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

Hello, everybody, and thanks for being with us on this morning's call covering our earnings for the first quarter of 2023. I want to note before we get started that certain remarks on today's call aren't historical facts and might be considered forward-looking statements. The factors that could lead actual outcomes to vary materially from what W. P. Carey expects are laid out in our SEC filings. A replay of this conference call will be posted online in the Investor Relations portion of our site, wpcarey.com, and it will stay archived there for around 1 year; you can also locate copies of our investor presentations and other related materials there. Having said that, I'll turn things over to Jason Fox, our Chief Executive Officer.

Appreciate that, Peter, and hello everybody. I'm pleased to share that our investing efforts have produced a strong beginning to the year. At the same time, we've continued to deliver the highest contractual rent increases in the net lease industry. Looking at 2023, we expect an average of about 4%, despite inflation having retreated from its peak, and we see that level remaining high in 2024. Shortly, I'll walk through what we've been doing lately on the investment side and in raising capital, and our CFO, Toni Sanzone, will walk through our results, guidance and how the balance sheet is positioned. Our President, John Park, and Brooks Gordon, who leads Asset Management, are here as well to answer questions. Let's start with external growth. So far this year, we've put $743 million to work. That breaks down as $178 million that closed in Q1, plus $566 million completed in Q2 up to this point. Those year-to-date investments came in at a weighted average cap rate of 7.2%, with a weighted average lease term of 21 years — right in line with what we focus on. Nearly all of them were industrial sale leasebacks, and that includes three industrial portfolios, each one above $50 million, plus, naturally, the Apotex deal, which was the biggest single piece at $468 million. Since Apotex was such a large sale leaseback, let me give a quick recap of it — it's a great illustration of how we work alongside private equity sponsors, using sale-leasebacks as one component of the capital stack when companies get acquired. This also shows we can find and pull off big transactions, and it highlights an edge we hold: we're able to finance deals — particularly sizable ones — completely through our own balance sheet. As a matter of fact, among the net lease purchasers we go up against, we think only a handful could possibly complete a deal on this scale. And hardly any of them could do so without relying on asset-level debt, which in today's market tends to be either financially impractical or simply not obtainable. The lessee here is a pharmaceutical firm operating worldwide and stands as Canada's biggest maker of generic drugs. You've got a portfolio made up of 11 properties, and those sit across 4 campuses focused on pharmaceutical R&D and advanced manufacturing. Most of them are in desirable infill spots within Toronto, where industrial real estate vacancy sits down in the low single digits. On top of that, these facilities matter enormously to what the tenant does — they account for the overwhelming share of that company's operations worldwide. Like other deals we closed this year, this one added to earnings, and it took the form of a triple-net master lease, with rents paid in U.S. dollars and fixed increases of 3% annually across a 20-year term. It was signed at the same time as Apotex's private equity buyout, receiving its funding on March 31 while closing on April 3. Because of when the deal closed, Apotex isn't included in the supplemental portfolio figures for Q1. Still, if you look at it on a pro forma basis, it would be our number three tenant and would account for a bit more than 2% of ABR. Combined with an additional industrial portfolio investment that closed in Q2, this brings our total warehouse and industrial exposure to about 53% of ABR. Now for the investment landscape. In the U.S., conditions are essentially the same as what we laid out on February's earnings call — cap rates on the investments we've made this year are about 40 basis points higher than those on transactions we closed in Q4. Looking at the kinds of deals we go after, industrial keeps offering the strongest prospects, since that's where cap rates have risen the most. Over in Europe, we've noticed more longer-range opportunities appearing since Q4, pushed along by rising interest rates. In a lot of ways, what's happening with transactions in Europe right now mirrors what we saw in the U.S. when Q4 of last year got underway, and we think it will trace a comparable path, throwing off a widening stream of appealing opportunities as the year rolls on, thanks to sale leasebacks becoming ever more competitive against the other ways sellers can raise funds. Across both regions, the bulk of the opportunities we're looking at still fall within a cap rate band stretching from the mid- to high 6s up into the 7s. Cap rates sitting in that band keep giving us a comfortable cushion over our cost of capital, and the strength of our balance sheet leaves us confident we can get deals done; that said, should capital markets stay choppy or borrowing costs climb further, we'd anticipate added upward pressure on cap rates during the back half of the year. Corporate M&A may have cooled off, but a bigger share of transactions now involve sellers weighing sale leasebacks, corporate refinancings among them. The setup for sale leasebacks is still favorable overall. Because leveraged loans and high-yield debt remain expensive, more and more companies and private equity sponsors are exploring sale leasebacks. As the top player in this area, we expect to remain the primary winner from that trend. We also have an advantage with sellers who are concerned about execution risk, thanks to our solid balance sheet and our ability to get transactions done without depending on debt at the asset level — which is very important for the below-investment-grade tenants we target. On the whole, the environment for investing remains positive, and we are set to complete significantly greater investment volume than was the case last year. Our pipeline is active, spanning several hundred million dollars of investments at different stages, plus a few early-stage opportunities in Europe. Internal growth is holding up very well too, thanks to the large share of leases featuring rent escalations linked to inflation. And while signs suggest inflation is starting to ease, the built-in delay before it reaches rents keeps our contractual same-store rent growth near 4% for 2023 and above 3% for 2024. Bear in mind, that assumes inflation drifts back to roughly 2% by the close of next year; so if inflation stays north of 2%, our same-store rent growth will stay higher as well. Turning to capital raising. We keep tapping into all the different places we can get capital from. Toni will walk through the specifics, but broadly speaking, what happened in the first quarter centered on raising equity capital, and we finished the quarter with a substantial amount of forward equity lined up to settle at prices significantly higher than where things stand now. Earlier this week, we closed a EUR 500 million 3-year term loan, which can expand to as much as EUR 750 million thanks to its accordion feature; so we still have money being deployed and we're in a strong position to finance the investment volume built into our guidance. Finally, since the chances of a recession during the back half of this year are growing, I'd like to emphasize again that our portfolio is well-diversified, made up of essential real estate leased to big companies under long-term agreements. That portfolio has shown it can hold up, with cash flow steadiness proven across many economic cycles and through the COVID stress test. Occupancy is still extremely high, and so are rent collections; plus our watch list is benign, with no specific patterns when it comes to tenant industry or property type; beyond that downside protection, we also pay a growing dividend that's well-covered, yielding roughly 6% at present. To wrap up, we're happy with how 2023 is going, which distinguishes us from nearly all other net lease REITs given today's conditions, especially our investment volume strength, which is backed by a solid balance sheet and access to multiple capital forms, along with the sector-leading rent growth we're delivering. With that, I'll hand things over to Toni.

