W. P. Carey Inc. (WPC) Earnings Call Transcript & Summary

Hello, everyone, and good morning. We appreciate your participation in today's call covering our fourth quarter 2019 earnings results. Prior to getting started, I want to note that certain remarks shared during this session do not reflect historical events and might be classified as forward-looking statements. Details regarding factors that might lead actual outcomes to vary significantly from what W. P. Carey anticipates can be found within our filings with the SEC. A web-based replay of this conference call is going to be accessible through the Investor Relations portion of our site, wpcarey.com, and it will remain archived there for roughly 1 year; copies of our investor presentations are also available at that location. Having said that, I will now turn things over to Jason Fox, our Chief Executive Officer.

Thank you, Peter, and good morning to all of you. To begin today, I'll take a quick look back at several highlights from 2019, then shift my attention to a handful of the investments we've made recently, viewed against the backdrop of the current market. Our CFO, Toni Sanzone, will walk through the 2019 results, the 2020 guidance, and where our balance sheet stands, including the added flexibility that came from renewing and upsizing our credit facility; our President, John Park, is with us, as is our Head of Asset Management, Brooks Gordon, and both are ready to field questions. Over the course of 2019, we carried out a range of significant initiatives. As we entered the year, our attention was on strengthening the advantages that came with our merger with CPA:17, while also seizing chances to further improve our portfolio and balance sheet and to keep swapping investment management fees for lease revenue of a higher quality. On the portfolio side, our weighted average lease term kept growing as we lifted portfolio quality, which included bringing down tenant concentration, cutting back on office assets, and transitioning a sizable operating self-storage portfolio into net lease, with investment-grade rated extra space serving as the tenant. Thanks to our merger and our ongoing investment activity, real estate AFFO per share rose 8% compared with the prior year, something we feel especially pleased about given that we simultaneously brought leverage down and removed earnings tied to investment management. Our balance sheet has never been stronger, and the quality of our earnings, EBITDA and dividend coverage all improved markedly in 2019, with investment management accounting for only 5% of total AFFO — a share that will keep shrinking as the remaining funds wind down. In the capital markets, we tapped multiple channels, bringing in a record amount of capital through the public markets. We prepaid more than $1 billion of mortgage debt and locked in the tightest coupons and spreads in our company's history across both the U.S. and eurobond markets, all while pushing secured leverage under 10%. Given how strongly we executed on many fronts, we delivered a total shareholder return of 29% and received a positive outlook from S&P. Above all, we think these efforts will pay off for shareholders, not only in 2019 but well into the future, as we finish winding down our investment management business and concentrate on generating consistent, steady results from our real estate portfolio. Now to the fourth quarter. On the investment side, it was a particularly busy quarter, with roughly half of our 2019 investment volume completed, mostly in warehouse and industrial properties at appealing spreads relative to our cost of capital, and that momentum has carried over into the new year. The market backdrop in the fourth quarter was once again shaped by the competitive dynamics seen all through 2019, supported by low interest rates; throughout Europe, extremely low rates kept driving capital into the region, with growing sums of money pursuing widely marketed deals. Developments on Brexit helped revive appetite for U.K. assets, and the Nordic commercial real estate market posted a record year for deal flow. Within the United States, industrial and logistics remained the most in-demand categories of real estate as