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

Hello everybody, and thanks for being with us today for the earnings call covering our first quarter of 2024. Prior to starting, I want to note that certain remarks on this call aren't historical facts and might be considered forward-looking statements. Factors that could lead actual results to differ materially from what W. P. Carey expects are described in our SEC filings. A replay of this conference call will be accessible online in the Investor Relations portion of our site at wpcarey.com, where it will remain archived for roughly one year, and where copies of our investor presentations and other related materials can also be found. With that said, I'll turn things over to Jason Fox, our Chief Executive Officer.

Thanks, Peter. Morning, everyone. My comments today will center on what we've been investing in lately, how robust our pipeline looks right now, and I'll also say a bit about where we stand and what we expect going forward. With me, as always, is Toni Sanzone, our CFO, who'll walk through the first quarter results and the balance sheet, plus what we've been doing on the asset management side recently. John Park, our President, and Brooks Gordon, who leads Asset Management, are also on the line for questions. Let me begin with the investment side. So far this year, we've closed deals worth $375 million in total, and industrial properties made up the overwhelming share of that. That figure breaks into $280 million closed in Q1 plus a $94 million purchase in early April of a roughly 1.2 million sq ft distribution building close to Rickenbacker International Airport, just outside Columbus, Ohio. I'm happy to report that in Europe, bid-ask spreads have narrowed quite a bit, which means more opportunities there than we saw a year ago. Roughly 70% of what we've invested year-to-date sits in Europe. Being present in Europe also hands us cheaper debt, since we can issue bonds denominated in euros. Right now that edge has come back toward its historical level, with rates about 150 basis points tighter than what issuing U.S. bonds would cost us; because high-yield debt and other financing options are still quite pricey, sale leasebacks remain an appealing way to raise capital and make up the biggest share of our investments so far this year. One major plus of sale leasebacks is that we get to negotiate the lease terms directly, rent escalations included. That leaves us in a distinctive spot among net lease peers, since 99.6% of ABR comes from leases featuring built-in rent growth, which on a contractual same-store basis currently sits a bit above 3%. Because our rent growth is so strong across lengthy lease terms, we think it matters to examine both initial cap rates and average yields against our cost of capital. The investments we've made year-to-date carried a weighted average going-in cash cap rate of roughly 7.4%, which gives us accretion from the start, and average yields of about 9%, which captures rent growth across the life of those leases. For average yield, our assumption is 2% inflation, matching the Fed and ECB targets, though that could turn out conservative given inflation has run above 2% for a while now and is broadly expected to keep doing so. We'll keep investing across a variety of cap rates, but for the full year our target is initial cap rates averaging in the mid-sevens and average yields across lease lives in the nines. At present our pipeline is strong, totaling more than $500 million of investments, with around $300 million in advanced stages that should close within the next few months. On top of that, $66 million of capital investments and commitments are slated to wrap up during 2024. So when you put it all together, we've got clear line of sight into more than $700 million of investments already made in 2024, covering deals that have closed or that we see as about to close, plus there's another several hundred million dollars of identified deals sitting in the pipeline that will take longer to wrap up. That means we're moving along nicely toward the $1.5 billion to $2 billion investment volume target in our guidance. The substantial liquidity we've accumulated hands us a real edge when it comes to getting those transactions done. In effect, we're pre-funding the pipeline at a moment when rate expectations have grown more and more murky and net lease REITs in general are dealing with an unattractive cost of equity. In Q1, we boosted our liquidity, mainly via the State of Andalusia and U-Haul dispositions. Toni will walk through the details, but what I really want to get across is that even after we