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

Good afternoon, everyone. Welcome to the 1:15 p.m. session here at day 2 of Citi's 2022 Global Property CEO Conference. I'm Manny Korchman joined by Parker Decraene with Citi Research, and we're pleased to have with us W. P. Carey and CEO, Jason Fox. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. Everyone has been with us for a while. So I think we got questions down. Jason, I will turn it over to you to introduce any team members that are there with you, and then you can come back to me for Q&A.

Yes, sure. Thanks, Manny. Good to see you. Sorry you're not here in person with us, and thanks for hosting us, Parker as well. With me today is Jeremiah Gregory, heads up capital markets for us. And happy to take questions.

Great. What are the top 3 reasons an investor should buy W. P. Carey's stock today instead of any other listed property company?

Yes. I think #1 is our increased external growth. 2021 demonstrated our ability to significantly increase external investment deal volume. We did a record $1.7 billion, $1.72 billion of deals last year. And we're at a strong pace thus far in 2022. I think it's sustainable going forward. I think it's reflected in the initial guidance we released a couple of weeks ago at earnings at $1.5 billion to $2 billion for the year, $1.75 billion at the midpoint. And we have good visibility into a growing pipeline. So we feel good about that number. I think that's number one. Number two, the benefits from our recently announced CPA:18 acquisition. It's immediately accretive to real estate earnings, real estate AFFO by about 2%. That's going to offset some of the roll-off of some of the lower-quality fee income that we receive from managing CPA:18. There is embedded upside. I think there's a self-storage portfolio, which we're happy to talk about some as well as some mortgage debt that's in place that we think over time, we could refinance out at a nice spread to those current rates. And it's a portfolio we clearly know well, minimal balance sheet impact. And it does provide simplification, but happy to go into more details. I think lastly is our internal growth. We feel that W. P. Carey is the best positioned of all the net lease REITs for inflation. It's really a significant differentiator for us relative to our net lease peers, who largely have no or relatively flat rent growth. So that's certainly a tailwind, and we can talk about some details of that as well. So those are the 3 reasons.

Right. I guess we'll try to hit those sort of one by one as we go through our conversation here. The external growth, just thinking about your pipeline and when you're sitting back in December trying to figure out where the world is, what specifically were you targeting or would you like to target in that $1.75 billion that you're looking at?

Yes, sure. I mean, look, one of the benefits of being diversified is that we have a wide opportunity set, both across geographies as well as across property types. From a property type perspective, we've predominantly been targeting industrial assets. I think that's both logistics as well as manufacturing in addition to some of the other smaller subclasses such as food production, cold storage, some R&D as well. We also target retail predominantly in Europe. And it's mainly been the home improvement space, the do-it-yourself retailers in Europe, largely the market leaders as well as grocery, where we've been successful recently in buying a number of portfolios. In addition to that, we're also clearly buying industrial in Europe as well. In terms of geographies, last year, we saw our allocation was roughly in line with our ABR, which is about 2/3 U.S., 1/3 Europe. We've seen a bit of a shift going into 2020 where we're seeing more opportunities, perhaps some larger opportunities that are moving the needle in Europe. So I think that we're certainly at least 50-50, maybe even at this point in the year given the visibility we have into our pipeline, maybe leaning a little bit further towards Europe. And that's a good thing. I mean, that's one of the differentiators for us. We've always talked about Europe being an advantage. In addition to providing another channel for growth, we also see better spread opportunities in Europe. The cost to borrow there has been meaningfully cheaper than it is in the U.S., and cap rates maybe are only slightly inside of what we're acquiring in the U.S. So better spread opportunities because of the less competition and maybe just a less developed market.

Europe has obviously been in the news for a lot of reasons recently. Have your views there changed? Have you seen anything on the ground that would change the way we should be thinking about Europe or the way that you're thinking about Europe right now?

