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

Hello, everyone, and good morning. We appreciate you being with us on this call covering our results for the third quarter of 2020. Prior to getting started, I want to note that certain remarks we make today do not relate to historical facts and might be considered forward-looking statements. Details about factors that could lead actual outcomes to vary significantly from what W. P. Carey anticipates can be found in the filings we make with the SEC. A web-based replay of today's conference call is going to be posted in the Investor Relations portion of wpcarey.com, and it will remain archived there for roughly 1 year; that same location also has copies of our investor presentations along with other associated materials. Having said that, I'll now turn things over to Jason Fox, our Chief Executive Officer.

Thanks, Peter, and good morning to all. I trust everyone is staying safe and healthy as we continue adapting to remote work and navigating the COVID-19 pandemic. I'm happy to report that external acquisition activity picked back up in Q3. With robust liquidity and a favorable cost of capital, we're in a strong position to pursue our expanding pipeline of investment opportunities. We've brought back formal guidance, which Toni Sanzone, our CFO, will walk through, together with our Q3 results, and he'll also address some elements of our portfolio and balance sheet. Joining Toni and me today are John Park, our President, and Brooks Gordon, our Head of Asset Management, who will be available for questions later on the call. Q3 represented yet another stress test for net lease REITs, and throughout it, our portfolio has demonstrated impressive resilience and consistency, with rent collections that rank among the strongest in the net lease peer group and across the broader REIT sector. All told, we gathered 98% of rents owed in Q3. Collections once again proved consistently strong in each of the the 3 months and across our core property types, including retail — where we brought in 100% of Q3 rents — and across both U.S. and European portfolios. On top of that, as of today, every one of our top 10 tenants has stayed 100% current on rent throughout the pandemic. I'm also glad to share that the overall strength of our collections has carried into Q4, with a 99% collection rate on rent due in October. This speaks to our underwriting process — centered on deep credit analysis and mission-critical assets — as well as the skill of our investments and asset management teams. W. P. Carey's portfolio produces rental income that is more dependable and, as a result, more valuable than what REITs with weaker or more inconsistent collections generate. The downside protection this offers is a differentiating factor that we feel the market is presently undervaluing, particularly in today's environment, given the recent spike in case numbers and the possibility of new lockdown measures. Now to our recent investment activity. While transaction activity hit pause after the first wave of COVID, substantially reducing our deal volume over the summer, we concentrated on rebuilding our pipeline, which is now producing deal closings. In Q3, we finished investments totaling $112 million, made up of the origination of 2 industrial sale-leasebacks in the U.S. and the completion of a warehouse expansion project for one of our grocery tenants in Europe. To be specific, in September, we closed the $44 million sale-leaseback of 2 state-of-the-art food manufacturing facilities in the Midwest. The tenant is a top manufacturer of a broad range of pretzels and related snacks, including well-known food brands. These facilities are highly critical, making up the tenant's entire manufacturing footprint, and the tenant has invested substantial capital into equipment there to support rising demand for its products. These are master leased on a triple-net basis for a period of 25 years, with rent increasing at fixed annual intervals. Additionally, during September, we closed a sale-leaseback worth $40 million involving a light manufacturing property net leased to Weber Grills, which is the top global player in barbecue grills and accessories. This property represents the main North American manufacturing operations for Weber, where the company has invested substantial capital. Its location is strategic — close to Weber's worldwide distribution hub, as well as near the I-90 freeway and Chicago's O'Hare International Airport. It