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

Hello, everyone, and good morning. We appreciate you being here today for the earnings call covering our first quarter of 2021. Prior to starting, I want to note that certain remarks on this call do not reflect historical facts and might be considered forward-looking statements. The factors that might lead actual outcomes to differ significantly from what W. P. Carey anticipates are laid out in our SEC filings. A web replay of this conference call is going to be accessible through the Investor Relations portion of our site, wpcarey.com, and it will remain archived there for roughly 1 year; you can also locate copies of our investor presentations and other associated materials there. With that said, I'll now hand things over to Jason Fox, our Chief Executive Officer.

Thanks, Peter, and good morning, everybody. I'm happy to share that a lot of the favorable momentum from Q4 2020 has carried over into 2021. On multiple fronts, the year has gotten off to a really robust beginning. To begin with, we're now tracking ahead of our original 2021 targets for investment volume, and our near-term pipelines look robust — arguably the strongest they've ever been — with more than $500 million of active deals at an advanced stage, a large portion of which we anticipate closing in Q2. Next, throughout the pandemic we achieved rent collections that led the industry, and we remain highly confident about how our portfolio will perform down the road, particularly given a macro backdrop in which the US and global economies should strengthen as COVID cases fall and business activity picks up. Third, we completed two major bond issuances in Q1, which demonstrates our ability to access very attractively-priced capital, securing record low coupons in both the US and Europe and refinancing most of our near-term debt maturities, with our next meaningful maturity now set for 2024. Additionally, last week Moody's moved us to positive outlook, a reflection of the positive trajectory of our business and balance sheet, and it gives us confidence that we'll keep enjoying access to attractively-priced capital going forward. Fourth, we raised equity through our ATM, accretively funding our recent investment activity and modestly delevering relative to where we finished the fourth quarter. Beyond that, we still have equity proceeds available from the equity forward we raised in 2020. So we have plenty of flexibility in how we fund our investment activity for the rest of the year. Thanks to the mix of closed investments, our active pipeline, strong portfolio performance and raising capital at attractive spreads on new investments, we've been able to raise our AFFO guidance for 2021. Toni Sanzone, our CFO, will go over our guidance raise as well as our quarterly results and balance sheet activity. Joining Toni and me this morning are John Park, our President, and Brooks Gordon, our Head of Asset Management. In Q1 we finished $214 million of investments, made up of $149 million of acquisitions and $65 million of completed capital projects. Our Q1 investments carried a weighted average initial cap rate of 6.6% and, like virtually all of our investments, come with built-in rent growth averaging 2.25% for those with fixed increases, which occur over long lease terms averaging 23 years. Mirroring our diversified approach, our Q1 investments span most of our core property types, though the bulk of our deals remain in industrial and warehouse, which today make up about half of our portfolio on an ABR basis. I'll highlight a few of the more notable deals from Q1. Back in February, we wrapped up a $75 million sale-leaseback involving two facilities used for packing, production and distribution, which are net leased to Primo Wawona — the top vertically-integrated grower, packer and shipper of seasonal high-value summer fruit across the US. If peaches are something you enjoy, there's about a one in three probability that the most recent one you consumed came out of these facilities. These properties sit strategically close to the tenant's farmland in California Central Valley and account for the bulk of its storage, processing and distribution operations, with a sizable share being cold storage. The tenant has put substantial capital into the facilities, which highlights how critical they are, along with their triple net lease, structured under a master lease spanning a 25-year term with fixed yearly rent increases. Also during the quarter, we finished the $52 million build-to-suit of a new industrial R&D facility in Germany, net leased to American Axle, a global Tier 1 supplier of automotive components and systems, including electric drive technologies. That facility occupies a strategic spot in a prime industrial park close to the Frankfurt Airport and is triple net leased for a 20-year term, with rent increases linked to German CPI. Since the quarter ended, we've closed three more acquisitions worth a total of $186 million, the bulk of which ties to our second major investment in grocery retail over the past six months. To be specific, in early April we closed the $119 million sale-leaseback of three hypermarket properties in Southern and Central France, which are among the tenant's best-performing sites. They're triple net leased to Casino, one of the world's largest food retailers. From an ESG standpoint, this also gave us a chance to invest in a tenant dedicated to shifting toward renewable energy. These properties sit on a long-term master lease with rent increases linked to French CPI. Counting the transactions we closed in April, our investment volume year-to-date comes to $400 million. Beyond accretive acquisitions, a meaningful driver of our future growth stems from the rent increases embedded in our leases, a significant share of which is tied to inflation. With expectations for higher inflation having renewed, I'll take a moment to give a bit more detail on our rent escalations. Leases with some form of built-in rent increases generate 99% of our ABR. Leases tied to inflation account for 61% of ABR; so should we enter a stretch of sustained inflation, we remain very well positioned for it to flow through as incremental rent growth. Among our leases with rent increases tied to inflation, the majority — representing 38% of total ABR — is based on uncapped CPI, with the largest category being those tied to US CPI. The remaining 23% of ABR tied to inflation consists of leases with floors and/or caps, which we call CPI-based. In this category, the average floor is around 1.5% on an annualized basis and the average cap is approximately 3%. When inflation is running hot, if those 3% caps ever start to matter, that would probably signal we're getting same-store rent growth much bigger than what we see right now. That said, at present the floors remain the bigger factor compared with the caps when it comes to driving yearly increases in our leases. Last, leases with fixed rent bumps account for 35% of ABR, and those bumps average roughly 2% annualized. Typically, rent goes up once a year, so in time that will make its way into rents. Based on how our rent escalations look, we think we're among the net lease REITs positioned best for inflation. Now to how we stand in today's environment; in the US, with economic indicators moving in a positive direction thanks to a vaccine-driven recovery, we're seeing robust deal flow in nearly every property type, with office the one exception, since sellers there appear to be waiting to see how things play out, because work-from-home rose so much amid the pandemic. Industrial assets keep drawing aggressive interest from a broad set of buyers, yet it's still a very deep and varied sector, and we keep uncovering ample accretive opportunities, as our recent transaction momentum shows, supported by our cost of capital. With the manufacturing sector in the US continuing to gain momentum, that ought to bolster rising interest in sale-leasebacks as a way to unlock capital for redeployment into a company's core businesses.

