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

All right. Good morning, everybody, and thank you for joining us. We're pleased to have W. P. Carey here with us today. I'd like to try and make this as interactive as possible, so feel free to please submit any questions into the Q&A box, and we'll get those answered. And with that, I'm going to turn it over to Jason Fox and Jeremiah Gregory. And we're going to run through -- we're going to try and make this a little more informal and back and forth with some Q&A that we have. But I was hoping maybe, Jason, you could start out. And just for those that aren't as familiar with W. P. Carey, can you talk about -- just give some highlights and some differentiating factors for the company, and then we'll run through some questions.

Yes, sure. And thanks, R.J., for being here with us today and certainly NAREIT for hosting us. So W. P. Carey, we're one of the most diversified net lease REITs with a market cap of about $14 billion and an enterprise value right now of over $20 billion, which ranks us in the top 20 REITs in the MSCI U.S. REIT Index at the current time. We've been doing this for a long time with almost a 50-year history investing in net lease, and that includes operating over multiple business cycles. Right now, I'd say there are 3 main areas that we and really investors, too, are currently most focused on. I think first and foremost, it's external growth. And our diversified model, which is a hallmark of how we operate, provides a wider opportunity set for acquisitions across the whole host of property types, warehouse, industrial, retail, self-storage to name a few, and across continents, really U.S. and Europe for that matter. Diversification also protects us from overexposure to any one property type or industry or geography. So no tenant concentration issues, really, we run up against. And that really is highlighted in how we fared through COVID. We had one of the best-performing portfolios with consistently the highest collection rates in the upper 90s. So number two, I think, access to capital and really our cost of capital, and favorable cost of capital at that is where we've seen a lot of focus. We have access to multiple forms of capital, including lower-cost, euro-denominated debt, which again is a benefit of the diversified model. And our cost of capital has improved in recent years. It provides right now a very attractive spread to the returns we generate on acquisitions, and that leads certainly to accretive AFFO growth. And I think lastly, I think inflation and its impact on net lease and really the protections and upside embedded into our portfolio, that's been a topic of conversation. Virtually, all of our leases have some form of built-in rent growth with some of the highest contractual rent bumps in the sector. We typically average between 1.5% to 2%, and that's been during a benign inflationary environment. Over 60% of our ABR has rent bumps tied to inflation. So we think there's additional upside embedded in our portfolio if we do see sustained inflation like, I think, a lot of people are expecting. And I think lastly, the rent bumps are over a very long period of time. For instance, our year-to-date deals, our leases average 22 years on a weighted average basis. So we're providing more accretion over time than maybe is captured in the initial or going-in cap rate, especially compared to maybe many of our peers who have flat leases. And I think it's probably -- maybe I'll mention quickly the balance sheet as well. Generally, net lease balance sheets are in good shape across the sector. So -- and maybe it's not a key differentiator or focus of investors for that matter. But it's worth noting that we're conservatively leveraged, ample liquidity, largely undrawn credit facility, which provides a nice run rate for us. And we also just recently launched a forward equity offering earlier this week. So we're feeling good about funding our active deal pipeline.

Thanks, Jason. I think that was a pretty good summary, but we'd like to unpack that a little bit.

Sure.

So you mentioned the performance through COVID. Rent collections were, not only for the net lease space, well above a lot of other property sectors. But W.P. Carey was higher in that net lease bucket as well. And so can you talk about maybe how the portfolio was crafted to sort of generate those types of results and that type of resilience?

Yes, sure. I mean it's been a hallmark of how we've operated for a long, long time, and there's really 3 main criteria we focus on in making new investments. Certainly, the credit, when you have a long duration lease, is going to be important. The criticality of that real estate, how it fits into their operating model, that helps you get more protections in downside situations and certainly also makes the properties stickier. And you have better outcomes on maturity expirations and re-leasing events. And then the real estate itself is very important, obviously. That's the collateral. We like to buy good real estate and with strong fundamentals and growing markets. So that's a big part of it. On the credit side, a lot of where our focus has been, it's not necessarily investment-grade tenants. While we do have about 30% of our portfolio with investment-grade ratings, we think the sweet spot in net lease has been investing just below investment grade. We can dictate better lease term structures and pricing for that matter. But when we do focus on just below investment grade, we are targeting larger companies. And the vast, vast majority of our companies are large with institutional balance sheets, and that really was a benefit during COVID. I think most companies had some level of disruption. But the larger companies had strong balance sheets, were able to still maintain their ability to pay rent and operate in that environment. I think another component of our performance is the underweighting of retail. We've had a bias towards overweighting industrial for quite some time as well as underweighting retail, especially in the U.S., where it's more competitive. So our collections were quite high. Our exposure to maybe the most troublesome area of real estate, at least in net lease real estate, fitness facilities, restaurants and movie theaters, were less than 1% and really sit at only 1% right now. So we feel quite good about where we are and how we're set up.