carries a triple net lease lasting 15 years, with scheduled fixed annual rent increases. In that same month, we finished a $28 million capital project involving a 300,000-square-foot warehouse expansion close to Lisbon, Portugal, alongside our current tenant Sonae, among the biggest food retailers in that nation. This illustrates well our capacity to complete follow-on transactions with tenants we already have, which we recognized when making the initial acquisition back in 2018. The expansion got incorporated into the existing lease, and that lease was prolonged by 10 years, resulting in a new 20-year term. The property features a solar roof installation of 4,000 megawatts and has received approval for a LEED Gold rating. Investments made during our third quarter carried a weighted average going in cash cap rate of 6.5%, which offers a solid spread relative to our cost of capital, along with a weighted average lease term of 21 years, which helps sustain our overall portfolio's weighted average lease term at 10.6 years. Through these investments, total volume for the first 9 months of the year reached $516 million. Following the quarter's end, we have closed one more investment of $51 million, which brings the total to $567 million in investments, at a weighted average cap rate of 6.6%, for the year-to-date period up through today. Turning to the market backdrop: within the U.S., cap rates have kept compressing, especially for industrial properties or those whose tenants operate in industries resilient to the pandemic. With robust demand and low interest rates — which are anticipated to stay low even with expectations of additional government stimulus — it has been fairly common for such assets to change hands at cap rates below where they stood before COVID. In Europe, the situation has been comparable, set against an even lower interest rate environment and government initiatives that have offered capital alternatives. Capital markets across both regions have reopened and been tapped by corporations, which adds to the downward pressure on cap rates. That said, sale-leasebacks continue to be a workable option for corporations looking to free up capital currently locked in real estate, and they let us achieve incremental yield compared with trades of secondary net lease assets. From a cost of capital standpoint, we stay competitive, capable of executing higher quality deals at tighter cap rates in a way that is accretive. Strong liquidity along with our capacity to deliver certainty of closing keeps giving us an edge, particularly when corporations are looking to finalize transactions before year-end, which frequently means our fourth quarter ends up being the year's most productive period for closing deals. Now, a quick look at what we've been doing lately in the capital markets, plus a few final thoughts on our pipeline. The equity forward that closed in June, together with the U.S. bond transaction from earlier this month, shows how far we've come on this front over the past several years. Institutional investors backed both deals strongly, and that group included the traditional institutions focused on REITs, which gave us favorable pricing. Through the equity forward, we gain considerable flexibility, since it secures our capacity to match fund transactions in our pipeline using equity sold at a set price. Because demand for the bonds we priced in early October was so strong, we were able to grow the offering substantially, bringing in $500 million of senior unsecured notes and pricing them at the narrowest spread to the benchmark 10-year treasury rate we've ever achieved. We also think that, at 2.4%, it marked the lowest coupon ever recorded for a 10-year net lease bond. Even with cap rates this tight, robust appetite for our capital has delivered a cost of capital that can support accretive investment activity. Since summer ended, deal activity has picked back up, and our pipeline keeps growing, now back at levels seen before the pandemic. We've made more headway on a range of industrial opportunities across the U.S., though we're also finding pockets of opportunity outside industrial, and Europe has historically provided stronger retail fundamentals; given ample liquidity, we feel confident about executing on our robust pipeline. And with where we sit in the year, we can see clearly which transactions are likely to close before year-end, and our guidance assumptions reflect that; with that, I'll pass the call to Toni.

