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

Good morning, everyone. We'll get started now. Welcome to the 8:45 W. P. Carey panel. My name is Chris Lucas. I'm the lead REIT analyst at Capital One Securities, and I'm pleased to introduce today Jason Fox, the CEO for W. P. Carey; and Jeremiah Gregory, who is Head of Capital Markets and Strategy. I guess maybe, Jason, let's get started with just sort of a quick overview of the company, what you do and how you're investing.

Yes, sure. And thanks for joining us and moderating for us today, Chris, and thanks, everyone, for joining us early this morning. So I think a lot of you probably are familiar with us. But as a reminder, for those that are new to W. P. Carey, we're the second largest net lease REIT with a market cap of approximately $16 billion with a total enterprise value of around $23 billion, which puts us among the top 25 REITs by market cap in the RMZ index. Our enterprise value is expected to increase to about $25 billion once we complete the CPA:18 merger during the third quarter, which will add around $2 billion of assets. We've been around for almost 50 years at this point in time. And really, the focus throughout that history has been investing in high-quality, single-tenant net lease assets across property types as well as geographies, namely industrial and warehouse in retail, along with self-storage properties, both in the U.S. and Europe. The diversified approach is something that we've been focused on really since inception of the company. We've been investing in Europe actively since 1998, so over 20 years at this point in time. The portfolio is comprised of -- about 2/3 of our assets are in the U.S., about 1/3 in Europe. In Europe, it's largely located in Northern and Western Europe. We have a strong balance sheet, which Jeremiah can field questions on, investment-grade rating from both Moody's and S&P, both of whom have us on positive outlook at this point in time. We also have a well-laddered debt maturities with really no bonds maturing until 2024. That's at this point in time. We feel we offer investors a unique combination of both growth and downside protection. 2021, we had a record year of investment volume of $1.7 billion, $1.75 billion. And at this point, we're off to a great start for 2022. We've closed around $300 million through Q1, another $400 million that were announced yesterday with about $100 million of build-to-suits or expansion projects we expect to complete in Q2 and more expansion projects throughout the year, and of course, a growing pipeline that we can get into as well. I think one of the distinguishing characteristics of us is the percentage of inflation increases embedded in our leases, which I think is an important topic in today's environment, which I think we'll get into some as well. I mentioned downside protection. It's a hallmark of how we invest in net lease through both diversification as well as our underwriting, focusing on downside protection within our structures, acquiring critical operating assets on master leases, ones that companies will need through expansionary times as well as recessionary times. So with that, let me hand it over you, Chris, for some questions.

Okay. Well, I appreciate that. I also want to encourage any audience questions. I prefer an interactive process. So if we can, that would be great. I guess maybe let's just start -- let's talk about what you announced yesterday in terms of the acquisitions. What did you buy? What was compelling about it? And what were the -- what sort of set those out as things that you wanted to allocate capital to?

Yes, sure. It's an interesting environment right now to be investing in, of course, when there's not a lot of visibility and a lot of volatility, especially on the debt capital market side. We've been doing this for a long time. I think in environment like we're in right now, where there is dislocation and volatility, someone like us who has a long history of execution tends to do quite well in looking at assets at this point in time. Advisers and companies looking to do sale leasebacks or build-to-suits are not necessarily focused on the highest price at this time. Execution is most important. I think we bring that to the table. And I think that's a common theme to a lot of what we've been buying. We've been quick to close and commit. I think that cap rates have expanded some which is important. We are diversified, but we have been overweight in industrial and warehouse, and that's reflected in the deals that we've done year-to-date, I think about 2/3, maybe a little bit above that, have been in the industrial and both manufacturing as well as warehouse. There's some European retail in there as well. It's mainly been focused on grocery. And I think importantly, we've continued to maintain our underwriting standards. We've seen cap rates come up. And the deal structures are consistent with what we've done in the past, many of which still have inflation increases. In fact, over 50% of our new deals still have inflation-linked rent bumps tied into the leases.

Okay. So a lot of questions that come from all of that. So would you say that the pool that you acquired is typical of the opportunity set that you've been looking through? Or is there something unique about it? And then I guess you have also mentioned the cap rate adjustments, maybe you could describe with a little bit more color on like product type and markets where that cap rate movement has actually happened, what you're really seeing at real time?