Yes. Look, from a -- from our own portfolio, we're in all NATO countries. Maybe the exposure to look at most closely might be Poland. We have about 5% of our assets in Poland. I think it's important to note, close to half of those are with one tenant, a company called OBI, which is one of Europe's largest do-it-yourself retailers. We have a number of properties within Poland. And OBI is a great company. They're very profitable. It's German-based. And I think that's a theme for a lot of what we own in Poland. These are big multinational companies with multinational guarantors. Apart from OBI, they tend to be logistics and manufacturing assets that are on long leases, many of which are recently built. They're part of the supply chain into Germany as a low-cost source of manufacturing and distribution. So we feel good about what we own there. I think more broadly, we're not as concerned about what's happening in Ukraine spilling over into some NATO countries. I mean, anything could happen, of course, but I think that's probably, in my view, unlikely. So the question is probably more around what's the impact on businesses in Europe, whether through supply chain or energy prices or just broader turmoil, and will there be some distress. And I think the theme is still true. Our tenants in Europe are large multinational companies. We tend to have good real estate on long leases, tends to be highly critical operating real estate. And while the situation is obviously very different than, say, COVID from the last 2 years, I think there are parallels into what we could expect out of our portfolio. If you think about severe disruption in businesses like what happened with COVID, we fared very, very well. We were a sector leader throughout COVID in collection rates. We quickly -- we're at kind of the high 90s, 98%, 99% collection rates really shortly after COVID began. We wouldn't expect anything different to the extent there's more disruption or distress across Europe.

Right. I'm going to skip to point number three for a second. We'll come back to CPA:18. You've been talking about inflation probably longer than any other rate in the house there. During the last 2 days, I've probably heard more about inflation than I wanted to in a long time. I guess, firstly, you've had this competitive advantage. Are others trying to replicate it at this point as inflation starts to ramp? Maybe people have been complacent over the last few years because we haven't had to think about it. Are you seeing any of that out there?

Yes. I mean, I would think companies that are structuring leases will try to implement that type of bump structure for lots of reasons. I mean, we focused on it for many, many years. And for us, currently, about 60% of our portfolio has CPI-linked leases. And that's on a $20-plus billion portfolio. And so there's a massive installed base of CPI-based increases that is really going to drive our growth. I think right now, as you can imagine, it's incrementally more difficult when structuring new leases to get CPI. We're still achieving, especially in Europe where it's much more customary to have CPI, but we're seeing it in the U.S. as well. So I think that, that is probably something that people are targeting. And really, I think the other benefit to our model, originating most of our deals through sale-leasebacks and build-to-suits. We do have the ability to dictate what structures are. And this is just an economic point. It's a negotiation. You look at going-in cap rates, you look at bump structures, you look at lease terms, you look at rents and basis. And you triangulate to what you think is the right deal. We've always focused on CPI in the past, and that's an important component to us. I think we still are, but there's trade-offs. I think we've seen it flow through to the fixed rate increases, which is really the other 40% of our portfolio's bump structure. And in the past, I would say we've averaged in and around 2%, but we're negotiating leases on an annual basis for bumps. We've seen that drift up to 2% to 2.5% and even in some markets closer to 3%. So while we may not be getting as many inflation-based links -- linked leases at this point in time, it is flowing through to the fixed rate leases as well. And they'll provide longer term and higher levels of growth for our portfolio.

Yes. And Manny, maybe just one thing to add to that. I mean, although everyone is, I think, rightly focusing more on inflation and that's been an area we focused on for a while, I think it's also a distinguishing factor that we've just focused more on growth in our leases overall than I think some of our peers, perhaps many of the peers. And so we've really tried to highlight that whether it's the 2% fixed bumps or the CPIs that there's more to our investments than just the going-in cap rates. We've talked, I think, recently about the average yield on many of our investments that the average lease term is 20 years. And if we're 2% plus on bumps, that could be an average yield in the mid-7s, even if we're going in around the 6%. So while I think some of our peers could have wider going-in cap rates than us, we still think that whether it's our unlevered returns or our average yields, these are very attractive to our cost of capital and very attractive kind of overall returns relative to others. So I think it's the focus on inflation link, but also just the focus on growth in our leases as kind of a distinguishing factor.

Right.