Thanks, Jason, and good morning to all of you. Earlier today, we announced total AFFO of $1.15 for each diluted share in Q3, with 97%, or $1.12 per share, generated by our Real Estate segment. Our lease revenues keep climbing, driven by net acquisition activity along with the contractual escalations embedded in our leases, and we also saw rent collections improve to 98% in the third quarter versus 96% in the second quarter. Although uncollected rents have had a de minimis effect on our portfolio as a whole, I want to take a moment to explain how that shows up in earnings. On revenue recognition, we followed the same method I described three months ago, consistent with accounting guidance and adopting a conservative stance regarding collectibility. Consequently, only roughly $1 million of uncollected rent is reflected in our third quarter AFFO, and we anticipate collecting that amount in full within the next 6 months. Roughly $5.7 million of uncollected rental income, net of recoveries, was excluded from AFFO in Q3, a decrease from $8.5 million in Q2 as some tenants started paying rent again. Around half, or $2.8 million, of the uncollected rent this quarter stemmed from 1 deferral agreement that we signed and described three months ago as part of a larger lease restructure. That agreement involved a 6-month deferral, payable across 5 years, and the tenant began paying rent again in Q4, including the deferred piece. Most of the remaining unrecognized rent in Q3 consisted of amounts owed by fitness centers, theaters and restaurants, several of which have gone back to paying partial rent but will stay on a cash basis for AFFO purposes for the foreseeable future. Now to leasing activity. During Q3, we finished 7 lease renewals or extensions spanning multiple property types, accounting for slightly less than 1% of ABR, on which we recaptured 95% of the previous rent and tacked on 7.3 years of incremental weighted average lease term. Because this metric naturally fluctuates from quarter to quarter, we keep our internal focus on it across the trailing 8 quarters. During that period, we've recaptured 97% of the prior rent and added 7.3 years of incremental lease term, while investing only $1.42 per square foot in tenant improvements and leasing commissions. Contractual same-store rent growth, calculated using ABR on a constant currency basis and capturing the year-over-year rent growth baked into our leases, came in at 1.6% for Q3. This metric's decline relative to Q2 mainly reflects a periodic rent increase rolling off the calculation for U-Haul, our largest tenant. Comprehensive same-store rent growth, which we introduced to our disclosure earlier this year, relies on pro rata rental income included in AFFO, factoring in any leasing activity, vacancies, restructurings, rent deferrals or abatements, and thus captures in full how the pandemic affected earnings year-over-year. During Q3, that figure came in at negative 1.7%, an improvement from negative 2.6% in Q2, largely because tenants went back to making their scheduled rent payments and we recovered past-due rent from some tenants. Now a quick word on expenses. Over the past 2 quarters, property expense has risen modestly, and the reason is that we are accruing real estate taxes on properties where we think there's a greater chance tenants won't cover those expenses themselves. The way we accrue property expense matches how we assess whether a tenant can pay rent, and that produced an extra accrual of $2.4 million in Q3 and $4 million on a year-to-date basis. G&A expense came to $19.4 million in the third quarter, and we still expect it to land between $76 million and $79 million for the entire year. Let me turn to our capital markets activity and balance sheet. We keep managing the balance sheet from a position of strength, which lets us tap equity and debt capital when opportunities arise, at pricing that allows accretive investment. Late in the third quarter, we brought in $100 million of net proceeds by issuing roughly 1.5 million shares through the equity forward agreements we established in June. Since those shares came out right at the end of the quarter, the effect on diluted share count will show up beginning in the fourth quarter. All told, we have now settled 2.95 million shares through the equity forwards, generating $200 million, which leaves us able to issue another 2.5 million shares, or about $166 million in equity. In the third quarter, we paid off mortgage debt amounting to $192 million, carrying a weighted average interest rate of 5.1%; that brought secured debt as a percentage of gross assets down further, to 8% at quarter end versus 12% a year earlier, and freed up an additional $30 million of ABR along the way. Our balance sheet metrics are still strong, and we closed the third quarter with debt to gross assets at 40.6%, basically unchanged from the prior quarter and at the low end of our target range. Net debt-to-EBITDA stood at 6.1x at quarter end, up slightly from the second quarter. If we count the shares we can still issue under our equity forward agreements, net debt-to-EBITDA would fall below 6x. We finished the third quarter with $1.9 billion of total liquidity, which includes $1.6 billion of availability on our credit facility, cash on hand, and the roughly $166 million of proceeds available under equity forward agreements that I mentioned earlier; and as Jason noted, we improved our positioning further early in the fourth quarter by successfully issuing $500 million of 10-year U.S. bonds with an annual coupon rate of 2.4%, far under the interest rate on the mortgage debt we repaid in the third quarter and also under our overall weighted average interest rate of 3% at quarter end. Combined with our favorable cost of funding, that provides a distinct route for us to carry out our investment pipeline accretively through the close of the year. Now, moving on to what we're projecting for 2020. Given how much visibility we currently enjoy for the rest of this year, we have brought back formal 2020 AFFO guidance, setting a range from $4.65 to $4.75 per share, which includes real estate AFFO of between $4.51 and $4.61 per share. As Jason mentioned, investments made so far this year, through today, came to $567 million, and for the full year our guidance presumes total investment volume somewhere between $750 million and $1 billion, depending on the pipeline visibility we have right now; regarding dispositions, taking into account what has closed year-to-date along with what we expect in the fourth quarter, we're assuming 2020 dispositions in total of between $300 million and $350 million. To wrap up, I'm happy to report that our third quarter results represent yet another quarter of consistently strong rent collections, which our portfolio has delivered ever since the pandemic began, showing how dependable our earnings are and putting us in position to do well if the recent surge in case counts leads to additional economic turmoil. With substantial liquidity, a favorable cost of capital and more deal activity, we also feel confident about our capacity to create growth by carrying out the accretive investment opportunities sitting in our pipeline. With that said, I'll hand the call back to the operator for questions.