funded new investments, we closed out the first quarter sitting at a bit above $1 billion in cash and barely drawn on our $2 billion revolver. Both of those can be used either to fund investments or to pay off near-term debt maturities, yet our strong preference in the near term is still to put that capital to work in new investments. Looking further out, the distinctive extra internal sources of capital we have — our equity stake in Lineage and our operating self-storage portfolio among them — keep setting us apart in a meaningful way from other net lease REITs, which gives us a longer runway for investing if the capital markets stay difficult for a prolonged stretch, plus more flexibility in the way and the timing of our access to those markets. Finally, with our strategy to exit the office assets in our portfolio almost complete, now is a good moment to take stock of where we are, including the near-term earnings effects compared with how we're setting the company up for stronger growth over the long haul. Because of the office assets we've spun off or sold, together with the U-Haul purchase option being exercised, 2024 AFFO won't line up with prior periods — instead it establishes a fresh baseline AFFO to grow from going forward, free of the headwinds tied to deteriorating office fundamentals and with no purchase options on significant assets sitting in front of us. To a smaller degree, 2024 AFFO has also taken a hit from certain tenant matters; we've made solid headway working through those and don't anticipate any further downside beyond what's currently baked into our guidance. Toni will go over the specifics here as well, but to sum up: the Hellweg restructuring closed on the terms we anticipated and that tenant is current on rent and on track with its turnaround plans. The Prima Wawona lease covering 4 cold storage and packing facilities was rejected, which we discussed last quarter. In April, we managed to sell one of those facilities; we expect to finish selling a second, smaller property in the next few weeks, and we're actively working on the remaining two. On top of that, the big empty warehouse we discussed three months ago is now fully re-leased — and we did it at a rent above what the previous lease brought in, with a tenant whose credit is stronger, so that turned out really well. Since we last spoke, we've put out further tenant disclosures, among them figures indicating that 85% of our ABR is attributable to tenants whose own or parental annual revenue exceeds $500 million, or else to government entities on our side. Our approach, as you'll recall, centers on mission-critical real estate while leaning toward sizable corporations. When the economy goes through its harder stretches, bigger firms typically enjoy easier access to liquidity and are much likelier to keep running critical properties through a restructuring than smaller firms are — and smaller firms face a greater chance of liquidation. We've likewise broadened the top tenant disclosure in our supplemental so it now lists our 25 biggest tenants, and those are mostly very large businesses spanning investment-grade and robust sub-investment-grade credits. Among that group of 25, one we're watching carefully is Hearthside — North America's biggest contract food manufacturer — which brings in roughly $4 billion of revenue each year and supplies essential production capacity to a set of well-known, long-tenured blue-chip customers. It has seen some credit deterioration, yet we don't anticipate any interruption to our rents, even if a restructuring occurs, because the properties we hold are so highly critical — they make up the large majority of Hearthside's two largest divisions, and every one of them was central to the original thesis behind our investment in this portfolio. To wrap up, now that our office exit strategy is complete this year and several recent tenant matters are resolved, we anticipate finishing 2024 with a portfolio that's even stronger. We're advancing well against our investment volume guidance, with a solid pipeline that we're extremely well-positioned to execute on thanks to the liquidity we've built up. The complete effect of putting that capital to work will come through next year, and that, together with the strength of our rent escalations, leaves us confident we'll record a meaningful rise in year-over-year growth during 2025. Once that growth shows up in our cost of capital, we think we'll be well-positioned to deliver total shareholder returns across the long term in the low double digits, combining earnings growth with our dividend yield. With that, I'll hand things over to Toni.