Yes. I mean the portfolio we've acquired year-to-date is largely in line with what we've been acquiring in the last couple of years. As I mentioned, it's overweighted towards industrial. There's maybe a slight trend for us back to Europe right now. I think that 2021, maybe it was 2/3, 1/3 U.S. versus Europe. Current deals we've closed to date as well as our pipeline are split around 50-50, maybe even a little bit heavier on the pipeline in Europe. I think part of that is that there's -- to kind of shift to cap rates, we've seen over the last month to 2 months, a quicker, sharper movement, believe it or not in borrowing costs in Europe. I think it lagged the U.S. in terms of rates rising, and I think that has spooked some of our competition, mainly competition that is reliant on debt to make their purchases. This is typically a private equity buyer who relies on, call it, 65% leverage. These are mortgages at the asset level. And it's a financing contingency typically in a deal. So that does put us at a competitive advantage when we can bid all cash. We are relying on low leverage in our model. Typically, I think our balance sheet, net debt to -- debt to gross assets is in and around the low 40s right now, which is consistent with our underwriting. So even though we've seen rates and our cost of debt rise, it's not as impactful to us, especially given the offsets we've seen in our equity price. So I think our cost of capital really hasn't moved as far as one might think. And for that reason, we're still generating good spreads, and we're being opportunistic around cap rates, which we have seen expand, I would say 25 to 50 basis points. It's probably both in the U.S. and Europe, pretty similar since the beginning of the year, and we would expect to see that trend continue as we get through the second half of 2022.

So your comment is interesting as it relates to sort of the European rise in borrowing costs given the fact that the ECB has actually not been proactive at this point, right, that has been. How are you guys thinking about how that trend as the ECB actually does start to move rate?

Yes. I mean, interestingly, you're right, I think that base rates probably have not risen as much in Europe as the U.S. but spreads, borrowing costs have. I think that's where we've seen more of the -- it means lack of supply and lenders, but it's typically in the mortgage market. And it's true in the U.S. as well, but maybe particularly acute in Europe right now, both availability and pricing and leverage, which is leading to, for us, better opportunities to fill the void that some of the higher leverage buyers have been creating.

Okay. And Jason, you mentioned earlier that you were getting -- still getting your CPI adjusted bumps in the deals you're doing now. I guess maybe you could just sort of take a step back and kind of remind us of how the portfolio is positioned to handle an inflationary environment? And maybe a little bit of color on sort of what's already getting processed into the system? Is it in sort of rent bumps for this year and maybe what you're kind of seeing into next a little bit?

Yes. A very, very relevant question. Obviously, it's something that is a big differentiator for us compared to virtually all of our net lease peers. 99% of our leases have bumps built into leases. In fact, it's above 99%. Of that, 58% of our leases are linked to inflation. And within that category, 38% of the 58% is tied to uncapped CPI. So in the current environment, where we're seeing 8%, 9%, 10% print, and this is both in the U.S. and Europe for those that aren't tracking Europe as closely. Inflation there has been as high and in many countries higher than what we've seen in the U.S. So there's a real tailwind that we have flowing through to our portfolio. There is a bit of a lag effect on how inflation flows through typically the way that the formulas work in leases, there's a look back, you do look back 3 months and take an average of that 3-month period and compare it to the 3-month period from the year prior, and that's going to be your increase. So you're always looking back about 3 months and then to have the data, you probably add another month lag here. So I think inflation, how it flows through to our leases has lagged a little bit from the start. But it also means that it's going to linger longer on the back end if inflation starts to moderate over the coming quarter or next year. So the way that's translated to earnings for us are really, I should say, same-store growth. Historically, we've always been higher than our peer set on a same-store growth. I think typically, we've been in the 1.5% to 2% range where our peers have probably been half of that, maybe half of that. What we've talked about more recently based on our forecast for inflation, we would expect same-store growth for 2022 across our whole portfolio to be above 3%, maybe as high as 3.5%, and that should continue to accelerate into 2023 given this lag effect and the fact that not all of our leases are on annual increases, some of them are on increase that happen every 2 or 3 or even in some cases, every 5 years. So 2023, we're expecting could be 4% or higher. And of course, if inflation comes in hotter or persists longer than our current expectations, we could see some upside from that as well.

Okay. So just going back to the -- yes, sir, go ahead.

Just one follow-up. Jason, so if you look at roughly [indiscernible] of the leases are in investment caps or...

Let me clarify, 99% of our leases have all those categories fixed or tied to CPI or capped CPI. It's 58% of that 99% that's inflation-linked; 38% out of that 58% is uncapped inflation.

Exactly. I think we're saying the same think. [indiscernible] it's [ 62% ] capped or fixed.

Or fixed, yes, I got you. Yes.

So, if you go back to the residual, the 38%, that is tilted [indiscernible] disclosure on others in the sector for the [indiscernible] sometimes a little thin or little [indiscernible] if you talk about those sectors, particularly in Europe, energy cost, [indiscernible] to what extent do you think your officers [indiscernible].