Over in Europe, competition is still intense when it comes to industrial assets too, but because our borrowing costs there are much lower, spreads typically come in 50 to 100 basis points wider than what we see on similar assets in the US. Food retail, and grocery in particular, has shown itself to be a sector that held up well through the pandemic, and cap rates have compressed further, above all in the US, as investors flocked toward quality. Our preference is generally for retail in Europe, given that square footage per capita there is lower, entry barriers are higher, and there's less rivalry. As the sizable retail grocery investments we made recently show, we can access deals in this sector well, and we've executed successfully on top-performing stores. One recent theme in the European market has been the unprecedented volume of real estate that companies are selling off as they try to strengthen balance sheets hit by COVID. Since we lead the market for sale-leaseback deals in that region, this trend works in our favor, widening our addressable market, and we're confident we can claim our portion of those transactions. Before wrapping up my comments, I'd like to say a few words about spreads and about how we can keep producing growth even when cap rates stay tight. Our cost of debt has grown more and more efficient over the past several years. In Europe, we brought nine-year bonds to market in the first quarter carrying a coupon under 1%; and in the U.S., we sold 12-year bonds with a coupon in the low twos. On top of that, attractive built-in growth remains a feature of our investments. And the leases we originate are typically the longest ones in the net lease sector. In our view, investors need to grasp not just the day one accretion from our going-in cash cap rates, but likewise the average yield we're getting across lease terms of 20 years or more, with solid annual rent bumps. Take an investment at an initial cap rate in the mid-6s: the average yield across 20 years, with 2% annual rent bumps, comes to roughly 8%. To wrap up, thanks to the combination of deals we've already closed, the capital projects and commitments due to finish this year, and a near-term pipeline that's the strongest we've witnessed in many years, we're set for a record year in deal volume, backed by a favorable cost of capital, substantial liquidity, and the flexibility to tap capital markets when opportunities arise; and with that, I'll hand the call to Toni.