Thanks, Jason, and good morning, everybody. First-quarter AFFO came to $1.14 per share, and the decrease versus earlier periods was driven mainly by us carrying out our office exit strategy, plus the effect of a three-month rent abatement tied to the Hellweg lease restructuring, which reduced first-quarter AFFO by roughly $0.03 per share. With the investment activity we've done so far this year and the strength of our pipeline, we're still positioned to deliver full-year AFFO consistent with the midpoint of our guidance range; during the first quarter we finished the vast majority of the 2024 dispositions we had anticipated, among them 72 properties sold through our office sale program for gross proceeds of $411 million, which leaves only seven office assets, equal to 1.3% of ABR, still to be sold under that program. In the quarter we also closed the sale of our U-Haul portfolio through its purchase option for gross proceeds of $464 million, and we sold three more assets for a total of $15 million, which brought first-quarter dispositions to about $890 million. First-quarter releasing activity featured completion of the Hellweg lease restructure, producing a 14.6% rent reduction effective April 1st and lowering its ABR to $25.2 million. The lease term also gained seven years, and we granted a rent abatement for the first quarter. Apart from Hellweg, releasing activity produced overall rent recapture of 107% and added 3.4 years of incremental weighted average lease term on 40 basis points of ABR. As Jason said, Prima Wawona rejected our lease in April, and we sold one asset in that portfolio for gross proceeds of $9 million; we're now pursuing resolutions on the remaining three, one of which is near a sale. We collected rent on the portfolio for the entire first quarter, and our guidance still assumes no further rent from these assets in 2024 while we work toward a resolution and hold the properties vacant. Occupancy finished the first quarter up 100 basis points at 99.1%, mostly because of the lease-up of a 1.6 million sq ft warehouse property just outside Chicago. As Jason pointed out, we got a great result on this asset, signing a lease with the U.S. logistics division of Samsung for a 10.5-year term with attractive fixed rent escalations. The initial ABR of $6.4 million equals 102% of the prior-in-place rent, with cash rent starting in the first quarter of 2025. Now to same-store rent growth. For 2024's first quarter, contractual same-store rent growth was 3.1% year-over-year, and we expect that to moderate and average roughly 2.7% for the full year. Comprehensive same-store rent growth was — 30 basis points year-over-year, as reported, largely reflecting the abatement of Hellweg's first quarter rent. Without this abatement, first-quarter comprehensive same-store would have grown at just over 2% year-over-year. For the full year, we expect comprehensive same-store to be relatively flat, inclusive of the Hellweg impact. Lease-related income from other sources came in at a lower level during Q1, totaling $2.2 million. Given where negotiations currently stand, we anticipate settlements and recoveries tied to leases will be greater across the remaining three quarters, and our present guidance factors in a full-year figure somewhere in the low to mid-$20 million range. Turning to G&A, that came to $27.9 million in Q1. We don't consider that a run rate, because the first quarter typically sees higher G&A than later periods owing to when certain payroll-related items land. Consequently, for the entire year we still anticipate G&A landing between $100-$103 million. Non-operating income for Q1 reached $15.5 million, consisting of $9.4 million in interest earned on cash, $3.1 million from realized gains on currency hedges, plus the $3 million Lineage annual dividend that arrived in January. Cash generated interest income at an average rate of roughly 5% during Q1, though we anticipate interest income shrinking across the remaining quarters as cash gets deployed into new investments; across the full year, we look for non-operating income to land between $35 million-$39 million. Now shifting to the balance sheet. Our liquidity grew in Q1, fueled by proceeds from the office sale program together with U-Haul dispositions. We closed the quarter with roughly $2.8 billion in total liquidity, comprising $1.7 billion available under our revolver, just under $800 million in cash, and $284 million of 1031 exchange proceeds, which show up as restricted cash inside other assets on our balance sheet. Our liquidity position remains robust, and we note that very early in Q2, we paid off our $500 million U.S. bonds at maturity using cash on hand. The 2024 debt maturity schedule stays quite manageable, with EUR 500 million of euro-denominated bonds coming due in July, plus a bit of incremental mortgage debt maturing. Because we've accumulated substantial cash, our revolver balance stayed fairly low, which trims our exposure to floating-rate debt. As a result, our weighted average interest rate held at 3.2% in Q1 and should average in the low to mid-3% range across the remainder of 2024. With plenty of capital to fund our pipeline, we retain a great deal of flexibility in how we tap the capital markets during 2024. We strongly prefer deploying existing liquidity into new investments and anticipate seeing suitable windows of opportunity to complete bond deals this year, in both Europe and the U.S. We finished Q1 with debt to gross assets at 40.9% and net debt to EBITDA at 5.3x, inclusive of 1031 exchange proceeds. Although net debt to EBITDA sat below the low end of our target range of mid-5x to high-5x, we expect it to move back into that range during the back half of the year as capital gets deployed into new investments. Finally, regarding sustainability, I am happy to report that over 50% of our portfolio has now been signed up for the program through which we report electricity usage — an important move toward better measuring and lowering our carbon footprint. We keep including green lease clauses in our agreements, and at present, 25% of our portfolio is covered by leases featuring such provisions. We anticipate providing more information about our ESG targets and the strides we've made when our sixth annual ESG report comes out, which should be released before this month ends. To wrap up, our Q1 AFFO along with investment activity so far this year leave us confident about meeting our goals for the entire year. Transactions have accelerated, and with the capital we've gathered plus extra liquidity at our disposal, we are in a solid position to carry out a robust deal pipeline. Inside the portfolio, we've achieved meaningful headway in settling certain short-term tenant matters, and our strategy to exit the office segment is nearly finished; we think these elements, together with the robust rent increases embedded in our portfolio, set us up for growth over the long term. Having said that, I'll now return the call to the operator so we can take questions.

