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

Hello, everybody, and welcome. We appreciate you being with us on this call to discuss the results of our second quarter of 2020. Prior to getting started, I want to note that certain remarks we make during this session do not relate to historical events and might be classified as forward-looking statements. Details about the factors that could lead to actual outcomes varying significantly from what W. P. Carey anticipates can be found in the documents we file with the SEC. A webcast replay of today's call is going to be posted in the investor relations area of wpcarey.com, and it will stay there for roughly 12 months; that same location also has our investor presentations and other relevant materials available. Having said that, I'll now turn things over to Jason Fox, our Chief Executive Officer.

Thanks, Peter, and good morning to all of you. I trust everyone is staying safe and healthy as we keep confronting the difficulties brought by COVID-19. My comments today will center on a few key subjects. How our portfolio has performed lately during the pandemic, what investment activity we've recently undertaken, current conditions in the transaction market, and the way we're positioning the company for growth while sustaining strong performance. Following that, Toni Sanzone, our CFO, will walk through our second quarter results, which show our robust collections and our ongoing exit from the managed funds business, and she'll also discuss our recent leasing activity plus some details regarding our balance sheet and liquidity position. With us today are John Park, our president, and Brooks Gordon, our head of asset management, and they'll be available for questions once we reach that portion of the call. The entire 2020 second quarter felt the pandemic's effects, amounting to a stress test for net lease portfolios. I'm happy to report that our collections stayed consistently solid through the quarter, placing among the best in the net lease peer group and among the strongest collections in the wider REIT sector, which mirrors several essential aspects of our strategy. When you own single-tenant assets under very long-term leases, frequently exceeding 20 years, unforeseen events or major market shifts are bound to happen. Our diversified strategy makes certain that problems in any single asset type or industry won't have an oversized effect on how we perform. Beyond that, our disciplined investment process has consistently emphasized deep credit underwriting and mission-critical assets. Over the past five decades, we've made important choices to concentrate on companies, industries, and real estate that we believe are able to endure market dislocations and adapt to challenges and shifts in the business environment. By prioritizing long-term risk-adjusted returns instead of near-term growth at any cost, we have delivered strong total returns for our shareholders over the long run while preserving exceptional downside protection, which is evident in our rent collections. Net lease is rightly regarded as a fairly steady business, and we believe that delivering better downside protection and reduced volatility in our cash flows is a key feature of the returns we produce for our shareholders. Our approach has plainly yielded more durable rental streams, resulting in higher quality and thus more valuable revenues and earnings; this approach, combined with our emphasis on keeping a strong and flexible balance sheet, has placed us in a highly advantaged position today. All told, we collected 96% of rent due during the second quarter. Notably, collections were consistently strong in each of the three months, throughout our core property types, and across both our U.S. and European portfolios. Warehouse, industrial, and self-storage assets together make up roughly half of our portfolio. For the second quarter, our rent collection rate came in at 94% for warehouse, 98% for industrial, and 100% for self-storage. Our office segment, representing slightly less than 25% of ABR, did about the same, with rent collections reaching 99%. When it comes to retail, a sector where we've held an underweight stance for a long time and which accounts for only 17% of ABR, we brought in 98% of rents for the second quarter. Our retail investments have been kept to a minimum, and