Fitch Ratings has affirmed the ratings of Spirit Realty Capital, Inc. (SRC) and its operating partnership Spirit Realty, L.P., including the Long-Term Issuer Default Ratings (IDRs) at 'BBB'.

Fitch has also assigned a 'BBB' rating to Spirit Realty's $500 million unsecured term loan due June 2025. The Rating Outlook is Stable.

The affirmations and Stable Outlook reflect the company's solid operating results and recovered rent collections, as well as Fitch's expectations that the company will sustain metrics appropriate for the rating and maintain stable operating performance over the long term.

Key Rating Drivers

Strong Asset Quality: SRC's operational performance returned to pre-COVID levels with occupancy at 99.8% and collections at 99.7% as of Sept. 30, 2022, compared to occupancy at 99.7% and collections at 99.7% as of Dec. 31, 2019. Occupancy remained above 99% through the pandemic highlighting the company's strong asset quality. Despite the company's exposure to discretionary and service retail, operations have been durable. The company's weighted average lease term is 10.4 years as of September 30, 2022.

Well Balanced Portfolio Diversification: As of Sept. 30, 2022, SRC's top ten tenants represented 22.4% of ABR, which is appropriate for the 'BBB' category. The largest tenant exposures are Lifetime Fitness (4.1% of ABR) and Invited Clubs (2.8%). Fitch views SRC's portfolio as well-diversified by individual tenant, reflecting its successful portfolio refinement efforts following the SMTA spinoff. SRC's tenant diversification, contractual rent increases, and long-dated lease maturities improve the durability and predictability of operating cash flows and provide a cushion for the issuer to maintain its metrics in the event of tenant credit issues.

Fitch also views favorably the growing percentage of industrial and manufacturing assets (20.7% of ABR; up from 14.9% as of Dec. 31, 2020), and related decrease to retail sector (70.4%; down from 77.9% as of Dec. 31, 2020). Retail includes only 11.5% classified as non-discretionary retail, but the service retail and discretionary retail segments include categories such as pet supplies, home furnishings, pharmacies, quick service restaurants, and others that have performed relatively well through the pandemic.

Investment Grade Credit Metrics: Fitch expects SRC's leverage (net debt before preferred stock to operating EBITDA) to sustain in the low-to-mid-5x range consistent with the company's financial policy of below 5.5x as well as with historical leverage levels. Management has demonstrated a commitment to preserving the balance sheet as it resumed external growth activity, and issued $531.6 million in common stock in the first nine months of 2022 to partly fund $1.1 billion in acquisitions. Historically, the company has had good access to both bank debt and public bond markets in addition to equity: SRC issued $800 million in unsecured term loans in the first nine months of 2022 and issued $1.25 billion in unsecured notes over 2020-2021.

Largely Unencumbered Pool: SRC properties are generally unencumbered, with only two encumbered properties as of Sept. 30, 2022; down from 88 properties as of Dec. 31, 2020. Fitch estimates the ratio of unencumbered assets to unsecured net debt at 2.0x, assuming a 10% stressed cap rate, a level which is appropriate for the rating and serves as an additional source of contingent liquidity.

Solid Execution of Acquisition Strategy: Fitch views SRC's portfolio transition favorably as over the last few years exposure to the industrial sector (20.7% as of Sept. 30, 2022, compared to 4.4% as of YE 2018) has meaningfully increased. The portfolio has undergone a major transformation since YE 2017, including the gross acquisition of $4.8 billion of assets through 3Q22 to support a stronger asset quality and tenant base. During the first nine months of 2022, the company acquired $1.1 billion in assets, comprised of 64% industrial, 32% retail, 3% office, and 1% other. Fitch expects the industrial/manufacturing exposure to continue to increase over time with additional acquisitions.

