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

Good morning, everyone, and welcome to Citi's 2021 Virtual Global Property CEO Conference. I'm Manny Korchman with Citi Research, and we're pleased to have with us W. P. Carey and CEO, Jason Fox. This session is for Citi and clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast. For those joining us here today, if you'd like to ask management any questions, simply type them into the question box on the screen. They'll come to me, and I will do my best to ask them during the session.

Jason, I'll turn it over to you to introduce the company and your management team. And as you sort of conclude that, if you could answer the following question for us, that would be helpful. Coming out of the pandemic, if an investor were to choose only one real estate stock to own, what are 3 reasons they should choose W. P. Carey?

Sure. Thank you, Manny. Thanks for having us. And with me that I'll speak some today is Jeremiah Gregory, our Head of Capital Markets. I think that most people are aware of who we are. We're the -- one of the largest net lease REITs in the index, with around $18 billion total enterprise value. I think we're known for diversification across geographies and asset types, and we're currently focused on growth. So let me start with your question. So I think the 3 reasons are: number one, we view our stock as currently undervalued on an AFFO multiple basis. We're currently trading maybe 2 or 3 turns lower than much of the net lease peer group and lower than where we were -- where we traded pre pandemic. I mean, we believe investors are both under appreciating the value of our stable income throughout the pandemic and the benefits of diversification but, maybe more importantly, are underestimating our ability to resume external growth. We talked about this before. Deal volume rebounded for us in the fourth quarter, and we've continued to show strong momentum into 2021. We have guidance a couple of weeks back at earnings of $1 billion to $1.5 billion for this year that's coming off of a fourth quarter where we did around $300 million of investments, and we've also announced about $200 million of deals so far in 2021. There's another $100 million of capital projects that we'll deliver throughout the year. And then I talked on our earnings call a few weeks back about our near-term pipeline, strong as it's been in, I would say, 5 or 6 years, years in which we were doing $1.5 billion to $2 billion in net lease transactions across the platform. So we're feeling quite good about that. So that's number one. I think number two is our sound balance sheet management, something that we're constantly focused on maintaining, keeping it strong and flexible, access to multiperformance of capital. And really, when you think about where we were positioned heading into the pandemic, we had lots of liquidity having just recapped credit facility, very limited debt maturities, and that allowed us to be patient about accessing the capital markets. It also ensured that we were very well positioned when market activity kind of resumed, and it led us to having a very strong fourth quarter. So now in 2021, over $2 billion of total liquidity, coupled with a very strong pipeline. So we're feeling quite good about where we sit right now. And then number three, and we've mentioned this a number of times, we've proven that how we invest provides greater downside protection than our peers. And I think that if anything, the pandemic has been a real stress test on REITs and that really has proven the benefits of our investment approach, which is focused on deep credit underwriting, large public companies as our tenants and a diversified portfolio that's really always been underweight retail. Our collections have consistently been in the high 90% range for the second half of 2020 and now in 2021, so I think that's another reason. But really, the biggest opportunity, I think, is now our ability to drive future growth through the momentum that we're in right now and seeing external deal volume.

Right. There's a lot of topics to jump into there. I guess, maybe starting from diversification, which you brought up a couple of times. I think that the -- one of the more unique things is your diversification globally. If you were to go and start a new net lease REIT today, would you do when that was sort of domestically focused or global in the way that you're constructed now?

No. I mean, we would continue with the -- and actually, global model, when you say global model, it's really focused on 2 main geographies where we have a strong presence. The U.S., obviously, it's about 2/3 of our portfolio. And then Europe, we've been investing in Europe since 1998. We have around 40, 45 people based in Amsterdam who run our operations. We have a team of 7 or 8 people based in London that run the investment side. And really, diversification, whether it's across property types or, to your question, across geographies, there's really 2 components here. Number one, it does provide downside protection. There's not any overexposure to one aspect of our portfolio. But maybe more importantly, where we sit right now, it does provide more opportunities to growth. We can allocate capital where we see the best opportunities at any given point in time. And in particular, Europe, there's much less competition, especially as a net lease REIT. We are the de facto public net lease REIT in Europe. We are the largest owner of net lease European assets, and there are no publicly traded companies that focus on net lease. Very little competition, wider spreads. So yes, so we would continue with the same model, being diversified geographically across the U.S. and mainland Europe in the U.K.