Since we've got only a pair of months remaining before the year wraps up, I'm wondering what might push you toward the upper or lower boundary of that guidance range? Does that assumption include any possible tenant losses? Or is it truly driven only by the acquisition figure?

Yeah, regarding the low end, Greg, nothing particular worries us right now. That said, when deals close and the murkiness of today's conditions — those are the only things reflected in that downside scenario.

All right. Then when it comes to the possible fourth-quarter deals, should those anticipated purchases fail to close during this period, would it be more probable that they get delayed until the beginning of 2021? Or could they perhaps never get done at all?

Yeah. It's likely some mix of both, Greg. What I mean is, quite a few transactions we're working on are fairly advanced, and my sense is this is more about when things happen rather than whether they happen; even so, we're feeling positive about the pipeline at present. And should any deals end up spanning the close of the year, they'd simply get counted in the following year's deal volume. And truly, the key point is, regardless of whether they closed on December 31 or January 1, that wouldn't really change our 2021 figures in any meaningful way. Perhaps that's what's behind your question — will these deals keep driving growth into next year. And broadly, I'd say the answer is likely yes.

Alright, and one last thing from me. Regarding the rent we collect on warehouses, it stayed at 94% for this quarter — is that because of certain tenants specifically, and is there a chance we lose that for good? Or does it simply come down to the deferral arrangement you mentioned earlier?

Brooks, would you like to handle that question?

Absolutely. Right, that's essentially the single bigger opportunistic deferral we brought up during the earnings call for the prior quarter, and they are back to paying rent in accordance with the lease; thus we anticipate that will climb again.

A couple of fast questions. Could you refresh our memory regarding the Marriott lease — which varieties of Marriott properties does it cover? My assumption is that rent is still coming in, but I'd like to know what kinds of assets sit in that portfolio.

Yes. Speaking is Brooks. That's right. Throughout the coronavirus period, Marriott has stayed current. The properties involved are Courtyard Marriotts, and while they remain open, they're definitely running with reduced occupancy, as one would anticipate.

All right. Moving on, regarding the handful of leases we signed this quarter that saw double-digit declines — could you share some context about how those negotiations went?

Of course. I believe there are 2 you have in mind. The first involves our industrial portfolio — a long-term blend and extend arrangement covering a 2-property lease, with assets located in Kentucky and Tennessee. That kind of standard blend-and-extend deal generated a tremendous amount of value over the long haul, though it did come with a modest rent decrease right away. The second was a comparable transaction involving an automotive training school located in Sacramento. Once again, in both cases we believe significant intrinsic value is being created, but they did call for an upfront concession in return for extending the lease term.

All right. Then here's my final item. Toni, regarding your ability right now to bring Eurobonds to market, would you say you're completely matched at this stage? Or does a chance remain to complete one more institutional transaction with a long duration?

Yeah, so I'd say we keep examining our leverage metrics, I suppose, both with respect to the total amount and also, as you brought up, from a match-funding standpoint; and I believe that given the pipeline for acquisitions, we're seeing certain activity start to accumulate in Europe. So with that in place, I'd say Europe is always an option for us when it comes to the places where we might tap the capital markets. That said, we remain, in a sense, attentive to where overall leverage stands right now.

Jason, when we think about your pipeline, perhaps looking past the coming two months and toward '21, how large is that overall pipeline? I understand you'll be reluctant to provide guidance for the upcoming year, but will volumes resemble what we anticipated heading into '20? And what about the split between the U.S. and Europe — and specifically Europe?