Derivation Summary

SRC's portfolio metrics, including weighted average lease term, occupancy, leverage is consistent with peers in the 'BBB' category. Fitch's expectations of leverage sustaining in the mid-5x range are similar to triple net lease peer STORE Capital (BBB/RWN) around the mid-5x range, with the latter being on RWN due to uncertainty related to its acquisition by GIC and Oak Street.

SRC's has greater investment-grade tenant exposure (20% of 3Q22 ABR) as compared to STOR's focus on middle market tenants. Exposure to industrial assets, which Fitch views favorably, is comparable between SRC (21%) and STOR (21%). SRC's access to capital is stronger than peers Global Net Lease Inc. (BB+/Negative) and The Necessity Retail REIT, Inc. (BB/Stable), both of which are externally managed REITs, run at a higher leverage levels, and have greater tenant concentration.

Fitch rates the IDRs of the parent REIT and subsidiary operating partnership on a consolidated basis, using the weak parent/strong subsidiary approach and open access and control factors, based on the entities operating as a single enterprise with strong legal and operational ties. Fitch applies 50% equity credit to the company's perpetual preferred securities given the cumulative nature of coupon deferral. The instruments are subordinated to debt, lack material covenants and the terms of the change of control do not negate the equity credit judgement. Certain metrics calculate leverage including preferred stock.

Key Assumptions

Mid-single digits SSNOI throughout the ratings forecast, bolstered by 2% rent escalators and consistent high occupancy;

$1.5 billion of acquisitions and $250 million of divestitures in 2022, consistent with 3Q guidance;

Acquisitions made at a 7% cap rate in 2023 consistent with management expectations;

Dispositions made at a low to mid-5% cap rate consistent with historical disposition rates;

SRC manages its acquisitions, debt issuance, and equity issuance to keep REIT leverage within the 5x-6x range;

REIT FCC remains above 4.0x through the ratings forecast;

UA/UD remains above 2.0x through the ratings forecast.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch's expectation of leverage (as measured by net debt before preferred stock/EBITDA) sustaining below 5.0x;

Stable operating performance and track record, including maintaining occupancy levels and consistent tenant performance;

Fitch's expectation of FCC sustaining above 3.5x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Fitch's expectation of leverage sustaining above 6.0x;

Sustained deterioration in operating fundamentals or asset quality;

Fitch's expectation of FCC sustaining below 3.0x;

UA/UD sustaining below 2.0x and/or deterioration in the quality, value and/or ability to finance the unencumbered pool.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

As of Sept. 30, 2022, available liquidity was comprised of $109.8 million in cash and cash equivalents and the full $1.2 billion of borrowing capacity under the company's revolving credit facility. The company raised an additional $500 million through a term loan in November 2022.

SRC has ample liquidity with proforma liquidity coverage through fiscal YE 2024 at roughly 5.9x, pro forma for its November term loan and anticipated 4Q22 acquisition activity. The company is aided in this liquidity calculation by very few short to medium term debt maturities; the nearest material maturities are $800 million of total term loans due in 2025.

Fitch defines liquidity coverage as sources of liquidity divided by uses of liquidity. Sources include unrestricted cash, availability under unsecured revolving credit facilities, and retained cash flow from operating activities after dividends. Uses include pro rata debt maturities, expected recurring capex, and forecast (re)development costs.

Issuer Profile

Spirit Realty Capital, Inc. (NYSE: SRC) is a net-lease REIT that primarily invests in real estate subject to long-term, net leases in which taxes, insurance and maintenance expenses are typically the responsibility of the tenant.

As of Sept. 30, 2022, SRC's portfolio was comprised of 2,118 properties, including properties securing mortgage loans made by the company. SRC's owned properties, with an aggregate gross leasable area of 55.7 million square feet, are leased to 346 tenants, primarily engaged in the sale of retail goods and services, across 49 states operating in 34 industries. As of this date SRC's properties were approximately 99.8% occupied.

Summary of Financial Adjustments

No material non-standard financial adjustments. Stock based compensation was considered a reduction to SG&A and an addback to EBITDA.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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