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

Hello, and welcome, everybody. We appreciate you being with us today for the earnings call covering the second quarter of 2023. Prior to getting started, please note that certain remarks on this call are not historical facts and might be considered forward-looking statements. The factors that could lead actual results to differ materially from what W. P. Carey expects are laid out in our SEC filings. A web replay of this conference call will be posted in the Investor Relations portion of our site, wpcarey.com, and it will stay archived there for roughly one year; copies of our investor presentations and other related materials can also be found there. With that said, I'll turn the call over to Jason Fox, our Chief Executive Officer.

Thanks, Peter, and good morning to all of you. During the second quarter we achieved solid progress, completing a substantial amount of accretive new investments in a market that is still favorable for sale-leasebacks, which let us push cap rates higher. Our contractual same-store rent growth continues to rank among the strongest in the net lease sector. Although inflation is easing, we anticipate staying ahead of our peers when it comes to rent growth, thanks to the delayed effect of CPI on rents and the power of our fixed rent escalations. To start things off today, I want to briefly walk through what we've been doing on the investment side lately and explain what sets us apart in the net lease space. That comes down to both where we sit competitively and the variety of capital sources we're able to tap. Because of that, we feel good about continuing to put money to work during the back half of the year and about meeting our debt maturities in the near term, even if the capital markets stay tight. Joining me is Toni Sanzone, our CFO, who'll walk through the second quarter results, what we expect for the full year, and where our balance sheet stands. We also have John Park, our President, and Brooks Gordon, who leads Asset Management, on the line and ready to take questions. During Q2, what we saw in the transaction market was mostly a continuation of the trends from earlier in the year. Investment activity across Europe is still decelerating, driven by the sharp rise in interest rates there over the past twelve months, which has created a wide gap between what buyers are bidding and what sellers are asking. European cap rates have been slow to adjust, but we continue to identify select areas of opportunity, and we anticipate those will emerge over the coming 6 to 12 months as sellers begin to accept the higher cap rate requirements from buyers. Our market position is solid, and we have capital available to put to work, so we can capitalize on those opportunities. Conversely, North America still offers better cap rates, and most of what we've invested so far this year has gone there — among those deals, the $468 million industrial sale-leaseback involving APOTEX that was announced in April and that I covered during the prior earnings call. Like I mentioned before, this deal illustrates how we can tap into appealing possibilities through partnerships with PE firms that rely on sale-leasebacks within the capital structure for their corporate takeovers. It also shows the edge we gain by having the capacity to finance deals—even sizable ones—solely through our own balance sheet. APOTEX has become our third-biggest tenant, which boosts our exposure to warehouse and industrial assets even more. In the second quarter, we also closed a noteworthy $98 million sale-leaseback with ABC Technologies, a top-tier supplier to the worldwide automotive sector, covering a group of nine industrial properties across North America. That deal also allowed us to lengthen the lease duration on an already-held portfolio. Our latest ABC investment also pushes them into our ten largest tenants. Follow-on deals—either with companies already renting from us or with PE shops we've worked with before—are really important for the transactions we source on our own. Given the current environment, we've managed to expand those sponsor relationships, because buyout firms are increasingly exploring other routes to raise capital, including sale-leasebacks. Most of the capital we've deployed this year has gone toward newly formed sponsor relationships, largely on account of APOTEX. During Q2, we completed deals totaling $761 million. That brought our investment activity for the first half to $939 million, with a weighted average cap rate of 7.3%. That figure sits 120 basis points above the average on transactions we closed during the same stretch last year. Cap rates in certain segments of the net lease space have been slow to move—commodity retail is one example—but even so, we've been able to lock in stronger cap rates, especially on warehouse and industrial sale-leasebacks, which accounted for the