Yes.

It's a question of [indiscernible].

Yes. You are correct that we have a higher percentage of our inflation-based increases. In Europe, it's more customary there. It's less typical in the U.S., but it's a focal point of ours when we're structuring new deals, and we do get it in a substantial number of our U.S. leases as well. So the question on how does this impact credits and their ability to pay rent. I mean this is something that we've always focused on. Credit underwriting is a hallmark of how W. P. Carey transacts, considering downside protection, looking at scenarios and downside analysis. So I think the observation is correct. There are higher rents that they're paying now, and that's accruing to our benefit and our investors benefit. And that's putting incremental pressure on their ability to kind of service their leases as well as their debt. But there's plenty of coverage. I think with our retail, typically, depending on the asset class, we're well over 2x, maybe 3x and 4x depending on what we're looking at. It's not a relevant metric for other categories, industrial. It's something that we keep an eye on. And maybe the -- underlying your question is what happens as the economy softens and we're seeing recessionary pressures, both through inflation and energy costs and supply chain issues, et cetera. And I think that from our perspective, we have a great stress test to refer back to in COVID, and we were the market leader within net lease in terms of collections. Throughout COVID, we are in the high 90s for collections, which is higher than all of our peers. And we wouldn't expect anything different given how we structure large companies, critical operating assets, master leases, even if there is some distress, we have confidence that our leases are important to these companies, they're going to make them all.

Okay. I guess maybe we can move to the next sort of interesting area again, your investments in Europe create opportunity, but there is also some sort of leakage from the disconnect between the dollar and the euro.

Yes.

Euro has been weak recently, as the Fed has been more active. How do you manage your currency exposure? And sort of what should we be thinking about in terms of that leakage?

Yes. Let me hand it over to Jeremiah, who is at the focal point. He's Head of Capital Markets for us.

Sure. Let me lean into the mic here. So yes, I mean, the question about our euro exposure comes up regularly, and we have basically 2 approaches to hedging. They kind of combine to really mitigate and moderate the impact of movements in your currency. So first, we overweight euro debt and our capital structure through our Eurobonds. And so that has the effect of really offsetting most of the currency impact on our NAV to the extent one is kind of NAV focused in their analysis. From a cash flow perspective, it also -- it provides more interest expense. It's essentially offsetting the euro revenues we have. So the net cash flow we have in Europe that are ultimately covering our dividend and producing our AFFO, there's less euro exposure in there due to the fact that we're overweighting the debt, and we have more euro expense. On top of that, we also do cash flow hedging. And we -- as a net lease REIT, we obviously have a great sense of when our rent is coming in, when the euros will be paid to us. And so we're able to hedge out effectively 5 years with the banks. We're hedging approximately 65% of that net cash flow. And what that all boils down to is even when there's meaningful movements in the year, obviously, in the last, I think, 6 to 12 months, we've seen a lot of movement. The euro is probably at a relatively low point. Now one of the lowest points it's been in the last 5 or 6 years at least. But in any case, even with the movement of 20% in the euro, we would only expect perhaps around the 2% move in our earnings and our AFFO. And that would really be if the euro moved 20% in 1 day, and it persisted with that level for a full year. That could result in a 2% move. So while we have seen some movements in the euro over the last few months, it hasn't been as dramatic as that. It's really something that we would think would be pretty moderate in terms of our impact to earnings. And I guess the basic intuition is just that a weaker euro will cause a slight headwind to our overall earnings. And a stronger year will cause a slight benefit, but you're probably talking very small percentage points, maybe $0.01 or so of earnings. So it's not something that is usually that impactful on our overall story.

Okay. We go to the balance sheet. Let's talk about the CPA:18 merger. There's always a couple of questions around that merger or any of the mergers like this, where you're acquiring a company that has a lot of individual shareholders. So there's -- I guess, first thing is strategically, how does it fit in your portfolio? And then secondarily, what's been your experience when you've done these transactions in terms of the volatility that comes out of it as you're providing liquidity to a class of shareholders that have been sort of in a nontraded vehicle?

