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

Welcome to the 10:20 a.m. session at day 2 of Citi's 2020 Global Property CEO Conference. I'm Manny Korchman at Citi Research. We're pleased to have with us W. P. Carey and CEO, Jason Fox. This session is for investing clients only, and if media or other individuals are on the line, please disconnect now. Disclosure is available here and on the webcast. If you're in the room or the webcast, you can log into liveqa.com, enter code Citi2020 to submit any questions, or you can just raise your hand. Jason, I'll turn it over to you to introduce your company and management team. Please provide the audience 3 reasons why investors should buy your stock today.

Thank you for having us, Manny. And with me on the stage here, I have Jeremiah Gregory, who heads up capital markets for us; and Peter Sands, who heads institutional investor relations. So 3 reasons. Number one, our diversified portfolio of highly critical operating assets is positioned well to weather any downturn, and we also have one of the lowest tenant concentrations in the net lease sector and low exposure to net lease retail, for starters. Number two, a strong balance sheet. At 40% debt-to-EBITDA and 5.4x net debt-to-EBITDA -- sorry, debt-to-gross-assets, and 5.4x net debt-to-EBITDA. We have great flexibility in any market environment. And then lastly, I think, given the nature of our portfolio, in particular the 45% of our assets that are industrial, we have a unique pipeline of expansions and other build-to-suit opportunities embedded within our tenant base, which will provide incremental growth for us. And because these are truly proprietary deals, they tend to be very high risk/return opportunities for us. And it's become a growing part of our portfolio and our business, and we would expect, in 2020, this could make up as much as 20% to 30% of our total deal volume for the year.

Right. We've been asking each CEO here today about ESG. And the question is ESG is of increasing importance for all company stakeholders. What's one thing your company is doing to improve your overall ESG score over the next 12 months?

Yes. I mean within that lease, it's a little bit more difficult or less obvious on how to score on the E side of ESG. That said, we've had an increased focus within our portfolio. And in 2020, in particular, we're working with a number of our tenants to add roof solar panels. An example of this is a large asset, 1 million square foot asset, that we own in the Port of Rotterdam. We are currently installing solar roof panels. It'll be the largest in the Netherlands, and I think by output, it's expected to be the largest in all of Europe. So good for the environment, but also good for business for us as we'll be able to add incremental ABR without any additional cost to us. We're also actively looking to roll out this to other warehouse and industrial assets within our portfolio. There are 6 that we're targeting right now, all in Europe, but we tend to leverage that -- what we learn there and move it to the U.S. as well.

So I think your third reason was the focus on industrial assets as a big piece of the growth going forward. One thing that I think all the industrial REITs that are in the building are in agreement on is it's a very competitive space and there's lots of capital chasing it. So how do you operate and how do you try to focus your growth on a piece of the economy or real estate puzzle that has so much other competitive capital chasing it?

Yes. I think there's a couple of things. I think number one, the way we source our investments. We are focused on doing sale leasebacks where the upfront complexity kind of reduces the universe of potential buyers that compete in that space. If we look at the last 25 industrial deals that we've done, I believe 20 of them have been sale leasebacks. We're able to generate incremental yield based on that. But I think more importantly or maybe equally important is in addition to yield, we're also to impact structure. As a net lease REIT, we're very focused on durable cash flows with high visibility. By structuring sale leasebacks, we can dictate terms. We tend to do 15 to 25 years, and more recently, most of our deals have been in the 20- to 25-year terms. We also are able to structure with embedded bumps, typically averaged around 2% fixed per year. So I think we have good contractual rent increases built in within our portfolio. And then other lease provisions and reporting requirements, they tend to be a little bit stronger. I think on top of how we source transactions with true third-party deals, there's also a big emphasis on doing these expansions and build-to-suits within the existing portfolio, which I mentioned, as part of that. That's become a bigger part of our business. 2018 and 2019, that comprised of maybe 10% to 15% of our total deal volume. This year, we would expect that to be, as I mentioned a second ago, more along the lines of 20% to 30% of our business. A large percentage of those deals are in the industrial space where we're able to acquire at cost by definition, given that we're doing expansions or build-to-suits.