In other meetings, especially for companies that are transaction heavy, we've talked about the pause and sort of coming out of that pause, what that's going to look like. So I love your views on how you think when things unpause, the markets look both from a buyer and seller perspective, and what that means for you?

Well, I mean, we've -- when you say when things do on pause, I mean, I think we've seen that. We've seen momentum pick up. I think deal volume has increased. I think in our world, where we focus very much on sale-leasebacks, where we can dictate structure and terms, including rent bumps as well as generate incremental yields, we've seen that pick up. It probably started end of the summer, and it's really accelerated into 2021. I think there's a couple of reasons for that. I think there is some pent-up demand for transactions. But maybe even more so, I think companies are recognizing that the optimal balance sheet does not include having capital tied up into real estate. So more and more companies are, maybe for lack of a better word, outsourcing the ownership of their real estate to someone like us who has a cost of capital set up. So the unpause is happening. I think that we're well set up for it, as I mentioned, given the liquidity. I think our cost of capital is in a strong position. Any multiple on the equity side we've lost, and it's really not been substantial, has more than been made up for our cost of debt. So we're in a good position, and I think we're excited for the opportunities to come.

And what about the competitive side of that others that have capital, maybe cost of capital that's similar yours, north of yours, south of yours, doesn't really matter all that much, but they're targeting the same markets and same assets because there's a lot of cash in the system? Is any of that -- go ahead.

Yes. No, I think that's right. I mean, there's no secret that investors are seeking income right now and stability given the volatile markets. So I think there are -- there is a lot of competition. I mentioned earlier, Europe, we think there is less. I think a lot of the competition in the U.S. is focused on retail. That's the biggest component of net lease. It's also what we view as the commodity segment where it's easier to transact, and there's more trading of assets, there might be more supply. I think the unique area -- and there's others who do this. I'm not saying we're the only ones who do it, but we do have an advantage in the sale-leaseback market given our long execution history and our ability to do more complex transactions. So I think that will continue, and I think we'll continue to generate some incremental yield perhaps relative to the market pricing that we see out there.

And I guess, how deep is that moat of others not being in Europe currently? So if you take your largest U.S. competitor, and you say flights are going to start to London and Paris soon. They're going to send 5 of their best guys over there. They're going to tour some assets and they can cut a check. What am I missing? Why can't they sort of become competitive quickly?

Yes. I mean, you can do that. I think you're going to make mistakes. We've been doing this now for over 20 years, close to 25 years now, given our first deal was in 1998. And we made a lot of those mistakes early. There's a lot to learn over there. There's a lot of different jurisdictions to understand the regulatory and legal environments. But maybe, more importantly, is the relationship building, to be able to source deals. Especially ones that are either limitedly marketed or off market entirely, you need to have an established reputation there, and that doesn't happen overnight, and it certainly doesn't happen if you're just going to fly a couple of people over from New York and drop off some money. There's execution risk that I think a lot of people are not willing to take, and that's really where we excel and differentiate ourselves.

And if we go back to your comment, I think you said that the $1.5 billion, $2 billion sort of a year type of transaction volumes not unattainable, how big is your sort of pipeline to get down to completing that level of transactions right now?

Yes. So I mean, we did mention on guidance -- or on our earnings call, the latest guidance was $1 billion to $1.5 billion. We feel clearly good about that range. That's not a target. That's an assumption we make at the beginning of the year. It's hard to really predict a full year given that we only have visibility in the deals that will close probably over the next 3 months. But we see every deal opportunity that there is. We've been doing this for a long time and are one of the largest in the space. So we'll have the deal flow. From a pipeline standpoint, from a funnel standpoint, I mean, we see billions and billions of transactions each year. Maybe it's -- to put a round number on it, maybe it's $10 billion of deals. So I think that there is enough opportunity out there even -- given the competitive environment we're in to be able to do that deal flow. We also have a real installed base of tenants, which really drive follow-on deals. We recently announced the Eroski transaction that we did. That was the third or fourth sale leaseback we did with them. They're now a top 10 tenant, one of the largest grocers in Spain, really core locations, infill, strong barriers to entry. So I think that our installed base really gives us a big advantage to add deal volume relative to our smaller peers.