economic expansion carried on, underpinned by minimal joblessness, modest price growth, and inexpensive borrowing. All through 2019, our preferred methods for deploying funds on a risk-adjusted basis kept being sale-leasebacks, purchases made away from the open market, build-to-suits, and other capital endeavors. Even though warehouses and industrial properties offered the strongest prospects during 2019, accounting for nearly 80% of what we invested over the entire year, we stuck with our diversified strategy, closing deals worth $868 million spread across every major property category, covering 55 properties, net leased to 29 tenants, active in 14 distinct industries, situated mainly in the U.S. along with Northern and Western Europe. Over the course of that year, we also ingeniously transformed the majority of our self-storage assets in operation into net lease arrangements, which brought more variety to our net lease holdings and could generate future net lease possibilities as operators seek an asset-light model. During 2019, we made active use of our enhanced cost of capital to push our investments toward superior industrial and logistics properties that command reduced cap rates; even so, this did not push aside our continued emphasis on the wider set of net-leased assets we have historically put money into, specifically operationally essential properties net leased to expanding businesses positioned slightly beneath investment grade, thus delivering extra spread and attractive risk-adjusted yields across lengthy leases. Taken together, our 2019 investments were made at an initial weighted average cap rate of 6.7% and carried a weighted average lease term of 19 years. As we expected, our investment activity in 2019 skewed toward the latter part of the year, with a particularly busy fourth quarter in which we closed $412 million in investments at a weighted average initial cap rate of 6.3% and a weighted average lease term of 20 years. That figure encompassed the finishing of 3 capital investment projects amounting to $44 million, which lifted the full year tally for completed projects to $127 million, equal to roughly 15% of our total 2019 investment volume. These deals are genuinely off-market, letting us secure superior terms relative to deals marketed broadly and generate value within the lease structure itself. Transactions like these not only offer a dependable stream of additional deal flow thanks to the scale and scope of our portfolio, they likewise bring in top-tier real estate at cost. Let's walk through a few of the more noteworthy deals from the quarter. The biggest investment we made in the fourth quarter was the $94 million sale-leaseback of a logistics facility net leased to Stanley Black & Decker, the well-known maker of hand and power tools, which holds an A rating from S&P. This facility sits in the greater Charlotte area, near major transportation routes, and ranks as the tenant's second largest distribution center in the U.S; it is a triple net lease featuring fixed annual rent increases and carries below-market rent, offering possible upside when the 12-year term concludes. Back in December, we finished purchasing an experiential retail store for $56 million, which is net leased to Bass Pro Group — a top supplier of outdoor sporting goods across the U.S. and Canada. This location is genuinely a destination retail spot, and it has been running for over 17 years. The lease is triple net, spanning a 24-year term, and rent grows based on CPI. Our strategy in the retail sector stays selective; we keep concentrating on the highest-performing sites that have solid coverage, where the tenant pursues a differentiated approach that protects it from e-commerce rivals. During the earlier part of the quarter, we wrapped up a cross-border sale-leaseback worth $53 million involving 3 industrial facilities net leased to Apex Tool Group, among the biggest manufacturers of high-performance tools. Of those facilities, 2 sit in the U.S. and 1 is in Mexico, and every one of them is essential to that company's worldwide operating footprint. These properties are leased triple net in U.S. dollars across a 25-year period, with annual rent escalations that are fixed.