Excellent. The investment volume activity has been pretty strong so far this year. Can you talk about what categories you do like and that you are investing in, right? If there's an aversion to retail or general merchandise retail, where are you looking today? What's driving the acquisition?

[indiscernible] of most companies is cost of capital. That's a big driver, certainly. We continue to improve in that area. I think maybe Jeremiah can talk about some of the balance sheet work we've done recently and where our cost of debt has gone. And our multiple, which we still think has some runway to compress where it is relative to the differential between us and some of our peers, we have seen some good growth there. So that's one. Cost of capital has been very beneficial. And also our diversified approach, which is a bit more unique to us. We can target companies, as I mentioned earlier, across a wide range of property types, industries and geographies. We were really setting ourselves up to become the pure-play net lease that we are right now, net lease REIT that we are right now. And we're past a number of the distractions over the past 5 years. It included CEO changes and exit from the investment management business; more recently, the merger and internalization of our hotel funds, which are no longer part of our business; and of course, the impact on COVID. So where we are right now -- and we're set up nicely with the clear runway ahead of us, a focus on growth, and we really feel like that we're hitting our stride. We recently raised acquisition guidance on our Q1 earnings call to $1.25 billion to $1.75 billion, midpoint of $1.5 billion. I think there's other things that have led to our -- the increased transaction activity. Number one, we did reorganize how we cover -- our investment team covers the country in Europe for that matter. It's more regional now, more systematic approach that's worked well. I think the relationships are deeper, and we're getting better and earlier looks on deals, which helps. And we've also added to our team, both in the U.S. and Europe. And then lastly, we're seeing corporates continue to have a bigger focus on sale-leasebacks. I think a lot of that's coming out of COVID, where they're looking for ways to shore up their balance sheet and not have as much capital tied up into illiquid assets. Your question about what we're seeing, well, year-to-date, we've done about $815 million of deals. I think that's through Monday's equity issuance. We made some additional disclosures on a recent deal. And we feel good about the sustained volume going forward. It's -- year-to-date, it's been primarily warehouse and industrial. In fact, about 2/3 of it has been that. The bulk of the remainder is retail. And virtually all of that has been in Europe, where we see better opportunities for retail compared to the U.S. It's also been split, that $815 million, roughly 50-50 [ with retail ] compared to the U.S. It's also been split, that $815 million, roughly 50-50 between the U.S. and Europe. We've seen good opportunities on both geographies and really nothing that we can see that has been impacting that to the negative. I think the pipeline is similar. It's a little bit more weighted towards the U.S. right now, but it's still heavily weighted in industrial and warehouse. And when we think about industrial, it's kind of a broad set of asset types within that category. Certainly, logistics is probably the largest piece in addition to light manufacturing, but we also like cold storage, some food processing and production, cold storage as well. So we see a lot of opportunities, and again, a diversification really benefits us.

Yes. That's certainly one of the differentiators for WPC versus some of your peer group, is that optionality to not only go between different property types but also between the U.S. and Europe. And so I was hoping to have a -- get a little bit more color on Europe. And you guys were the -- essentially the first movers to go over to Europe, and this was quite a while ago, and we've seen some of your peers follow. Can you talk about the importance of being the first mover into that market, the opportunities that you've sourced over there? And then maybe, Jeremiah, if you could spend a little bit of time on what that -- the European exposure gives you on a -- from an optionality standpoint on the balance sheet.