Sure. We've got solid momentum at the moment. We referenced the $567 million completed year-to-date, and a number of deals are about to close that would push us close to the lower end of the reinstated guidance range Toni brought up previously. Past that, we're feeling quite confident regarding our pipeline as we move toward year-end. I believe there's visibility on multiple deals that might lift us into the upper half of our guidance range for this year. For 2021, projecting much beyond the coming two months is genuinely hard. Still, I believe we do carry good momentum. And a few points are worth remembering, at least regarding 2020. First, the range we reinstated, $750 million to $1 billion — naturally, we anticipate landing inside it. And that's even though our investment activity sat paused for nearly 6 months of this year due to the pandemic. Also for 2021, what we can see clearly is roughly $170 million of build-to-suits and expansions now under construction, which should be delivered and start generating rent during 2021. So — and I think we'll increase that figure, perhaps via a build-to-suit or 2 that could plausibly wrap up next year too; then consider our diversified model, which hands us that broader opportunity set. As Toni noted in her script, we've managed to pre-fund deals using our equity forward. And the recent bond offering we completed at really attractive rates provides us a fairly strong cost of capital for competing. So should deal opportunities present themselves, we feel quite confident about 2021 and our positioning; yet predicting things, as you'd imagine, much beyond a couple of months is tough. Truly anything in 2021, apart from those expansions, isn't in our pipeline right now.

Great. Then, regarding what you disclosed about collections from the third quarter through October — it seems the ABR along with the fitness restaurant in that segment actually declined from 2% down to 1%. That could just be rounding. Could a tenant have exited there? Is there anything else in play that would alter your exposure to that segment, despite collections having improved?

Yes. Brooks, would you like to address that?

Absolutely. So the weak spot when it comes to what we collect is genuinely within that single category. That category has actually declined somewhat. There are basically 2 reasons behind this. First, a number of gyms got rejected during the 24-hour fitness bankruptcy. Second, there was the restructuring of quite a few theater leases — so it's somewhat a mix of those 2 factors. Even so, when you put those together, they truly don't make a material difference to the collection store as a whole.

For a while now you've been describing the pipeline as tilted toward industrial, yet you also brought up other categories within your diversified approach. So what additional opportunities are surfacing in that pipeline that strike you as appealing?

Sure. We continue to lean toward industrial, and I'd regard that as our primary emphasis. If we pursue anything in office, I'd tend to label it opportunistic. We would need longer lease durations plus stronger credits, and on the whole we'd underwrite those deals with more caution, particularly when it comes to lease expiration scenarios. So office is less probable, though I believe it remains something we'd evaluate given the appropriate circumstances. Retail is more probable in Europe. In our view, supply fundamentals and pricing dynamics are superior there, and naturally there's reduced competition too, since no retail-focused net lease REITs exist in Europe. As a result, we can usually achieve wider spreads there, along with extending structure on lease duration, and so on. So I believe you'll keep seeing us pursue more industrial deals. That represents the majority of what we've completed so far this year. It accounts for most of what sits in our pipeline. Even so, we are diversified, which is a valuable advantage because it provides us with additional avenues for growth.

All right. Then when we turn to the list of your biggest tenants, Marriott and U-Haul, each has under 4 years remaining. So what would things look like for those two right now? Or how would you approach a mark-to-market on just those 2?

Brooks, would you like to address that?

Okay, I'll address those 2. As we've previously talked about, U-Haul holds a purchase option coming up in April 2024, and our expectation is that they will go ahead and use it. Turning to Marriott, that lease consists of 2 tranches; we stay in regular contact with Marriott about when these leases end; at this point it's simply too soon to say. What I'd say we appreciate is that there's some duration remaining, which lets us move beyond the COVID stretch before we actually reach the point of lease end outcomes; so yes, both rank among our bigger lease expirations, yet each one carries a fairly strong lease end outcome.

All right. Then, for my final question — I believe this one's directed at Toni — just to clear something up. You brought up certain property tax accruals, and I'm not sure I fully captured everything you said. But I'm simply attempting to get a handle on it: if I consider 3Q and the effect of COVID, it seems the extra accrual hit you, and perhaps some reserves or noncollections did as well. So what did those amount to together, I suppose?

Yeah, that's a fair thing to raise. What we're really zeroing in on is those 2 items taken as a whole; and I believe I noted roughly $5.5 million in lost or uncollected rent that flowed — or rather didn't flow — through AFFO. And on top of that, I'd put it at roughly a $2 million rise in our expenses during the quarter; so taken together, that NOI on our leases comes to approximately $7 million.

All right. And is the way we ought to think about those — that this will keep happening until things shift with those tenants?

Correct. I'd say it's comparable to the way we consider the tenants when it comes to revenue. When we observe them paying the rent, clearly — or rather, paying the taxes, we're able to reverse that. However, we're adopting a somewhat cautious approach by accruing it until we see some betterment on that front.