All right. One other thing that we spent quite a bit of time talking about on the public calls is your involvement in sort of the industrial space, both in the U.S., maybe to a lesser extent in Europe. That's been a market that's been on fire. Everyone has realized that if retail is bad and hotels are bad and everything else is bad, then industrial is good, and office is bad. What else is bad? Can we make a bad list? But industrial seems to be on the good list, no matter how people are looking at it. Yes, on the last call, you had a lot of confidence in being able to find deals that both underwrite well and have returns that are appropriate. What's the advantage there? How are you getting those deals?

Yes. I mean, I think there's a couple of things. I think number one, and we've emphasized this a lot, is how we source these transactions. Many of them -- most of them are sourced through sale leasebacks, which is going to provide an advantage. Again, we're not the only ones that can do sale leasebacks, but we certainly are one that has a very long history of good execution and that helps. I've mentioned a lot of the internal source deals, expansions, redevelopments, build-to-suit with existing tenants, that makes a big difference. But I think that one of the misperceptions maybe that all industrial assets are trading in the 3s and 4 cap rates and how are we competing with Prologis and others like them, and we're really not. Our model is not -- when I think a lot of the models are to buy shorter-term leases with rollover and exposure to mark-to-market opportunities, where they can really drive growth, where those 3 caps become 5 caps after you see that bump in resetting the market, our model is a little different. We like predictability. Our investors like predictability. So we're able to lock in longer-term cash flows. Perhaps we're not getting that near-term mark-to-market opportunity. And instead, the trade-off is we're buying these assets for 5 to 5.5 cap rates, which is a very interesting yield and a good spread to our cost of capital. So I think that's probably the primary driver here of what difference it is to our model. I think the second point is industrial is kind of a broad description of the asset class. We segment it into logistics as well as life manufacturing, and we're sourcing a lot of our sale leasebacks in the life manufacturing space. And maybe even some sub-asset classes like food production, which we feel have very strong dynamics given the nondiscretionary products they're generating, given the credits that we're doing as well as the lack of lease terms, these typically are 20 to 25 years. And so there's some niches within industrial that we've carved out and done quite well. At this point, industrial is almost 50% of our portfolio, so we've shown that we can be successful in adding more and more industrial assets to our growing portfolio.

Right. Do changing demographics or demographic shifts within the U.S. changed the way you're looking at potential deals or exposure at all?

And when you say changing demographics, what do you mean by that? Where people...

Every other meeting I'm going to have here talks about people leaving the coastal markets and going more, whether it be suburban or sunbelt. We're going to talk about -- in the industrial meeting, we're going to talk about onshoring, all of those types of trends together is sort of what I meant by demographics.

Yes. I think they're less impactful for someone like us. I mean, we are doing a lot of logistics and manufacturing, which is going to shift towards kind of the -- maybe it's the Southeast and the sunbelt. You're seeing more and more of that moving from the Rust Belt down South. So there's probably some impact to that. We are following our tenants and where their capital needs are and where they're growing their own businesses. But unlike, say, in office REIT or multifamily, there's probably a little less dynamics that are being impacted by kind of the current shifts in where people want to live and where the populations are changing.

People that open up your presentation or supplemental will notice that there is a slice of the pie that's office, and that will scare some people off. If they dig into it, a lot of that office is with the -- a government office in Spain, and so probably not as impacted as some of the trends that we see. Is that a correct assumption on my part that work from home and people moving out of dense urban centers is not going to impact your office exposure?

Yes. I think that is. Jeremiah, why don't you jump in? And you've talked about this before in the past, and you have a good perceptive on our portfolio.