And maybe, Manny, let me inject one more time. I mean, where we are right now, last year, I think our same-store growth was in the 1.5% to 2% range. We talked about in our last earnings call that based on forecast at the time for inflation, we could expect 2022 to generate same-store growth of between 2.5% and 3%. Inflation prints have come in higher than our original expectation. So I think at this point, we're seeing perhaps upside to the upper end of that range. And certainly scenarios if inflation remains high for longer, we could even be above that range on a same-store basis, which in a net lease portfolio, especially one of our size, provides real tailwinds to growth and maybe less reliance or a nice supplement to the growth that we can achieve through external investments.

Jason, is there a pricing pain point, if you will, that at renewal, you're just going to give a lot of this back if inflation is worse than expected? Are you just going to get there faster and so it's just going to change the renewal conversation? Or do you think it's kind of fluid?

Well, look, maybe the question is, might this put our rents above market at the time of leases if we have higher than originally anticipated rents? I mean, I think when we set our rents when we do sale leasebacks, where the ideal is to set around market or perhaps even below. And the bump structure is supposed to track what we expect market rents to grow at. So I think that to the extent we're in good markets, so to the extent we're seeing inflation flow through our leases, I think we can expect a lot of locations, market rents to track that as well. So each asset is going to be unique, of course. Some will be above, some will be below market. But by and large, we think the markets we're in should generally track inflation.

Great. Let's switch to -- you mentioned the benefits from CPA:18. The last week, we spoke about that pre-earnings was maybe it will happen, maybe it won't. I think people expected it. At earnings, you announced that it was -- or right after earnings you announced it was in fact happening. Let's talk about the better upside that you talked about in the storage portfolio and then maybe less on the mortgage stat because that sounds like it's probably further out.

Yes, sure. You're right. This is something that I think is probably widely understood that something was going to happen with CPA:18 in 2022. And look, we like the portfolio. We've managed it for a long time since inception. We assembled the portfolio based on the strategy we use in W. P. Carey. It's predominantly net lease. We did shift some of the investment focus outside of net lease when we started investing in net lease on our balance sheet to self-storage and student housing. So there are good-sized portfolios of both of those properties within the fund itself. I think the self-storage does provide some upside. It's an industry right now or a property type that's experiencing high growth. I think our portfolio is no exception to that. And there are lots of options for us in holding that portfolio. I think we've been in self-storage since 2004. We've owned operating assets for a large portion of that time. And we've had a lot of success acquiring operating properties in self-storage, both in CPA:17 and now in CPA:18. So certainly, we have the option to hold these assets as operating assets on our balance sheet when we acquired the portfolio, especially given the expected growth embedded in there. But we also have a blueprint on how to convert those to net lease that may be a better long-term fit for a net lease portfolio like we have. We did that with the assets we purchased from CPA:17 3 years ago, where we structured a net lease transaction with Extra Space. I think that, that blueprint is in place, and perhaps we could repeat that transaction with them. Perhaps there's other operators they'd be interested in as well. But certainly, that's a scenario that we consider. And then, of course, there's a pretty strong bid for self-storage, and you can pick the cap rate on where it may execute. But I think arguably, it's inside of where we have been and would expect to be acquiring net lease assets. So this is maybe a capital allocation question where depending on our funding needs and our alternative sources of funds, whether it's the debt or equity capital markets, we know we have a good alternative in storage, where we can sell some or all the assets and likely reinvest in that meaningfully higher cap rates. So I think the upside here comes in different forms. I think we have lots of options. We can be patient. Again, these are high-growth -- it's a high-growth industry right now. So it probably pays to be patient in making those decisions. But I think regardless, we have a number of really favorable paths to choose when it comes to what we do with the storage. In terms of the mortgage financing, I mean, like past CPA programs, there was a strategy to fund or finance the investments at the asset level. So most of the properties do have property-level mortgages. The interest rates are generally above and maybe well above where we could borrow in euros or U.S. dollar if we were to do a bond offering. So again, we'll always weigh the prepayment penalties and the timing versus the upside opportunity to put in place lower-cost debt. But we do think in any kind of -- certainly in the current market and even if there's further rising rates, we think we can pick up interest savings by paying off mortgages and terming out some bonds.