Have the, whether it be coronavirus or sort of the other concerns or threats on the economic growth, been of concern to your tenants recently, especially since you're more on the industrial side of industrial rather than the warehouse side of industrial?

Yes. I mean it's early to see how that flows through our tenant base right now. We have not seen any level of distress or any concerns about tenants' ability to pay rent. Clearly, it looks like it's going to impact consumer confidence. It's also impacting supply chains, especially those that go through China and other affected areas. I think what's important to note is that within the broader real estate sector, I think net lease is viewed more as a safe haven asset given the duration of the leases and the focus on credit underwriting. I think within the net lease peer set, I would expect us to outperform in a down economy or a downside scenario. Again, we have close to 11 years as a weighted average lease term. More importantly, our focus on underwriting and on managing our portfolio is acquiring operationally critical real estate, and in many cases, on master leases, which adds another degree of downside protection. We've seen that through past cycles. In fact, if anything, I think, given our business model, our flexible balance sheet, any kind of dislocation could create a buying opportunity for us to the extent our cost of capital maintains the current strength that it has now.

Can you give us an update on what the acquisition pipeline, mix, markets, et cetera, looks like right now?

Yes. Sure. So let me just give some color to 2019 first, and it'll inform us a little bit on 2020. So 2019, we did a little under $1 billion, about $900 million for the year. That was back-end weighted. In fact, almost half of that was completed in the fourth quarter. Collar was around 80% industrial, most of which we acquired, as I mentioned, through sale leasebacks. The majority of that, I think 75% to 80% of that, was also in the U.S. Cap rates have come down historically. If you looked maybe to 3 years prior, averaged in and around a 7% cap rate for new acquisitions across the portfolio. Last year, we talked on our earnings calls that, that came down to about 6.7% for the year. I think a lot of that can be attributed to, I think, 2 factors. One is there has been some cap rate compression, clearly. Two, given our cost of capital, we've widened the spectrum of yields that we target, mainly on the lower end where we've gotten more aggressive and perhaps lowered our hurdles for some higher-quality industrial real estate. An example of that was the Stanley Black & Decker deal we did at the end of the year, very high-quality logistics asset. One of their 2 most important properties within their logistics system, Charlotte MSA, we think, below-market rents, which provide the opportunity for upside upon lease expiration. So that's some color for 2019. Going into 2020, we've seen a lot of that momentum continue. We've closed about $200 million year-to-date at this point, mostly industrial, again. This time, there is some weighting more towards Europe where we're seeing more opportunities. In addition to the $200 million that we've closed, we have about $180 million of assets that are under construction as part of either build-to-suits or expansions. These are net lease assets with leases in place where rent commences upon completion. Those get added to our acquisition volume when they complete. And more importantly, they begin paying rent and adding to earnings as they complete as well. So $180 million of those. So at this point, 2 months into the year, we have clear visibility to almost $400 million of deals. Our pipeline currently is robust, especially compared to this time last year. It is weighted a little bit more heavily towards Europe relative to last year. But it's hard to have visibility past 3 months or so. Any deals that we'll close in the second half of the year are not part of our current pipeline. So we're feeling good about where we are right now, but it's difficult to predict what a full year would look like.

Any questions in the room? Experiential retail seem to be the solution to sort of part of what type of retail do you want to get into. I think the news over the last couple of weeks has given people pause as to whether that's a good sector of the economy to be in or not. Share your most recent views, especially in light of you buying a large retail experiential asset in 4Q.