we've sold off retail properties, particularly those located in regions hit hardest by e-commerce competition. The bulk of our retail sits in Europe, a market with tighter supply, and we concentrated on categories such as do-it-yourself and grocery, both of which have delivered solid results. The one small blemish on our otherwise robust portfolio performance remained fitness centers, theaters, and restaurants, from which we gathered 37% of second quarter rents, even though they make up merely 2% of our ABR. I'm happy to share that our strong rent collection trend has carried over into the third quarter, with a 98% overall collection rate thus far on rent owed for July. Since deferrals have stayed very low, we've had the ability to craft a customized response for each circumstance, rather than the sweeping measures that numerous other net lease REITs facing broad-based problems have had to adopt. This gave us a great deal of latitude, enabling us to pursue lease restructurings with tenants when the chance arises, generating value in the process. In the second quarter, we finalized one of these restructurings with a major tenant. Even though that tenant had paid its rent on time and was anticipated to keep doing so, in exchange for a deferral lasting six months, we obtained years of extra lease term, and we enhanced the rent escalations by tacking on 50 basis points to the yearly increases, while also securing the right of first refusal over any future sale-leasebacks. We'll keep seeking out these kinds of chances where we can assist solid tenants in conserving capital in the near term while building long-term value for our shareholders. Now shifting to investments. Over the quarter, we wrapped up three capital investment projects totaling $148 million, made up of two warehouses and one industrial facility, at a weighted average cap rate of 6.5% and a weighted average lease term of 23 years. The biggest among the warehouse investments was a $66 million build-to-suit project finished in June for a Class A distribution facility located in Knoxville, Tennessee, net leased to Fresenius, the top global supplier of dialysis clinics and equipment, which holds an investment-grade rating from Moody's. This facility ranks as the tenant's biggest distribution center within the U.S., backing its newest and largest production facility. The lease carries a 20-year term along with fixed yearly rent increases. Also during June, we finished the build-to-suit of a $74 million cutting-edge industrial food production facility in San Antonio, Texas, for Cuisine Solutions, an existing tenant of ours and the largest worldwide maker and distributor of sous-vide prepared food products. This property is extremely vital to the tenant's operations, underpinning its future growth plans, net leased for a 25-year term with fixed yearly rent increases. Here's another illustration of value generation via follow-on deals: we managed to place the just-finished build-to-suit together with the current property beneath a master lease, which tacked on 13 years of term to the current property while also pushing up its yearly rent escalations. Thanks to these investments, first half investment volume reached $404 million, with a weighted average cap rate of 6.5%, and portfolio quality improved, reflected in a weighted average lease term of 19 years. Our hands-on asset management strategy, combined with the investments we've completed, stretched the portfolio's weighted average lease term to 10.7 years, up from 10.4 years 12 months earlier, even with the passage of time working against us. Occupancy also stayed very strong, finishing the quarter at 98.9%. It's understandable that market activity decelerated across both the U.S. and Europe in the second quarter, as investors stayed on the sidelines given substantial uncertainty, while sellers grappled with the near-term effects of the pandemic on their business operations. Absent an urgent need, many sellers simply chose to hold off until markets settled. Early on in the pandemic, we likewise halted external acquisitions, concentrating instead on preserving financial flexibility; in the U.S., even with fewer deal closings, pricing stayed competitive, particularly in warehouse and industrial, where investors have typically shown greater willingness to underwrite than in retail and office.