Yes, sure. Let me start, and I'll hand it over to Jeremiah. There's [ relative ] questions. We've been in Europe since 1998. So we have a lot of experience being over there. We're the market leader in sale-leasebacks. I think we own a net lease -- the most European net lease out of anyone. It's roughly a $7 billion portfolio at this point in time. And I think one of the things that's really interesting about Europe is, for starters, there's less competition. There are no public net lease REITS. There is no pan-European buyer like us that can really target across geographies or cost -- countries within Europe, mainly targeting Northern and Western Europe. I think with this fewer competition, that leads to more interesting yields as well. Cap rates are maybe 25 to 50 basis points inside of where they are in the U.S. But we're generally able to borrow, call it, 100, even right now, probably 150 basis points inside of where we can borrow in the U.S. So our spreads are meaningfully higher there, and everything that we do over there does generate incrementally more accretion. The type of assets that we look at in Europe, certainly like the U.S., industrial is a core focus. It's kind of across that broader group of our definition of industrial that I mentioned earlier. But retail is also something that we've had a lot of success over there. If you think about retail assets in Europe, I think there's a number of reasons why we like it there relative to the U.S. And number one, supply is much different. There is somewhere on the order of magnitude of 8 or 9x more retail square footage in the U.S. compared to Europe. So much less supply. Part of that is barriers to entry are more difficult to develop, and there's less green space or more green space requirements and less open developable land. It's a big market as well. I think Green Street, recently, I think I saw some numbers. They estimated the owner-occupied real estate to be, call it, $4 trillion to $5 trillion in Europe. And that owner-occupied market is really our target for sale-leasebacks. And then lastly, with retail, we are seeing great opportunities in Europe, maybe more than what we see in the U.S. As I mentioned, there's much less of it in Europe and lower competition. And we've done some good deals in that space recently as well.

So R.J., if you want me to quickly touch on the balance sheet side, I mean I can talk about our history and what we've been doing recently in terms of euro bonds. And I think -- yes, and I think people that follow us closely know that we've been in that market. We've been issuing bonds in Europe for close to 7 years now, and so we have currently 5 bonds outstanding. They're all issued in euros. And I think the -- what we've talked about on this call and what I can focus on is just what that does for our overall cost of capital and what we're able to do in terms of issuing bonds over there, that those bonds have typically been anywhere from 100 to 200 basis points inside of where we could issue in the U.S. If you look at, in fact, our most recent eurobond, which we did just in the first quarter, we were able to issue a bond that was over 9 years for maturity, and that was under a 1% rate on -- under 1% coupon for kind of a fixed rate long-term bond. And so as Jason mentioned, we can do new investments in Europe. Cap rates are a little bit tighter, but the cost of debt is always -- or has always been over the last 7 years and continues to be at a meaningfully wider differential to the bonds we can issue in the U.S. And so what that does is it gives us wider spreads on the investments we're making in Europe, and it allows us to gain that much more accretion. And I think also perhaps when investors are thinking about the overall balance sheet and our overall cost of capital, what we can do, it's an important factor to keep in mind. I mean our weighted average interest rate for the entire balance sheet is now at 2.7%. That's been coming down steadily, and I think that average interest rate is perhaps lower than people realize if they just think about the U.S. bonds that we've been doing. And I think that as we continue to think about Europe and continue to look at what the opportunities are there, being able to issue long-term debt in and around 1%, which is still the case today, I mean spreads and base rates have moved up a little bit since we did our last issuance, but we're still able to issue in the very low 1s, which creates a pretty interesting opportunity set for us and just another advantage, as we've mentioned, kind of our diversified approach, our ability to go to different areas and look at different types of deals and generate different types and, in some ways, more attractive types of returns for our investors.