Appreciate you taking the question. I'm just attempting to get a bit of clarity around the capital markets plan. I believe, ToniAnn, you mentioned some planned notes offerings in Europe and U.S. this year. So does it appear that you'll re-file the July notes and then perhaps attempt to pre-fund the February? Is that how we should think about it in the back part of the year?

Yes, I believe those maturities are within our view. Like we mentioned, rates in Europe have shown some favorable shifts. Some appealing possibilities exist. At present, I think our feelings remain positive regarding the balance sheet's position, and we don't really need to access the capital markets, though we would aim to refinance those through bonds, probably during the later portion of the year.

Okay. So Jason, one thing I'd like to ask — I'm just interested in what the competitive landscape looks like when it comes to capital you could be up against in deals. How do you see things standing right now compared with, say, where they were in the later portion of last year? Are more players showing up, or does it remain fairly thin when it comes to the pools of deals?

Well, honestly, it seems to me that the private bid is still pretty weak. Buyers who depend on debt at the asset level — things like CMBS — are still limited and possibly not dependable. Sellers, I'd say, definitely place a lot more value on all-cash purchasers. That, in my view, hands us a significant edge. By and large, we don't come up against the public REITs very often, so the private bid is really where things get more competitive; that said, on the whole, we're in a fairly strong spot at the moment, particularly considering the liquidity position we currently have. So the environment is also quite interesting; we discussed Europe earlier in this call and how it's opening up, and we're finding more opportunities over there. So for us, 2024 is looking like it'll be an interesting deal environment.

Great. Thank you so much.

Morning, everyone. Thanks. Jason, would you mind expanding a bit on what you said regarding Hearthside? From a technical standpoint, does it sit on your watchlist, and I'm assuming their rent payments are up to date?

Right. So, yes, we brought up Hearthside. That company carries a lot of leverage, and the reason we discuss them is that a restructuring could happen down the road, and that's why it came up when we talked about our top 25 disclosure. It's a very big business. They supply essential production capacity along with their customer base, and what matters a great deal is that we hold real estate that is extremely vital to how the company runs. Given all that, our position feels very solid to us. At present they are paid up on rent, yet should the balance sheet be restructured, we still don't anticipate any rent interruption; putting it on our watchlist was a proactive step, and we're discussing it openly for transparency's sake, though we do believe they will keep paying rent well into the foreseeable future.

Okay, that’s really useful. Of course, it’s still quite early to say. Suppose things go as badly as possible and they chose not to remain — how would you place the rent levels on those properties compared with the market?

Brooks, you want to tackle that?