Sure. Yes. I mean, Manny, I'll start with the point that you made, which is our largest office tenant, which is probably, in and around, I think 2% of our total ABR. And I mean, it's probably worth emphasizing, that's probably around 10% of our total office portfolio is Spanish government. That's an investment grade-rated government credit with, I think, close to 15 years left on a lease. That is not something that we think is going to be impacted by any of the near-term trends, changes to office that I think everyone is thinking about and that we're obviously paying attention to. And I think maybe just extending that point a bit. Our office portfolio as a whole is the highest credit rated part of our portfolio. Like much of the rest of our portfolio, it has a longer weighted average lease term. And so while we are, I think, tracking whatever the changes in office are, I don't think it's something where we feel that it's going to have kind of the same kind of near-term impact or considerations that some of the large multi-tenant office REITs are probably dealing with where they have tenants rolling over every day, always kind of in the market dealing with re-leasing. I think for us, it's going to be a much more gradual shift, whatever the broader market forces are. That's going to have -- it's going to impact us over a 5- or 10-year period, not over a 6-month period or a 12-month period. And then I just think, bigger picture, Spanish government, in fact, isn't our only government credit in Europe. Several of our large office exposures, we have the U.K. tax authority in Manchester, England. We have a French police station in Paris. These are some of our largest European office exposures. And in the U.S., it's probably more of a mix of kind of suburban or certainly drive 2 locations, not CBD, downtown served by public transit locations. Again, it's probably -- we're all going to be watching to see what the overall shifts are in the market. But to the extent, one of the forces at work is people maybe migrating more up to the suburbs or those types of locations or smaller buildings, so the Sun Belt, that probably has more of a neutral effect on us or even perhaps, in some cases, a positive effect on our portfolio. So I think that, overall, office is -- has become and will probably continue to become a smaller and smaller part of our overall portfolio. That's primarily because we're overweighting the new investments in industrial. And at this time, you have certain types of retail in Europe. There's no real new investments that you've seen us make substantial new investments in office over the last few years. I think where it's been appropriate, we've been pruning that portfolio, selling off certain pieces of it. So we've already brought it down from where it was perhaps in the low 30s to closer to 20% of our annual rent, and I think you'll see that probably continue to decline over time. That's going to be the trend. But overall, I don't think we have sort of the near-term risk or a challenge that, perhaps, other office companies may have when they're dealing with how those forces might impact them in the very near term.

Jeremiah, is there sort of a pricing advantage or discrepancy if you were to go and sell some of those larger, especially, government occupied European office assets that, at least as a U.S.-based public company, don't give you much credit? Now you might say they're good cash flow, they're good credit, and so we like them as part of our portfolio construction. But are they better served as a use of capital to go other places?

I mean, Jason, I'll let you jump in. I'll just make one quick comment, which is, I think at any given point in time, we have many assets in our portfolio that we could sell for a tight cap rate, certainly sell for a cap rate inside of where we could potentially reinvest. But -- and I mean, frankly, that could be true of other net lease REITs as well. I think as a net lease REIT, the mandate, I think, from investors, what we're looking to do is continue to grow and fund these investments with our -- with new capital with -- that sort of the most accretive thing we can do is sell equity, raise bonds, buy new investments. And so there's always that opportunity where we can look in our portfolio and find assets that we can sell at a tight cap rate. And I guess, that just gives us, I think, more flexibility and certainly optionality. To the extent our cost of capital ever were to become dislocated, I guess those are opportunities for us. But just from a balance sheet perspective, from a cost of capital perspective, I would say our best approach right now is to continue to grow externally from that with new capital, which will be very accretive capital. Jason, I don't know if you would add to that.

No. I think you've touched on it well. I mean, I think the broader message you also touched on, where office has been shrinking and will continue to shrink over time given where we're investing and probably where we're pruning our portfolio as well.

If we think about some of the -- whether it be sale leaseback or sort of just new leasing that you're doing, have there been any changes in tenant expectations or tenant desires to those leases, more flexibility, shorter terms, longer terms? Any of that kind of stuff that's changed since we were last talking a year ago or 18 months ago?

Well, I mean, we manage our lease expirations highly proactively, and so we just haven't had -- I mean, one of the benefits of that is we just haven't had a lot of lease maturities or rollover over the past year. I mean, I think it's been less than 2%. And generally speaking, we're owning critical operating real estate, so I don't think the pandemic really has changed their approach. I think for an office REIT, and we had a lot of office exposure, this is not the time to be having the deals -- these maturities. And then on the new deal side, in terms of structuring, again, we're doing mainly sale leasebacks, and we're focused on critical operating assets. And to optimize pricing, in many cases, they're longer lease terms. And tenants are more than happy to trade that for what might be a little bit more aggressive cap rate. And so we're not seeing a lot of pushback there. Our weighted average lease term for our deals in 2020, I think, was right around maybe even slightly over 20 years. And we're seeing similar trends in our pipeline this year.