Thanks, Jason, and good morning to all of you. For the first quarter of 2023, our total AFFO came to $1.31 per diluted share, which represents a 1.6% increase over the previous quarter and was unchanged relative to real estate AFFO per share in the comparable period a year earlier. As Jason mentioned, investment volume year-to-date has been robust, reaching $743 million. The bulk of that closed after the quarter ended, contributing roughly $40 million of ABR in the early part of the second quarter. Our first quarter results kept drawing strength from the rent escalations embedded in our portfolio, as we posted contractual same-store rent growth of 4.3% year-over-year — a record — which is 90 basis points above the fourth quarter figure and 160 basis points above the same quarter a year ago. In the first quarter, roughly 45% of CPI-linked ABR underwent rent increases at the highest rates we have observed thus far, averaging 7.2% for leases featuring uncapped CPI rent escalations. This mostly stemmed from the timing lag with which our inflation-linked leases escalate. Because of that lag, we anticipate contractual same-store rent growth will average roughly 4% for 2023 and stay above historical norms at approximately 3% in 2024, even as inflation starts to moderate. Comprehensive same-store rent growth in the first quarter, which is derived from the pro rata net lease rent included in our AFFO, was 3.3% year-over-year, and we finished the quarter with occupancy of 99.2% in our portfolio, an increase from 98.8% at year end. Disposition activity in the first quarter consisted of 5 properties for gross proceeds of $43 million. In addition, for 2 of our dispositions, we negotiated and obtained early lease termination payments amounting to $11.4 million, which were contingent upon the sales of those properties and were recognized in the first quarter within other lease-related income. For full year 2023, we still expect other lease-related income to stay in line with 2022. As expected, during the first quarter we received notice from U-Haul of its intent to exercise the purchase option on our portfolio of 78 net lease self-storage facilities. That notice triggered certain accounting reclassifications, both of the asset on our balance sheet and the rent in our income statement, and produced recognition of a $176 million gain on sale in the first quarter. That said, these have no effect on our AFFO, ABR or portfolio metrics. At present, we estimate we will receive approximately $470 million in disposition proceeds, calculated based on CPI and expected to occur around the end of the 2024 First Quarter, resulting in a disposition cap rate around 8.2%. Importantly, we hold no other significant purchase options in our portfolio. Nonoperating income for the first quarter mainly consisted of realized gains from foreign currency hedges totaling $4.1 million. Our guidance continues to assume currency rates stay at or around first quarter levels, producing quarterly gains from currency hedges in line with those generated during the first quarter. Should the euro keep getting stronger, that would be a plus for our net euro cash flows, though hedging gains would be lower and offset part of it. Across all operating properties, NOI came to $21 million in the first quarter, mostly from our self-storage operating portfolio plus 2 months of operating NOI from the 12 Marriott hotels that shifted from net lease to operating properties in January of this year. Those Marriott operating assets are still noncore. We have 9 properties marked for sale, and for the remaining 3 we keep chasing appealing redevelopment chances. As long as these hotels haven't been sold or redeveloped, Marriott will go on running and managing them through long-term franchise agreements. We'll share updates as progress happens. For guidance purposes, though, we still assume the large majority stays on our balance sheet until late in the year; consequently, we still look for NOI from all operating properties to reach roughly $100 million for 2023. Now to expenses. Interest expense came in at $67 million in the first quarter, unchanged from the prior quarter and $21 million above the same period in the prior year. Our weighted average interest rate stood at 3.1% for the quarter, matching the fourth quarter but higher than 