing, retail and service. In collaboration with our tenants and third-party property inspection consultants, we have identified and created a survey designed to capture the approximate number of such features at STORE Property locations. We believe that ongoing tenant engagement and collaboration on environmentally focused property initiatives should create a long-term culture of sustainable tenant relationships.
Human Capital Management
We believe that to continue to deliver strong financial results, we must execute on a human capital strategy that prioritizes, among other things: (i) establishing a work environment that: attracts, develops, and retains top talent; (ii) affording our employees an engaging work experience that allows for career development and opportunities for meaningful civic involvement; (iii) evaluating compensation and benefits, and rewarding outstanding performance; (iv) engaging with, and obtaining feedback from, our employees on their workplace experiences; (v) enabling every employee at every level to be treated with dignity and respect, to be free from discrimination and harassment, and to devote their full attention and best efforts to performing their job to the best of their respective abilities; and (vi) communicating with our board of directors on key topics, including executive succession planning.
As part of our efforts to achieve these priorities:
|●||We seek to foster a diverse and vibrant workplace of individuals who possess a broad range of experiences, backgrounds and skills, starting at the top. At the management level, 33% of our board of directors, 33% of our executive officers, and 56% of our officers at the level of senior vice president and above are women, and overall, we have a deep bench of men and women who are collectively fully capable of professionally operating the business and fulfilling the S|T|O|R|E vision.|
|●||We empower our employees through employee-run engagement committees that develop and influence new employee onboarding, personal growth and professional development programs, company social and team-building events, and health and wellness programs. During the pendency of the COVID-19 pandemic, the health and safety of our employees has taken on particular importance; among other things, we immediately implemented a company-wide work from home policy, which continues in effect, and ensured each employee had access to the necessary tools to work remotely and remain in communication with all other employees.|
|●||We actively support charitable organizations that promote education and social well-being and we encourage our employees to personally volunteer with organizations that are meaningful to them. For example, we proudly sponsor local charities such as the Juvenile Diabetes Research Foundation and our employees volunteer in local charitable organizations such as Arizona Helping Hands and the Society of St. Vincent de Paul.|
|●||We seek to identify future leaders and equip them with the tools for management roles within our company. Our board periodically reviews with our CEO the identity, skills and characteristics of those persons who could succeed to senior and executive management team positions.|
As of December 31, 2020, we had 106 full-time employees, an increase of 9.3% over the total at December 31, 2019, all of whom are located in our single office in Scottsdale, Arizona. None of our employees are subject to a collective bargaining agreement. We consider our employee relations to be good.
We face competition in the acquisition and financing of STORE Properties from numerous investors, including, but not limited to, traded and non-traded public REITs, private equity investors and other institutional investment funds, as
well as private wealth management advisory firms that serve high net worth investors (also known as family offices), some of which have greater financial resources than we do, a greater ability to borrow funds to acquire properties and the willingness to accept more risk. We also believe that competition for real estate financing comes from middle-market business owners themselves, many of whom maintain a preference to own, rather than lease, the real estate they use in their businesses. The competition we face may increase the demand for STORE Properties and, therefore, reduce the number of suitable acquisition opportunities available to us or increase the price we must pay to acquire STORE Properties. This competition will increase if investments in real estate become more attractive relative to other forms of investment.
Our leases and loan agreements typically require our customers to maintain insurance of the types and in the amounts that are usual and customary for similar commercial properties, including commercial general liability, fire and extended loss insurance provided by reputable companies, with commercially reasonable exclusions, deductibles and limits, all as verified by our independent insurance consultant.
Separately, we purchase contingent liability insurance, in excess of our customers’ liability coverage, to provide us with additional security in the event of a catastrophic claim.
Regulations and Requirements
Our properties are subject to various laws and regulations, including regulations relating to fire and safety requirements, as well as affirmative and negative contractual covenants and, in some instances, common area obligations. Our customers have primary responsibility for complying with these regulations and other requirements pursuant to our lease and loan agreements. We believe that each of our customers has the necessary permits and approvals to operate and conduct their businesses on our properties.
We were incorporated under the laws of Maryland on May 17, 2011. Since our initial public offering in November 2014, shares of our common stock have traded under the ticker symbol “STOR” on the New York Stock Exchange, or NYSE. Our offices are located at 8377 E. Hartford Drive, Suite 100, Scottsdale, Arizona 85255. We currently lease approximately 27,800 square feet of office space from an unaffiliated third party. Our telephone number is (480) 256-1100 and our website is www.storecapital.com.
We electronically file with the Securities and Exchange Commission, or the SEC, our annual reports on
Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, pursuant to Section 13(a) of the Exchange Act. You may obtain a free copy of our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports, on the day of filing with the SEC on our website, or by sending an email message to email@example.com.
Item 1A. RISK FACTORS
There are many factors that affect our business, financial condition, operating results, cash flows and distributions, as well as the market price for our securities. The following is a description of important factors that may cause our actual results of operations in future periods to differ materially from those currently expected or discussed in forward-looking statements set forth in this Annual Report. The risks and uncertainties described below are not the only risks we face. Additional risks and uncertainties not presently known to us or that we may currently deem immaterial also may impair our business operations. Forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Annual Report, and we expressly disclaim any obligation or undertaking to update or revise any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based, except to the extent otherwise required by law. See “Forward-Looking Statements.”
Risks Related to Our Business and Operations
Actual or perceived threats associated with epidemics, pandemics, including COVID-19, or other public health crises could have a material adverse effect on our results of operations and our customers’ businesses.
Epidemics, pandemics or other public health crises, including the continued spread of the coronavirus (“COVID-19”), that impact states where our customers operate their businesses or where our properties are located, and preventative measures taken to alleviate any public health crises, including “shelter-in-place” or “stay-at-home” orders issued by local, state or federal authorities, may have a material adverse effect on our and our customers’ businesses, results of operations, liquidity and ability to access capital markets, and may affect our ability as a net-lease REIT to acquire properties or lease properties to our customers, who may be unable, as a result of economic downturns occasioned by public health crises, to make rental payments when due.
The top industries in our portfolio are restaurants, early childhood education, health clubs, metal fabrication and automotive repair and maintenance. Our customers in each of these industries, as well as our customers that operate other service and retail businesses, depend on in-person interactions with their own customers to generate unit-level profitability, and the COVID-19 pandemic has led to a decrease in customers’ willingness to frequent, and mandated “shelter-in-place” or “stay-at-home” orders have prevented customers from frequenting, our customers’ businesses, which may result in our customers’ inability to maintain profitability and make timely rental payments to us under their leases.