majority of our first-half investments. Net lease deal markets have broadly decelerated across the last 12 months, yet big corporate sellers that have a use for the money keep actively pursuing sale-leasebacks, because attractive funding options are scarce given tighter bank credit and a pricier corporate lending market. Another thing we've noticed is that fewer credible buyers are competing for deals. That backdrop, together with the substantial capital we can put to work, keeps making our competitive position stronger and our ability to push cap rates upward greater. We're also prepared to walk away from deals lacking adequate spread, and we're seeing some of those return to the market with improved terms. At the moment, we're focused on acquisitions where the initial cash cap rate lands in the 7% range. That translates into unlevered IRRs in the 8% range, and they reach the 9% range once you account for the rent growth we're able to lock in through long-term leases. When it comes to new transactions, the rent growth we're capturing exceeds what we've delivered historically. Consider deals with fixed rent escalations that closed during the first six months of 2023: those rent increases came in at an average of slightly below 3%, compared with historical averages of roughly 2%. As a result, we continue to generate a healthy spread over our cost of capital, and our outlook for securing deals and deploying capital accretively during the back half of the year is favorable. Now turning to capital raising. Over recent years, we've shown we can bring in well-priced capital from a variety of sources. Our balance sheet's flexibility is a key strength, especially when capital markets are capable of shifting fast. As we consider what capital we'll need in the second half of 2023 and on into 2024, our positioning feels very good to us. We still hold roughly $385 million in unsettled forward equity, which was raised at an average price above $83 per share. Together with proceeds from asset sales we've planned, that equity gives us the capital needed to fund the rest of the investment volume our guidance anticipates, all while keeping leverage conservative. We've got a $1.8 billion revolving credit facility, which gives us plenty of liquidity, and together with our 2 term loans, that accounts for a big chunk of the debt we have coming due in the next 2.5 years — roughly one-third. Thanks to the solid backing from our bank group, we're confident we'll push out the maturity on that credit facility via a standard recast near the end of this year. Since it carries a floating rate, the recent hikes in interest rates are already showing up in our interest expense on that slice of our maturing debt. The recent upgrades we received to BBB+ and Baa1 strengthen our credit profile. Despite ongoing turbulence in the debt markets, we believe we can continue to identify chances to bring new bonds to market, both in the U.S. and across Europe, where our position as a highly rated REIT gives us a solid foothold. In addition, I should point out that several other internal sources of capital are available to us, and they reduce what we need to raise externally — something particularly valuable amid today's unclear conditions in the capital markets and the interest rate environment. How the capital markets evolve from here will determine whether this turns into a real competitive edge in the years ahead. Like we said earlier, the money from the U-Haul portfolio is headed back our way during Q1 of next year — we figure it's roughly $465 million right now — since the repurchase option on those properties got exercised. On top of that, we continue to look at different possibilities for the sizable collection of self-storage assets we operate, and that includes tapping it for capital by selling some assets. Among real estate holdings, operating self-storage properties tend to be among the easier ones to turn into cash, and given current market conditions, we think our portfolio carries a value of approximately $1.5 billion. On top of that, we continue to own a sizable stake in Lineage Logistics. As of now, that position sits on our balance sheet at an approximate fair value of $400 million, and it isn't generating any dividend income at present. This asset falls outside our core operations, and once Lineage completes its IPO, we anticipate selling it at some future point. Doing so would free up cash we could redeploy in a way that's highly accretive. We can't say when that might happen, but over the coming years it could represent yet another substantial source of capital. Taken together, these possible capital sources total considerably more than $2 billion. That gives us confidence we're in a strong position to continue investing and to handle our debt maturities coming due, even in a scenario where conventional capital channels are tight. With that, I'll hand the call over to Toni.