Thanks, Jason, and good morning, everybody. Earlier today, we announced AFFO per diluted share of $1.22, along with real estate AFFO per share of $1.19. It was a robust first quarter across the board, since our investments and debt re-financings have put us in a solid position to lift our earnings guidance for the rest of the year. As Jason noted, our near-term pipeline holds more than $500 million in active deals. Our portfolio keeps delivering steady results, just as it has from the moment the pandemic began, with rent collections for the first quarter reaching 98% of ABR. Tenants experiencing rent disruption remain few in number and easy to handle, and there are no new themes worth mentioning. In the first quarter, a single retail tenant in Europe made a partial rent payment because of a temporary lockdown, and consistent with our ongoing conservative stance on revenue recognition, we removed the unpaid portion, which totaled $2.9 million, from AFFO. We are actively chasing that rent and would only record it in revenue and AFFO once collection becomes more certain. As a reminder, we carried no significant rent receivable from 2020, and rent deferrals were minimal. The handful of deferrals we granted formed part of wider lease restructures, in which the deferred amount now sits within current ABR and those tenants have gone back to paying rent. On the whole, our collection rate stays very strong and matches our expectations for the year, with April collections tracking the first quarter. Because of that, we will begin reporting rent collections each quarter going forward. Now to same-store rent growth: comprehensive same-store rent growth, which is calculated from pro rata rental income, included in AFFO was negative 0.6% year-over-year, partly because the prior period predated COVID. As we've said before, this metric will fluctuate quarter-to-quarter, particularly as COVID-related disruptions and rent recoveries work their way through the period-over-period comparisons in our results. For the full year, we anticipate comprehensive same-store rent growth will match our pre-COVID growth rates. Contractual same-store rent growth, which captures the average rent increases in our leases, came in at 1.6% year-over-year, up 10 basis points from the fourth quarter, mainly due to a rent escalation for Advanced Auto, which as a result has returned to our top 10 tenant list. Leasing activity this quarter consisted mostly of five-year lease extensions on properties leased to Obi, a do-it-yourself retailer in Europe, pushing maturities out from 2024 to 2029 with full rent recapture, covering $14 million, or 1.2% of ABR, and requiring no capital outlay. Over a trailing eight-quarter basis, we've recaptured 95% of the prior rent, tied to 11.5% of ABR, and added 7.2 years of incremental lease-term, while spending only $1.44 per square foot on tenant improvements and leasing commissions. Turning to balance sheet activity, the first quarter was a busy one for our capital markets work, raising more than $1 billion in well-priced, long-term and permanent capital. Back in February, we brought a deal of $425 million in 12-year senior unsecured notes with a 2.25% coupon, which priced at a spread of 108 basis points over the benchmark treasury. During that same month, we also placed €525 million in nine-year unsecured notes carrying a 0.95% coupon, a spread of 110 basis points to the benchmark. It's a pleasure to report that these two bond deals came with the tightest spreads and the lowest coupons we've ever achieved, which speaks to the ongoing improvement in our credit profile. The money raised from these offerings went mainly toward paying off roughly $400 million in mortgages whose weighted average interest rate was a bit above 5%, and toward redeeming early a €500 million bond that had a 2% coupon and was set to mature in 2023. Beyond capitalizing on attractive market conditions and moving ahead of a rising rate backdrop, we cut our refinancing risk meaningfully by taking care of most of the debt coming due prior to 2024, while pushing our weighted average debt maturity out from 4.8 to 5.9 years. On top of that, we made further progress on our unsecured debt strategy, bringing secured debt as a share of gross assets down to 4.6%, versus 7.2% at the close of the fourth quarter, and lifting our unencumbered ABR to 87%. Securing these long-term rates also brought down our weighted average cost of debt overall by 20 basis points, to 2.7%, which we expect to produce roughly $17 million in annualized interest savings. Because the debt paydowns happened nearer to the close of the first quarter, we anticipate the interest savings will begin flowing through earnings in a more meaningful way starting in the second quarter; on the equity front, we accessed our ATM program during the first quarter, issuing slightly more than two million common shares at a weighted average price of $70.26 each, which generated net proceeds of $140 million. Thus far in the second quarter, we've issued slightly more than 443,000 shares at a weighted average price of $71.67 each, bringing in additional net proceeds of about $31 million. We still hold the flexibility to settle roughly 2.5 million shares under forward agreements in 2021, for anticipated net proceeds of about $160 million. Looking at leverage, we closed the first quarter at 41.2% debt-to-gross assets and 5.9 times net debt to adjusted EBITDA, and that figure excludes the extra equity we can still issue under forward agreements. Our targets remain debt-to-gross assets in the low to mid-40% range and net debt to adjusted EBITDA in the mid to high five times. The capital we successfully raised this quarter has strengthened a balance sheet that was already solid, with more than $1.8 billion in credit facility essentially undrawn as the quarter ended, which keeps us extremely well-positioned to execute on our investment pipeline and preserve considerable flexibility over when we choose to tap the capital markets. Let me now move to our 2021 guidance. Like we said in this morning's release, we've bumped the midpoint of our AFFO guidance by $0.06. The main reason is how strongly our investment activity has performed so far this year, in both size and speed, along with the interest expense savings that the debt refinancing I mentioned earlier will produce. Our investment volume range now sits at $1.25 billion to $1.75 billion, and that figure always covers capital investments and commitments slated to close during this year. On dispositions, our outlook hasn't moved: still $250 million to $350 million for the year. So far this year, disposition activity has brought in roughly $93 million of proceeds, with $79 million of that closing during the second quarter. Our guidance still bakes in uncollected rents equal to 1% to 2% of ABR. For the entire year, we still anticipate G&A expense landing inside our initial $79 million to $83 million range; and keep in mind that first quarter G&A typically runs above the other quarters because of when payroll related taxes hit, so it shouldn't be treated as a run rate for the remaining quarters. Wrapped into our AFFO guidance is $9.7 million of cash dividends from other real estate investments, something we discussed on the previous earnings call. Back in January, our common equity investment in Lineage Logistics paid us a $6.4 million dividend, and we're assuming that will be the sole distribution from Lineage this year. Then in April, we collected $3.3 million of preferred stock dividends on our Watermark Lodging Trust investment, which represents what was owed for the preceding four quarters. Those dividends will make up most of a new income statement line item we're calling non-operating income. Putting all of that together, for the full year we presently anticipate total AFFO per share of $4.87 to $4.97, which includes real estate AFFO per share of $4.74 to $4.84. To wrap up, growth stays our focus. With the strong beginning to this year and a solid pipeline, we're positioned to achieve our largest annual investment volume since we became a REIT. On top of that, our balance sheet is set up well for a rising rate environment, since we have no significant maturities before 2024, and our net lease portfolio ranks among the best positioned, with embedded rent growth that's particularly valuable in an inflationary environment; and with that, I'll turn the call back over to the operator for questions.