Epidemics, pandemics or public health crises, and any current or future “shelter-in-place” or “stay-at-home” orders, may reduce the available workforce of our customers, which could adversely affect our customers’ abilities to maintain unit-level profitability. Risks related to epidemics, pandemics or public health crises could also lead to complete or partial shutdowns of one or more of our customers’ manufacturing facilities or distribution centers, temporary or long-term disruptions in our customers’ supply chains from local, national and international suppliers, or otherwise delay the delivery of inventory or other materials necessary for our customers’ operations. Such disruptions could adversely impact our customers’ ability to generate sufficient revenues, could force our customers to reduce or delay offerings of their products and services, or could result in our customers’ bankruptcy or insolvency, each of which would adversely impact our ability to receive rental revenue we are owed under our customers’ leases.
The continued spread of COVID-19 has already caused economic downturns on a global scale, and international financial markets may continue to experience significant volatility, which may adversely affect our and our customers’ respective businesses, financial conditions, liquidity and results of operations. Additionally, in June 2020, the National Bureau of Economic Research announced that the United States entered into a recession in February 2020. The impact of any epidemic, pandemic or public health crisis on our business, financial condition, liquidity and results of operations will depend on actions taken by local, state, national and international governments and non-governmental organizations, the medical community and other private actors, and the collective response to COVID-19, or any other public health crisis, cannot be readily predicted, and new information may be revealed, or new and unforeseen actions may be taken, which may alleviate or contribute to the further spread and effects of any such public health crisis.
The COVID-19 pandemic presents material uncertainty and risk with respect to our financial condition, results of operations, cash flows and performance, and many of the risks set forth in this section should be interpreted as heightened risks as a result of the COVID-19 pandemic.
The success of our business depends upon the success of our customers’ businesses, and bankruptcy laws will limit our remedies in the event of customer defaults.
We lease substantially all of our properties to customers who operate businesses at the leased properties. We underwrite and evaluate investment risk on the basis that the primary source that supports the payments on our leases and loans is the profitability of these businesses, which we refer to as “unit-level profitability.” We believe the success of our investments materially depends upon whether our customers successfully operate their businesses and generate unit level profitability at the locations we acquire and lease back or finance. The success of our customers requires consumers to use their discretionary income to purchase our customers’ products or services. Economic conditions are cyclical, and developments that discourage consumer spending or cause a downturn in the national economy, or the regional and local economies where our properties are located, could impair our customers’ ability to meet their lease obligations, resulting in
customer defaults or non-renewals under their leases, and reduce demand for our net-lease solutions, forcing us to offer concessions or reduced rental rates when re-leasing these properties.
If any of our customers struggle financially, as has occurred during the pendency of the COVID-19 pandemic, they may decline to extend or renew their leases, miss rental payments or declare bankruptcy. Claims for unpaid future rent are rarely paid in full and are subject to statutory limitations that would likely cause us to receive rental revenues substantially below the contractually specified rent. We are often subject to this risk because our triple-net leases generally involve a single tenant, but this risk is magnified when we lease multiple properties to a single customer under a master lease. Federal bankruptcy laws may prohibit us from evicting bankrupt customers solely upon bankruptcy, and we may not recover the premises from the tenant promptly or from a trustee or debtor-in-possession in bankruptcy proceedings. We may also be unable to re-lease a terminated or rejected space, on comparable terms or at all, or sell a vacant space, upon a customers’ bankruptcy. We will be responsible for all of the operating costs at vacant properties until they be sold or re-let, if at all.
The value of our real estate is subject to fluctuation.
We are subject to all of the general risks associated with the ownership of real estate. While the revenues from our leases are not directly dependent upon the value of the underlying real estate, significant declines in real estate values could adversely affect us in many ways, including a decline in the residual values of properties at lease expiration, possible lease abandonments by our customers and a decline in the attractiveness of triple-net lease transactions to potential sellers. In addition, a financial failure or other default by a customer will likely reduce or eliminate the operating cash flow generated by that customer’s leased property and might decrease the value of that property and result in a non-cash impairment charge. Also, to the extent we purchase real estate in an unstable market, we are subject to the risk that if the real estate market ceases to attract the same level of capital investment in the future that it attracts at the time of our purchases, or the number of companies seeking to acquire properties decreases, the value of our investments may not appreciate or may decrease significantly below the amounts we paid.
Some service and retail customers may be susceptible to e-commerce pressures.
Most of our portfolio is leased to or financed by customers operating service or retail businesses on our property locations. Restaurants, early childhood education, health clubs, metal fabrication and automotive repair and maintenance represent the largest industries in our portfolio. Service and retail businesses using physical outlets face increasing competition from online retailers and service providers. While we believe the businesses in our portfolio are relatively insulated from e-commerce pressures, these businesses may face increased competition from alternative online providers given the rapidly changing business conditions spurred by technological innovation, changing consumer preferences and non-traditional competitors. There can be no assurance that our customers’ businesses will remain competitive with e-commerce providers in the future; any failure to do so would impair their ability to meet their lease obligations to us and materially and adversely affect us.
Our investments are concentrated in the middle market sector, and we would be adversely affected by a lack of demand for our services or an excess of STORE Properties for rent in that sector.
Our target market is middle market companies that operate their businesses out of one or more locations that generate unit level profitability for the business. Historically, many companies have preferred to own, rather than lease, the real estate they use in their businesses. A failure to increase demand for our products by, among other ways, failing to convince middle market companies to sell and lease back their STORE Properties, or an increase in the availability of STORE Properties for rent, could materially and adversely affect us.
Geographic or industry concentrations within our portfolio may negatively affect our financial results.
Our operating performance is impacted by the economic conditions affecting the specific markets and industries in which we have concentrations of properties. As of December 31, 2020, we derived the largest amount of our base rent and interest from the following five states: Texas (10.5%), California (6.3%), Illinois (6.0%), Florida (5.5%) and Ohio (5.2%). As a result of these concentrations, local economic and industry conditions, changes in state or local governmental rules and regulations, acts of nature, epidemics, pandemics and public health crises (including the COVID-19 pandemic)
and actions taken in response thereto, and other factors in these states or affecting those industries could result in a decrease in consumer demand for the products and services offered by our customers operating in those states or industries, which would have an adverse effect on our customers’ businesses and their ability to meet their obligations to us. In particular, as of December 31, 2020, properties representing 12.8% of the dollar amount of our investment portfolio were dedicated to, and also 12.8% of our base rent and interest was derived from, customers operating in the restaurant industry, and the continuing downturn and ongoing business closures in the restaurant and retail industries resulting from the ongoing COVID-19 pandemic has negatively impacted our results of operations and could reduce the demand for our triple-net leases. As we continue to acquire properties, our portfolio may become more concentrated by customer, industry or geographic area. A less diverse portfolio could cause us to be more sensitive to the bankruptcy of fewer customers, changes in consumer trends of a particular industry and a general economic downturn in a particular geographic area.
Failure of our underwriting and risk management procedures to accurately evaluate a potential customer’s credit risk could materially and adversely affect our operating results and financial position.
