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

Hello, all, and welcome to today’s session covering our second-quarter 2021 earnings. Thank you for being with us this morning. Prior to starting, please note that certain remarks shared during this discussion are not historical in nature and might be considered forward-looking statements. Details regarding factors that could lead actual outcomes to vary materially from what W. P. Carey anticipates can be found in the filings we make with the SEC. A web-based replay of this call will be posted in the investor relations area of wpcarey.com, remaining accessible there for roughly 12 months; that section also hosts copies of our investor presentations along with additional relevant documents. Having said that, I’ll now hand things over to Jason Fox, our Chief Executive Officer.

Thank you, Peter, and good morning to all of you. Our portfolio demonstrated its resilience through the pandemic, and now the first six months of 2021 have been marked by growth that has sped up, chiefly because of unprecedented transaction volume, which lets us lift our investment outlook for the year even higher and increase our AFFO guidance; we're still seeing a great deal of deal activity, with several hundred million dollars' worth of transactions in our pipeline right now; with inflation front and center for investors, W. P. Carey is positioned well to create extra upside, since 60% of our ABR derives from leases featuring rent increases linked to CPI. This morning, I want to focus on two key drivers of our growth: investments that add to earnings, and the scheduled rent increases written into our leases. After I finish, I'll hand things over to our CFO, Toni Sanzone, who will walk through our results, guidance, and balance sheet. And as usual, our President, John Park, along with our Head of Asset Management, Brooks Gordon, are here with us. Let's start by looking at growth through acquisitions. In the second quarter, we invested $780 million, primarily by completing 11 acquisitions. The weighted average cap rate on our net lease investments came in at 5.6%, which reflects both the mix and the quality of the assets we acquired in a competitive market environment. To give you a sense of it, Class A warehouse made up about 40% of what we invested in Q2. That included $195 million put into a newly built logistics property in the U.K., which we expect to receive a BREEAM Very Good environmental rating and which is net leased to Jaguar Land Rover for 30 years. The weighted average lease term on Q2 investments was 21 years, and for those with fixed rent increases or floors, increases came to 2.2% on average. This kind of investment profile generates an average yield that is considerably more appealing than what peers get when they originate shorter leases with smaller rent increases or none at all. If you look at initial going-in cap rates by themselves, they don't tell you the full story of the long-term accretion we're able to achieve. Consider a 20-year lease that starts at a 6% cap rate, with rents rising 2.5% each year — that works out to an average yearly yield of more than 7.5%. Turning now to how we grow via rent escalations and how we're set up to handle inflation: built-in rent growth exists in 99.5% of our ABR, and leases linked to inflation account for 60% of that. Of this, the bulk — 37% of total ABR — consists of leases pegged to uncapped CPI, divided about 60/40 between Europe and the U.S. Another 23% of our ABR is tied to CPI leases featuring floors, caps, or both, with the typical floor at roughly 1.5% annualized and the typical cap at roughly 3%. To wrap up, about 35% of ABR comes from leases that include scheduled rent increases, and those bumps average roughly two percent per year. As for inflation, its effect on rents usually shows up after some lag. On the contractual same store rent growth side, we anticipate about a 100 basis point gain, going from 1.5% to somewhere near 2.5% over the next 12 months. If nothing else changes and based on current economic forecasts, that figure accounts for U.S. inflation of about 3.5% for the remainder of 2021, an average of 2.75% in Europe, and then roughly two percent in both regions during 2022. Naturally, should real inflation come in above what's currently being forecast, then we'd anticipate our contractual same store growth eventually landing higher than 2.5%. That gives you a picture of how inflation affects our rent growth roughly a year out, but naturally the effect on ABR accumulates, and over extended periods compounding can pack quite a punch. Now let's shift to the internal and external elements that support whether our elevated investment activity can be sustained. We closed $1 billion of investments during the first half of the year, have $122 million of capital investment projects set to wrap up in the back half, plus several hundred million dollars of deals sitting in our pipeline, so we're anticipating 2021 will set a record for deal volume. We also anticipate keeping deal volume elevated thanks to a mix of factors. Internally, now that the company's simplification is mostly behind us, our attention is squarely on investing for our balance sheet, and we believe we're gaining from stronger relationships and market expertise, along with a more efficient investment process. Looking at the broader economic picture, companies continue to favor sale-leaseback transactions, reflecting a wider movement away from owning property toward leasing it. Net lease deal flow is being driven higher by rising M&A activity, as firms seek ways to optimize their balance sheets while private equity players cash in on assets to produce returns. Our portfolio's scale represents yet another edge. Follow-on deals stemming from existing relationships with tenants and sponsors accounted for approximately 30% of investment volume in the second quarter. Though our diversified approach opens up an enormous, expansive addressable market across two continents, industrial and warehouse properties remain our primary emphasis when viewed from the top down, representing roughly 70% of Q2 deal volume. In these sectors, we've lately moved into appealing sub-sectors such as R&D and lab space, in industries including food processing and production, all of which lend themselves well to sale-leasebacks. We've additionally been putting money into essential retail properties throughout Europe, particularly stores showing strong unit-level performance, having finished investments in grocery portfolios in Spain and France during the last nine months. Beyond our core focus, we generate extra deal volume and growth via more opportunistic investments. A quite recent illustration of our capacity to deploy additional capital this way is the construction loan we took on during the Q2 tied to a retail complex that's presently being developed on the Las Vegas Strip. During June, we took an initial $85 million draw, and over the next 12 to 18 months we expect to take additional draws, potentially totaling up to $225 million. The interest rate applied to drawn balances is six percent, and upon completion, we hold the option to convert part of that loan into equity in net lease retail properties located in a highly sought-after area, at very appealing cap rates. To wrap up, with all of that in mind, along with a cost of capital that lets us keep making accretive investments on a consistent basis, we feel confident about sustaining a solid pace of investments through the second half of the year, and to reflect that, we've increased the investment volume in our 2021 guidance. Finally, though the worst of the COVID pandemic appears to be behind us, the recent jump in Delta variant case numbers is an important reminder that beyond investment volume, underwriting and portfolio quality continue to matter, and that the demonstrated performance of our portfolio keeps setting W. P. Carey apart from other net lease REITs. With that, I'll hand the call to Toni.