Thank you, Jason, and good morning to all. For the second quarter of 2023, our total AFFO came to $1.36 per diluted share, which is a 3.8% increase from the first quarter. That was mainly driven by the accretive effect of recent investments and the ongoing strength in our rent growth, though higher interest expense partly offset it. The second quarter also had certain non-recurring items in non-reimbursable property expenses and income taxes that mostly canceled each other out, and I'll return to that in a moment. As Jason mentioned, since cap rates are still well above 2022 levels, we kept finding accretive investments, which pushed investment volume for the first half of the year to $939 million. Additionally, our portfolio's built-in rent increases continue to work in our favor. Contractual same-store rent growth remained at its highest point, 4.3% compared with the prior year, a figure that exceeds where it stood twelve months earlier by 130 basis points. When it comes to leases featuring CPI escalations without a cap, contractual same-store rent growth reached 7.5% in the second quarter, which captures how CPI affects rents after a delay as well as the growth tailwind already baked in. Moreover, we anticipate that our fixed rent bumps will continue climbing, since we've been securing larger fixed escalations on newly signed leases, and that supports keeping same-store rent growth elevated even as inflation eases. Looking ahead, we anticipate our organic growth will remain robust during the back half of 2025, with same-store contractual rent increases averaging roughly 4%. For 2024, we expect that figure to come in at about 3%, assuming inflation projections hold steady. When it comes to comprehensive same-store rent growth — the metric tied to net lease rent within our AFFO — the second quarter delivered 3.9% growth compared to the prior year, boosted in part by specific rent recoveries recorded during that period. Going forward over the longer horizon, our expectation remains that comprehensive same-store rent growth will typically trail the contractual same-store figure by approximately 100 basis points. Beyond our solid same-store performance, we also managed to bring back nearly all of the rent we had before through re-leasing during the quarter, covering roughly 1.5% of ABR, and those deals added about six years to the average lease term. The investments we closed in the first six months of the year carried a weighted average lease term of 22 years, and when you combine that with the favorable results from our second quarter re-leasing, the portfolio's overall weighted average lease term stretched to 11.2 years. Other lease-related income came in at $5 million for the second quarter, which puts that line item at $18.4 million for the year so far. Our expectation for full-year other lease-related income is still that it will stay consistent with 2022. We didn't do much selling in Q2 — just three properties, which brought in $5.5 million gross. That puts us at $48 million in total positions for the first six months. Looking at the whole year, our guidance still assumes we'll dispose of somewhere between $300 million and $400 million, and that figure includes selling 9 of the 12 Marriott operating hotels we own right now — those account for roughly two-thirds of the annualized NOI our operating hotel portfolio brings in. The Marriott sales are progressing well; a purchase and sale agreement now covers the majority of those properties. For 2023, our current expectation is that NOI from all operating properties will come in at roughly $90 million-$95 million, largely a reflection of when the Marriott sales land, plus the effect of somewhat slower growth in operating self-storage as that sector comes off its recent peak. Now on to expenses. Interest expense came to $75.5 million in the second quarter, and the rise versus the first quarter was driven by funding our investment activity. Compared with the same quarter a year ago, the increase also reflects higher base rates. As we wrapped up Q2, the weighted average interest rate we recorded was 3.3%. That's pretty much where it was in Q1, but it's higher than the 2.6% we saw in the same period last year. On the non-reimbursed property expense side, we had $5.4 million for the second quarter, and that figure came down thanks to a $6.3 million reversal tied to property tax accruals. These were taxes we'd been setting aside because one tenant had not been paying them for several years. That tenant ended up paying the full amount straight to us, so we were able to reverse those accruals during Q2. As a result, we're anticipating this line item will return to a more typical quarterly run rate, roughly $12 million, for the remainder of 2023. In Q2, G&A costs totaled $25 million, down about $2 million from Q1, which usually runs higher because of when certain payroll-related items land; for the entire year, we still expect G&A to land somewhere in the range of $97 million to $100 million. On an AFFO basis, tax expense for the second quarter was $12.8 million, and that figure included an extra $3.3 million of expense related to the tax audit in Europe. For the remainder of the year, we anticipate the quarterly run rate will be nearer to $11 million. Now, a quick word on guidance. We've tightened the range for our full-year AFFO guidance by $0.04, so it now sits at $5.32 to $5.38 per share. The midpoint didn't move, and that points to roughly 3% growth year over year in real estate AFFO per share, even with the pressure that higher interest rates are creating. Our guidance still bakes in investment volume of $1.75 billion to $2.25 billion for the year. And as I mentioned before, dispositions of $300 million to $400 million. Let me turn now to what we're doing in the capital markets and how the balance sheet is positioned. During our previous quarterly results discussion, we mentioned that in April we finalized a fresh unsecured term loan lasting three years worth EUR 500 million, and at the same time put an interest rate swap in place locking the rate at 4.3% until 2024's conclusion, using the funds mainly to reduce what we owed on our revolving credit facility; no equity forwards were initiated or concluded by us in Q2, and we still have roughly $385 million in forward equity that could be settled. Now shifting to the main leverage and liquidity figures as of Q2's close. Our debt-to-gross-assets ratio stood at 41.3%, while net debt to EBITDA came in at 5.7 times — both comfortably inside our target leverage ranges of low to mid-forties for debt to gross assets and mid to high five times for net debt to EBITDA. That figure doesn't yet capture the pro forma effect from settling undrawn equity forwards, which would bring net debt to EBITDA down further, to 5.4 times. At the close of the second quarter, we had roughly $530 million drawn against our $1.8 billion revolving credit facility, and we kept a solid liquidity position of about $1.9 billion. If you take what's left on our credit facility, add our unsettled equity forwards and the disposition proceeds we expect in the back half of 2023, we can cover the rest of the investment volume factored into our guidance for this year while keeping leverage flat, and we won't have to bring in additional capital in 2023. That gives us the freedom to move opportunistically any time we decide to go to the capital markets. Jason already noted that we remain very comfortable with our debt maturities in the near term, and that comfort comes from where our liquidity stands, our ability to access capital, and the flexibility provided by the substantial internal capital sources we can draw on in the years ahead. In closing, we feel good about how much ground we covered in the first six months of the year relative to the amount of investment baked into our guidance, and we look for that pace to carry forward through the back half, helped by how competitive sale-leaseback is and by the spreads we're generating on investments. In the same way, we expect our same-store growth to remain at the front of the Net lease peer group. Thanks to the different kinds of capital available to us, including what we generate internally, we have confidence in our capacity to finance our investments along with our other capital requirements through the remainder of this year and on into 2024. On that note, I'll hand things back to the operator so we can take your questions.