Our success depends in part on the creditworthiness of our middle-market customers who generally are not rated by any nationally recognized rating agency. We analyze creditworthiness using Moody’s Analytics RiskCalc, our methodology of estimating probability of lease rejection and the STORE Score, each of which may fail to adequately assess a particular customer’s default risk. An expected default frequency (“EDF”) score from Moody’s Analytics RiskCalc lacks the extensive company participation required to obtain a credit rating published by a nationally recognized statistical rating organization such as Moody’s Investors Services, Inc. (“Moody’s”) or S&P Global Ratings, a division of S&P Global, Inc. (“S&P”), and may not be as indicative of creditworthiness. Substantially all of our customers are required to provide corporate-level financial information to us periodically or at our request. EDF scores and the financial ratios we calculate are based on unverified financial information from our customers, may reflect only a limited operating history and include various estimates and judgments made by the party preparing the financial information. The probability of lease rejection we assign to a particular investment may be inaccurate, and may not incorporate significant risks of which we are unaware, which may cause us to invest in properties and lease them to customers who ultimately default, and we may be unable to recover our investment by re leasing or selling the related property, on favorable terms, or at all.
Contingent rent escalators may expose us to inflation risk and can hinder our growth and profitability.
A substantial portion of our leases contain variable-rate contingent rent escalators that periodically increase the base rent payable by the customer. Our leases with rent escalators indexed to future increases in the Consumer Price Index (“CPI”) primarily adjust over a one year period, but may adjust over multiple year periods. Generally, these escalators increase rent at the lesser of (i) 1 to 1.25 times the change in the CPI over a specified period or (ii) a fixed percentage. Under this formula, during periods of deflation or low inflation, small increases or decreases in the CPI may cause us to receive lower rental revenues than we would receive under leases with fixed-rate rent escalators. Conversely, when inflation is higher, contingent rent increases may not keep up with the rate of inflation. Higher inflation may also have an adverse impact on our customers if increases in their operating expenses exceed increases in revenue, which may adversely affect our customers’ ability to satisfy their financial obligations to us.
We may be unable to identify and complete acquisitions of suitable properties, which may impede our growth.
Our ability to continue to acquire properties we believe to be suitable and compatible with our growth strategy may be constrained by numerous factors, including the following:
|●||We may be unable to locate properties that will produce a sufficient spread between our cost of capital and the lease rate we can obtain from a customer, which will decrease our profitability.|
|●||Our ability to grow requires that we overcome many customers’ preference to own, rather than lease, their real estate, and convince customers that it is in their best interests to lease, rather than own, their STORE Properties, either of which we may not be able to accomplish.|
|●||We may be unable to reach an agreement with a potential customer due to failed negotiations or our discovery of previously unknown matters, conditions or liabilities during our real property, legal and financial|
|due diligence review with respect to a transaction and may be forced to abandon the opportunity after incurring significant costs and diverting management’s attention.|
|●||We may fail to obtain sufficient equity, adequate capital resources or other financing available to complete acquisitions on favorable terms or at all.|
We typically acquire only a small percentage (approximately 10%) of all properties that we evaluate (which we refer to as our “pipeline”). To the extent any of the foregoing decreases our pipeline or otherwise impacts our ability to continue to acquire suitable properties, our ability to grow our business will be adversely affected.
We face significant competition for customers, which may negatively impact the occupancy and rental rates of our properties, reduce the number of acquisitions we are able to complete, or increase the cost of these acquisitions.
We compete with numerous developers, owners and operators of properties that often own similar properties in similar markets, and if our competitors offer lower rents than we are offering, we may be pressured to lower our rents or to offer more substantial rent abatements, customer improvements, early termination rights, below-market renewal options or other lease incentive payments in order to remain competitive. Competition for customers could negatively impact the occupancy and rental rates of our properties.
We also face competition for acquisitions of real property from investors, including traded and non-traded public REITs, private equity investors and other institutional investment funds, as well as private wealth management advisory firms, some of which have greater financial resources, a greater ability to borrow funds to acquire properties, the ability to offer more attractive terms to prospective customers and the willingness to accept greater risk or lower returns than we can prudently manage. This competition may increase the demand for STORE Properties and, therefore, reduce the number of, or increase the price for, suitable acquisition opportunities, all of which could materially and adversely affect us.
Some of our customers rely on government funding, and their failure to continue to qualify for such funding could adversely impact their ability to make timely lease payments to us.
Some of our customers operate businesses that depend on government funding or reimbursements, such as customers in the education, healthcare and childcare related industries, which may require them to satisfy certain licensure or certification requirements in order to qualify for these government payments. The amount and timing of these government payments depend on various factors that often are beyond our or our customers’ control. We will likely continue to invest in properties leased by customers operating in these industries and acquire other businesses in industries that rely significantly on government payments. If these customers fail to receive necessary government funding or fail to comply with related regulations, their cash flow could be materially affected, which may cause them to default on their leases and adversely impact our business.
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.
Many of our customers operate their businesses under franchise or license agreements, which generally have terms that end earlier than the respective expiration dates of the related leases. In addition, a customer’s rights as a franchisee or licensee typically may be terminated by the franchisor and the customer may be precluded from competing with the franchisor or licensor upon termination. A franchisor’s or licensor’s termination or refusal to renew a franchise or license agreement would impact the customer’s ability to make payments under its lease or loan with us. We typically have no notice or cure rights with respect to such a termination and have no rights to assignment of any such agreement, which may have an adverse effect on our ability to mitigate losses arising from a default by a terminated franchisee on any of our leases or loans.
If a customer defaults under either the ground lease or mortgage loan of a hybrid lease, we may be required to undertake foreclosure proceedings on the mortgage before we can re lease or sell the property.
In certain circumstances, we may enter into hybrid leases with customers. A hybrid lease is a modified sale-leaseback transaction, where the customer sells us land and then we lease the land back to the customer under a ground lease and simultaneously make a mortgage loan to the customer secured by the improvements the customer continues to
own. If a customer defaults under a hybrid lease, we may: (i) evict the customer under the ground lease and assume ownership of the improvements; or (ii) if required by a court, foreclose on the mortgage loan that is secured by the improvements. Under a ground lease, we, as the ground lessor, generally become the owner of the improvements on the land at lease maturity or if the customer defaults. If, upon default, a court requires us to foreclose on the mortgage rather than evicting the customer, we might encounter delays and expenses in obtaining possession of the improvements, which in turn could delay our ability to promptly sell or re lease the property.
As leases expire, we may be unable to renew those leases or re lease the space on favorable terms or at all.