Right. I mean, the way I'd frame it is by looking at what it would cost to swap out that capacity. I mean, this is extremely important capacity, not just for the company but for a lengthy roster of their blue-chip clients too. So if that capacity weren't there, you'd see a massive disruption in that packaged food operation. Replacing this capacity would run orders of magnitude more expensive than our facilities. Rents come in below $5 a foot, so that's reasonable. But then again, what really matters here, I think, is how mission critical this real estate is for the company and for their end customer as well. So you've really got two layers of criticality. And so we feel good about where things stand; but like Jason said, we want to get out ahead of it.

Okay, and I’m sorry, but could you remind me what share of your private tenants provide you with some form of entity-level financial data or information related to the property type? I understand these aren’t retail properties in the strict sense, but since you’re bringing this one up proactively, for instance, just update us on how much visibility you have on an operational and financial basis from those private tenants.

Yes. Financial statements come in from practically all of our tenants, which works out to essentially 100%, or 99% plus, measured by ABR. Those usually arrive each quarter, followed by yearly audits. There is a lag. Once the quarter closes, they put the statements together and forward them to us; we monitor that process extremely carefully. Our visibility is quite strong. And I think, significantly, as has come up in prior discussions, one essential element of how we handle this is engaging with tenants too. It isn't only about reviewing the figures — we also aim to maintain ongoing communication with those businesses and the people running them.

Terrific. I'll get off. Thank you very much.

You're welcome.

Appreciate it. Toni, could you perhaps help us understand how you expect overall revenue growth to land for this year, and what assumptions you've baked in on the credit side — whether those are ones you've already mentioned or perhaps ones you haven't brought up?

Okay, yes. At this point, I believe we said comprehensive is roughly negative 30 basis points during Q1; the front weighting from the Hellweg abatement is truly incorporated in that; and like we stated, Prima will remain vacant through the remainder of the year, if we don't sell those assets; so all of that is factored in; beyond that, roughly 70 basis points of rent contingency exists, which we haven't drawn on yet this year. Across all 4 quarters combined, we do anticipate being approximately flat overall, possibly a bit positive should that rent contingency go unused.

All right. Do you have any idea what kind of effect that has when we look ahead to 2025 on a full-year basis? Or it seems like many of those credit matters were weighted toward the beginning of this year, so most of it hits us.

Correct. As I see it, right now we lack any real visibility on significant credit rent issues that we'd anticipate carrying into next year. We're only at the start of the year, so we'll keep watching it closely. Still, I don't anticipate anything substantial hitting the comprehensive side. Historically, our trend has usually sat at roughly 100 basis points under contractual. It may rise or fall in any particular quarter, yet that's broadly the run rate we'd anticipate over the long term.

All right. I mean, regarding credit, I suppose what you described makes it seem as though there’s nothing further on your radar right now. So I’m just attempting to figure out whether that applied only to the top 25 or to the whole portfolio, since it kind of looks like you had a run of credit issues here, and so I wasn’t sure whether that was chance or whether there’s simply other things you’re monitoring; so perhaps a bit more detail on that would be useful.

Okay, so, um, regarding rent collections specifically — in Q1, roughly 90 basis points of rent went uncollected from cash-basis tenants, and we didn't include that in AFFO. Most of it should still come in, so we're not treating it as a credit problem or a long-term bad debt charge. From where we sit, it's mainly a timing matter. So once again, we don't expect to need that entire 70 basis points I mentioned, though it's still fairly early in the year and we'd rather stay cautious.

Okay, so looking at things through the lens of our credit watch, I just want to make it clear that Jason brought up Hearthside by name. We do have additional tenants sitting on that list too. Compared with the quarter before, the figure has risen a bit. It stands at roughly 5% of ABR, while the earlier quarter was about 4.5%. Honestly, what accounts for the difference is Hearthside being added. Several tenants also dropped off the list. One of them was JOANN, the retailer, and after coming out of bankruptcy their balance sheet is far stronger. As a result, they are no longer on our credit watch list. That basically describes where credit watch stands in terms of ABR at the moment.