Thanks. Given what was announced yesterday — Realty Income picking up VEREIT — I'd like to know whether you expect the competitive picture to shift now that Realty Income is moving into continental Europe, and if that makes securing deals there harder or more contested for you?

Morning, and thanks for the question. No, my sense is nothing much really shifts here. Sure, they've become a bigger net lease REIT at this point, but they've been steadily advancing into Europe — the UK came first, and from what we've seen reported, they've indicated Europe is the next step. That's a substantial market; it's every bit as big as the United States, possibly bigger, and owner-occupied property makes up a bigger share there, which means sale-leaseback activity runs even deeper. By and large, we aren't going head-to-head with them stateside. In Europe there's likely somewhat more overlap with what we do, yet I don't see this altering the situation. If anything, I'd argue that whenever the net lease sector draws more notice — especially a diversified approach within it, one that also spans multiple geographies — from where I sit, that's a good thing.

Thanks; I've got one more as well. Could you discuss how occupancy has fallen quarter over quarter across the last 2 quarters? What's causing that? And could you also share what you anticipate moving forward? I realize you don't give guidance on this, but even just your perspective would be useful.

Sure. Brooks, do you want to handle that question?

Alright. So vacancy went up just a bit. From what I understand, it's a handful of buildings — 5 during that stretch — where leases ended. There isn't much of a pattern to point to; it's fairly anecdotal. Our expectation is that occupancy will climb back into the 99% range. Throughout this year, quite a bit is happening: active negotiations are underway on about 30% of the empty square footage, and the rest looks promising. It'll fluctuate quarter to quarter, but over time we'd anticipate it staying within that 99% range.

Okay. Thank you.

You’re welcome.