Hello, and thanks. Elmer Chang here, joined by Greg. Appreciate you making room for us. Your past purchases have tended to fall within the $10 million-$20 million band. Since sale-leasebacks have grown steadily more appealing as a financing route for operators over the past few quarters — driven by higher capital costs and tighter capital supply — how has rivalry in that sale-leaseback space been moving, maybe quarter to date? I believe you mentioned this a bit in your remarks. How does that look when you compare different North American regions? And what are talks like with current clients versus new ones, considering that year-to-date acquisitions have come mostly from new clients?

Yeah, sure. Those are good questions. As for how the sale-leaseback market has shifted this year, I'd say it's been fairly steady throughout the year. That's particularly true in the US. When I think about the bigger transactions you brought up — and yes, we have seen larger transactions this year, and perhaps starting at the end of last year, more so than in the past. Historically, we've probably still aimed at deal sizes around the $50 million range, give or take. I'd say we're probably somewhat above that year to date, even setting aside the APOTEX deal, maybe closer to $75 million. Look, I think the themes remain unchanged. Competition has become sparser for us. Many of the private equity real estate players we used to bid against depend on mortgage financing, and that has gotten more costly and harder to obtain. The forces pushing sale-leasebacks — particularly among sub-investment grade names, private equity sponsors — are the expense of other capital sources. High-yield bonds or leveraged loans remain much pricier than the pricing we aim for on sale-leasebacks. That holds across North America. As you noted, North America — we've really always treated it as a single market. Practically every deal we complete in North America is dollar denominated, and I think they're perhaps more influenced by what's going on in the US market. There's some consistency in that. And it remains quite constructive and maybe about as strong as we've seen the sale-leaseback market in a long while. Did I leave out any other questions in there?

Understood. No, that was really useful. Appreciate the detail you gave. Let's shift topics to office, since you disposed of quite a few properties during Q1, yet this quarter you didn't sell any assets, and it's been a while since you've really acquired office. Could you remind us of your overall perspective on that portfolio and how you're thinking about leases that might roll over in the near term? I realize the WALTs across that portfolio run somewhat below the portfolio average. Yeah, whatever thoughts you have would be great.

Yeah, I'd say at a high level, as you pointed out, we haven't purchased any office in recent times, probably for more than the last 5 years. Our office exposure has dropped meaningfully, from above 30%, 5 years back, to roughly 16% today. Pardon me. That reduction came about because we've made no acquisitions in that category. During that stretch, we've generally divested more office, relative to our overall dispositions. Basically, we've been directing new capital disproportionately toward industrial warehouse and, to a smaller degree, retail. Regarding office, our approach, I'd say, remains the same. In the end, we do anticipate bringing our exposure down to zero, though there isn't any particular timeline we're targeting for that. I'm not sure, Brooks, whether you'd like to add anything regarding specific expirations you want to mention there.