Deals of superior quality, supported by solid tenant credit, kept drawing in capital. That factor, combined with sellers still holding elevated expectations, meant transactions closed at capitalization rates in line with, or occasionally even lower than, levels at which comparable properties changed hands prior to the onset of the pandemic. Lately, purchasers and vendors have begun stepping back into the market, and we're observing a greater volume of transactions; we anticipate that activity in the U.S. will accelerate during the latter six months of the year. Across Europe, numerous nations are moving along the path toward reopening, and staff members are heading back to their offices, though a degree of unease persists. Since anxieties center more on mass transit than on safety within workplaces, regional cities are resuming activity more quickly. Initial signals likewise suggest Europe stands in a stronger position than America to climb out of the economic consequences of the pandemic. European investors are coming back as well. Queries directed at brokers by companies seeking to examine their alternatives seem to have risen, and there is considerable optimism that today's early signs of activity promise well for the back half of the year. A great number of businesses have satisfied their need for liquidity via short-term government stimulus programs, and we foresee that appetite for long-term capital obtained through sale-leasebacks will come back more substantially once those programs start to wind down. Looking forward, though we stay conscious of the ongoing ambiguity regarding the pandemic and how it affects economic activity, unlike numerous other net lease REITs, we are positioned quite favorably to deliver results across a range of economic conditions and to get back to deploying money in the near term. Over a history spanning nearly 50 years, W. P. Carey has been through numerous business cycles. We've refined the safeguards embedded in our leases and established the infrastructure needed to handle lease expirations, tenant credit difficulties, and restructurings effectively via our seasoned asset management team. We've taken encouragement from how strongly our portfolio performed during the first six months of 2020, and we hold great confidence that our team will keep proactively working with tenants to remain ahead of any problems and secure the best possible results; we came into the second quarter with considerable liquidity, chiefly by way of our $1.8 billion revolving credit facility, which is still nearly fully undrawn. During that quarter, we seized the chance to further strengthen our balance sheet position via the forward equity offering we wrapped up in June, securing a cost of capital that will underpin accretive investment activity. As we always do, we concentrate on transactions that provide appealing long-term risk-adjusted returns, while also keeping downside protection in mind, putting money into essential properties with robust tenant credit, preferring large firms able to tap liquidity, and sectors that hold up through an economic slump. Our recent discussions with CFOs reveal that the pandemic has left them more conscious than before of the advantages of obtaining long-term capital via sale-leasebacks. The smooth completion of our recent forward equity issuance demonstrates the confidence we hold in our capacity to reach a broad array of accretive investment possibilities. Such chances could arise in sectors that weathered the pandemic strongly and still command valuations comparable to what we've paid for targets acquired over the past few years, or in sectors where pandemic-driven difficulties have thinned out the field of buyers, resulting in better deal terms. Once again, deploying new capital sits at the top of our list. We're hard at work expanding our pipeline and anticipate completing several transactions during the back half of this year. On that note, I'll pass things to Toni.