Thanks, Jason. Good morning to all of you. I'm happy to report that our second quarter results came in ahead of what we had anticipated, capping off a robust first six months of the year and putting us in position to once more lift our guidance for the entire year. During the quarter, our total AFFO came to $1.27 per share, while real estate AFFO was $1.23, up 12% compared with the same period a year earlier, which mirrors the quicker tempo of our investment efforts so far this year along with the ongoing durability of our rent collections, which reached 99% for the quarter. We are boosting our full-year AFFO guidance, lifting it by $0.06 at the midpoint. As things stand, we anticipate producing total AFFO in the range of $4.94 to $5.02 per share for the whole year, with real estate AFFO of $4.82 to $4.90 per share within that, equating to more than five percent growth versus last year at the midpoint; we have increased our full-year projection for investment volume to somewhere between $1.5 billion and $2 billion, counting capital investments and commitments slated for completion during this year. Our investment volume also encompasses the construction funding for the Las Vegas retail complex that Jason mentioned. Income from that investment should contribute roughly $3 million to AFFO in this year, and it will show up in earnings from equity method investments. We closed $86 million in dispositions over the second quarter, which brings first-half dispositions to $100 million. Given what we can currently see regarding the timing of certain sales, we have reduced our forecast for total dispositions this year to a range of $150 million to $250 million. Comprehensive same-store rent growth, calculated using pro rata rental income that is included in AFFO, came in at two percent versus a year ago. Looking at the full year, we anticipate that our comprehensive same-store rent growth will surpass the growth rates we saw recently before COVID, fueled by consistent 99% collections along with certain COVID-related rent recoveries that we expect to take place in the latter half of the year. In the second quarter, we went back to collecting essentially all of the quarterly rent owed by a retail tenant in Europe that had been making partial payments in earlier quarters because of lockdowns. Our AFFO guidance range now incorporates an assumption that across the second half of 2021, we will recoup most, and possibly all, of the $4.5 million in unpaid rent owed by that tenant. Lease termination and other revenues rose in the second quarter, largely because we received $4.4 million in lease-related settlements; at present we are assuming no material further payments of that kind in the back half of the year. When it comes to G&A expense, we have raised and tightened our full-year guidance outlook to a range of $82 million to $84 million, a moderate increase over what we previously expected; on our call last quarter, I pointed out that in April we collected preferred stock dividends of $3.3 million from our investment in Watermark Lodging Trust, which represented the amount owed for the previous fourth quarter and was the main factor behind our non-operating income line item in the second quarter of 2021. Looking ahead, we anticipate collecting roughly $800,000 in preferred dividends each quarter, and that figure is baked into the guidance we've given for the full year. Now let's turn to what we did in the capital markets and our balance sheet. The first quarter was busy — we sold bonds at the tightest spreads and cheapest coupons we've ever achieved — and then in the second quarter we brought in equity at attractive pricing. During June, we closed an equity forward offering covering slightly more than 6 million shares, which secures our capacity to match fund acquisitions through $455 million of equity raised at a gross price of $75.30 per share; part of those newest forward agreements was settled in the second quarter, along with the leftover forward agreements from the ones established last year; shares were also issued through our ATM program. All told, 6.7 million shares came out during Q2, producing $472 million in net proceeds. Most of that share issuance took place toward the end of the quarter, so it will show up in full within our Q3 weighted average share count. As of quarter end, the weighted average interest rate stood at 2.6%, down considerably from 3.2% the year before, which shows our cost of debt keeps improving. Interest expense came to $49.3 million in Q2, a drop of six percent versus a year earlier, mainly because we enjoyed a full quarter's benefit from the interest savings created by the debt prepayments and refinancings done in Q1. On leverage, debt to gross assets sits at the bottom of our target range, finishing Q2 at 41.1%. Net debt to adjusted EBITDA reached 6x when the quarter closed, and 5.8x once you factor in the shares still available under our newest equity forward. Our liquidity stays quite robust, so we're in good shape to fund fresh acquisitions and to keep tapping capital markets when opportunities arise. Total liquidity at the close of Q2 came to about $2 billion, made up of cash, the unused portion of our $1.8 billion credit facility, and our capacity to settle 4 million shares still remaining under forward agreements before 2022 ends, which we expect will bring in net proceeds of roughly $300 million. To wrap up, with the recent momentum in deal volume — which we think will carry into the back half of the year — we're looking at a record year for acquisitions, backed by solid liquidity, flexibility in the capital markets, and an attractive cost of capital. Beyond the downside protection our portfolio has demonstrated, if inflation stays elevated, we'd expect it to deliver extra upside to our growth over the longer run. With that, I'll give the call back to the operator for questions.