Yes. We did buy one. It was a Bass Pro. One of their higher-performing stores, and one that we had a high degree of conviction in its ability to withstand cycles and changes in e-commerce and other impacts. But generally speaking, we still are underweight retail. The portfolio right now, it's comprised about 17% of retail, only 4% of which is located in the U.S. The 13% that is in Europe is more focused on what we view as subsectors of retail that have more resistance to e-commerce, auto dealerships for starters, do-it-yourself retail and some grocery as well. So we still view, back to the U.S., even experiential real estate, whether it's C stores, restaurant franchisees, that's still a bit of the commodity market where yields have compressed a lot. It's hard to differentiate yourselves other than pricing. We think a lot of the credits tend to be franchisees as opposed to something that's got more substance to it. So we value diversification. We'll continue to look at those. We're more likely to do high-performing stores if they're on a one-off basis. Or even more likely, portfolios where we have a critical mass and can make the argument that within a master lease structure, that a pool of assets that we own is important to the ongoing operations of a tenant.

Just switching over to cost of capital, what steps are you taking to protect yourself against changes in the equity or debt capital markets so you can continue to find the spreads to make acquisitions accretive?

Yes. Jeremiah, do you want to take that?

Sure. We've actually, I think, done a lot of transition of the balance sheet over the last couple of years. I think those of you who've followed us know that we've been on a long-term trajectory of paying down all the mortgage debt, converting entirely to unencumbered and accessing the bond markets. I think what you've seen more recently over the last 12 to 18 months, I'm really going back to the merger that we closed with CPA:17 in the fourth quarter of 2018, we did a stock-for-stock deal there. We acquired a portfolio that was slightly lower-levered than our balance sheet, and that started some delevering. And then throughout last year, access to capital markets, both on the bond side and also on the equity side, resulting in our overall leverage coming down from -- it was probably around 50% at the time of the merger on debt-to-gross-assets, and now, around 40% on debt-to-gross-assets. On net debt-to-EBITDA, that's come down to 5.4x, and that's come down even though we've eliminated a substantial portion of investment management fees that we were earning. And so those fees have gone away. We now have predominantly real estate earnings, and so the quality of those earnings has gone up as the debt -- net debt-to-EBITDA has also gone down. So the balance sheet is in a stronger place and as conservative a place as it's really been in probably since we converted to a REIT. I think we're on positive outlook from S&P. That happened last year as a result of, I think, some of the improvements and changes we were making to the balance sheet. We just actually renewed our credit facility. That was announced just before our earnings call a couple of weeks back. And so we have a new 5-year term on that. We upsized the revolver a bit to $1.8 billion. It's substantially undrawn. And I think we certainly feel like we're in a very strong place wherever the capital markets go. We think we actually have -- we continue to have good access to capital. We expect to continue to have good access to capital. But I think we've constructed a balance sheet that could certainly withstand a substantial downturn. And in fact, we talk about this a lot, in a downturn, net lease, that can be some of the most interesting net lease investment opportunities in a world maybe where there's a lot of uncertainty or a lot of concern about where markets are going and maybe rates are low as a result, but you can buy assets at wider yields. That's really the perfect environment for net lease investments. So I think we've intentionally constructed a balance sheet that we believe can be very active in those types of markets. And I think the bottom line is we would say we have a balance sheet that is well suited to really any market environment.

Do you think the fed cut this morning has any impacts on the acquisition markets, positive or negative?

I think you got to kind of wait and see how that flows through the system, coupled with whatever economic dislocation we may see from the coronavirus and the impact it has in demand and supply chains. It seems like the initial reaction is flowing through to improvements in cost of capital, at least on the equity side. On the debt side, it seemed to perhaps been on it's -- where it's expected, or maybe even under something that was lighter than expected. I mean ultimately, spreads will matter, and base rates have gotten quite low. I think we need to wait for the dust to clear over the next couple of days, and there may be weeks to come to see where the bond markets are. And assuming a couple of REITs will hit the bond markets in the coming days as things settle down, and that'll be a good litmus test. But ultimately, cap rates certainly lag cost of capital changes. They lag interest rate changes. There's a lot of private capital out there who -- that needs to invest and is less impacted by the market's movements of up and down, so I don't think it's going to be anything soon. The search for yield does not seem to be changing. I think that given the perceived nature of net lease as a safe haven, I think net lease will continue to see capital flows within the real estate community. So it's hard to predict. I think Jeremiah touched on it. If there is distress, that is a good buying opportunity, but I don't know if we're expecting to see that any time too soon.