Yes. And R.J., maybe it's helpful to give a couple of examples of some recent deals we did do in Europe, particularly in the grocery space, where we think there's a good market for us. And clearly, it's performed quite well in the face of COVID and we think will continue to perform well even with pressures from e-commerce. Yes. So one recent deal that we announced was a $119 million sale-leaseback with Groupe Casino, which is one of the largest food retailers in the world and certainly one of the largest in France. We did a sale-leaseback direct with the company. They did not use advisers, and we selected 3 of their top-performing sites. These are A-plus locations, infill and some of the most profitable ones within their 100-plus portfolio of hypermarkets. These are on long-term master leases, which is typical for us, and importantly, rent increases tied to inflation. It's French CPI actually. And then before that, we did another grocery deal in Spain. I think it was at the end of 2020. That was a $100 million sale-leaseback for 27 supermarkets in Northern Spain in addition to the Balearic Islands. It's an existing tenant of ours, one that we work with a number of times over the last, call it, 10, 15 years. It's called Eroski, which is one of the largest supermarket chains in Spain. These are a little different than what we bought in France. These are primarily located in dense residential neighborhoods, in many cases, on the ground floor of high-rise buildings. So you can get a sense for these kind of irreplaceable locations with very limited to little competition. There also tends to be strict planning laws and licensing requirements to build in these downtime-type areas. So really strong assets. Again, triple net leased on a long lease term. In this case, they were 20-year master leases, and again, rent tied to Spanish CPI. So a bit of a theme there. We do get a lot of our leases, a large percentage of them tied to inflation, which we think is going to be quite beneficial to us in the current marketplace.

Thanks for those examples. So this is probably a good time to just poll the audience and see if anybody has any questions. Feel free to submit them, and we'll get those asked. Jeremiah, you were talking about your lower cost of capital on the debt side. And Jason, you mentioned the stock prices appreciated, trading at a higher multiple. So your cost of equity has come down. But can you talk about where investing spreads have gone given the fact that cap rates continue to compress for net lease assets? What are you seeing from a competition standpoint?

Yes. I mean for us, we disclosed our weighted average cap rate for the first quarter -- or through the first quarter of this year. It was 6.6%, and that's really across the portfolio of new deals that we purchased. Generally speaking, I would say we target a range of 5% to 7%. If you think about that spectrum, it's a relatively wide range, but it makes sense when you think about our diversified model. In the lower end of that range, call it, the bottom half, that's likely where we're doing most of our logistics assets. And that's the space that, frankly, we all recognize as we see the most interest from investors and, therefore, the most cap rate compression. I think what's different for us in that we are still able to source deals with good industrial logistics assets maybe at the lower half of that range that I mentioned is that we're buying a little different asset than what's garnering the headlines, headlines of sub-4% or even sub-3% cap rates. Deals that trade in those ZIP codes typically are shorter lease term. It might be multi-tenant. In most cases, there is a view that the markets are under rent, and there's a real opportunity to mark-to-market within a short period of time. Those typically, when they're mark-to-market, will stabilize yields maybe closer to where we're buying, high 4s, into the 5s and sometimes even higher depending on the market. The difference is we're buying assets that are already at stabilized yields, 20-year contracts typically with either fixed or CPI-based increases. And we're buying those in the 5s, which we think are still generating really attractive spreads to our cost of capital. The trends are certainly downward. I would expect that, that 6.6% weighted average cap rate, that could come down as we do more deals this year, and we'll talk about that we can get to earnings calls, of course. A lot of that is driven by just the general market compression. I think some of it within our portfolio, if we do see cap rates come down some, it's probably about asset mix as well, we might be doing more of these logistics assets or perhaps more deals in Europe, where we talked about before the cap rates are lower but the spreads are greater. So lots of opportunities still for us out there, and I think that we like the momentum that we have right now.

And Jason, maybe I'll just add while we're talking about spreads, I mean, I think 2 things to keep in mind about our going-in cap rates. I mean one, we've mentioned Europe. And I just want to reemphasize that, that our mid-6s cap rate or even as cap rates continue to come down, that incorporates, of course, all the European deals we're doing as well, which are being done at a much lower cost of debt, of course, and so still a very good spread. And I think the other thing that we think is important to note is that most of our leases tend to be among the longest that are being originated amongst our peers at 20-, in some cases, 25-year leases. We also think we have some of the most attractive bumps amongst our group. And so the difference in our mind is that if you originate 6.5% going-in cap rate on a 20-year lease with 2% bumps, that's actually really averaging close to an 8% yield over the life of the lease. And so I think in some cases, you could do perhaps higher going-in cap rates, shorter lease terms, less bumps. And it may screen a little bit higher on that day 1 accretion, but it's not necessarily a better deal than something that has a long lease term with high bumps built into it. And so I think the average yields we're achieving on these long leases with good bumps are, in fact, well in excess of the going-in cap rates. So I think just an additional point to make about really the amount of spread that we can generate is definitely interesting in the market that we're in right now.