As of December 31, 2020, leases and loans representing approximately 20.6% of our base rent and interest will expire prior to 2031. We may not be able to renew leases or re lease spaces without interruptions in rental revenue, at or above our current rental rates or without offering substantial rent abatements, customer improvement allowances, early termination rights or below market renewal options, and the terms of renewal, extension or re-lease may be less favorable to us than the prior lease. Because some of our properties are specifically designed for a particular customer’s business, we may be required to renovate the property, decrease the rent we charge or provide other concessions in order to lease the property to another prospective customer. If we need to sell such properties, we may have difficulty selling them to a third party due to the property’s unique design. Real estate investments are generally less liquid than many other financial assets, which may limit our ability to quickly adjust our portfolio in response to changes in economic or other conditions.
Defaults by customers on mortgages we hold could lead to losses on our investments.
From time to time, we make or assume commercial mortgage loans. We have also made a limited amount of investments on properties we own or finance in the form of loans secured by equipment or other fixtures owned by our customers. In the event of a default, we would not earn interest or receive a return of the principal of our loan and may also experience delays and costs in enforcing our rights as lender. Foreclosure and other similar proceedings used to enforce payment of real estate loans are generally subject to principles of equity, which are designed to relieve the indebted party from the legal effect of that party’s default. Foreclosure and other similar laws may limit our right to obtain a deficiency judgment against the defaulting party after a foreclosure or sale, and may lead to a loss or delay in the payment on loans we hold. If we do have to foreclose on a property, we may receive less in the foreclosure sale than the amount the customer owes us or that is needed to cover the costs to foreclose, repossess and sell the property.
Construction and renovation risks could adversely affect our profitability.
In certain instances, we provide financing to our customers for the construction and/or renovation of their properties. We are therefore subject to the risks that this construction or renovation may not be completed. Construction and renovation costs for a property may exceed a customer’s original estimates due to increased costs of materials or labor, or other unexpected costs. A customer may also be unable to complete construction or renovation of a property on schedule, which could result in increased debt service expenses or construction costs. These additional expenses may affect the ability of the customer to make payments to us.
Our ability to fully control the maintenance of our net-leased properties may be limited.
Because our customers are the tenants of our net-leased properties and are responsible for the day-to-day maintenance and management of our properties, we may incur expenses for deferred maintenance or other liabilities if a property is not adequately maintained in accordance with the terms of the applicable lease once the property is no longer leased. We visit our properties periodically, but these visits are not comprehensive inspections and deferred maintenance items may go unnoticed. Our leases generally provide for recourse against a customer in these instances, but bankrupt or financially troubled customers may be more likely to defer maintenance, and it may be more difficult to enforce remedies against such customers. We may not always be able to ascertain or forestall deterioration in the condition of a property or the financial circumstances of a given customer.
Risks Related to the Financing of Our Business
Our growth depends on external sources of capital, which are outside of our control and affect our ability to seize strategic opportunities, satisfy debt obligations and make distributions to our stockholders.
We rely on third-party sources to fund our capital needs. Our access to third-party sources of capital depends, in part, on general market conditions, the market’s perception of our growth potential, our current debt levels, our credit ratings, our current and expected future earnings, our cash flows and cash distributions, and the market price per share of our common stock.
In addition, in order to maintain our qualification as a REIT, we are generally required under the Code to, among other things, distribute annually at least 90% of our net REIT taxable income, determined without regard to the dividends paid deduction and excluding any net capital gain, and we will be subject to income tax at the regular 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, without access to third-party sources of capital, 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 maintain our qualification as a REIT.
Our operating results and financial condition could be adversely affected if we are unable to make required payments on our debt.
Our charter and bylaws do not limit the amount or percentage of indebtedness that we may incur, and we are subject to risks normally associated with debt financing, including the risk that our cash flows will be insufficient to meet required payments of principal and interest. If we are unable to make our debt service payments as required on loans secured by properties we own, a lender could foreclose on the property or properties securing its debt. This could cause us to lose part or all of our investment.
Failure of our subsidiaries to make required payments on borrowings secured by a significant portion of our assets could materially and adversely affect us.
A significant portion of our investment portfolio consists of assets owned by our consolidated, bankruptcy remote, special purpose entity subsidiaries (“SPEs”) that have been pledged to secure the long-term borrowings of those SPEs. As of December 31, 2020, the total outstanding principal balance of non-recourse debt obligations of our SPEs was $2.2 billion, and approximately $3.5 billion in assets held by our SPEs had been pledged to secure such borrowings. We or our other consolidated subsidiaries are the equity owners of our SPEs, which entitles us to the excess cash flows after debt service and all other required payments are made on the debt of our SPEs. If our SPEs fail to make the required payments on such indebtedness or fail to maintain the required debt service coverage ratios, distributions of excess cash flows to us may be reduced or suspended and the indebtedness may become immediately due and payable. If our SPEs are unable to pay the accelerated indebtedness, the pledged assets could be foreclosed upon and distributions of excess cash flows to us may be suspended or terminated, which could reduce the value of our portfolio and revenues available for distribution to our stockholders.
Current market conditions, including increases in interest rates, could adversely affect our ability to refinance existing indebtedness or obtain additional financing for growth on acceptable terms or at all.
In periods during which credit markets experience significant price volatility, displacement and liquidity disruptions, liquidity in the financial markets can be impacted, making financing terms for customers less attractive, and in certain cases, rendering certain types of debt financing unavailable. In such periods, we may be unable to obtain debt financing on favorable terms, or at all, or fully refinance maturing indebtedness with new indebtedness. 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, and the increased interest rates could cause our interest costs and overall costs of capital to increase.
The agreements governing some of our indebtedness 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 some of our indebtedness contain restrictions and covenants, including financial covenants, 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 indebtedness, could cause us to forego investment opportunities, reduce or eliminate distributions to our common stockholders or obtain financing on less than favorable terms. The covenants and other restrictions under our debt agreements may affect our ability to incur indebtedness, create liens on assets, sell or substitute assets, modify certain terms of our leases, prepay debt with higher interest rates, manage our cash flows and make distributions to 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.
Our hedging strategies may not be successful in mitigating our risks associated with interest rates and could reduce the overall returns on an investment in our company.
We attempt to mitigate our exposure to interest rate risk by entering into long term fixed-rate financing through the combination of periodic debt offerings under our unsecured debt program and STORE Master Funding program, our asset-backed securities conduit, through discrete non-recourse secured borrowings, through insurance company and bank borrowings, by laddering our borrowing maturities and by using leases that generally provide for rent escalations during the term of the lease. However, the weighted average term of our borrowings does not match the weighted average term of our investments, and the methods we employ to mitigate our exposure to changes in interest rates involve risks, including the risk that the debt markets are volatile and tend to reflect the conditions of the then current economic climate. Our efforts may not be effective in reducing our exposure to interest rate changes, which may increase our cost of capital and reduce the net returns we earn on our portfolio.