Do you think you would be doing anything different if we're in a significantly rising rate environment than you are right now?

Would we do anything different? Well, I mean, I think that we've -- our balance sheet, and I'll let Jeremiah dig into this as well, is set up for this. We're pushing on maturities. We're paying off mortgages. In some cases, prepaying where it makes economic sense to push maturities further. We just recast our credit facility. We have a lot of flexibility. We're at the lower end of our target ranges for leverage profile. So I think we're set up well to the extent we see a rising rate environment at some point in time, and that correlates to higher cap rates. We'll see if that happens. I mean I'm not holding my breath right now.

Yes. I mean Manny, just to expand on that, I mean, I think that the reality is that sort of how we look at the balance sheet, how we look at trying to push out our debt maturities and set our leverage levels, I mean, we're doing that intentionally to try and derisk and mitigate the risk of massive changes to capital market or if it switched to a rising rate environment. So I would say on the margin, I mean, I guess, just common sense would be if we all believe we are in a rate environment that was moving up quickly, which is, I think, pretty different than where we find ourselves today potentially, yes, on the margin, that increases the incentives to push out debt maturities and to try and be, I think, very careful about how you match funds, new investments with the capital markets issuance. You certainly want -- wouldn't want to get into a position where you acquire some very large amount of assets on the line at one pricing and then you have to go issue a bunch of permanent capital in a very different pricing. But I think the reality is we already look at things that way. We already think that way. So I wouldn't want to say that would be some dramatic shift in how we look at it, but I think we would be cognizant of that environment and it would inform our decision-making that much more.

Yes. I think the other thing to think about is how we structure our leases with a large percentage of -- in fact, about 2/3 of our leases have inflation-based increases. We have a good fixed base that averages around 2%. But the inflation base and uncapped CPI increases also provides that hedge where we think, on a same-store basis, in a rising rate environment, we should outperform and perhaps will help us have a more competitive cost of capital in that type of market.

Are you guys willing to invest in more specialized assets, cold storage, data centers, those types of things? I guess the caveat that you would probably say, they would have to be attached to existing customers or primary to that customer's needs. But just do those types of over-improved assets, if you will, scare you?

Yes. There's certainly a place for those in our portfolio. We are -- have a diversified approach across geographies and asset classes. The more special purpose an asset, I think we'll look for other criteria that will be important, such as lease term and credit quality. In cold storage, for example, we've been an investor in that space for quite some time. In fact, 20 years ago, buying cold storage, we were ahead of the curve. And the view was it was expensive industrial, and it wasn't quite its own niche class at that point in time. I mean we've built a sizable cold storage portfolio. There's a -- the largest cold storage operator is Lineage Logistics, and we helped seed that with some initial sale leasebacks as well as investment in the operating company. It's a good business. While they may be specialized in terms of the equipment, it tends to store food products, nondiscretionary items that do quite well in -- across economic environments. Our portfolio of cold storage, which is sizable, we had barely a blip in our -- in the quality of our credits during the 2008 downturn, slightly a downtick in margins, but no distress or questions on whether or not they would pay rent. So I think it depends on the asset class. We have done some food production as well, limited amount, but these tend to be highly critical assets to the companies, which are important. They tend to have a high amount of tenant investment. They also tend to have long lead times in terms of getting those online. So there's other benefits to special purpose that perhaps offset the -- maybe the smaller universe of potential users upon a lease expiration or upon a default. And we're also getting paid more for those. So I think that there is a degree of making sure that we're achieving the right risk-adjusted returns if you're taking on something that's a bit more specialized. But generally speaking, our portfolio is standard industrial, light manufacturing and warehouse. And there is a place for those type of assets, but it's not a large component.

And maybe, again, turning back to the comment you made earlier, that concentration of those buckets of assets you just mentioned, are those going to be the same in the U.S. and Europe? Or is there going to be some asset-type differentiation in your investments in one versus the other?