Is there any reason structurally or otherwise that the storage assets within 18 weren't done the same way they were in 17 at that time? Was it just that the 18, it made sense to hold operating assets rather than convert them to net leases?

Well, if you recall, the CPA:17 storage assets were all operating assets as well. We acquired that fund with the storage's operating assets in the fall of 2018. It wasn't until, I think, the summer of 2019 that we actually converted those into storage. So it was a good 9, 10 months after we acquired the portfolio. So yes. And I think, look, the mandate for the CPA programs maybe is a bit broader. As I mentioned, we did shift our investment strategy away from net lease because we wanted to put more net lease into our balance sheet. And it was something that we pitch to the directors of those funds. They like the idea of student housing and self-storage. I think that we were very forward thinking at the time over the last 10 years to go pretty heavy into both those asset classes. And it's turned out pretty well. With regards to the student housing, those are operating assets as well. They're development assets that are mostly complete. Many of them are up and operating. Some of those are completing construction shortly. But those have been -- and we've talked about this. Those have been under a lease structure within a large asset manager in which there is a purchase auction embedded that we -- that gets triggered with the change of control that we have reasonably high expectations will get exercised. So I think that we would not be taking on the student housing onto our balance sheet. That would likely be sold prior to the closing of the merger. I think it's important to note that the structure of this deal is a little bit different than at least the CPA:18 structure in that this is just a partial stock, and there is some cash component. It was a $10.45 price, $7.45 stock and $3 of cash. And we sized the cash component roughly in line with our planned dispositions, including the student housing portfolio as well as 3 or 4 other assets, predominantly European office assets that we expect to sell at or before the closing of the merger. Those dispositions will account for the large portion of that $3 of cash. And it's important to note that there is no funding requirements for this deal. It's stock and cash that we're going to generate from dispositions. We don't need to rely on the capital markets to close this. Instead, we'll look at capital markets as we have funding needs for our deal flow.

Are there any remaining office assets in 18 that you're going to actually keep?

Yes, there are. I mean, I think the assets that we plan to sell, they probably make up a little less than half, maybe 40% of ABR, probably a little bit more of the value in some of the larger assets. So we're selling off a good portion of it. And I should say at cap rates that will be accretive to the overall deals cap rates. These are good quality office assets, long leases with good tenants in good cities. I think they're in Rotterdam, Oslo and another Dutch market. It might be a second one in Rotterdam as well.

And maybe it's a silly question, but then why sell them? It sounds like they're good assets that might fit the mold of what you maybe end up buying 1 day?

Yes. Look, we have not been acquiring or targeting office assets for some time. If you look back, call it, 5 years ago, our office ABR as a percentage of total ABR was in and around 30%, low 30s. Today, it sits at around 20%. And that's mainly because we've been targeting other asset classes, predominantly industrial and retail. And I think that focus is going to continue in that direction. We really haven't bought any material office assets apart from ones that may have come in a portfolio deal with -- that's been largely industrial. So I think that trend will continue. We'll look at ways that we can find good execution for office assets and focus on our core investment targets, which are going to be industrial and retail.

We had a question here in the live QA. Can you discuss cap rates you're seeing for the type of industrial assets you're looking to buy?

Yes, sure. So I would say, generally speaking, we've been targeting really over the last number of years cap rates in the 5% to 7% range. I think it goes without saying that industrial assets will likely be at the lower end of that range. And we've even found some various opportunities that are even below 5% that work with our cost of capital, especially when you take into account the bump structure we can put in place for the point that Jeremiah made a few minutes ago. We're sourcing these predominantly through build-to-suits and sale-leasebacks. Actually in sale-leasebacks and build-to-suits, more sale-leasebacks than build-to-suits as well as expansions and some redevelopments with our existing portfolio. So because of how we source them, because of the upfront complexities involved with the sale-leaseback on the smaller universe of buyers, we are able to generate higher cap rates, wider spreads than you might think or see trading in the open market. I think furthermore, the most aggressively priced industrial assets, especially the most aggressively priced warehouse assets, tend to be those with shorter-term leases, where there are below market rents and a real mark-to-market opportunity in the short term, which can bump you up to perhaps closer to the stabilized asset level yields that we're acquiring in these high 4s, well into the 5s and maybe even some unique cases into the 6s.