Yes, sure. I mean in terms of fit, I mean, it's a portfolio that we've assembled from inception and managed from inception as well. The strategy was very similar to the strategy we have on how we acquire assets for our balance sheet. So there's a consistency across the portfolio, maybe with one exception, which I'll talk about in a second. But it's diversified across property types and geographies and fits seamlessly into our portfolio. And the great thing about acquiring a portfolio that we've managed is we are very familiar with it. There's basically 0 integration risk and there's no significant changes that occur apart from blending it into our accounting. But the operations and how we oversee that portfolio is unchanged. The one unique component of the portfolio that's a little bit different compared to CPAs that we've acquired in the past is the amount of self-storage in this portfolio, which we feel is one of the selling points of the transaction as well as a source of what we view as potential upside, both in terms of value creation and also rental growth. The self-storage portfolio is about $55 million of NOI. So a large portfolio. When we add that to our balance sheet with both the net lease self-storage assets that we currently have as well as the handful of operating assets still in our balance sheet, it puts us at one of the largest self-storage owners globally. An asset class that we know extremely well, we've been acquiring and managing these assets since 2004. That category, the CPA:18 assets over the last 10 years or so. So it's something that I think we're going to have a lot of options on what to do with that portfolio, and it's a big part of the value that we see in it. In terms of process, the deal is progressing forward nicely at this point in time. The 30-day go-shop ended several months back with no activity. At this point in time, we're working towards a vote at the end of July and an expected closing date in Q3, likely early August. You asked about the effect of the retail shareholder base once we acquire it. This is a little bit different compared to CPA:17 merger, for those that you've been following us for several years now. The CPA:17 merger, that made up about 50% of our shareholder base once closed. So meaningful in size, WPC share was both smaller at that point in time and CPA:18 was a larger portfolio. CPA:18 will only make up about 7% of our shareholder base. So any kind of increased trading volume as a result of the retail investor shareholder base is going to be largely muted compared to years in the past. We would expect elevated trading for a handful of days in all likelihood, but the magnitude of that elevated trading will be certainly less noticeable compared to CPA:18 at this point in time.

Okay. That's helpful. I guess maybe then let's move over to the balance sheet. What's the current leverage? What are your range of targets? And then when we think about this post-merger company, sort of where do you see -- are there opportunities on the refinance side? Are there -- what does the post-leverage look like, those kinds of questions.

Yes. In terms of current leverage, at the end of the first quarter, we were at around 5.5x on net debt to EBITDA. We were just over 40% on debt to gross assets, and that's really to the low end of what we've sort of stated as our target ranges, which is mid- to high 5s on net debt to EBITDA and mid- to low 40% range on debt to gross assets. And so we do feel like the balance sheet is in a good place, certainly, a place that gives us a lot of flexibility, I think. I think we're comfortable within these ranges. So not to say that it couldn't take up 1% or 2 on the debt to gross asset side or a fraction of a turn on net debt to EBITDA. But I would also say we -- Jason mentioned at the beginning, we're on positive outlook from both Moody's and S&P kind of philosophically. Our bias is probably to the low end of this range into maintaining kind of conservative leverage if we do -- when we get an upgrade, that could be operating as a BBB+ REIT. That could be a bit of a catalyst, even potentially incrementally lower those ranges. Although I do think where we're at now is probably sufficient for an upgrade. So I think that going forward, with the merger and the opportunities or how that might impact the balance sheet, the biggest probably change from the merger is just it's bringing on some secured debt. As Jason mentioned, this is a much smaller fund compared to some of the previous funds. So in the overall picture of our balance sheet, it's probably not enormously impactful, but there is secured debt in that fund. It's a laddered maturity schedule like all of our debt probably over the next, call it, 5 years, maybe $700 million to $1 billion of mortgage debt to pay off. So it's something that's very manageable, but something that we'll be focused on as we have been over the last -- really the last 8 years, but certainly, a lot of our mortgage debt repayment and prepayment has accelerated in the last couple of years. We're down to, I think, about 2% to 3% secured debt to gross assets. And so while secured debt to gross assets may tick up about 5% as a result of this merger, I think we'd see it quickly coming down through either just regular repayments or perhaps proactively repaying it. As far as the overall leverage metrics, it's relatively leverage neutral, again maybe could leverage tick up 1% or could the net debt-to-EBITDA go a fraction of a turn just as a result of how we close the transaction, it's possible, but certainly nothing that we think would get us elevated unreasonably high or well outside our ranges.

And the ratings outlook incorporates this idea that you're going to take on this additional secured debt?

Yes. Yes. The ratings outlook, yes, we've certainly discussed at length the merger with the rating agencies. I guess it's always a little bit of a black box, what their decision processes and what their timing is. It's certainly possible that part of the reason we're on the outlook and not fully upgraded is they're going to wait for the merger to close and kind of just let that play out a bit. But they're very comfortable with the progress we've been making on secured debt over the years. We've been, like I said, extremely proactive over the last several years, in particular. And being above 5% secured debt is still below 10%, but that's not going to be a major concern to them. I think they expect, as we're saying that we'll be back down well below 5% and approaching 0% relatively quickly. So I don't think the secured debt is really any concern.