I think that we probably have a little higher percentage of our cold storage assets in the U.S.

I'm sorry, I meant the -- you mentioned light manufacturing, warehousing, industrial as sort of your focus. Is that focus global? And so if we do, let's call it, $1 billion of acquisitions. 30%, 40%, 50% of that will be industrial split evenly? Or is it Europe will be 80% of that and U.S. will be 10% of that?

Yes. I mean I would expect the industrial to still make up the bulk of our investments in both the U.S. and Europe. I think where we've differentiated our strategy a little bit in Europe is in retail. We think the supply dynamics there are much different. There's something along the lines of 7 or 8x more retail square feet per capita in the U.S. relative to Europe. So we're a little bit more bullish on retail given just the supply differences over there. E-commerce is less developed as well, but eventually, Europe will catch up. I think that's one of the main differences. I think the other area in terms of property types by country or by region would be self-storage. It's become a growing part of our portfolio base. This is self-storage under a net lease structure. 2 of our top 10 tenants are U-Haul and Extra Space under long-term leases, triple net leases. That's more focused -- or it's entirely focused on the U.S. where we have experience running an operating platform of operating assets in our funds business, and that expertise has carried over to the net lease side as well.

Anyone in the room? Quiet Crowd. Can you talk about any tenant purchase options that are left in your portfolio? I guess, the New York Times is the biggest and most meaningful one recently, but just what other things should people be wary of?

Yes. New York Times is pretty well telegraphed. We wanted to be sure that, that was pretty well understood by the market. That did close in December. The other one that we talk about on -- with investors and in public earnings calls is the U-Haul portfolio. There is a purchase option at the end of the 20-year lease term, which is in 2024. It's not a fixed dollar amount like the New York Times transaction was. It's more based on the original purchase price from 2004, increased over time by inflation. It appears that, that's in the money option at this point in time. So we would expect that they would exercise it. But over the next 4 years, we think there may be opportunities to have discussions with the tenant to see if there are alternatives to their exercising. That's the biggest one, that's the most noteworthy. There are other options embedded in our leases, at times, as part of the negotiation on 20- or 25-year deals. We do give purchase options. The vast, vast majority of those, though, are at the greater of some premium to our purchase price or fair market value. So in those scenarios, we generally capture all the upside of the value of that asset in that purchase option, unlike what we experienced in the New York Times deal, which is just a different structure and more of a unique transaction.

Aside from the, I guess, the internalization or a combination with the CPA entities, large-scale M&A hasn't really been part of your growth over the years. Is there a chance that, that would become a bigger part of your business going forward?

Is there a chance that the investment management would be part of our business...

No. Sorry, the M&A would be a bigger piece of the puzzle.

Yes. I mean certainly, without a doubt. I mean we're focused on growth. We do have a number of paths to do that. Certainly, what's most common in the net lease world is the external growth, which we have a team that is experienced and has done meaningful deal volume over the years. We also have very high same-store growth. We talked about the embedded opportunities within our portfolio of expansions and build-to-suits. But certainly, portfolios and other M&As is on the table. We have the scale, we have the cost of capital to evaluate these transactions. Being diversified is also beneficial where we can look at property-specific portfolios, and they'll fit seamlessly into a diversified portfolio without really changing our overall diversification or property mix. We have an interest in finding ways to grow, and we think that, that's certainly something that we would consider and would hope to do in time.

Sorry. Is there an opportunity to sort of add other income streams to any of your larger assets? The industrial, we need to talk about it a lot, whether it be solar or helping tenants source product, or some of your scale sort of allows you to sort of think about those initiatives. It's not something I think you've spoken a lot about in the past.