Are -- is there any tenant type or geography that you're currently not in and the determinant or the thing that's holding it back is just scale? Like you could go into another asset type, geography, whatever that you're not in with scale solved, what would that be?

Yes. I mean, look, we have a big balance sheet, and there is certainly the challenges of the larger denominator. I think we're meeting a lot of those challenges by ramping up deal volume like we have over the past 15 months. And we have a great pipeline, as I mentioned now. We have no reason to think that the level of deal volume won't continue and hopefully even increase. We are diversified. We do have lots of paths to find opportunities. I think for us, it's important to have a platform where we invest. So I wouldn't expect us to expand outside of North America, where we clearly have been investing for a long time as well as Europe. And in Europe, it's mainly Northern and Western Europe. We do have a platform based out of Amsterdam. We have 45 people in Amsterdam, probably another 5 to 8 people out of London. That's predominantly our investments team. So I don't think there's more geographies that we'll enter. We have a lot of options. And depending on the point in time, there are different opportunities and maybe better opportunities in one market over the other and we can take advantage of that. I think the same can be said with property types. We are generally focusing on industrial, but we view an industrial as a pretty diverse asset class in itself. What we own right now is about -- it's about 50% of our total ABR is industrial. And if you split that in half, about half of it is warehouse, and about half of it is manufacturing. And within the manufacturing segment, there's even more diversification from basic manufacturing and pretty straightforward boxes that have distribution components to food production and processing that might have more specialization, which also includes higher tenant investment, longer lease terms and higher likelihood of renewals. The things like cold storage, an asset class that we've been investing in for a very, very long time well before it became its own asset class. And we have a big portfolio of self-storage that we think is very valuable at this point in time. And of course, retail. We've been doing that in Europe for a long time. We've kind of been more opportunistic in what we've been acquiring in the U.S. I think that's an opportunity that could be expanded over time. We certainly monitor what's happening there. It's been more competitive. But we do have an appetite for growth, and we have the cost of capital that works. So that could be an area where you could see us allocate more capital over time.

Right. Maybe I'll ask this question differently. I think if I were to ask you this question, I think your answer would be inflation. But I'm going to assume that the market has a pretty good handle on your sort of inflationary story. So I'm going to ask the -- now I'm going to ask the question.

Other than inflation.

What is the biggest growth opportunity that you believe the market is not giving you credit for?

Yes. Well, look, it's [ deemed ] around growth. And if it's not internal growth from inflation, I think it's still perhaps an underappreciation, our ability to grow externally. We do have a big denominator, but we have ramped up our investment volume. We've seen our pipeline grow. Again, we've set ourselves up very well from a capital markets and funding perspective. We did a record capital markets last year, over $2 billion of capital raised, probably split roughly between equity and debt. We still have $300 million of funding left on a forward equity that we can settle, and our balance sheet is in very good shape from a liquidity standpoint. So we're well set up for growth. We have a team in place that's highly motivated. The diversified strategy gives us opportunities across a number of property types and geographies. And look, we've had some lulls in the past that perhaps coincided with the simplification and transition of our business away from investment management to a pure-play net lease REIT. That's all done now, especially with the conclusion of CPA:18. So we feel good about our prospects going forward, and I think the current visibility into our pipeline supports that as well.

Yes. And Manny, maybe I would just reiterate the point I made earlier about the growth in our leases, whether it's inflationary or fixed bumps. But that I think that perhaps it's underappreciated, the unlevered returns or the average yields we're generating because people sometimes focus just perhaps exclusively on the headline cap rate. And I think on the other side, on the funding side, I think people are aware of this, but perhaps it's not always top of mind, our sort of blended cost of debt that we've really over the last 4 or 5 years, if you account for our euro debt, we probably have around the lowest or truly the lowest cost of debt in the net lease sector. And I think both on the funding side and the kind of investment return side, I think maybe it's not always obvious how well positioned we are and kind of the true spreads we're generating.