The final item I want to bring up is that $38 million sale-leaseback deal that closed in November, covering 2 logistics properties located in Denmark and Sweden and net leased to Stark Group, the biggest provider of building and construction products across the Nordic region. Both of these assets sit in strategic spots, with convenient access to major highways and shipping routes. They carry triple net leases running 20 years, with rent bumps tied to CPI each year. Our 2019 investments, together with how proactively we've managed assets, also lifted the quality of our portfolio on a number of important metrics. ABR coming from warehouse and industrial properties rose to 45% of ABR, while office ABR fell to 22%, versus 25% a year earlier. We pushed up the share of ABR coming from investment-grade tenants to 30%, and brought our top 10 tenant concentration down further to 22%, which is still among the lowest in the net lease peer group. We also stretched the portfolio's weighted average lease term out to 10.7 years — 6 months more than a year earlier, even with time passing — and moved nearer to full occupancy, finishing the year at 98.8% occupied. Going forward, we anticipate a competitive market backdrop in 2020, with central banks in both the U.S. and Europe indicating they plan to hold rates low. Brexit has seen some meaningful progress, and worries about a trade war with China have softened a bit. That said, how the coronavirus affects global growth and supply chains has turned into an unknown. Over the long run, we think the net lease market opportunity stays enormous. Our diversified strategy lets us put money to work across property types and on 2 continents; and our cost of capital lets us do that accretively, backed by established capital markets access and a well-positioned balance sheet with plenty of liquidity to act on our investment pipeline. As I noted, the deal momentum from the fourth quarter has carried over into 2020. So far this year, we've added $206 million of investments, made up of 2 closed acquisitions totaling $139 million and 3 completed capital projects totaling $67 million; on top of that, we have another 6 projects totaling $176 million slated to finish by the end of this year. That gives us good visibility right now into roughly $380 million of investment volume for 2020, plus a healthy pipeline of further new investments — a great spot to be in this early in the year. With that, I'll turn the call over to Toni.