We depend on the asset backed securities (“ABS”) and the commercial mortgage backed securities (“CMBS”) markets for a substantial portion of our long term debt financing.
Historically, we have raised a significant amount of long-term debt capital through our STORE Master Funding program, which accesses the ABS market, and, to a lesser extent, through the CMBS market. Our ABS debt is issued by our SPEs, which issue multiple series of investment grade ABS notes from time to time as additional collateral is added to the collateral pool. Our CMBS debt is generally first mortgage debt incurred by other SPEs. Our ABS and CMBS debt is generally non recourse, but there are customary limited exceptions to recourse for matters such as fraud, misrepresentation, gross negligence or willful misconduct, misapplication of payments, bankruptcy and environmental liabilities.
We have generally used the proceeds from these ABS and CMBS financings to repay debt and fund real estate acquisitions. Our obligations under these loans are generally secured by liens on certain of our properties. In the case of our STORE Master Funding program, subject to certain conditions and limitations, we may substitute real estate collateral for assets in the collateral pool from time to time. No assurance can be given that the ABS or the CMBS markets or financing facilities with similar flexibility to substitute collateral will be available to us in the future.
A disruption in the financial markets for ABS or CMBS debt may affect our ability to obtain long-term debt, which, in turn, may force us to acquire real estate assets at a lower than anticipated growth rate and negatively affect our return on equity. Furthermore, a reduction in the difference, or spread, between the rate we earn on our assets (primarily the lease rates we charge our customers) and the rate we pay on our liabilities (primarily the interest rates on our debt) could have a material and adverse effect on our financial condition.
A downgrade in our credit ratings could have a material adverse effect on our business and financial condition.
The credit ratings assigned to us and our debt, which are subject to ongoing evaluation by the rating agencies who have published them, could change based upon, among other things, our historical and projected business, prospects, liquidity, results of operations and financial condition, or the real estate industry generally. If any credit rating agency downgrades or lowers our credit rating, places any such rating on a so-called “watch list” for a possible downgrading or
lowering or otherwise indicates a negative outlook for that rating, it could materially adversely affect the market price of our debt securities and our common stock, as well as our costs and availability of capital.
General Real Estate Risks
Real estate investments are relatively illiquid and property vacancies could result in significant capital expenditures.
We may desire to sell a property in the future because of changes in market conditions, poor customer performance or default under any mortgage we hold, or to avail ourselves of other opportunities. We may also be required to sell a property in the future to meet debt obligations or avoid a default. Particularly with respect to certain types of real estate assets, such as movie theaters, that cannot always be sold quickly, 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 addition, as a REIT, the Code limits our ability to dispose of properties in ways 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. We may be required to invest in the restoration or modification of a property before we can sell it. The inability to respond promptly to changes in the performance of our property portfolio could adversely affect our financial condition and ability to service our debt and pay dividends to our stockholders.
The loss of a customer, either through lease expiration or customer bankruptcy, may require us to spend significant amounts of capital to renovate the property before it is suitable for a new customer and cause us to incur significant costs in the form of ongoing expenses for property maintenance, taxes, insurance and other expenses.
Uninsured losses relating to real property may adversely affect our returns.
Our contracts generally require our customers to maintain insurance customary for similar types of commercial property. Depending on the location of the property or nature of its use, losses of a catastrophic nature may be covered by insurance policies held by our customers with limitations, such as large deductibles or copayments, that a customer may not be able to meet. In addition, factors such as inflation, changes in building codes and ordinances, environmental considerations, public safety threats and others may result in insurance proceeds that are insufficient to repair or replace a damaged or destroyed property. In the event of a substantial or comprehensive loss of any 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 under insurance policies, due to the upgrades needed 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.
Certain provisions of our leases or loan agreements may be unenforceable, which could adversely impact us.
Our rights and obligations with respect to our leases, mortgage loans or other loans are governed by written agreements. A court could determine that one or more provisions of such an agreement are unenforceable, such as a particular remedy (including rights to indemnification), a loan prepayment provision or a provision governing our security interest in the underlying collateral of a customer. We could be adversely impacted if, for example, this were to happen with respect to a master lease governing our rights relating to multiple properties.
Compliance with the Americans with Disabilities Act and fire, safety and other regulations may require us to make significant unanticipated expenditures that could materially and adversely affect us.
Our properties are subject to the Americans with Disabilities Act (“ADA”), which requires public accommodations to meet federal requirements related to access and use by disabled persons. Compliance with the ADA, or future legislation, could require us to modify the properties we own or may purchase to remove architectural and communication barriers and may restrict renovations on our properties. Failure to comply with the ADA could result in the imposition of fines or an award of damages to private litigants, as well as costs to make modifications to attain compliance. Our customers are generally required to maintain and repair our properties in compliance with the ADA and other similar laws and regulations, but we could be held liable as the owner of the property in the event of a customer’s non-compliance. Any required modifications could involve greater expenditures than anticipated or the modifications might be made on a
more accelerated basis than anticipated, either of which could adversely affect the ability of our customers to cover such costs.
Our properties are also subject to various laws and regulations relating to fire, safety and other regulations, and in some instances, common area obligations. Our customers have primary responsibility for compliance with these regulations but may not have the financial ability to fully maintain compliance, which may cause them to be unable to pay rent on time or default. If this were to occur, we would be required to make substantial capital expenditures to comply with these regulations, which we may not be able to recoup from our customers. We may also face owner liability for failure to comply with these regulations, which may lead to the imposition of fines or an award of damages to private litigants.
Environmentally hazardous conditions may adversely affect our operating results.
Our properties may be subject to known and unknown environmental liabilities under various federal, state and local laws and regulations relating to human health and the environment, some of which may impose joint and several liability on certain statutory classes of persons, including owners or operators, for the costs of investigation or remediation of contaminated properties. These laws and regulations apply to past and present business operations on the properties, and the use, storage, handling and recycling or disposal of hazardous substances or wastes. We may be liable regardless of our knowledge of the contamination, the timing of the contamination, the cause of the contamination or the party responsible for the contamination. Our customers generally must indemnify us from all or most environmental compliance costs, but if a customer fails to, or cannot, comply, we may be required to pay such costs. These costs could be substantial, and because these potential environmental liabilities are generally uncapped, these costs could significantly exceed the property’s value. There can be no assurance that our environmental due diligence efforts will reveal all environmental conditions at the properties in our pipeline.
Under the laws of many states, contamination on a site may give rise to a lien on the site for clean-up costs. Several states will grant priority to a “super lien” for clean-up costs over all existing liens, including those of existing mortgages. If any of the properties on which we have a mortgage are or become contaminated and subject to a super lien, we may not be able to recover the full value of our investment.