Jeremiah, is there any FX concern that people should start thinking about given where exchange rates have gone especially the last couple of weeks?

No. I mean, I think that we've talked about this with you and many of our investors on our earnings calls in the past that we have the same hedging program that we've had in place for many years now. And so the first layer of protection is, of course, euro bonds we issue that provides a good hedge on our assets and our NAV. It also provides, of course, an expense and offset to some of our European-denominated revenues. So it lowers sort of the net cash flow essentially coming from European currency. But on top of that, and maybe this is what you're getting at, we have always done true cash flow hedges going out 5 years. We're taking the forward curve. And so in a moment in time like this, where the currency may be moving around, we have the majority of our net euro cash flow hedged at a rate that was set years ago. That's the rate that we'd be exchanging at today. So clearly, today, those hedges are in the money. And that will offset some of the -- if there's any sort of negative movements here. I mean -- and really, the way the hedging program is set up at a high level, it would take something what we would view as a very significant move, like perhaps a 20% move in the currency happening in 1 day and then persisting for an entire year. Even a move like that with the hedges we have in place with these offsets, we don't think that would affect our earnings by more than 1% to 2%. So it would -- while there is more volatility, it's certainly not at a level that we think kind of changes how people should look at our cash flows or kind of any expectations going forward.

Yes, Manny, I would just add. I think that's another thing that perhaps is underappreciated is I don't think we get enough credit for our ability to blend in lower cost euro debt into our cost of capital. I mean, we may have one of the lower -- Jeremiah, you can correct me if I'm wrong. We may have one of the lowest cost of debts of all of our net lease peers given our ability to blend in low-cost euro-denominated bonds.

Jason, what's your #1 ESG priority in 2022?

I mean, the area we have the most room to improve is going to be on the environmental side. I would say our #1 priority in 2020 is really to work with our tenants on how they can reduce their carbon footprint. And I think maybe it's helpful just to give you a little bit of background on what we are doing on the environmental side. It's really focused on 3 interrelated areas kind of each leading to the next one. The first step is really data collection and analysis. And we have systems and technology in place that we integrate with energy usage with a large portion of our tenants who are working to grow that. But this will allow us over time to benchmark and as well as allow us to report to some of the different environmental rating agencies like GRESB or the CDP. We made some pretty good progress there. I think the second part of that is tenant outreach. As part of our approach to asset management, we've always been very proactive in working with our tenants. And in this case, helping them solve their own ESG problems. And so we've been successful reaching out to our tenants with a focus on sustainability for them. And then lastly, what it leads to are lots of projects. I think in 2021, a little over 1/4 of our total investment volume was in green projects that fell under a LEED or BREEAM rating that could qualify for green bonds. And we did do a green bond at the end of 2021. And I think these projects, I would say the biggest component of that and maybe the one that could move the needle the most are solar projects. I mean, one of the opportunities of having a large industrial portfolio with lots of big buildings with large roof square feet is we do have opportunities to do solar projects. And we're seeing more and more of that. In fact, we're just now completing, maybe we just did complete what at the time when we began the project was the largest solar installation, solar rooftop installation in all of Europe. I think at this point, there may be some larger ones, but I think it's still the largest solar roof installation in the Netherlands at a large asset we own in the Port of Rotterdam. So I think that's the priority, is to find ways to work with our tenants. We can put some money to work. We can generate good spreads. We can also have conversations about extending leases and have follow-on transactions. But ultimately, we're going to help them in their own sustainability efforts, which from our viewpoint is a positive for lots of reasons.

We'll go to our rapid-fire questions. What will same-store NOI growth be for the net lease sector overall in 2023?

I think 1.5%, and I think we'll be double that.

What will the 10-year treasury yield be a year from today?

2.5%.

And will the net lease sites have more or fewer public companies a year from now?

Yes, there's too many. There's over 25 -- or there's over 20, maybe close to 25. So I say fewer.

They're going to say, keeps growing. We get to 30 quicker. All right. Thank you all.

Okay. Thank you, Manny. Good to see you.

That ends our conference.