Yes. I mean there's a little -- as a net lease REIT with these long duration leases, we don't have any operational responsibilities. There's a little bit more limit of an opportunity to create some of those value-add opportunities. That being said, I mentioned at the beginning when you asked about ESG, we are looking to and have an initiative in place to reach out to our tenants on various green projects. Solar is the most obvious, you mentioned that one. We are doing that 1 million square footer in Rotterdam. It's going to be meaningful from a publicity standpoint. It does add some ABR without any cost. I think it would add to the renewal probability as well. And of course, it's good for the environment as well. There is a pipeline of those that we're looking at. I think we're in conversations with 5 or 6 other tenants across Europe. We do have a large installed industrial base of assets, so that's a possibility. The other things we're looking at, and this is a means to maintain and engage our client base, is converting to LED lights. We're offering programs where we could fund those conversions. They start the dialogue for other opportunities, such as extending the leases, maybe expansions on top of that. So any tenant engagement that we could do, especially as a net lease owner, we tend not to have operational responsibilities, is a good thing. So I think there's a lot of benefits coming from those initiatives. So we're going to do more of it, and we're finding ways to really reach out and find some of those opportunities. So I think they exist.

I think another opportunity, too, that's probably a little distinct for us is the capital investment projects that we have that when we are either doing build-to-suit or expanding existing facilities, when we're doing new work, that's oftentimes the chance or the opportunity then to maybe produce something that could be LEED-certified or sort of higher environmental aspects to it than maybe the existing portfolio. I think we do have -- we've talked about it a lot. That's been a growing part of our business. And I think you'll see with the various projects that we're working on or other new ones that come into the pipeline, I think there will be a decent amount of opportunity there to do things that are environmentally attractive.

Talk about dispositions and your plans to sort of get rid of anything you feel is noncore to the portfolio.

Yes. Sure. So our guidance included dispositions of $300 million to $500 million. One of -- a large asset we've already sold this year. This was a legacy hotel operating asset that we acquired as part of the CPA:17 merger. This is -- and we've talked about this prior. It was expected to close in 2019, and it slipped from Q4 to Q1 of this year, which is part of the reason why disposition volume was less than we originally expected in 2019 and perhaps the reason why our range for 2020 is between $300 million and $500 million. That was 100 -- $110 million disposition. Importantly, we've noted this before, it was a hotel that experienced damage from Hurricane Irma and a number of rooms had been off-line. As a result, it's back stabilizing now. It was, at the time of the sale, expected to be breakeven for the year. So despite the size and the timing of that disposition at the early part of the year, it won't be a dilutive sale given its low contribution to earnings. On top of that, we do have a couple other noncore assets embedded in that range, one of which is the last remaining Asian asset that we own. It's a property in Japan, maybe in and around $50 million, that's slated to be sold this year. Also included is our last remaining operating hotel asset. It went through a PIP last year. It's stabilizing right now. We think that depending on what the hotel market acquisition environment looks like -- it's not great now, but depending on what that looks like, we may market that at the end of this year. So that cost beat, that's part of the reason for the range as that could fall into next year. We have the ability to be patient. It's a performing asset, cash flowing, and we'll wait for the right environment. But ultimately, we'll sell our noncore assets. I mean that's the bulk of the disposition pipeline. I think there's probably some opportunity to take some profits with 1 of our top 10 tenants, again, to continue to lower our top 10 tenant concentration and maintain a higher level of diversification that'll be driven by opportunistic pricing, but that's embedded in the $300 million to $500 million range as well. There are a few vacant assets in there. I know that that's a typical question that gets asked. It's under $40 million, maybe even under $30 million of sales for the year.

Any last questions in the room? All right. We'll go to the rapid-fire questions. Will you -- will the net lease property sector have more or fewer public companies a year from now?

I think more. Even with the dislocation in the broader markets, we think net lease will continue to be a relatively safe and stable environment. I think the public markets will perhaps be more receptive to some of the privates.

What will same-store growth -- NOI growth be for the net lease sector overall, not just your company, in 2021?

Yes. I think it'll be in and around 1%. We should be double that.

What will the 10-year treasury yield be 1 year from today?

How about 1 year -- or 1 week from today?

You can give us both, we'll note them both.

Let's say, 1.5%.

Great. And then in what year will the U.S. enter a recession?

Next year, 2021.

Thank you.

Great. Thanks, everyone.