Certain federal, state and local laws, regulations and ordinances govern the use, removal and/or replacement of underground storage tanks in the event of a release on, or an upgrade or redevelopment of, certain properties. Such laws, as well as common law standards, may impose liability for any releases of hazardous substances associated with the underground storage tanks and may allow third parties to seek recovery from the owners or operators of such properties for damages associated with such releases.
In a few states, transfers of some types of sites are conditioned upon cleanup of contamination prior to transfer, including in cases where a lender has become the owner of the site through a foreclosure, deed in lieu of foreclosure or otherwise. If any of our properties in these states are subject to such contamination, we may be subject to substantial clean-up costs before we are able to sell or otherwise transfer the property. Additionally, certain federal, state and local laws, regulations and ordinances govern the removal, encapsulation or disturbance of asbestos containing materials (“ACMs”) in the event of the remodeling, renovation or demolition of a building. Such laws, as well as common law standards, may impose liability for releases of ACMs and may impose fines and penalties against us or our customers for failure to comply with these requirements or allow third parties to seek recovery from us or our customers.
In addition, our properties may contain or develop harmful mold, exposure to which may cause a variety of adverse health effects. Exposure to mold at any of our properties could require us to undertake a costly remediation program to contain or remove the mold and could subject us to liability if property damage or health concerns arise.
If we or our customers become subject to any of the above-mentioned environmental risks, we may be materially and adversely affected.
We may be subject to liabilities and costs associated with the impacts of climate change.
The impacts of climate change on our properties or operations are highly uncertain and would be particular to the geographic areas in which we operate, including Florida, Georgia and Texas. Such impacts may result from increased frequency of natural disasters, changes in rainfall and storm patterns and intensities, water shortages, changing sea levels,
rising energy and environmental costs, and changing temperatures, which may impact our or our tenants’ ability to obtain property insurance on acceptable terms. While 99% of our leases are triple-net, and generally impose responsibility on our tenants for the property-level operating costs and require our tenants to indemnify us for environmental liabilities, there can be no assurance that a given tenant will be able to satisfy its payment obligations to us under its lease if climate change adversely impacts a particular property.
Risks Related to Our Tax Status and Other Tax Related Matters
Failure to qualify as a REIT would reduce our net earnings available for investment or distribution.
Our qualification as a REIT requires us to satisfy numerous highly technical and complex requirements for which there are only limited judicial or administrative interpretations, and which involve the determination of various factual matters and circumstances not entirely within our control. No guarantee can be made that we will be able to continue to remain qualified as a REIT in the future. If we fail to qualify as a REIT in any taxable year, we would be subject to federal income tax and increased state and local taxes on our taxable income at the regular corporate rate and be unable to deduct dividends when computing our taxable income. Also, unless the Internal Revenue Service (“IRS”) granted us relief under certain statutory provisions, we could not re-elect REIT status until the fifth calendar year after the year in which we first failed to qualify as a REIT. The additional tax liability from such a failure would reduce or eliminate the amount of cash available for investment or distribution to our common stockholders, which would likely have a significant adverse effect on the value of our securities and our ability to raise additional capital, and we would no longer be required to make distributions to our common stockholders.
Potential tax law changes could affect our ability to qualify as a REIT and could adversely affect our stockholders.
U.S. federal income tax laws governing REITs and other corporations and the administrative interpretations of those laws may be amended at any time, potentially with retroactive effect. The new administration may enact significant reform of the Code, including significant changes to taxation of business entities, tax deferred exchanges and the deductibility of interest expense. There is a substantial lack of clarity around the likelihood, timing and details of any such tax reform and the impact of any potential tax reform on us or an investment in our securities. Future legislation, new regulations, administrative interpretations or court decisions could adversely affect our ability to qualify as a REIT or adversely affect our stockholders.
Even if we qualify as a REIT for purposes of the Code, we may be subject to other tax liabilities that reduce our cash flow and our ability to make distributions to our common stockholders.
As a REIT, we are subject to annual distribution requirements, which limit the amount of cash we may retain for other business purposes, including amounts to fund our growth. We generally must distribute annually at least 90% of our net REIT taxable income to our stockholders, excluding any net capital gain, in order for our distributed earnings to not be subject to corporate income tax. Additionally, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions we pay 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. If we have net income from the sale of foreclosure property that we hold primarily for sale to customers in the ordinary course of business or other non-qualifying income from foreclosure property, we must pay a tax on that income at the corporate income tax rate. Further, if we sell an asset, other than foreclosure property, that we hold primarily for sale to customers in the ordinary course of business, our gain would be subject to the 100% “prohibited transaction” tax unless such sale were made by our wholly owned taxable REIT subsidiary, or if we qualify for a safe harbor from such tax. We do not intend to engage in prohibited transactions. We cannot assure you, however, that we will only make sales that satisfy the requirements of the safe harbors or that the IRS will not successfully assert that one or more of such sales are prohibited transactions, as this determination is generally a question of the facts and circumstances regarding a particular transaction, and we have not sought, and do not intend to seek, a ruling from the IRS regarding any such dispositions.
We intend to make distributions to our common stockholders to comply with the requirements of the Code. However, differences in timing between the recognition of taxable income and the actual receipt of cash could require us to sell assets or borrow funds on a short-term or long-term basis in order to meet the 90% distribution requirement of the Code when the prevailing market conditions are not favorable for these borrowings.
Dividends paid by REITs generally do not qualify for reduced tax rates.
In general, the maximum U.S. federal income tax rate for dividends that constitute “qualified dividend income” paid to individuals, trusts and estates is 20%. Unlike dividends received from non-REIT corporations, our distributions are generally not eligible for reduced federal income tax rates, unless they are attributable to dividends received by the REIT from other corporations otherwise eligible for the reduced rate. Beginning in 2018 and for taxable years prior to 2026, non-corporate stockholders may generally deduct up to 20% of the aggregate amount of ordinary dividends distributed by us, subject to certain limitations, which would reduce the maximum marginal effective tax rate for individuals on the receipt of such ordinary dividends to 29.6%. Although these rules do not adversely affect the taxation of REITs or dividends payable by REITs, investors who are individuals, trusts or estates may perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could materially and adversely affect the trading price of our common stock.
Recharacterization of sale-leaseback transactions may cause us to lose our REIT status.
The IRS may take the position that certain sale-leaseback transactions that we characterize as leases are not true leases for federal income tax purposes but are, instead, financing arrangements or loans. If a sale-leaseback transaction were so re characterized, we might fail to satisfy the Code’s REIT asset tests, income tests or distribution requirements and consequently lose our REIT status effective with the year of recharacterization unless we elect to make an additional distribution that subsequently enables us to maintain our REIT status. Alternatively, the amount of our REIT taxable income could be re-calculated, which might also cause us to fail to meet the Code’s distribution requirements for a taxable year.
We could face possible state and local tax audits and adverse changes in state and local tax laws.