No, there's nothing particular. What I'd say is that it's fairly well spread out, and honestly it leans quite heavily toward the later part of the decade and after. In any individual year, you know, we don't really have a steady stream of leases rolling over or any big spikes. It's something we can handle, and those office expirations definitely get a lot of our attention. Understood. Thank you. Appreciate your time.

Yeah. Thanks, everyone. Thanks for making the time. I realize you gave some detail during the opening remarks, but perhaps we could dig a bit deeper into what we should anticipate for how rent increases will develop, especially given where inflation has been going. Just thinking about the timing effects. I believe we've discussed this before, but a refresher would be really helpful.

Yeah. Toni, would you like to speak to that?

Okay, yes, I understand. As far as what has been observed up to now goes, I believe we announced 4.3% contractual same store across the opening 2 quarters of this year. That represents our highest point; we do expect that lag to keep unfolding, and we will more or less remain around 4% during the latter half of this year, then easing to roughly the 3% average across all of 2024. We are still witnessing some growth that is above what is typical, once again driven by CPI flowing through, and likewise from simply securing larger fixed rent bumps in the deals closed more recently; this is helping to maintain that over a longer horizon. So, 4% near the end of this year, 3% moving into next year, and, once again, perhaps a bit of upward drift compared with historical levels after that.

Right, and Josh, that’s based on the forecasts as they stand now. Obviously, should conditions shift — you know, we just got some pretty upbeat GDP figures released a couple of days ago — and if inflation were to turn back upward somewhat, then those figures might shift too. Even so, I’d say same-store results remain quite appealing, you know, when compared with the net lease peer group.

All right, thanks for that. So perhaps a quick follow-up regarding the office exposure. Within your portfolio, do you have any sublease activity at all, or would you say it's basically just the direct tenants? Brooks?

It's a bit of a mix. Direct tenants make up the majority, and we aren't the ones handling property management for those in particular. The master tenant, you see, is truly the relationship we hold. There is a bit of subleasing occurring in certain places, which is fairly typical. That has more or less always been the situation; it isn't especially recent, though it is definitely something we're monitoring.

All right. Has it gone up because of that, or does that explain your monitoring, or is this simply routine operations?

Of course, we're constantly keeping an eye on what's happening with our tenants. I haven't observed any truly significant rise in subleasing. As is true for every company, utilization varies from one firm to another. That itself shifts around quite a bit, and we have noticed some favorable movement there. Subleasing, you know, is definitely one aspect of holding any single-tenant property, and it's a component of our office portfolio.

Got it. Thanks, guys.

You're welcome.

Yeah, thanks. You gave us quite a bit of detail about how the U.S. situation looks better at the moment. I'm wondering whether anything has begun shifting so far in 3Q when it comes to the environment in Europe? If nothing has, what sorts of things do you believe would need to shift before you folks could witness activity abroad that's more compelling or, say, more opportunistic?

Yeah, so we are beginning to observe movement in that region. If you consider Europe, the size of the hikes in rates was bigger there. Sellers continue to be in a period of adjusting to that rapid rise in rates. Opportunities are picking up, in our view. My sense is that bid-ask spreads remain perhaps broader than what we'd consider appropriate for getting deals closed. Activity, I believe, is on the rise, and that's. That's roughly the way it seemed in, in the US, perhaps as we headed into Q4 of last year, when more sellers were participating, despite the fact that we couldn't really reach an agreement on price. That sort of process has begun in Europe. My view is that sellers, particularly ones who have, you know, a use for the proceeds in mind, and these will be sale-leasebacks, you know, will eventually turn into price takers since their other capital sources are, you know, possibly less appealing than a sale-leaseback. That gives us a bit of optimism that in the second half of the year, you know, there might be some, you know, some activity in Europe that's more meaningful.

All right. There's got to be a spread there, I'd imagine. Could you put a number on the gap between bids and asks that you're still observing over in Europe?

Sure. It does vary, yes. Let's put it at 25 to 50 basis points, roughly. We're never exactly on the basis point when it comes to how we set prices on deals, of course, but it appears that there's a... and with so few transactions taking place, we can't fully tell where sellers stand. One thing we can say is that there isn't a... there isn't any willingness to accept the levels we're bidding at on things. The sense is that it has narrowed, and it may sit within that range.