Good morning, everyone. Like Jason mentioned, we're quite happy with what we accomplished on a number of fronts during 2019, and given our present outlook, we feel we're in a strong position going into the coming year. Let's begin with the results. Just to recap, our 2019 figures show the effect of a full twelve months following the merger with CPA:17, and that substantially enhanced the mix of what we earn — 95% of total AFFO came from our core real estate operations. Since the fees we earn from investment management are shrinking as time passes, we're busy substituting them with steadier real estate cash flows that carry a higher valuation. We were glad to deliver 8% growth in real estate AFFO per share versus the prior year, while also cutting leverage considerably and making our balance sheet stronger. For the fourth quarter, total AFFO came to $1.28 per share, which brought the full year figure to $5 per share — down 7.2%, owing to the anticipated drop in investment management earnings. Real estate AFFO was $1.21 per share in the quarter and $4.74 per share across the full year, up 8% compared with the previous year, powered by much greater lease revenues from the properties picked up in the CPA:17 merger, plus our net investment activity and robust same-store growth. Real estate AFFO for 2019 also reflected 2 notable lease-related settlements and recoveries amounting to $16 million, which we went over on earlier calls. As Jason explained, our investment volume in the fourth quarter reached $412 million, which is nearly half of the $868 million total for the full year. And since most of those investments closed toward the end of the quarter, their effect on fourth quarter and full year earnings was minimal. Disposition activity was likewise concentrated toward the back end of the year, largely because of the New York Times repurchase at the beginning of December. In the fourth quarter, we sold 12 properties for $348 million, which took full year dispositions to $384 million. Once the year wrapped up, we closed on selling a Miami hotel that was in operation, bringing in $115 million. That leaves us with just one operating hotel, which we expect to offload sometime in the coming year. In 2019, the dispositions we made that were occupied closed at a weighted average cap rate of 7.8%, leaving out the New York Times, since we view that one as an outlier due to its fixed price purchase option. During the fourth quarter, we also disposed of 6 retail properties and 1 educational facility — every one of them vacant — handing them back to the lenders and eliminating the carry costs associated with them. ABR increased 5% compared to the same period last year, driven by our net investment activity during 2019, the transition of self-storage properties into net lease arrangements, and reliable contractual rent increases relative to the previous year. Applying our own definition, same-store rent growth reached 2%, a figure that mirrors the typical contractual rent bump embedded in our leases. Many of you know that net lease REITs have faced growing demand to report a same-store growth measure reflecting leasing activity, vacancy impacts, and credit losses. Had we incorporated those factors, our same-store rent growth would have been approximately 100 basis points lower, and beginning with future supplemental disclosures, we plan to report it that way. Now, on the re-leasing front, we had a lot going on in Q4 — 15 leases were renewed or extended, which works out to 2% of ABR. Some of that activity came out of the lease restructuring tied to 4 manufacturing facilities that we discussed during the last earnings call. That restructuring played out the way we anticipated: rent initially fell from $5.4 million down to $1 million, and then it will step up gradually until it reaches $2.4 million in year 4 of the lease. The size of that roll down was bigger than the positive re-leasing spreads we captured across a number of office and warehouse properties. All told, our re-leasing efforts brought back 89% of the previous rent and added 7 years of weighted average lease term. Since this figure tends to fluctuate each quarter, our internal practice is to look at it over the most recent 8 quarters. Across that span, we brought back 97% of the rent we had previously collected, and on a weighted average basis we extended lease duration by 7.7 years, all while committing just $1.16 per square foot toward tenant improvements and leasing commissions. Turning to new leasing activity, we executed 11 new leases at existing properties, carrying a weighted average lease term of 17 years. Among these was an agreement covering approximately 1 million square feet of rooftop area for solar panel installation at a logistics facility we own in the port of Rotterdam in The Netherlands, which we recently expanded. The arrangement generates additional lease income without requiring any further capital outlay from us. The sheer size of our warehouse and industrial portfolio has opened up a range of possibilities, so we're working hard to reproduce those leasing successes elsewhere — efforts that also move our ESG goals forward. Turning now to what we did in the capital markets and on the balance sheet: across 2019, we kept a number of financing channels open to us, bringing in $1.4 billion altogether in attractively priced, long-term and permanent capital. In June we accessed the U.S. dollar debt capital markets, and in September the euro ones, pulling in roughly $900 million through unsecured bond offerings. Most of the net proceeds from those deals were used to pay down balances on our unsecured credit facility and to retire mortgage debt carrying higher yields, moves that pushed our unsecured debt strategy further along. In Q4, we paid down $324 million in mortgage debt, bringing the 2019 figure to $1.3 billion. As a result, secured debt fell to 9.7% of gross assets by year-end, roughly half the level it had been during 2019, and that move freed up another $180 million of ABR. So when 2019 ended, unencumbered ABR accounted for 73% of the total, up from 53% at the start of the year. The bonds we issued in 2019 had a weighted average interest rate of 2.3%, well under the 4.8% weighted average cost on the mortgage debt we retired, which will produce meaningful interest savings in 2020 and later years. On top of that, our ATM program raised $523 million in equity capital over the course of 2019, with a weighted average price of $79.70. That entire amount was completed before the year's later months, as we didn't do any ATM activity in Q4. When the year ended, our net debt-to-adjusted EBITDA stood at 5.4x, while debt-to-gross assets came in at 40.3%. That lowered overall leverage from where it was a year prior, when those figures were 5.8x and 42.8%. Starting from the end of the year, we made changes to and restated the senior unsecured credit facility, bringing the overall capacity up to $2.1 billion. That figure includes a $1.8 billion multicurrency revolving line of credit, a GBP 150 million term loan, and a $105 million equivalent multicurrency delayed draw term loan. Every one of these comes due in 5 years. The increased scale, combined with improved pricing, duration and other conditions, reflects the considerable strides we've made across the past several years in carrying out our business strategy, as well as the robust appetite in the bank market for our credit. We're starting off the year with a balance sheet that's in great shape and very strong, with plenty of liquidity. That gives us a lot of room to maneuver when it comes to funding our pipeline of acquisitions, and it also lets us keep tapping the capital markets when the timing makes sense. Now, on to guidance. Looking at 2020, our expectation is total AFFO per share somewhere in the range of $4.86 to $5.01, and that figure includes real estate AFFO per share of $4.74 to $4.89.