Right. We can turn to ESG. What are your top 3 priorities to improve your ESG score over the course of next year?

Yes. Sure. Well, I think, first of all, we're very focused and try to excel in all 3 of the ESG categories. But given that we're already quite strong in governance and social standards, for that matter, I think where we can make the most progress on our score over the next year is going to be focused on environmental. It's probably important to start by saying that the work that we're doing with our tenants, it's not just about achieving a score there. We're still doing our best to be good corporate citizens, and that's the primary driver here. But there is a real business case to many of -- or maybe even most of our initiatives on the ESG side. So I think it's also important to note, we're only 1 of 2 REITs in our immediate net lease peer group that currently issues an annual ESG report, so we've already are showing ourselves as a good of -- a leader in the space. So 3 areas. I think first would be information gatherer. As a net lease REIT, we don't operate most of our properties, so we don't have easy access to, for instance, utility data. So I think that's key. We want to do that really for 2 reasons. One is to benchmark where we are today, so we can make and measure progress as we go forward. And then two, we want to start reporting to the key environmental agencies, such as GRESB and CDP. We currently report to ISS and MSCI, but we want to continue to kind of push the needle on all of this, and that's going to require a lot of work with our tenants. We're going to be employing technology. I think that we're seeing much more reception in Europe, which is not surprising. And we have done a lot of tenant outreach on how to best collect that data, and I think we are going to have some good success there. I think number two, we do want to focus on reducing the environment impact of our portfolio, and we can do that by buying or modifying our buildings into more green -- to more of a green portfolio. So new investments. I wouldn't say this is a primary driver of the deals we're doing, but it certainly is a secondary driver. Example is a $75 million build-to-suit that we recently completed in San Antonio, food production facility leased to Cuisine Solutions. I was told that, that was awarded the 2021 Sustainable Plant of the Year by Food Engineering Magazine. So we're doing some good things there. And then projects within our existing portfolio, we just completed 1 million square foot solar rooftop installation on a logistics building in the Port of Rotterdam. I'm told that's the -- it's the largest or one of the largest in Europe based on generation capacity. And then lastly, we want to continue to be forward thinking on green financing opportunities and engaging with green investors. And to that end, we're currently exploring the potential to issue a green bond, and we have a goal to be in the market, if not possible, as soon as this year. More work to be done there. And again, it's about data gathering, but we feel good about the momentum we're seeing there.

Two follow-ups on that. Do you find that -- since you have a little bit less control of the actual box than the tenant does, do you find that they're exploring these same ESG or at least the e-concept and are aligned with you to make that happen? And so if they have to invest some capital to do it, they're with you doing that.

Yes. I mean, there's a real business case for it. I mean, there is -- there certainly is the push from investors to have a greener footprint, and I think that's going to drive a lot of the tenants within our portfolio. But there's also the economic benefits of generating their power needs through solar projects. We have some wind turbines in some of our facilities as well, so there's a partnership there. I think maybe, more importantly, I mean, this is an opportunity for us to continue to dialogue with our tenants, understand how they use our real estate, how we can continue to invest alongside them and maybe even fund many of these projects for them in exchange for lengthening lease terms. Obviously, we would earn interesting yields on a lot of this capital investment that we're willing to do, and that's a good partnership that we've seen our tenants be very receptive to.

Jeremiah, a topic near and dear to your heart in our last few minutes here, rising rates as a net lease investor and landlord.

Sure.

How should the market be thinking about the fact that there's been so much focus on the tenure? And it's obviously a big part of your capital stack.