All right, thank you. That's the final one. To reach the top end of what you've guided for acquisitions, I'm wondering whether you'd require additional opportunities coming from Europe, or do you figure you could get to that top end based on what the US is showing you? From what I understand, you've grown somewhat pickier when it comes to US retail industries. My understanding is you've been aiming more at industrial. So I'm just wondering if reaching the top end would be doable with Europe contributing very little.

Yeah. Well, Europe would definitely help, that's for sure. As I said a few minutes back, we've been seeing bigger deals. In the US, if we're able to find larger transactions or a greater number of them, such as APOTEX, that clearly will have a significant effect on where we end up landing inside the guidance range. It could happen, though having Europe involved makes it easier. Obviously, right now we can't see what Q4 transactions will look like. In most years, it does tend to rank as one of our busiest quarters, maybe even the busiest. That probably gives us some grounds for optimism, but there's a great deal of volatility right now, and predicting is difficult. At this stage, I believe the range makes sense.

Thank you for the color.

Yep, you're welcome.

Thanks. I suppose my first question concerns the guidance. When you look at the midpoint of what you've provided for the year, it implies an AFFO run rate of $1.34, which is basically level with what you posted during the first half of the year. Considering the investment activity you've completed and the yields you've managed to get, plus the pipeline, it just surprises me that it hasn't increased, and I'm curious what your thinking is there.

Tony, you want to talk about that?

Alright, yes. So, I believe there are several developments taking place that deserve a quick recap, and a number of them came up in what I said earlier. When you examine the second quarter specifically and compare how we performed against the remainder of the year, the significant factors that pushed Q2 upward — which we do not anticipate carrying over into the latter six months — include the reversal of the property tax accrual I referenced, totaling roughly $6 million. On top of that, we had certain extra rent recoveries during this quarter, which lifted our comprehensive same store figure. Now, if you balance that against the income tax expense — the added cost of approximately $3 million that I brought up — you essentially need to strip that out of the run rate when looking at the back half of the year. And then, really, once you factor in simply the greater interest expense, along with the heavier weighting of dispositions falling in the back half, those are truly the significant items that move you toward the midpoint of the guidance range we provided.

Regarding the overall same-store figure, you said it sits 100 basis points under the contractual long-term level, and that contractual will be roughly 3% next year. My understanding was that the gap between comprehensive and contractual was mostly a lag or timing matter, not something that acts as a permanent drag. Could you explain why it will keep coming in below contractual?

Absolutely. Yeah, I'd say there are, you know, several line items flowing through comprehensive. Keep in mind, that's essentially what flows through AFFO, unlike our contractual same store, which is an ABR or a point in time. A portion of that is timing, like you said, but vacancy definitely factors into that delta. I think you've probably closed most of the gap between contractual and comprehensive in, in the recent past, and also, you know, it cuts both directions. Extra rent recoveries or interruptions in rent collection account for the majority of that variance. I'd say vacancy is likely the meaningful delta there.

Alright. Jason, I was hoping to get some clarity on what you said regarding the storage operating portfolio. A modest operating portfolio was acquired by you during this quarter. I'm curious whether you discussed it as a possible use of funds. I recall you mentioning that previously. Apologies, a possible source of funds. That's something you brought up before. Do you feel more willing to divest the operating portfolio now compared with the last few quarters?

Yeah, listen, I believe every option available to us has always been under consideration, and we've discussed them. Of course, you know, one possibility is selling them, and, you know, doing just one thing isn't required. Some could be sold, some could be converted, and, and perhaps there's a case for keeping some as operating assets for, you know, later sales or conversions. You know, we're examining this more carefully at the moment. I think we're definitely aware, you know, that being liquid is beneficial in the current environment. Storage, I'd say, ranks among the more liquid asset classes available, so we want to be ready if that's a, a solid method to fund deals, you know, preferable to perhaps issuing equity or, or other avenues that, that are possible. You know, we, we're evaluating it. I think sharing anything specific is premature. Selling nothing at all is possible, but I think it's probably somewhat more, something we're assessing, you know, more closely now than, than, you know, one or two quarters ago.

Okay, great. Thank you.

Yep, welcome.