We’re assuming somewhere between $750 million and $1.25 billion in investment volume in our guidance, and that figure takes into account capital investment projects we anticipate finishing within the year. Now, on the timing of 2020 investments. As Jason said, we have already closed $206 million of investments this year, which shows the momentum carrying over from a busy fourth quarter. On top of that, we have another $176 million of capital investment projects slated for completion in 2020, and the expected completion dates for each one are laid out in our supplemental. Drawing on what we’ve seen, our guidance also bakes in the assumption that investment activity not yet in our pipeline will probably skew toward the later part of the year. For dispositions, we expect the total for the year to land somewhere between $300 million and $500 million; that range includes the $115 million sale of an operating hotel that closed in January, which I mentioned earlier. When it comes to forecasting, one thing worth noting is that this hotel is operating close to breakeven, so selling it won’t move the needle much on 2020 AFFO. As we anticipated, our investment management earnings will keep shrinking as a result of the pending merger and internalization of the CWI lodging funds. Right now we expect that transaction to close at the end of the first quarter, assuming shareholder approval comes through, and at that point we’ll receive an estimated $32 million of common stock and $65 million of preferred stock in the combined company, which we expect will carry a 5% dividend. That comes on top of the roughly $100 million of common stock we already hold in the CWI funds. At the same time, we’ll stop earning asset management fees and profits interest in the funds, and we’ll no longer be paying sub-advisory fees; turning to expenses, we expect total G&A for 2020 to come in between $80 million and $84 million; that includes roughly $4 million of certain one-time expenses in 2020 tied to our move to a new headquarters office later this year. Beyond that, we expect to take on the cost of platform costs that were previously shared, since the reimbursements we got from the CWI funds for transition services will taper off as the year goes on. To give a bit more context around our 2020 expectations compared with this year’s results, AFFO for 2019 benefited from significantly higher lease termination and other income than we’re expecting in 2020, mainly because of the 2 larger lease-related recoveries that added up to $16 million in 2019. In a similar vein, during 2019 we recognized certain income tax benefits totaling more than $5 million, which brought our cash tax expense down to about $20 million on an AFFO basis. Given what we can see right now, we wouldn’t anticipate comparable benefits in 2020, and that means our cash tax expense will be higher. Finally, we expect interest expense to come down significantly in 2020, driven by the full year impact of last year’s capital markets activity, which lowered our cost of debt to 3.2% at year-end. Although we don't give detailed forecasts regarding activity in the capital markets, the range we've laid out presumes that, when looking at debt relative to gross assets, we keep our balance sheet neutral in terms of leverage. To wrap up, our balance sheet has never been in better shape, featuring modest leverage, plenty of liquidity, and firmly established channels for accessing multiple kinds of capital. We're happy with the initial traction we're observing from the investments that have already been finalized up to now, as well as the way our pipeline is growing. As Jason mentioned, through deals that have already been completed and capital projects planned for — to be finished before the year is out, we enjoy solid visibility into roughly $380 million of 2020 deal volume; and once the CWI merger closes as expected at the conclusion of the first quarter, our business will become even more streamlined, bringing us step by step nearer to earning 100% of our income from real estate. With that said, I'll hand things back to the operator so we can take questions.