Okay. I guess one of the things that you guys have positioned yourself and the stock has done well this year. It's held up relative to certainly the peers. It's been a significant outperformer. I guess just sort of how do you think about the utilization of equity and the equity debt mix for the remainder of the year.

Go ahead, Jeremiah.

Yes. I mean I think that really big picture and kind of over the long term, we expect to do things leverage neutral. So when you think about acquisitions over multiple years, we would expect the balance sheet to be run in relatively the same position it is. And so of course, that's a -- it's a mix of debt and equity to fund new acquisitions. It's in line with what our overall leverage targets are and approximately where the leverage is today. As far as kind of week-to-week, month-to-month or each capital markets transaction, we will, of course, also be mindful of what we think the most efficient sources of capital are what we view as kind of our projected needs and all of that. And so I think in the current environment, certainly, equity is interesting relative to debt given that our equity has held in and even outperformed in the last couple of months, whereas the debt markets are obviously a little more choppy, and there haven't really been a lot of data points out there even for anyone to see. So I think it's possible that in an environment like this, perhaps we, in the short term, consider over-equitizing new investments, if that's where the markets are at. And then like I said, we have this ratings consideration in the background, perhaps it's good timing to be over-equitizing on the margins. But over the long term, it's going to be a mix of both bonds and equity and maintaining the leverage and then about the zones that we have.

Okay. So we've seen this disruption in the bond market. I guess maybe if you could give us a sense as to where you think 10-year money in the U.S. and Europe would price for you roughly? And then how you would balance that with sort of, I guess, what's been more efficient currently, which is bank debt?

Yes. I mean I think in terms of pricing, it's probably easiest to start with just what's going on in the U.S. and then kind of work from there. But on the U.S. side, we've probably seen our bond pricing move 200 to 250 basis points relative to 2021. I guess it depends on exactly where you pick in 2021 to make that comparison. And so that leaves us, we think, somewhere in the high 4s on the new issuance. I think the caveat and I think every REIT would probably have this caveat is that you just haven't seen a lot of transactions getting done. There's not a lot of price discovery out in the market. So it's maybe a more theoretical or academic perspective than it is when you see a lot of bond deals getting done. So maybe that pricing comes in and spreads compress before people start doing issuance or maybe things could go the other way, but that's sort of the levels you're seeing in terms of where things are trading or where things can get done. On the European side, we're still -- we still have all-in cost of debt in Europe that's cheaper than in the U.S. That's always been the case for the last 8 years or so since we've been in the bond markets. I think historically, it's probably been somewhere between 100 to 200 basis points differential between our cost of U.S. debt and European debt. I think right now, that's really probably -- that differential is also compressed, meaning maybe it's 100 basis points less, maybe it's even inside of that. It's probably as close as it's been really over the last 7 or 8 years between the U.S. and Europe. So there's been a lot of movement in Europe, too, and that differential has compressed, although we can still do cheaper all-in yields in Europe. I think on your bank debt point, the bank market hasn't moved as much, and maybe that's a market that it's much more sticky, I guess, in some ways than certainly the bond market or the equity market. I think that when we think about bank debt, though, that's not something we would say as a solution to the entire capital structure. I think we've always had term loans. We, of course, always had a revolver, likely I think all REITs do. And I think for us, having a $300 million, $400 million term loan is something kind of in any environment, we would see as being appropriate for a balance sheet that may have $8 billion to $10 billion of debt. I don't think that's something where we would start leaning into the bank market, though, to kind of solve all of our financing needs. So perhaps there's a one-off bank deal to be done if markets are dislocated and that's something we think about. We actually did up our term loans recently. So we did add a couple of hundred million dollars of bank debt, I think, last quarter. But I think in the longer term, we're certainly going to be looking at the bond markets for funding. And I think the bank debt market, if it's there, is more sort of a one-off transaction or a smaller transaction.

So we're about out of time. Any questions, I've got one more to -- go ahead, sir.

How much volume do you think there is in the self-storage market? You guys going to buy more self-storage assets in that market?

Yes. Look, we know this space well. We've been in the market for a long time since 2004. I think we do want to grow it. But you're right, I mean it's had a laddered growth over the last year. I think there's still expected growth through the end of this year. 2023 is a little bit uncertain with the economy, with supply. But we feel good about the portfolio we own and we'll kind of evaluate deals as they come in. Yes.

Well, with that, I thank the panelists.