Yeah. Hi, everybody. Trust you're all doing fine.

Hi there, good morning, Josh.

I'd like to ask about inflation. Which measure of inflation do you use as the basis for your leases? Also, how much delay is there between inflation showing up and its effect on your P&L?

Josh, apologies — I missed the opening portion of what you said. You asked which metrics, is that right?

Yeah, when you mention that inflation metric, are we talking about core CPI, CPI, or something else entirely?

Right. Obviously, that varies by region. Brooks, could you walk us through which type of CPI is involved here?

Right. Yeah, like Jason mentioned, it's genuinely a mixed picture. Still, when you weigh it all up, most of them are headline-based. Over in Europe, you see somewhat greater variation depending on the specific country or on whether the metric leans more toward being a producer measure. All the same, by and large, headline-type metrics dominate. Then when you look at timing, CPI inherently carries some lag, simply because real price hikes work their way into that year-over-year figure. From where we sit on leases, it truly comes down to the moment the actual increase lands. How often do our bumps happen? Typically once every 12 months. On a weighted average basis, I believe it's roughly 1.5 years. So it will definitely make its way into our revenues, though some lag exists in that process.

All right, that's pretty intriguing. Great. And next, regarding the...

Also, Josh, as I believe you're aware, nearly two-thirds of the leases we hold are linked to CPI — which is obviously the reason you're raising that point; therefore, we believe our same-stores may see some genuine upside down the road.

Yeah, I get it; and it's good that this is likely the main inflation figure as well. It appears to carry somewhat more punch compared to core. So, well done. And then regarding the — push on the euro debt issuance under 1%. Do you figure you'll keep sort of boosting your leverage in Europe so as to sort of keep improving your spreads, or is there a sort of limit that you'd restrict yourself to in that region?

Yeah. I'd say it's more of a hedging tool for sure. But Toni, why don't you go into a few of the specifics?

Absolutely. We do aim to boost our position in Europe and take on extra leverage there as a hedge against currency exposure. From a leverage standpoint, I wouldn’t anticipate pushing that much beyond our current level. For the most part, I expect we’ll maintain the balance we have; and as things stand today, I don’t believe we’re trying to engineer any kind of mix that would deliberately manufacture an arbitrage opportunity.

Thanks guys. Appreciate it.

Thanks Josh.

Morning to you. Jason, you mentioned fresh possibilities starting to appear in manufacturing; on the whole, do those assets carry a notably higher yield than the more conventional warehouse properties? Also, might you offer additional detail on where these deals are coming from? Do they reach you through broad marketing efforts, or do relationships bring them in?

Right. Let me address the opening portion of what you asked before anything else. We all see stories about logistics properties changing hands at cap rates in the 4% range, sometimes even below 4%. A big part of what drives those numbers is the kind of real estate and where it sits, plus the reality that many of these leases run for shorter terms and involve multiple tenants, which creates a genuine chance to reset rents to market levels once those leases roll off — meaning the stabilized yields could end up considerably higher. Our focus is on stabilized assets. So for logistics properties themselves, the cap rates we'd target would likely fall somewhere in the low 5% range up to the 6% range, depending on various factors. You brought up sourcing. A large share of our activity involves sale-leaseback transactions, which means the pool of purchasers active in that space is naturally somewhat restricted. That gives us, we believe, a degree of leverage over pricing, alongside the advantages we capture in structuring and underwriting, since the party leasing the property is simultaneously the party on the other side of the sale. Looking more closely, industrial strikes us as a sector with real depth and variety. It isn't limited to logistics properties, as you noted. We also focus on manufacturing, especially lighter types, and we do a substantial volume within food production and cold storage, which we've mentioned before. Across every property category, R&D included, we've managed to find good opportunities, and these assets usually deliver a solid yield advantage because not many buyers compete for them. On cap rates broadly speaking, our range is 5% to 7%, and over the past 18 months, possibly a bit more, we've landed in the middle of the 6s on average. I expect that pattern to hold as we move forward. It might come down somewhat, though, based on which assets make up the mix and whatever shifts we're seeing in the market. Still, we're fairly confident in our ability to locate these opportunities—often without them being publicly listed, and occasionally with minimal promotion, because of how each deal is put together.