I wanted to ask whether you can share some perspective on same-store NOI within self-storage, since it came in especially strong. Do all of those assets sit under leases? And what exactly was fueling that increase and the participation tied to the leases?

Brooks here. Within the Extra Space transaction, the overwhelming majority are net leased. Right now, 10 are operating properties, while another 9 are set to be added into the Extra Space lease. As for same-store results, that performance is essentially built into the portfolio itself. Those assets are located in markets where rents have risen nicely. Take the 10 we keep as operating properties — they've posted quite strong growth, with NOI up more than 10%; meanwhile, the net lease assets fall under a long-term rent growth formula containing a fixed piece plus a variable piece tied to revenue growth.

All right, excellent. Then — please continue.

And on top of that, U-Haul experienced an increase there too, and that represents a significant part of the overall picture.

Exactly. And regarding the negative leasing spread for industrial, did a single deal distort that figure? I'd just like a bit more detail on the industrial leasing spreads.

Yeah, that is essentially entirely attributable to the one workout Toni brought up during her opening remarks. So excluding that, leasing spreads for this quarter were pretty robust, somewhere around 112%. However, that single workout transaction involving 4 industrial properties was really what caused it.

All right. Then one final thing. Could you share a few thoughts on the tenant watch list and how it's been trending? Also, are there any tenants worth flagging that we should keep an eye on?

Absolutely. At the moment, credit quality looks pretty solid. Our heightened watch list represents less than 2% of ABR. As far as concentration goes, no real industry patterns show up in it. It's simply a blend. Once more, we keep a close eye on every tenant and we're very careful, ready to move names down onto the watch list in a fairly proactive way; so we view that as a list that's safe to examine and one we're fairly comfortable with; so nothing in the way of real concentrations or especially noteworthy names.

Toni, could you help us reason through the acquisition guidance — what sort of underwriting assumptions sit behind it, whether that means cap rates or investment spreads?

Greg, it's Jason here. Happy to handle that. In the guidance we provided, we mentioned a range for acquisitions spanning $750 million to $1.25 billion in new investments. Within that, I'd say we've observed some cap rate compression across the year, in both the U.S. and Europe. Looking at our Q1 deals so far — the $200 million we mentioned earlier spanning 5 investments, covering both new investments and capital projects — those combined to roughly a 6.5% cap rate. It's tough to forecast an entire year, where markets are headed and where opportunities will emerge, but I'd say that's likely a solid run rate for you to use for the year; it has decreased somewhat from the mid- to high 6s we saw as a blended cap rate in 2019. I believe that mirrors 2 factors: First, we've continued to witness yield compression; but just as significant, we're expanding the kinds of deals we pursue. We remain focused on what we've historically done — sale-leasebacks, critical operating properties where we've achieved above-market yields — yet we're also bringing in higher quality real estate that might trade at lower cap rates, might carry greater embedded growth or improved re-leasing outcomes once the terms end. The Black — the Stanley Black & Decker would illustrate that well. So those 2 elements are really what's pushing the modest cap rate compression, at least as we see the year playing out.

Also, I realize you may have addressed this earlier, so my apologies if that's the case. On the capex front, you're aiming to deliver close to $0.25 billion worth of projects in 2020 — does that strike you as a sensible baseline for deliveries moving forward? I'm just wondering how you'd characterize the depth of that pipeline among the potential investment projects already in the current portfolio. And beyond that, what does the sourcing process look like for bringing in more?

Yeah, I'll kick things off, and I'll check whether Brooks has anything to add. Sure. So in 2018 and 2019, roughly 10% to 15% of our deal volume consisted of these capital investment and development projects, which, by the way, also encompass build-to-suits; this year, you've heard the figures we just referenced. We anticipate that will double relative to — the 2019 figures. My expectation is somewhere around $240 million of investments are on track to be finished this year, again both build-to-suits and expansions. A portion of those have already been completed year-to-date. We've additionally got another $130 million sitting in our supplemental that should wrap up in 2021; so it's hard to forecast, as is always the case, but a solid run rate is likely somewhere in that 20% to 30% range; it's turned into a major priority for our investment management team; we possess the skill set for spotting the tenant relationships. We've also got a substantial pool of assets, and in particular, the industrial assets that generally lend themselves fairly well to expansions. And as we've mentioned before, we're deploying more capital while also deploying capital at better yields. We're lengthening lease terms when we carry out expansions; it's real estate of higher quality, and we're also boosting the portfolio's criticality since we're building or expanding to match a tenant's current specifications and requirements. So there are plenty of positives that result from that kind of investment. And I believe you'll keep seeing us concentrate on it and, ideally, an increasing share of our annual deal volume.

This is for Jason, or perhaps Brooks, though what I'm hoping is that we might receive some kind of update regarding the Pendragon situation — whether any conversations are happening about possibly restructuring those leases, and whether that's something we should watch for potentially in 2020? Then, as a follow-up, the Pendragon property count decreased by an asset. It now sits at 69, yet nothing appeared on the disposition page showing a sale; so any detail on that would be appreciated too.