Thanks. And talking about the bumps or rental rate increases that are built into the leases, obviously, a lot of talk about inflation. We just got a big inflation report this morning. Can you talk about how WPC is positioned to weather some outsized inflation and maybe dive into some of the structures of the leases? Because one of the things that we think is the differentiator for WPC is that there's a larger portion of the leases that are more CPI based, and so I'd just like to hear a little bit more color about thinking about a higher inflationary environment.

Yes, sure. Yes, of course. In addition to accretive acquisitions, certainly, a meaningful contributor to our growth comes from the rent increases built into our leases. And you're right, recent inflation numbers, there were some new numbers that came out this morning, higher than expected. And year-over-year inflation, it's accelerating its fastest pace, I think, since 2008. So there certainly feels like there's an inflationary market in place now and perhaps coming even faster. As you mentioned, we have one of the best positioned portfolios in the net lease market for embedded rent growth, especially in an inflationary environment. Virtually all, 99%, of our ABR is generated by leases with some form of built-in increase. 61% of that comes from leases tied to inflation. So it's the same inflation. We're very well positioned for it to flow through to incremental rent growth. The majority of the inflation-linked increase, actually 38% of that 61% is based on uncapped CPI. And within that category, the largest component is tied to U.S. CPI. The other 23% is tied to inflation that includes both floors and caps, and we call that CPI based. In some cases, there might be multipliers as well, but it's primarily with floors and caps. The average floor is around 1.5% on an annualized basis. So the floors over the last, call it, 10 years has come into play from time to time. It has been a nice anchor to some minimum level of rent growth. Now the average cap is around 3%. So with inflation kicking in, and I think the numbers today, we're in excess of 3%, we're going to be achieving substantially higher same-store growth and even a bigger spread relative to our peers right now. We have the uncapped inflation that's going to have the full upside of that. And if we hit 3% bumps, I think we're in pretty good shape regardless. The other 35% of ABR is generated by leases with fixed rent increases. Those tend to average in and around 2% on an annual basis. But there's a wide range, and it's not all annual increases. Sometimes it's over every 2 years or even over 5 years occasionally. So it is a strong point of differentiation between us and our peers, especially those focused on retail properties, which more likely than not have a much flatter, in some cases, completely flat lease structure. So we are positioned very well for inflation. I also have to say interest rates rise as a result of inflation expectations. We're also in good shape there, having locked in much of our debt costs over the last number of years, especially with the strong execution of 2 bond issuances earlier in the first quarter.

Thanks, Jason. So we don't -- I don't see any questions in the queue, and so we'll probably wrap it up a minute or 2 early here. But any final thoughts, Jason or Jeremiah?

Well, I think the final thoughts here are -- is that we like where we're positioned right now. The pipeline is strong, perhaps as strong as it's been in quite some time. We have been closing a lot of deals that I mentioned, $815 million year-to-date. And we have another $180 million of construction projects in process. These are build-to-suits or expansions within our existing portfolio. About $130 million of that $180 million is going to deliver this year in 2021 and begin paying rent. So we have really clear visibility into just under $1 billion of deal flow, and we're just a little over 5 months into the year. But you also got to keep in mind that our fourth quarter tends to be the highest deal volume quarter of the year. It doesn't happen every year. But historically, most years, the fourth quarter is the highest. So we feel really good about where we sit right now from a growth perspective. Clearly, we feel good about the existing portfolio and how it performed through COVID. So we're kind of looking forward to continuing to invest and grow earnings through this year and going forward.

Yes. I mean I think we can echo that on the balance sheet side. We've been very proactive in terms of accessing capital this year and into the end of last year, and no maturities really meaningfully until 2024. We just completed a forward equity issuance at a level that we think is very accretive to the deals we're doing. So I think we're set up really well, as Jason said on the portfolio perspective, with the pipeline but also with the balance sheet to fund this and to continue to be able to have good access to capital opportunistically and when we want to and how we want to. So I think both the balance sheet and the kind of investment strategy are set up to work really well for the rest of the year.

Excellent. Guys, well, really appreciate the time, and thank you for the overview.

Yes, of course. Thanks, R.J. Thanks, everyone, for joining.

Thanks, everybody.