Yes. I mean, I think it's -- we're, obviously, acutely aware of the focus on base rates, and we're focused on that as well. I think that, frankly, to the extent there is a rising rate environment, and especially to the extent that, that's correlated with inflation, I think we're particularly well positioned to do well and probably even outperform our peers in that type of environment. I think we haven't talked about it a lot on this call, but as many of you may know who follow us, a large portion, approximately 2/3 of our leases are, in fact, indexed to inflation. Many of those completely uncapped. But again, the majority of leases that we have would, in fact, show better internal growth, in some cases could be much better internal growth for our portfolio in an inflationary environment. I think on the balance sheet side, though, to really get to the heart of your question in terms of rates, I mean, I think what we've done there is we try to be very proactive in managing our debt maturities and in taking advantage of the environment. The fact that we've been in over the last year, we've done 3 bond financings. Going back to the end of last year, we just completed about $1 billion of financings really in the last week or 2, where we pushed out much of our remaining mortgage debt maturities into a U.S. dollar bond with a 12-year -- $425 million, 12-year maturity, that's a 2.25% coupon. On the euro side, we took out the 2023 maturity with a new 9.25% year bonds, that's with a sub-1% coupon. So we don't really have any meaningful maturities until 2024. So I think that really we're -- we've positioned ourselves to be, I think, have a lot of flexibility. Even in a rising rate environment, we don't need to be hitting the markets kind of right into the face of whatever that volatility is. And I think we can be thoughtful about how we continue to deploy capital. And presumably, in the past, at least as rates have moved, ultimately, if the cap rates adjust as well, I mean, they tend to be correlated. So I think in the medium term or long term, we continue to see a spread between wherever rates are and wherever our new investments are. And I think that the key for a net lease REIT, the key for us is to make sure that we continue to maintain flexibility on the balance sheet side, so that we don't have pressure basically to jump into the markets if rates rise rapidly over a short period of time.

And just to finalize the green bond discussion, if you were to go to the market today, what would the pricing advantage be of a green bond versus not?

Yes. I mean that's a great question, and I'm sure there's perhaps a variety of views on it. I mean, my own observation from dialogue with our investment banking partners and just sort of tracking the market is that if you've gone back a year or 2 ago, I would sort of consistently heard that there perhaps wasn't a big differential between the pricing that you could get on a green bond versus regular bond, all things being equal, of course, same maturity, same issue or all of that. I think what we've seen over the last year, and particularly perhaps recently, there does seem to be a bit of a pricing advantage that can be identified in many of the recent issuances and how those bonds are trading. So what I've heard anecdotally is perhaps 5 basis points in the U.S. and perhaps as much as 10 basis points in Europe, all things being equal. I think that a lot of people are interested to see if that's just sort of a moment in time in the markets or if that pricing differential persists over a longer period of time. I think for us, we probably have appetite and interest doing a green bond either way. But for sure, to the extent that there's a pricing benefit and advantage, we'd love to take advantage of that, too. And I think our point of view is in the long term, this is just all going to get more focused. I mean, clearly, that's where the trajectory and the long-term focus of investors will be. I would expect there to be some kind of advantage in the long term for these capital markets. And perhaps, we're seeing that starting today.

Right. Well, we only have a couple of minutes left, so let's turn to our rapid fire closing questions. When we're sitting physically together in Florida a year from today, what will be the one thing that will have surprised people the most about your business over the prior 12 months?

I'd say our ability to deliver significantly higher deal volume in 2021 and really prove our ability to provide real externally driven growth, despite having such a large asset base.

What do you think your corporate travel budget will be next year as a rough percentage of what you spent in 2019?

I would say about 75%, and that assumes that deal-related travel for our investment team kind of continues and returns to 100% probably more quickly. And then the jury is still out on whether the rest of our travel return to pre-pandemic levels or if the use of video kind of stays at similar levels to where it is today.

What will same-store NOI growth be for the net lease sector overall in 2022?

It is a little bit trickier one. I think there's a couple of ways to define same-store growth. I think contractual, which is just year-over-year built into the leases, I would say it's going to be around 1%. I think we'll meaningfully outperform that maybe by double. The other one is -- that's even more difficult to probably put a number, too, is what we call comprehensive same-store growth that will take into account things like leasing activity and vacancies and deferrals and restructurings. I think the overall sector average will most likely depend on how much unpaid rent gets reset at either lower levels or returns to pre-COVID levels as opposed to any other kind of bumps there. So I'm going to say there's going to be a fair amount of return to pre-COVID level. So let's say, 3% on that definition.

And the final one here, what will the 10-year treasury yield be one year from today?

2%, and I think that given the reasons Jeremiah just talked about with our inflation, hedges built into our bumps, I think that we should outperform, like we do in benign times as well as in higher inflationary times with same store.

Right. Thank you very much guys.

Right. Appreciate it, Manny. Thank you.