2.5% in the year ago quarter, because base rates have risen. Non-reimbursed property expenses were $12.8 million in the first quarter, down 8% from the fourth quarter and 7% from the year ago quarter. As I noted earlier, portfolio occupancy rose compared with last quarter, which feeds into our expectation that non-reimbursed property expenses will keep falling throughout 2023. G&A expense was $26.4 million in the first quarter, reflecting greater compensation costs and more professional fees stemming from the CPA:18 merger. Keep in mind that G&A expense usually runs higher in the first quarter than in the rest of the year, mainly because of when certain payroll-related items land. For the full year, we still expect G&A to land between $97 million and $100 million. Tax expense was $11 million in the first quarter on an AFFO basis, higher than both the fourth quarter and the same period last year, chiefly because CPI-linked increases affected foreign rents. The year-over-year rise also reflects assets added in the CPA:18 merger. A quick word on guidance. We're keeping our full year AFFO guidance range at $5.30 to $5.40 per share, which at the midpoint implies nearly 3% year-over-year growth in real estate AFFO per share. Our guidance still assumes investment volume of between $1.75 billion and $2.25 billion for the year and disposition volume of $300 million to $400 million. Now on to our capital markets activity and balance sheet positioning. We keep drawing on our access to a range of capital sources. First quarter activity was led by equity capital raising, followed more recently by the term loan we announced earlier this week. On the equity side, we settled 3.1 million shares tied to outstanding equity forwards by the close of the first quarter, which brought in $250 million. Because of when that happened, those shares will show up in full in our second quarter diluted share count. We also sold more equity forwards during the first quarter through our ATM program, expecting net proceeds of $104 million. When you combine that with equity forwards that were still unsettled from before, we finished the quarter with roughly $385 million in forward equity available to settle. Turning to our key leverage and liquidity metrics: debt-to-gross assets stood at 40.3% at the end of the first quarter. Net debt to EBITDA came in at 5.8x, since we funded about $470 million for our Apotex investment in the final days of the quarter, while EBITDA from that investment doesn't begin until the start of the second quarter. I want to point out that our leverage metrics don't capture the pro forma effect of settling undrawn equity forwards, which would push our net debt to EBITDA to the low end of our target range. At present, we expect to stay comfortably inside our target leverage ranges of low to mid-40s for debt to gross assets and mid- to high 5x for net debt to EBITDA. Our liquidity position stayed strong at roughly $1.7 billion, including undrawn equity forwards, even though we had $670 million drawn on our $1.8 billion revolving credit facility at quarter end — once again, mostly because of funding the Apotex transaction. As Jason mentioned, earlier this week we closed a EUR 500 million 3-year unsecured term loan and put an interest rate swap in place, locking the rate at 4.3% through the end of 2024. That term loan was fully drawn at closing, and we mainly used the proceeds to pay down our revolving credit facility. With the availability on our credit facility, unsettled equity forwards raised at over $83 per share, and expected disposition proceeds, we're well-positioned to fund the remaining investment volume embedded in our 2023 guidance on a leverage-neutral basis without having to go back to the capital markets this year, which lets us stay opportunistic when we do raise capital. Finally, our near-term debt maturities remain manageable: we have just over $300 million of mortgages due in 2023, some of which will be retired through our disposition plans, and no bonds maturing until April 2024. To wrap up, we're focused on building on our strong start to the year in a transaction environment that remains favorable for sale leasebacks and an inflationary environment that continues to drive superior rent growth; and with that, I'll hand the call back to the operator for questions.