Yes, good morning. Jason.

Hello, Sheila.

Morning, everyone. It was a huge quarter for investments, and our pipelines have grown. Could you walk us through why activity levels have risen this dramatically? Did you bring on additional staff? Have you loosened your starting yield requirements, given that your cost of capital has gotten better? Or is it simply that more product is available, perhaps because M&A activity is on the rise?

I'd say it's likely a mix of all those things. Definitely, since the CPA merger, our operational streamlining is largely complete, and with our investment management business continuing to wind down, we're now much more focused on growth. Our cost of capital remains very strong, and obviously a diversified strategy helps too. It provides us with a broad opportunity set that's clearly in the U.S. and Europe. As you mentioned, we're able to compete across a wide range of cap rates. We've widened that target cap rate range somewhat, and I believe this lets us acquire higher quality assets, probably mostly industrial ones, which is driving the higher deal volume. Regarding what you mentioned about M&A, in our view that has resulted in additional sale-leaseback transactions, and it looks like there may be a longer-lasting change in the way corporations think about whether to own or lease their properties. Naturally, since we are the top player in sale-leasebacks, this trend works to our advantage too. A great deal has shifted. Beyond that, I believe we implemented several smaller adjustments to our investment approach, and to our team as well. My sense is that everything together has produced a level of deal activity we see as more durable. Looking at our current position, the deal opportunities have consistently been available, and we see no real basis to expect that pace of transaction activity to stop going forward; our confidence in where we stand is strong.

All right, that’s excellent. One additional item. I believe it was useful to point out the extent to which your leases are connected to uncapped CPI. I’m just curious whether you might clarify the mechanics of that. Would it be a yearly reset based on looking back at the prior 12 months, and I’d assume CPI is moving quite substantially across the various nations where you hold assets. I’m simply asking whether that reset happens once a year, once every 5 years, or in some other way?

Every lease has its own terms. Most of our agreements, I'd say, do include yearly escalations, though we definitely also have contracts that step up every 2 years or every 5 years. You'll find those in the portfolio too. As you mentioned, there's a delay, I think, since the leases lean more toward that yearly rhythm. With certain ones, it could take 12 months before it works its way fully into our ABR. That's correct — the U.S. leases, by and large, are tied to CPI. Over in Europe, it varies. A portion of them track Eurozone inflation, while others are tied more to a specific nation — German CPI, Dutch CPI, or U.K. RPI. It truly comes down to the individual deal. Broadly speaking, I'd say we appreciate having this inflation exposure. I think it's among the things that set our portfolio apart.

Thank you.

You're welcome.

Thanks. Regarding that construction loan, I wanted to ask whether you could give us some additional detail about the risk-adjusted yields you anticipate from it, compared with what you'd expect from more conventional acquisitions and capital investment projects.