As a REIT, we are generally not subject to federal income taxes, but we are subject to certain state and local taxes, which change from time to time and may result in an increase in our tax liability. A shortfall in tax revenues for states and municipalities in which we own properties may lead to an increase in the frequency and size of such changes in tax laws. If such changes occur, we may be required to pay additional state and local taxes. These increased tax costs could adversely affect our financial condition and the amount of cash available for the payment of distributions to our common stockholders. In the ordinary course of business, our SPEs may also become subject to tax audits. If our SPEs become the subject of state or local tax audits, the ultimate result of such audits could have an adverse effect on our financial condition.
Risks Related to Our Organization and Structure
Our Board may change our investment or financing strategy, or leverage policies, without stockholder consent.
Our Board has the overall authority to oversee our operations and determine our major corporate policies. This authority includes significant flexibility. For example, our Board can, among other things: change any of our strategies, policies or procedures with respect to property acquisitions and divestitures, including the creditworthiness standards with respect to our customers, subject to provisions in our charter, prevent the ownership, transfer and/or accumulation of shares in order to protect our status as a REIT or for any other reason deemed to be in the best interests of us and our stockholders, or determine that it is no longer in our best interests to continue to qualify as a REIT. Any of these actions could increase our operating expenses, impact our ability to make distributions or reduce the value of our assets without the consent of our stockholders.
Our Board’s power to increase or decrease the number of authorized shares of stock, classify and reclassify unissued stock and issue stock without stockholder approval may negatively impact our existing stockholders.
Our charter authorizes us to issue up to 375,000,000 shares of common stock and up to 125,000,000 shares of preferred stock. Our charter authorizes our Board, without stockholder approval, to amend our charter to increase or decrease the aggregate number of shares of stock or the number of shares of any class or series of stock that we are authorized to issue, to authorize us to issue authorized but unissued shares of our common stock or preferred stock, to classify or reclassify any unissued 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. Accordingly, our Board could authorize the
issuance of shares of capital stock that could have the effect of delaying, deferring or preventing a change in control of us that our existing stockholders may view as favorable, 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. In addition, our Board may increase our authorized stock in order to issue additional shares in connection with future financings and other transactions. These additional issuances could dilute the ownership interests of our existing stockholders.
Limitations on share ownership and limitations on the ability of our stockholders to effect a change in control of us limit the transferability of our stock and may prevent takeovers that are beneficial to our stockholders.
To qualify as a REIT, no more than 50% in value of our outstanding capital stock may be owned by five or fewer individuals, including entities specified in the Code, during the last half of any taxable year, and this capital stock must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of 12 months or during a proportionate part of a shorter taxable year. To comply with these requirements, our charter contains stock ownership and transfer restrictions such as, for example, a provision that generally limits ownership by any person of more than 9.8% (in value or by number of shares, whichever is more restrictive) of our outstanding common stock, unless our Board exempts the person from such ownership limitation, and transfers in violation of such limitation may be void. These restrictive provisions may have the effect of delaying, deferring or preventing a change of control that does not threaten our REIT status, including those that involve a premium price for our stockholders or that might otherwise be in our stockholders’ best interests.
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
As permitted by Maryland law, our charter limits the liability of our directors and officers to stockholders for monetary damages, except for liability resulting 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. As a result, we and our stockholders have limited rights against our directors and officers. Accordingly, if good faith actions taken by any of our directors or officers impede our performance, our ability and the ability of our stockholders to recover damages from such directors or officers will be limited. In addition, our charter authorizes us to obligate our company, and our bylaws 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.
Risks Related to Ownership of Our Common Stock
Changes in market conditions and volatility of stock prices could adversely affect the market price of our common stock.
Our stock price, particularly since the beginning of the COVID-19 pandemic, has experienced significant price and volume fluctuations, often without regard to our operating performance. As a result, investors in our common stock may experience a decrease in the value of their shares, including decreases unrelated to our actual operating performance or prospects. A number of factors could negatively affect the price per share of our common stock, many of which are out of our control, including:
|●||general market and economic conditions;|
|●||actual or anticipated variations in our quarterly operating results or dividends, or those of our competitors;|
|●||changes in our funds from operations, adjusted funds from operations or earnings estimates, including as a result of changes in the financial condition, liquidity, results of operations, and prospects of our customers;|
|●||difficulties or inability to access capital or extend or refinance existing debt;|
|●||publication of research reports about us, our competitors, our customers or the real estate industry;|
|●||the market’s perception of REITs as equity security and changes in market valuations of REITs;|
|●||a change in ratings issued by analysts or nationally recognized statistical rating organizations;|
|●||adverse market reaction to additional debt we may incur or equity-related securities we may issue;|
|●||strategic decisions by us or our competitors, such as acquisitions, divestments, spin-offs, joint ventures, strategic investments or changes in business strategy;|
|●||governmental regulatory action and changes in tax laws; and|
|●||the issuance of additional shares of our common stock, or the perception that such sales might occur.|
Increases in market interest rates may have an adverse effect on the value of our common stock if prospective purchasers of our common stock expect a higher dividend yield, and increased borrowing costs may decrease our funds available for distribution to our common stockholders.
The market price of our common stock will generally be influenced by the dividend yield on our common stock relative to market interest rates. An increase in market interest rates, which are currently relatively low, may lead prospective investors to expect a higher dividend yield. However, higher market interest rates would likely increase our borrowing costs and potentially decrease funds available for distribution. Thus, higher market interest rates could cause the market price of our common stock to decrease.
Future offerings of debt, which would be senior to our common stock upon liquidation, or preferred equity securities, which may be senior to our common stock for purposes of dividend distributions or upon liquidation, may adversely affect the market price of our common stock.
In the future, we may issue debt or preferred equity securities. Upon liquidation, holders of our debt securities and shares of preferred stock with a liquidation preference, and lenders with respect to other borrowings, will receive distributions of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or otherwise reduce the market price of our common stock, or both. Holders of our common stock 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 ability to make distributions to holders of our common stock. 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. Thus, our stockholders bear the risk that future offerings may reduce the market price of our common stock and dilute their stock holdings in us.
A substantial portion of our total outstanding common stock may be sold into the market at any time, which could cause the market price of our common stock to drop significantly, even if our business is doing well, and make it difficult for us to sell equity securities in the future.
The market price of our common stock could decline as a result of actual or anticipated sales of a large number of shares of our common stock. These sales, or the possibility that these sales may occur, also might make it difficult for us to sell equity securities in the future at times or prices that we deem appropriate. We filed a registration statement on Form S-8 under the Securities Act to register the offer and sale of up to 7,314,221 shares of our common stock or securities convertible into or exchangeable for shares of our common stock that may be issued pursuant to our 2012 Long Term Incentive Plan and our 2015 Omnibus Equity Incentive Plan, and recipients of those shares may generally freely resell them in the open market, subject to certain limitations governing our affiliates. In addition, as we continue to issue additional equity securities periodically to finance our growth, including through our “at the market” offering programs, these issuances will dilute the interests of our existing stockholders and could adversely affect the value of their investments. If our performance or prospects decline and we are unable to access the equity markets when needed in the future, our ability to grow our business will be adversely impacted.