Could you give us a bit more detail about how the transaction market looks in the U.S. and also in Europe? Which industry is getting the heaviest marketing push right now? After that, could you break down roughly how deals are split between the U.S. and Europe?

Yeah, absolutely. The overall setting, I'd say, is still pretty much the same as it was when the year started. In the U.S., what we've observed is that cap rates keep moving and might have gotten closer to an equilibrium point compared with what we're seeing in Europe. Europe, I'd say, is at a somewhat earlier phase. I'd describe it along the lines of how the U.S. looked at the start of the fourth quarter, when sellers began shifting more toward the prevailing interest rate environment. So — and our deal flow shows that. For the U.S., that's where a greater share of the deals sit. We've watched cap rates rise to levels that are genuinely attractive for us at this point. Over in Europe, as things stand, I'd say the pipeline is roughly 25% Europe. So there is some activity we're seeing, but the weighting is still going to lean more heavily toward the U.S. at this time?

Also, during the quarter you folks sold off a number of office properties. So I'd say this is a category that's been out of favor for a while, but I'm just wondering what led to the choice to sell those properties in this quarter? And then it would help if you could also give a bit of detail on the handful of office leases that you extended during the quarter?

Yes. Brooks, would you like to offer any color regarding the office dispositions?

Of course. Yeah, as we've mentioned on earlier calls, office continues to be an area where we're underweight, and it's going to be overweight when it comes to dispositions. These deals in particular were specific to the deal. And like Toni said, we're also tied to a fairly sizable lease termination payment. So that genuinely ought to be factored into the total value there; as for — sorry, what was the second half of your question?

My apologies — what I meant to ask about was why you chose to sell off the office properties during Q1, especially since that category has performed poorly for a while now.

Understood. When you look at Q1 specifically, the timing really comes down to the individual deals. We got strong execution on them. The biggest one was a Chicago property, and on that one we'd already collected a significantly larger termination fee during an earlier quarter — roughly $41 million, if you remember. So when you add up the proceeds from the dispositions and those termination fees, the overall economics come to a fairly substantial figure. So the execution on these specific assets was solid, but in terms of timing, it's genuinely deal by deal.

Regarding the contractual rent growth number you mentioned for '24 — that figure above 3% — what portion is already locked in at this stage? And what portion hinges on how inflation moves between now and that point?

Right. Toni, could you share some specifics on that?

Sure, I can speak to that. What I'd say is that the bulk of it — when we discussed same-store for this year, that's pretty much locked in, considering where rent escalations fall based on the timing in our leases. As for the 3% we're pointing to for next year, that mostly assumes CPI begins to settle down more as 2024 nears its end. So yes, it could shift from that point, but I'd say all of that is baked into the roughly 3% we anticipate for next year.

All right, understood. Then regarding the Apotex transaction, I believe you mentioned there were 3% yearly escalations. That clearly appears larger than what normally would be observed with fixed escalators. So I'm wondering what portion of that reflects the current climate we're operating in? And what portion is due to the particular circumstances?

Yeah. Well, I'd say much of it relates to the climate. Our leases remain centered on CPI-driven rent growth; though naturally, that's become more of a negotiation today and perhaps somewhat harder to secure. I believe it remains standard practice in Europe, but perhaps within the U.S. and Canada. It's something requiring more back-and-forth from us. And whenever we aren't securing inflation-linked adjustments, that shifts into our fixed escalation, and Apotex serves as an illustration of that, where substituting for CPI formed part of the bargaining. Another element at play, I'd say, is the particular markets where we're putting capital, which are infill Toronto industrial assets, exceptionally robust markets, with vacancies in the low single digits. And whenever we put together our transactions, we want our rent step-ups to mirror what we anticipate market rents will do; and these are exceptionally robust markets that we believe could certainly expand at 3% annually across a lengthy horizon.