Yes, absolutely. Look, acquiring industrial and warehouse properties across the U.S. and Europe remains our primary focus, and that includes retail in Europe too. As for retail in the U.S., our approach tends to be more opportunistic, and this transaction, I'd say, fits within that bucket. As far as the construction loan goes right now, I believe we've mentioned that it will generate six percent interest over the construction period, and we view that as a fairly attractive rate, particularly given how cap rates have moved. The location is phenomenal. In my view, it ranks among the best development parcels anywhere on the Las Vegas Strip. If you're familiar with that market, it sits where Las Vegas Boulevard meets Harmon. It's located at the southern edge of the pedestrian bridge connecting the Cosmopolitan Hotel with CityCenter and Crystals Mall. Based on what we've analyzed, foot traffic there is among the highest anywhere in the United States. When it comes to risk-adjusted returns for us, we actually finished a highly comparable project directly across the street roughly six or seven years back; it performed very well; the same operating partner is involved, so our confidence in their execution ability is strong. As I mentioned, we consider this a solid risk-adjusted return for the loan. Right now it's a loan, though ultimately there will be a chance, via certain purchase options, to acquire some longer-term net leases. If that comes to pass once construction wraps up, we can get into the details of how that would work.

All right, that's great. I get that your attention has been on industrial, as you noted in your prepared remarks, and I realize you don't yet have a crystal ball for everything in 2022. Looking ahead, though, how optimistic are you, or do you have a sense of how much of the addressable market in Europe is still tied to that property type?

The question was specifically about industrial in Europe, correct?

Yeah.

Broadly speaking, regarding how we view our capacity to continue increasing transaction volume?

Either one works, but sure, no, to be more precise regarding industrial, since that's the area you've concentrated on.

Right. We're seeing it in both the U.S. and Europe. Well, obviously, everyone can see that industrial has drawn lots of investor attention, with enormous amounts of capital flowing in. What we avoid is battling over the shorter-duration multi-let industrial properties making news, the ones we observe; cap rates were at 4, and today they're likely at 3 on an entry basis. The reason those trade at such levels is a belief — probably accurate — that strong mark-to-market potential exists there; our emphasis leans toward longer-dated leases of 15, 20-plus years attached to solid industrial properties. That might mean logistics. It might mean top-tier assets, such as the JLR transaction we closed earlier in the year. Beyond that, we target light manufacturing, food production, R&D, and all of those also sit within what we call industrial. Our sourcing record is quite strong, mostly via sale-leasebacks, and I believe that's a major factor in why we can secure these using such structures, at what we consider above-market cap rates too. Well, forecasting what will occur in 2022 isn't easy, yet we believe our positioning is excellent, as I said before in response to Sheila's question, to keep demonstrating the acquisition momentum we've built.

Great. Thanks for the color.

Yeah, you're welcome.

Thanks. Maybe I overlooked it, but could you say something about what’s in your pipeline right now and the imbalance between Europe and the U.S., plus how yields could compare with the 5.6% figure you referenced in Q2?

Yes, absolutely. As we've discussed, the pipeline looks robust. To give a quick recap of where we stand year to date, we've closed roughly $1 billion in deals, and that figure includes the $780 million from Q2. On top of that, we have $122 million in capital projects, expansions, and build-to-suits that should wrap up during 2021. Once those are finished, they'll be folded into our volume and rent roll; at this moment we've essentially got $1.1 billion locked in, and our pipeline is still going strong. Right now there's more than $300 million in deals sitting in advanced stages, and we're confident a large portion of those will close in Q3. Past that, we have another $200 million in identified deals that are at earlier stages but are moving forward through diligence and the closing process. Naturally, Q4, as we've mentioned before, is usually our busiest quarter of the year. We can't see into it at this point, but it does typically end up being the most active period. I believe much of that is what drove our guidance raise; we're comfortable with that midpoint and possibly there's room to reach the upper half of the range too. There's genuinely no cause to expect any slowdown here, provided market conditions stay broadly the same. You brought up the U.S. compared with Europe. So far this year, it's roughly 60/40 favoring the U.S. over Europe. Europe has eased somewhat, though that's normal for this season. I'd say the current pipeline is closer to, let's call it, three quarters U.S. and one quarter Europe. We'd anticipate that shifting upward as the year progresses. I believe the final piece of your question concerned cap rates. We consider quite a broad span of cap rates, which is partly what a diversified strategy gives you. I'd describe our target as deals falling in the five percent to seven percent cap rate band. You noted that the quarter came in at a 5.6% weighted average cap rate. Year to date, it's roughly 5.8% weighted average cap rate. That's the going-in cap rate. I think that distinction matters. Much of that, in my view, comes down to market compression. Also, as we've mentioned, given the mix of assets we're buying, higher quality warehouse will simply trade at somewhat lower levels, but we believe we're achieving solid risk-adjusted returns on where we'd buy them. Then you brought up Europe as well, and Europe does carry lower cap rates. That's contributing to the total too. As you're aware, our borrowing cost in Europe is significantly cheaper. Even though we may accept tighter going-in cap rates in Europe, they still produce the same, or perhaps even stronger, spreads. One more thing worth mentioning: when it comes to accretion, going-in cap rates aren't our main focus. When you consider in particular the way our transactions are put together, nearly every lease we hold includes scheduled increases. A lot of those, as we've mentioned, are tied to inflation. For the ones set at a fixed rate, the figure is likely around 2%. These leases run for a long time. Across a 20-year span, with attractive step-ups, the average yield comes out considerably greater, and my belief is that this will hold true for each of the deals we bought during this year.