Good morning, everyone. Let me begin by walking through what happened in our second quarter, both in terms of results and portfolio activity; since we aren't offering formal guidance, I'll share some thoughts on the areas where visibility into the rest of the year is somewhat better. Total AFFO came in at $1.14 per diluted share for Q2, and 97% of that was generated by our real estate segment. When you look at comparisons against the same period a year ago, they keep showing the continued runoff of investment management fee streams, which reflects how far along we are in getting out of that business. Turning to the real estate segment, lease revenues for the second quarter were higher than a year earlier, helped by net acquisition activity and contractual rent increases, plus the deal we struck last year to convert self-storage assets into net leases. Those gains were more than enough to offset what lease restructurings and uncollected rents cost us during the quarter. Lease termination and other income fell to $1.9 million in Q2, a big drop from both the previous quarter and the prior year, and that's because the earlier periods had unusually high lease-related settlements. This line item can bounce around from one quarter to the next, but at present we anticipate it will decline further across the back half of the year. As Jason noted, our portfolio has held up well through the pandemic so far, with 96% of total rent due in the second quarter collected, and the trend keeps improving — 98% has been collected for July. Consistent with accounting guidance and a conservative look at tenant rent collectability, only about $500,000 of uncollected rent is baked into our second quarter lease revenue and AFFO, and under short-term deferral agreements we expect to collect all of it in 2020. We left $8.5 million of contractual rental income owed for the period out of second quarter AFFO. Roughly 30% of that unrecognized rent sits under executed deferral agreements — mostly the longer-term restructuring with a significant tenant that Jason talked about — and it will flow into future AFFO once the cash comes in. The remaining approximately 70% is largely rents owed by our fitness centers, movie theaters, and restaurants, and we'd only recognize those amounts if they're collected. On the leasing side, we finished three lease extensions on warehouse properties accounting for 1.3% of ABR, recapturing 95% of the prior rent and adding four years of incremental weighted average lease term. Because this metric naturally varies quarter to quarter, we track it internally across the trailing eight quarters, and over that span we've recaptured 97% of the prior rent and, on a weighted average basis, added 7.3 years of incremental lease term while spending just $1.57 per square foot on tenant improvements and leasing commissions. Contractual same-store rent growth was 1.9% year-over-year, measured on an ABR basis to capture the rent increases built into our leases. On a comprehensive basis, same-store rent growth is calculated using pro rata rental income that's part of AFFO, so that leasing activity, vacancies, restructurings, rent deferrals, and abatements are all factored in. This metric came in at -2.6% for the second quarter, which captures the complete effect of rent collections and deferrals on earnings. Over time, we'd anticipate this metric to normalize, and it could improve considerably in quarters when we start collecting deferred rents that haven't been recognized yet. Now for investment activity. As Jason mentioned, we finished three capital investment projects during the quarter, with a total cost of $148 million, and all of them closed at the end of June, so their effect on second quarter lease revenues was minimal. Investment volume for the first half totaled $404 million; at present we anticipate completing three capital projects amounting to $42 million in the back half of the year, which would take us to roughly $450 million of investment volume for 2020, before factoring in new external investments in the second half. Dispositions through the first half totaled $116 million, since we made no dispositions in the second quarter. Compared with prior years, we currently expect disposition activity to be lower. With the market environment as it is and our strong liquidity position, we're taking an opportunistic approach to asset sales when we think execution and pricing are attractive. Now on to expenses. Interest expense came to $52 million in the second quarter, a 13% decline year-over-year, which reflects interest savings from the significant mortgage debt prepayments we completed in 2019. Our weighted average cost of debt at quarter end was 3.2%, compared with 3.5% in the prior year period. Total G&A expenses declined again year-over-year as we keep focusing on operational efficiencies throughout the business. That said, we do expect G&A to trend higher over the next two quarters, mainly because of non-cash straight-line rent tied to the lease on our new headquarter space. Our expectation for total G&A expense remains between $76 million and $80 million. Turning briefly to our Investment Management segment. Investment Management revenues fell 50% year-over-year, with segment AFFO of $6.2 million, or $0.04 per diluted share for the second quarter, which reflects the merger and management internalization of the CWI lodging funds completed in April. The fee streams that remain from the managed programs are laid out in our supplemental report and should be relatively consistent over the coming quarters. Because of the CWI transaction, in the second quarter we recognized a non-cash net gain of approximately $33 million within equity earnings from redeeming our special GP interest in those funds, and that is excluded from AFFO. Our remaining interest in the combined entity consists of our common and preferred equity, and from that we don't currently expect to recognize dividends in AFFO for the rest of the year. Now that the CWI deal has closed and the revenue tied to those funds has been shut off, we see our transformation into a net lease REIT operating on a pure-play basis as essentially finished. When it comes to how we report segments, starting in Q2, every G&A expense — apart from what the managed funds reimburse us for directly — gets folded into our real estate segment. Shifting to capital markets and the balance sheet. Our balance sheet is still in a really solid place, giving us plenty of liquidity access and only minimal obligations coming due soon; and we made it even stronger in Q2 via the equity forward deal we got done successfully in June. Thanks to robust demand from institutional investors, the underwriter's over-allotment option was fully exercised, and the deal priced at a gross $70 per share, bringing in $382 million in gross proceeds. Through the forward agreements, we can issue slightly fewer than 5.5 million shares across 18 months. When June wrapped up, we chose to issue roughly 1.5 million out of those 5.5 million shares, netting $100 million. As of quarter end, total liquidity stood at $2.2 billion, made up of cash on hand, unused room on our $1.8 billion credit facility, and the shares still left to issue under the equity forwards; that keeps us in great shape to go after fresh investments and lets us keep tapping the capital markets when opportunities arise. We closed the quarter at 41% debt to gross assets, sitting at the bottom of our leverage target range. Net debt to adjusted EBITDA came in at 6x at quarter end, higher than prior quarters, which mirrors the effect of rent we couldn't collect in Q2. If all remaining shares under our equity forwards are settled and issued, net debt to adjusted EBITDA would land inside our target range; to wrap up, our Q2 results show how consistently strong rent collections have been over the last few months, carrying into July, plus ongoing gains in the quality of our earnings. That strength in collections also showed up in the steadiness of our dividend, which we boosted during Q2 to an annualized rate of $4.17 per share. Looking at the balance sheet, we've bolstered our position further, making sure we're ready both to seize new investment opportunities and, should the need arise, steer through more uncertainty tied to the pandemic's continuing economic effects; with that, I'll hand the call back to the operator for questions.