All right, understood. And clearly, that U-Haul choice is going to get watered down in the coming year; however, my recollection is that you previously discussed the possibility that Lineage stock could serve as a counterbalance. Could you explain how you calculate that, and whether it might offset things during 2024?

Sure. Regarding the U-Haul deal, we have discussed it across several quarters now — perhaps even across several years — during which it was anticipated. My sense is that inflation has pushed the option's purchase price significantly higher; likewise, the cap rate on reinvestment has risen along with the market; as a result, the gap, or the dilution from disposing of that property, has shrunk considerably and should not prove very significant. As for Lineage, which you brought up, that is a counterbalance we sometimes prefer to pair with U-Haul, an asset of comparable scale. At Lineage, our current valuation sits at approximately $400 million. We lack solid visibility regarding when that will occur. A liquidity event will likely happen at some point within the coming two years, though we cannot see it clearly. Whenever an exit does present itself, we'd sell that $400 million holding, which today yields no dividend whatsoever, then deploy those proceeds into accretive reinvestment. Consider it this way: if we put money back to work at 7 caps, moving from 0 to 7 on $400 million is quite substantial and more than compensates for whatever dilution arises from divesting the U-Haul portfolio near the low 8s while redeploying around a 7 cap. So the timing could align flawlessly, yet I believe Lineage has drawn less attention, and it is a rather valuable asset in our possession.

Jason, I believe the first question is directed at you. Could you bring us up to speed on where your head is at regarding the self-storage properties you operate? That sector, or that line of business, appears to be experiencing a slowdown in expansion, and yet cap rates in the private market continue to look quite robust. So, any fresh perspective on how you are approaching that portion of the company?

Yes. Of course, Tony. Yes, listen, this is a matter we keep assessing. I believe the 3 wide-ranging paths we have discussed remain on the table, meaning we can keep holding them as operating assets; we have the ability to transition the operating assets into net lease, much like the deal we completed a couple of years back; and then, as you mentioned, we could likewise dispose of them at what would probably be appealing cap rates and put that capital back to work in net lease. I think these are all solid choices, and we are constantly weighing every one of them, and that will keep being our approach. I think for now, even though same-store has decelerated, the mid-single-digit growth showing up in our portfolio still pleases us. We are also fond of how self-storage holds up when a recession hits; and honestly, it pairs nicely with our net lease portfolio; so I think there is something worth pursuing there, and we will keep assessing, though I would describe nothing as imminent at this moment.

Okay. Then I suppose, once more, we're beginning to peer toward 2024 on a few of these things where some detail is starting to emerge. There's that Las Vegas retail loan. What ought we to expect regarding it in the coming year?

Yeah, absolutely. As a fast refresher, we originated that loan — I believe in June 2021. It was for construction of a retail project at a prime, prime spot along the Las Vegas Strip. One could make the case it's among the finest sites on the Strip. The maximum commitment stood at roughly $280 million — or $260 million — and right now I believe it's funded at about 80%. Everything is progressing well. We're within budget, I believe, and on schedule. Our expectation is that it will finish in this year's fourth quarter, and leasing has gone really, really well. Still, my suspicion is our partner would consider a refinancing at some stage, though it's equally possible our loan remains outstanding a bit longer, simply because of conditions in the broader capital markets. Let me also note that we hold purchase options on certain net lease units, which we'll evaluate once completion occurs, and there's no requirement to exercise them immediately. So that's roughly where things stand. Yet I'd say the larger takeaway is that it's proceeding as anticipated and doing quite well.

All right. I'm simply attempting to reason through this — ought we to view it as a situation where the result is more incremental from an earnings standpoint, since perhaps you either put money back to work at a greater rate or you withdraw it and use the purchase option, or conversely, I suppose?

Yeah. Listen, some movements in and out are going to occur. My view is that repayment of the loan might happen at some point, yet I believe what balances that repayment is our ability to redeploy into the net lease units. Beyond that, we hold an option to acquire a stake in the broader portfolio or the broader development, and in my view that might prove highly accretive. So expect further updates on this; no decisions regarding those options must be made by us at present; however, I think, as you suggest, some significant offsets exist regarding the loan repayment whenever it occurs.

In your commentary, you mentioned that contractual growth ought to be 4% for this year and above 3% for next year. I'm simply wondering if the earlier remarks about this comprehensive same-store growth being roughly 100 basis points below that should also continue through this year. And then, if you have any visibility into next year at this stage, whether that would also remain true.