Understood. I just want some background regarding how long your deals tend to run. When a deal arrives, is the length already fixed so your only choice is accepting or walking away, or would you prefer a lengthier term and therefore give up something else in order to secure it, or what's the process there?

The bulk of the opportunities we originate come by way of sale-leasebacks along with build-to-suits. Every element of the arrangement gets negotiated. You have concessions in both directions all the way through that process. Lease duration, of course, matters a great deal to us. The kinds of escalations built into our contracts — that matters a great deal to us too, particularly with inflation. My view is that nothing is off the table, and trade-offs exist, above all when the market is competitive. As should be clear, we've managed to get deals done featuring exceptionally lengthy lease durations, quite compelling escalation structures, while at the same time preserving a solid initial cap rate and spread across the year relative to the cost of capital.

Okay, thanks. I’ve got one final item, and it’s more of a detail-level question. Lease termination income looked somewhat high this quarter. Could you give any context on that, and does it affect the NOI run rate we ought to keep in mind moving forward?

Toni, you want to take that one?

Yeah, I have that. Thanks, Jason. I believe we did point out that this particular quarter featured a few bigger tenant payments. The total came to roughly $4.5 million, plus a modest bankruptcy settlement of the same size. I think a portion of this line item does show up each quarter on a recurring basis — these kinds of one-time amounts that have a tendency to pop up periodically over the course of a year. On average, I'd put it at roughly $12 million across the full year, which matches up with where it stood a year ago. I don't think we're actually anticipating anything, or at least we don't see anything on the horizon at this point for the rest of this year. This quarter, I'd say, was definitely a step up.

All right. So with regard to the payments, there wasn't any connection to us being required to carve out a portion of your run-rate revenue as a result of some significant cancellation or anything along those lines?

No, those were payments due when a lease ends, usually for getting the space back into shape; when a tenant leaves, we reach a settlement with them. There’s no recurring NOI component in that, but it is definitely an economic piece of the lease that we make sure gets honored.

Understood, that makes sense. Appreciate it.

Hey there, thanks everyone. Thanks for having me on the call. I've got a few questions. First, you brought up the uptick in interest around sale-leaseback activity; specifically, which sectors or property types are showing more of that now compared with, say, 2 years ago? And on that same topic, could you give us an update on lab office, or interest in lab R&D space? What are you seeing in that area? Which markets? Is it the mega clusters where some of the other public REITs have holdings, or is it secondary markets? Thanks.

Yeah, absolutely. On sale-leaseback, I'd say the increase is broadening as corporates — maybe this comes out of some of the liquidity crunches they went through during COVID. Corporates, I believe, are shifting more toward leasing instead of owning their real estate; that covers critical operating real estate that makes for good sale-leaseback candidates and long-term leases. That's the space we've been targeting. We describe industrial as a broad asset class for us. There are definitely plenty of warehouse deals we're doing. Inside that, we're also doing, as you brought up, R&D, cold storage, food processing and production. I think each of those fits well with sale-leasebacks, again, given how critical the assets are, which fits well with corporates being willing to sign very long-term leases. Your specific question on lab. Lab isn't our primary focus. I think it'll be more incremental deal volume when opportunities for sale-leasebacks come up. We won't be competing with the Alexandrias of the world in Cambridge and San Diego. It's just a somewhat different approach for us.

Okay, so one question I have. As 2020's fourth quarter wrapped up, roughly 9.5% of your ABR leases were set to roll in 2024, and today that figure sits at only around 8%. Does that come from pushing leases higher, from disposing of properties? What's the right way to view what's happening in the portfolio across the coming years, and how retention might shape up? Thank you.

Brooks, would you like to handle this one?