Morning, everyone. Jason, let's begin with you. When you consider the second half of this year, I believe you mentioned your drive and your capacity to push volumes higher. Which kinds of assets are you going after, particularly since you noted that industrial is so sought after while other net lease sectors may carry greater risks?

Yes, that's correct. Our portfolio has performed strongly. Our balance sheet remains very healthy, so we anticipate returning to an aggressive stance during the latter six months of the year. The pipeline is growing steadily. We noted that roughly $400 million in transactions have been completed, largely those capital improvement projects that came online this year, with another, say, 40 still to come before the year ends. Looking ahead, I'd say the pipeline currently leans somewhat more toward the U.S. Europe is displaying clearer indications of a rebound, so we'd anticipate that region to gain momentum as we move through the year. Our emphasis is increasingly on industrial, even though those assets are attracting greater capital inflows and likely more cap rate compression. As a matter of fact, I'd say the finest industrial properties are now being priced at levels tighter than what they commanded before COVID. That simply demonstrates the appetite in that segment, particularly for top-tier tenants when it comes to quality. We'll concentrate more on sale-leasebacks. That's how we're able to pick up industrial properties. I believe the intricacies of finding and putting together sale-leasebacks will allow us to capture some added yield. It also lets us assess these transactions more effectively too. With sale-leasebacks, you usually gain greater and superior access to senior management, because the company itself serves as your counterparty in the transaction. That's what we favor, particularly amid today's uncertainty, and I think you'll witness more of that; as for other asset categories such as office and retail, I'd say we'll take a more opportunistic approach there, and likely be somewhat more cautious in how we underwrite, especially regarding lease expiration scenarios, since we recognize those aren't as important. We do support diversification, so I believe you'll continue to see us examine the full range of asset classes.

OK. Toni, this one's directed at you. Back in June, you were sitting there asking, "We want to strengthen our capital position. What's the way to get there?" So what drove the decision to go with a bigger forward instead of either an ATM back then — pulling that $100 million you folks ended up using during the quarter — and then basically counting on or wishing for the market to bounce back when you need additional capital, rather than pursuing that forward equity transaction?

Yes. Manny, my view is that the equity forward brings us a handful of benefits; it secures the cost of our equity capital, and at that level we're able to fund deals accretively. On top of that, it provides some flexibility for matching our capital requirements with our investment opportunities, really depending on when those come in across the year. We went ahead and used the chance to draw down $100 million from that forward in order to finance the completion of two of our projects near the end of June.

Thank you.

Thanks, Manny.

Frank, good morning to you. Jason, previously you brought up the possibility of shifting toward less risk and buying assets with lower cap rates because of where your cost of capital sits. I'd like to hear what you think now, and whether that option remains available.

Sure, absolutely. Because of the diversification we have, we're able to look at a broad set of asset categories and, for that matter, geographies. That also ties into a pretty wide band of cap rates. Our view is that accretive investments in the mid- to low-5% remain achievable. Those would involve higher quality properties, most likely logistics assets such as the Fresenius transaction we announced recently or the Stanley Black & Decker transaction completed at the close of last year. There's definitely still appetite, perhaps a lean toward completing additional higher quality transactions, even when the spreads are tighter. Once again, sale-leasebacks let us enter those at what we view as incrementally better yields; we continue to review transactions in the mid-6% and up through the 7%. These are perhaps closer to our standard sale-leasebacks, through which we can again generate some incremental yield by sourcing and structuring, or perhaps concentrating on investment grade credits of that sort, where our underwriting capabilities let us set ourselves apart and place bets on particular credits and tenants.

All right, I'd like to build on what you said regarding the emphasis on industrial acquisitions, and you mentioned the greater competition you're observing in that asset class. How does that stack up against the competition that existed before COVID, and is the pool of buyers shifting in any way?

Before COVID, industrial was, I believe, still the asset class people wanted most. It was the one that had seen the greatest cap rate compression. So that aspect really is unchanged. When it comes to who's buying, part of it, I think, hinges on whether we're talking about the U.S. or Europe. There are, I'd say, some haves and have-nots. Many of the industrial REITs clearly have performed very well when it comes to collections, much like we have even though we're diversified. Typically, we aren't competing with the industrial REITs. In many instances, they concentrate more on multi-tenant industrial assets. In other instances, when they're single tenant, the leases are usually short-term. They're able to capture mark-to-market opportunities. Our preference remains the longer-term net leases. That aligns with our model of stability and predictability in our cash flows. There hasn't been much movement in who those players are, since that asset class has, on the whole, held up pretty well.