We may change the dividend policy for our common stock in the future.
The decision to declare and pay dividends on our common stock, as well as the form, timing and amount of any such future dividends, is at our Board’s sole discretion and will depend on our earnings, cash flows, liquidity, financial
condition, capital requirements, contractual prohibitions or other limitations governing our indebtedness, the annual distribution requirements under the REIT provisions of the Code, state law and other relevant factors. Any change in our dividend policy could have a material adverse effect on the market price of our common stock.
Other General Risks
We face risks associated with security breaches through cyber-attacks, cyber intrusions or otherwise, as well as other significant disruptions of our IT networks and related systems.
While we do not collect or maintain the types of information that are most often targeted in cyber-attacks, such as credit card data, bank account information, or sensitive personal information, we nevertheless face risks associated with security breaches through cyber-attacks, malware, computer viruses and malicious codes, ransomware, unauthorized access attempts, denial of service attacks, phishing, social engineering, bad actors with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of a security breach has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Our IT networks and related systems are essential to the operation of our business, the availability and integrity of our data and our ability to perform day-to-day operations, and security breaches or system interruptions could result in misstated financial reports, violations of loan covenants, missed reporting deadlines, our inability to monitor our compliance with the rules and regulations regarding our qualification as a REIT, unauthorized access to, and destruction, loss, theft, misappropriation or release of proprietary, confidential, sensitive or otherwise valuable information of ours or others, the diversion of management attention and resources to remedy any resulting damages, liability for claims for breach of contract, damages, credits, penalties or termination of leases or other agreements, or damage to our reputation among our customers, lenders, vendors and investors generally.
We rely on information systems across our operations and corporate functions, in particular our finance and accounting departments, and depend on such systems to ensure payment of obligations, collection of cash, data warehousing to support analytics, and other various processes and procedures, and there can be no assurance that our security efforts will be effective in deterring security breaches or disruptions. Even the most well protected information, networks, systems and facilities remain potentially vulnerable because the techniques, tools and tactics used in such attempted security breaches evolve and generally are not recognized until launched against a target, and in some cases are designed to not be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers, disaster recovery or other preventative or corrective measures, and thus it is impossible for us to entirely counteract this risk or fully mitigate the harms after such an attack. And as we periodically upgrade our IT systems, we face the risk that these systems may not function properly and expose us to increased cybersecurity breaches and failures, which would expose us to reputational, competitive, operational, financial and business harm, as well as potential litigation and regulatory action.
We depend on key personnel; the loss of their full service could impair our ability to operate successfully.
We rely on the experience, efforts and abilities of senior leadership and other key personnel. We cannot guarantee the continued employment of any of the members of our senior leadership team or key personnel, each of whom could be difficult to replace, given their extensive knowledge and experience. The loss of services of one or more members of our senior leadership team, or our inability to attract and retain highly qualified personnel, could adversely affect our business and be negatively perceived in the capital markets, diminish our investment opportunities and weaken our relationships with lenders, business partners, and customers.
We are subject to litigation which could materially and adversely affect us.
From time to time, we are subject to litigation in connection with the ordinary course operation of our business, including instances in which we are named as defendants in lawsuits arising out of accidents causing personal injuries or other events that occur on the properties operated by our customers. We generally seek to have our customers defend, and assume liability for, such matters involving their properties. In other cases, we may defend ourselves, invoke our insurance coverage or the coverage of our customers, and/or invoke our indemnification rights included in our leases. Resolution of these types of matters against us may result in significant legal fees and/or require us to pay significant fines, judgments or settlements, which, to the extent uninsured or in excess of insured limits, or not subject to indemnification,
could adversely impact our earnings and cash flows. We also may become subject to litigation relating to our financing and other transactions. Certain types of litigation, if determined adversely to us, may affect the availability or cost of some of our insurance coverage, which could expose us to increased risks that would be uninsured and materially and adversely impact our ability to attract directors and officers.
Item 1B. UNRESOLVED STAFF COMMENTS
Item 2. PROPERTIES
As of December 31, 2020, our total investment in real estate and loans approximated $9.6 billion, representing investments in 2,634 property locations, substantially all of which are profit centers for our customers. These investments generate cash flows from approximately 750 contracts predominantly structured as net leases. The weighted average non-cancelable remaining term of our leases was approximately 14 years.
Our real estate portfolio is highly diversified. As of December 31, 2020, our 2,634 property locations were operated by 519 customers across the United States. Our customers are typically established regional and national operators, with over 70% of our base rent and interest coming from customers with over $50 million in annual revenues. Our largest customer represented approximately 3.1% of our portfolio at December 31, 2020, and our top ten largest customers represented 18.1% of base rent and interest. Our customers operate their businesses across approximately 760 brand names or business concepts in over 100 industries.
The following tables summarize the diversification of our real estate portfolio based on the percentage of base rent and interest, annualized based on rates in effect on December 31, 2020, for all of our leases, loans and direct financing receivables in place as of that date.
Diversification by Customer
As of December 31, 2020, our property locations were operated by 519 customers and the following table identifies our ten largest customers:
Spring Education Group Inc. (Stratford School/Nobel Learning Communities)
Fleet Farm Group LLC
Bass Pro Group, LLC (Cabela's)
Cadence Education, Inc. (Early childhood/elementary education)
Dufresne Spencer Group Holdings, LLC (Ashley Furniture HomeStore)
US LBM Holdings, LLC (Building materials distribution)
CWGS Group, LLC (Camping World/Gander Outdoors)
American Multi-Cinema, Inc. (AMC/Carmike/Starplex)
Loves Furniture, Inc.
Zips Holdings, LLC
All other (509 customers)
Diversification by Industry
As of December 31, 2020 our customers’ business concepts were diversified across more than 100 industries within the service, retail and manufacturing sectors of the U.S. economy. The following table summarizes those industries into 76 industry groups:
Customer Industry Group
Early childhood education centers
Automotive repair and maintenance
Pet care facilities
All other service (28 industry groups)
Farm and ranch supply stores
All other retail (16 industry groups)
All other manufacturing (22 industry groups)
Diversification by Geography
Our portfolio is also highly diversified by geography, as our property locations can be found in every state except Hawaii. The following table details the top ten geographical locations of the properties as of December 31, 2020:
All other (39 states) (1)
|(1)||Includes one property in Ontario, Canada which represents less than 0.1% of base rent and interest.|
The following table sets forth the schedule of our lease, loan and direct financing receivable expirations as of December 31, 2020: