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

Hello, all, and welcome aboard. We appreciate you spending part of your day with us for the earnings call covering the fourth quarter of 2022. Prior to getting started, please bear in mind that certain remarks shared during this session do not reflect historical events and might be classified as forward-looking statements. Details concerning elements that might lead actual outcomes to diverge substantially from what W. P. Carey anticipates can be found within the documents we file with the SEC. A web-based recording of this call will be posted within the Investor Relations area of wpcarey.com, our company site. There it will remain accessible for roughly 1 year, and that same location also offers our investor presentations along with other associated materials. Having said that, I will now hand things over to Jason Fox, our Chief Executive Officer.

Thanks, Peter, and good morning to all of you. For W. P. Carey, 2023 brings a number of milestones. Bill Carey started this company 50 years back; 25 years have passed since we went public; and it was likewise 25 years ago when we made our first investments in Europe, a market where we were early movers in sale-leasebacks. Over the past half-century, this company has changed a great deal. The latest step in that evolution was leaving the non-traded REIT space, which finished with the CPA:18 merger. When we wrapped up our shift to being a pure-play net lease REIT in 2022, it showed how committed we are to real estate AFFO growth, powered by accretive acquisitions and rent escalations. Even with the difficult market conditions we faced in 2022, real estate AFFO per share grew 6.3% for that year. This morning, my comments will center on what we've been investing in lately and what lies ahead, and Toni Sanzone, who serves as our CFO, will walk through our results, the 2023 guidance we released this morning, and where our balance sheet stands. Joining us on the line to field questions are our President, John Park, and Brooks Gordon, who leads Asset Management. Let me begin with growth from external sources. During 2022, the U.S. 10-year treasury rate climbed by more than 200 basis points, and cap rates trailed far behind because sellers took their time adjusting expectations. Buyers struggled to hold onto spread, so deals frequently required more time to negotiate and finalize, particularly sale-leasebacks connected to corporate M&A. All told, our investment volume reached $1.4 billion for the year, with a weighted average cap rate of 6.3% and a weighted average lease term of 20 years. On top of that, through the CPA:18 merger we brought in over $2 billion of real estate at a cap rate in the mid-6s. October brought yet another increase in interest rates, so during the fourth quarter we took advantage of our pricing strength, insisting on stronger yields and opting to stay patient while cap rates began to move, which created opportunities for transactions at more attractive spreads. As a result, I'm pleased to share that our fourth-quarter closings came at significantly higher cap rates, even though deal volume was lower than anticipated, totaling $159 million. Across those investments, the blended weighted average cap rate was 6.8%, largely driven by warehouse and industrial purchases whose going in cap rates landed in the high 6s and into the 7s. Even though rates have eased somewhat compared to fourth-quarter levels, the bulk of deals we're currently evaluating also come with cap rates in the upper 6s and reaching into the 7s. That translates to investment spreads that look much better than what prevailed for the majority of 2022, and they're sitting at a point where we feel good about transacting. As we look ahead, we're well positioned to take advantage of present market conditions. Our diversified strategy lets us deploy capital across a range of property types, throughout both the U.S. and Europe, which ensures the widest possible set of opportunities involving companies in a wide array of industries. And although right now we’re finding more opportunities we can act on in the U.S., where cap rates have moved faster, we do expect European cap rates to catch up to higher interest rates. On top of that, the sale-leaseback backdrop is the most favorable we have ever witnessed, since high-yield debt and leveraged loans are still very costly. More and more companies are looking into alternative capital sources, sale-leasebacks among them. In fact, private equity firms that in the past we never saw turn to sale-leasebacks are now considering them as a way to raise capital, which lets us build new sponsor relationships; we anticipate these market conditions will persist for the foreseeable future and that, as the market leader in sale-leasebacks, we will be the main beneficiary of the growing deal flow. And naturally, the strength of our balance sheet, including substantial liquidity, gives us an edge with sellers who are still worried about execution risk. When you compare us with buyers who rely on debt at the asset level, our edge is especially clear, since that kind of financing has become either too expensive to pursue or simply unavailable—particularly for renters whose credit sits just under investment grade, the exact group we go after. Right now our short-term pipeline looks strong, with over $500 million in investments either far along in talks or covered by letters of intent. Add to that about $156 million in capital investments or commitments scheduled to close during 2023, plus the transactions we've already completed so far this year, and we can see at least $700 million in deal volume—all just a bit more than one month into the year. Taking everything into account, given current conditions, we anticipate that investment volume for 2023 will end up substantially greater, reaching approximately $2 billion, with cap rates that are higher and spreads that are wider. Now moving on to what we did in the capital markets. Despite interest rates climbing steeply and a rocky environment in the capital markets for a large portion of 2022, our share price performed very strongly, and by year-end we ranked among the best-performing REITs. Because our stock has been relatively strong, we've been able to issue equity capital at attractive prices, and at present we have roughly $560 million in equity available for settlement through forward sale agreements, which were raised at an average price of around $84 per share. Turning to borrowing: in 2022, only a fairly limited set of REITs—us included—managed to raise debt on favorable terms. Our first-ever EUR 350 million private placement bond came in September, carrying an interest rate in the mid-3s. I'm also happy to report that the ratings agencies took note of how our credit profile has strengthened: Moody's moved us up to Baa1 in September, and a few weeks ago S&P followed by raising us to BBB+. Each of these upgrades gives us a bit more access to debt and trims our cost of debt, which right now ranks among the most competitively priced in the net lease sector. Because we secured capital on favorable terms during 2022 and also have our revolving credit facility available, we came into 2023 in a very strong position, holding ample dry powder to complete the near-term pipeline we have without adding leverage. Given where this capital came from, we are fairly confident we can deploy it in a way that creates value, both through the deals already in our pipeline and through new investments, since capitalization rates on transactions appear to be stabilizing around present levels. We're likewise confident about our capacity to keep making accretive investments at cap rates tighter than the targets we currently hold, should appealing opportunities arise, in light of where we anticipate being able to bring in capital during 2023. Finally, I'd like to briefly address our portfolio's quality given worries regarding inflation and the possibility of at least a modest recession. Within net lease, we stay uniquely situated, boasting best-in-class rent growth along with demonstrated resiliency. Our ownership consists of a well-diversified collection of essential real estate, rented to sizable companies under long-term agreements having a weighted average lease term of slightly less than 11 years; it also continues to be healthy, with occupancy reaching 98.8%, fourth quarter rent collections exceeding 99% and a watch list that's benign. Before handing things to Toni, I want to use this moment to express gratitude to our staff, both past and present, who helped mold W. P. Carey across the last 50 years into what it is now. Every milestone we're marking this year and the strong results we've delivered couldn't have happened without our committed and gifted team; and I take pride in the fact that we've made the Bloomberg Gender Equality Index for a third consecutive year, among just a small number of REITs picked this year, underscoring our enduring dedication to gender equality and a culture of inclusion. With that said, I'll turn the call over to Toni.

Thank you, Jason, and good morning to all of you. Earlier today, we announced AFFO per share of $1.29 for Q4, which brought our full-year AFFO per share to $5.29, while real estate AFFO per share came in at $5.20 — a 6.3% gain compared with the previous year. That reflects the accretive effect of new investments as well as our merger with CPA:18, completed in August, plus the strength of our rent growth. Through the fourth quarter, the inflation protection embedded in our portfolio kept working in our favor. On the whole, contractual same-store rent growth stayed at a record 3.4% versus a year earlier, which represents a 160 basis point improvement over the same quarter last year. Because of the timing lag in how our inflation-linked leases step up, we anticipate contractual same-store rent growth will stay elevated across 2023 and far into 2024, even should inflation decline. Our estimate is that it will rise to approximately 4% during the first quarter, when about 40% of ABR with rent increases tied to inflation undergoes scheduled rent bumps, and will hold near 4% for the entire year. Comprehensive same-store rent growth in Q4, calculated using the pro rata net lease rent included in our AFFO, was 1% year-over-year, mainly due to elevated rent recoveries during the prior-year period. Once those recoveries are normalized, comprehensive same-store comes in above 2%, roughly 100 basis points under our contractual same-store figure and consistent with historical trends. Comprehensive same-store in Q4 2022 also reflected downtime on vacant assets, and the vast majority of those are either being repositioned or are expected to be sold in the first half of this year. Leasing activity in the fourth quarter consisted of 9 renewals or extensions. All told, we kept achieving positive rent recapture, reaching 110% of prior rents, led by warehouse and industrial, while adding 8.3 years of weighted average lease term. Other lease-related income in Q4 included a $5 million settlement of a claim against the guarantor of a prior lease, and its timing was accelerated, which brought the full-year total for that line item to $33 million — slightly above what we had expected for the year. For 2023, we are presently assuming other lease-related income stays fairly consistent with 2022 levels. Nonoperating income in the fourth quarter was mostly made up of realized gains from currency hedges totaling $6 million, a decrease from nearly $9 million in the third quarter. For the full year, nonoperating income reached $30 million, which included $24 million of realized gains from currency hedges. Our 2023 guidance assumes currency rates stay at or near where they are now, which would produce anticipated gains from currency hedges of roughly $15 million. As a reminder, a stronger euro would benefit our cash flows and earnings, offset by lower hedging gains. Nonoperating income in 2022 also included $4 million of dividends received from our equity interest in Lineage Logistics. We did not receive a dividend from that investment in 2023 and do not expect one. Lineage keeps delivering strong results, and we now have just over $400 million invested in it. That figure includes a $39 million mark-to-market gain in Q4, which came from the valuation in its latest offering. When it came to dispositions in the fourth quarter, we sold 6 properties, generating $68 million in gross proceeds. That pushes disposition proceeds for the entire year to $244 million. A significant share of those were legacy CPA:18 assets, and their sale was envisioned as part of the transaction. Our operating properties produced $17 million of NOI in Q4, compared with $12 million in Q3. That rise mostly came from having a full quarter of contribution from the operating self-storage portfolio that came to us through the CPA:18 merger. As of year-end, our operating assets consisted of 84 self-storage properties, 2 student housing properties and 1 hotel. In a separate matter, this January, 12 Marriott hotels that we own, previously under net leases, became operating properties when their master lease expired. Marriott will keep operating and managing these hotels through long-term franchise agreements, and we anticipate their NOI contribution will be slightly above the $16 million of ABR they produced in 2022 as net lease assets. These are noncore assets we intend to sell, except for 3 where we are pursuing highly attractive redevelopment opportunities. We'll share updates as we move forward with the Marriott sales, but for our 2023 guidance we assume those sales close late in the year, while acknowledging they could slip into 2024. Looking at 2023, we anticipate NOI from all operating properties will come to approximately $100 million, with about 3/4 of that generated by self-storage, which we expect to deliver NOI growth in the mid- to high single digits versus 2022. As a reminder, the same-store metrics I mentioned earlier only cover net lease assets and nonoperating properties. Now on to expenses. Interest expense came to $68 million in the fourth quarter, which brought the full year figure to $219 million, an 11% increase from the prior year. Our debt carried a weighted average interest rate of 3% in Q4 and 2.7% for the full year. Our guidance right now assumes that higher base rates will push our weighted average cost of debt toward the mid-3s, though that depends on the specific timing and execution of capital markets activity, along with further moves in interest rates. Non-reimbursed property expenses reached $14 million in the fourth quarter, taking the full year total to $51 million. Both periods saw elevated amounts because of higher carrying costs on vacant assets, greater maintenance and legal expenses, and real estate tax accruals. For 2023, we currently expect non-reimbursed property expenses to fall to somewhere between $43 million and $47 million for the full year, driven by anticipated sales and leasing of vacant assets. How certain tenant-related back taxes get resolved and when asset sales occur could push us toward either end of that range. For the fourth quarter, G&A came in at $23 million, which puts the entire year at $89 million, within the range we guided to. Looking at 2023, G&A should land somewhere between $97 million and $100 million; that figure accounts for losing the reimbursements tied to CPA:18 and mirrors both our expanded asset base and the effects of inflation. On an AFFO basis, tax expense for the fourth quarter reached $10 million, mostly made up of foreign taxes related to our European portfolio; for 2023, we anticipate tax expense landing between $40 million and $44 million, pushed by inflation's effect on foreign rents plus the assets we picked up through the CPA:18 merger. Now shifting to the 2023 guidance that we put out this morning. We anticipate producing AFFO per share somewhere between $5.30 and $5.40, every bit of it generated by real estate following our departure from the non-traded REIT business, which works out to roughly 3% growth in real estate AFFO at the midpoint; underlying this is projected investment volume ranging from $1.75 billion to $2.25 billion. And per what Jason mentioned, we've currently got solid visibility into no less than $700 million of that total.

At this point, we're working under the assumption that investment volume is spread fairly evenly across the year. As for disposition activity, we currently expect it to land somewhere between $300 million and $400 million for the year, with most of that expected later in the year, which mirrors the anticipated timing for the Marriott operating hotel sales I discussed earlier. Turning to capital markets activity and how we're positioned on the balance sheet: we continue to hold a very strong capital position, with substantial dry powder, plenty of liquidity, and only moderate leverage, all of which our capital raising efforts further reinforce. Late in the fourth quarter, we settled just under 2.6 million shares tied to our outstanding equity forwards, so that will be fully captured in our first quarter diluted share count; on top of that, we issued more equity forwards through our ATM program, both in the 2022 fourth quarter and during January of this year. Combined with the equity forwards already in place, that leaves us with roughly $560 million of forward equity available to settle at present. We closed out 2022 with $276 million drawn against our $1.8 billion revolving credit facility, and together with our undrawn equity forwards, that keeps us in an excellent liquidity position, totaling a bit more than $2.2 billion, which gives us plenty of liquidity to carry out our near-term pipeline on a leverage-neutral basis and ensures we retain significant flexibility regarding when we tap the capital markets; right now we have $430 million of mortgages coming due in 2023, some of which will be retired through our disposition plans, and nothing maturing in the bond market until 2024, all of which we still see as very manageable, particularly with debt capital markets improving and our demonstrated capacity to raise capital even through choppy markets, as happened in 2022. As of year-end, our leverage metrics stayed inside our target ranges. Debt-to-gross assets came in at 39.8%, at the low end of our mid- to low 40s target range, while net-debt-to-EBITDA was 5.7x against our target range of mid- to high 5x. Cash interest expense coverage was 6.3x, which came down relative to the 6.7x posted in the third quarter, mostly a reflection of rising interest rates. Finally, we keep delivering stockholders growing, well-covered dividend income, with a payout ratio of 80.2% for the year and an appealing dividend yield of roughly 5.2% at present. To wrap up, even with the difficult market backdrop, we delivered solid full year results, driven mainly by the accretive impact of new investments, our merger with CPA:18, and the strength of our rent escalations. And looking forward, we have a strong near-term pipeline that we're well positioned to execute on thanks to the strength of our balance sheet. With that, I'll turn the call back to the operator for questions.

Eric here, filling in for John. I was wondering whether you might sort of take us through what's driving the AFFO guidance — the pluses and minuses. How much does FX affect it per share, and how much comes from interest expense?

Toni, would you like to handle that question?

Yeah, I caught that one. Thank you, John. So yeah, I believe we've pointed to several items during this call. Just to sort of wrap it up, we're experiencing quite a bit of expansion from our investment activity and from the embedded CPI-based rises within our portfolio, yet we're also encountering several counterbalancing items. Regarding interest expense, I'd say that's truly the largest headwind we're facing, and it accounts for roughly about 3% growth on the offset. As for FX, I'd say it matters less in terms of what we're forecasting for 2023, simply given where rates stand right now, and where they settled during the latter portion of the year. So I'd say FX might actually become a tailwind for us, unlike how it worked against us in 2022. So I'd certainly say the biggest drivers sit on the interest expense side; but beyond that, I mentioned several other points, including some leakage we'd anticipate from vacancy or downtime at certain assets, and then a few smaller items, which are the dividend payments we aren't getting from Lineage and WALTs that we got in the prior year, plus some higher G&A and tax expenses. So all of that really adds up against the growth we're seeing and brings us to about 3% for the year.

All right, thanks for that. I also appreciate the detail about cap rates trending wider as we head into Q1. Could you break down how cap rates differ across the various sectors and geographies? And where are the largest spreads you're currently observing?

Yeah, absolutely. So our view is that cap rates have more or less settled into some balance during Q4, and that's continued into this year. Cap rates in Q4 came in around 6.8%, and that was 50 basis points above the full year average, on average — or higher than it, rather. I believe that's also showing up in the transaction markets. When it comes to regions, U.S. versus Europe cap rates, I'd describe them as perhaps comparable ZIP codes right now. My sense is the U.S. may have steadied somewhat more, since given the situation with borrower costs in Europe, we'd likely — we would probably need to observe somewhat more cap rate growth to produce the sort of spreads we believe we want to transact at in Europe. Then looking at property types, I'd say the smaller end of the increase is likely in U.S. retail, which has shown itself to be somewhat stickier. Perhaps that's logical — it's somewhat more crowded when it comes to competition in net lease, and perhaps there are still some 1031 trades hanging around. On the larger end, I think the area where we've witnessed cap rates shift would be industrial, especially sale-leasebacks. When you consider corporates as well as private equity firms making use of sale-leasebacks, they're really evaluating what other sources of capital they have, which would primarily be the leveraged loan market or high-yield debt markets, and those remain mostly dislocated. So I think we currently have some pricing power in that market, and cap rates are showing that.

Happy anniversary, and I appreciate the thorough way you kicked things off. Honestly, most of what I'd planned to ask has already been covered. That said, I've got a few held back; so first, Jason, could you speak to what kinds of assets are currently in the pipeline? From a tenant and property type angle, where are you finding the greatest success with assets that carry more sensible cap rates?

Yes, absolutely. Let me walk through the visibility and deal volume we're seeing — I referenced over $700 million, and roughly $500 million of that consists of pipeline we describe as investments at advanced stages. The remainder is split between transactions already closed year-to-date and the capital projects and other commitments we take on annually that are set to wrap up in 2023. That piece accounts for roughly $150 million out of the $700 million. As for what kinds of deals sit in our pipeline, the weighting leans more toward the U.S. at present, or perhaps North America as a whole; that region appears to be where more actionable deals are coming from, and as I said before, transaction markets in Europe still have a bit of — some room left to adjust to the sharper rate increases we saw in Europe. So the tilt is somewhat more toward the U.S. and North America. On property type, it mirrors what we've historically acquired. It's 2022. My recollection is that 70% of our deals were industrial, covering warehouse and manufacturing plus some R&D; and I believe the rest was probably retail. The pipeline follows that same pattern; it will be mostly industrial, R&D, warehouse production, and we also have some retail opportunities under review in both the U.S. and Europe. And I want to note that the bulk of our activity, once again, is sale-leasebacks, and the bigger transactions in this pipeline involve private equity-backed deals, largely in support of M&A activity. So there's some uncertainty around how the timing shakes out, since more moving parts come into play when you're closing transactions concurrently with the buyout. But naturally, execution plays or execution risk is something the sellers are much more focused on. And I believe that's why we're a great partner, and it shows up in the pricing we can get from those deals.

All right, I appreciate the additional detail. I have a few brief questions regarding lease expirations. To start, is the 1% tied to Marriott part of that 3.9% rolling off in 2023? And given that rent recapture has been quite robust lately, particularly for industrial properties, should we think of this as potentially a more typical pattern going forward for those warehouse and industrial leases?

Brooks, would you like to handle that?

Okay. So Marriott is part of that 3.9%. If you remove it, you get roughly 2.8%, and another, let's say, 50 basis points has more or less been settled already; what remains, then, is approximately 2.3% of ABR set to expire during 2023. That's pretty manageable. As for what you asked about the leasing metrics themselves, we've certainly posted a solid stretch of results, and that has us feeling fairly optimistic. Even so, I wouldn't take any single quarter, or even two quarters, and project it forward. Our preference is really to focus on a trailing 8 figure, which sits at roughly 102% recapture. So projecting from one quarter is tough, since it depends heavily on the individual transaction. Still, I'd agree there are certain tailwinds, particularly among our warehouse and industrial assets, which have been working in our favor, and we intend to keep seizing that.

Dan here, alongside Josh Dennerlein. What do you anticipate for same-store in 2023? And we'd welcome any extra insight into what's behind your guidance.

Sure. Toni, would you like to address that?

Yeah, regarding the same-store side, I do have a few remarks there. Because of the lag in our leases, we anticipate inflation will keep flowing through. So we expect that figure to rise to roughly 4% and stay near that mark across the entire year, and that applies to the contractual same-store side. I missed the latter portion of your question.

Would you mind adding any further thoughts about what is behind the guidance you gave?

Sorry — behind the what?

The guidance you provided.

The guidance.

In terms of the growth for the full year?

Yes.

Yes. I believe I already touched on a portion of the challenges we'll face in the years ahead, with interest expense standing out as the biggest one, like I said. Beyond that, it's essentially a combination of several smaller things I pointed out — tax expense, G&A expense, plus a portion of the dividend we got during 2022 from Lineage and from WALT, which won't be there next year. So all of that is piling up, on top of some leakage tied to vacancy and some negative impact from downtime at certain assets.

Yes. Regarding the Marriott properties, I realize you'll share additional details down the road. Still, I'm wondering whether you could give a big-picture take on what the market for these properties looks like right now?

Sure. So yes, as we mentioned, 12 of those properties were switched over to operations in January, an extremely smooth handover, with Marriott still running them, and they're performing nicely. It's difficult to judge precise timing and execution; however, we believe interest will be quite robust. Our guidance assumed we'd sell 9 of those properties and that they'd close at year-end; but once more, it's tough to pin down timing precisely, and we wouldn't discuss pricing right now. 3 of the properties that we're keeping are genuinely outstanding development possibilities. One is an industrial prospect in New York. Another is a potential lab opportunity in San Diego with a truly great location, and the third sits in Irvine, California. And once again, those will run without interruption in the interim while we chase those possibilities, but they're very strong redevelopment sites.

And then perhaps on a wider scale regarding the transaction market. Could you all just give us some insight into how overall deal volume that you've sourced so far this year in both the U.S. and Europe stacks up against last year?

You mean up to now in the year versus the same time a year ago? Is that what you're asking, Spenser?

Yeah. I'm just attempting to understand what the broader market appears like, perhaps not regarding every single thing you're actively underwriting, but rather concerning the total amount of deals being sourced out there?