All right. Let me just squeeze in one final question here. You mentioned, I believe, mid-sevens for the pipeline over the remainder of the year; then an article came out regarding the Columbus deal that placed it in the sixes. So I'm just curious whether that was accurate, or whether there's sufficient higher-yielding material to reach that mid-sevens figure you're targeting and thereby offset it.

Correct. We're still aiming for the mid-7s, potentially a bit greater should rates remain unchanged and we observe some cap rate expansion; however, we do put money into a broad spectrum of yields, with certain transactions exceeding that goal, reaching as high as the 8s. For others, particularly those involving superior-quality properties featuring solid rent escalation and possibly rents under market, we may accept slightly lower returns, and those could drop somewhat beneath the bottom of that range. And yes, the HanesBrands transaction fits that description. It's a Class A, recently constructed, contemporary DC, with rents below market. Crucially, it also carries 3% yearly rent growth, which I believe must always be taken into account when evaluating sort of entry cap rates against other transactions we complete or against those of certain competitors. Yet it's a well-positioned property, Rickenbacker International Airport, which ranks among the more robust industrial markets nationwide. But yes, it will span a variety of cap rates, and we'd still anticipate landing in that mid, even high 7s through the remainder of the year.

Okay. Thank you.

You're welcome.

Hey. Jason, regarding that cap rate detail you provided earlier — the mid-to-high 7s — what's the picture like when comparing the U.S. with Europe?

Yeah. I mean, that's a fair question; here in the U.S., cap rates began leveling off as the year got underway, but now interest rates have turned somewhat more unpredictable and it appears increasingly likely that the Fed will delay rate cuts until the second half of the year, or possibly not at all. So the U.S. could see some modest room for cap rates to rise. What stands out most at present, I'd say, is how much has shifted in Europe. Things have been extremely fluid in that region. Through most of the past 12 to 18 months, the transaction markets there were basically stuck. Rates had jumped, and that trend has since swung the other way. As I said before, our borrowing cost in euros has returned to what I'd describe as long-term norms compared with what's available to us in the U.S., roughly a 150 basis point gap. So yeah. So I think what we've observed is that in Europe we're able to be somewhat more aggressive, or accept tighter cap rates, than what we've been considering, perhaps even compared with the U.S; because of that, we've seen greater activity in that region. Roughly 70% of our deal volume so far this year has come from Europe, and our pipeline is close to 50/50. But cap rates do vary. I mean, they differ by nation, by property type, by transaction. Take Germany — it's likely toward the tighter end of what we're aiming for, while a country such as Italy could sit at the higher end; still, you always need to account for or incorporate rent growth whenever cap rates come up. When initial cap rates land in the 7s alongside increases that have averaged roughly 3% for us, the result is average yields across the lease term reaching well into the 9s. And compared with our cost of capital today, that's a fairly compelling yield.

All right. So when it comes to Europe, they clearly have plenty of liquidity at the moment, plus additional asset sales bringing in more cash; but regarding acquisitions over there, given what debt costs over there, should we still expect you to be issuing debt denominated in euros?

Yes. Well, look, I'd say this: if we decided to issue bonds right now, and I want to stress that we enjoy substantial flexibility thanks to our liquidity, and there's no need for us to tap the capital markets for quite a while. That said, if we did decide to issue bonds right now, then yes, we would likely favor doing so in euros, judging by the quotes that keep coming our way in every market and by watching how various bond deal executions have played out. Still, flexibility is something we have. One advantage of diversification, along with being able to issue bonds across different markets, is that we can identify where execution becomes achievable again. So we'll keep assessing that.

All right; and so considering the tenant problems you told us about during the prior quarter, along with certain difficulties you may have encountered involving Hearthside or Casino and, before that, JOANN, has your approach to acquisition underwriting changed, or the way you assess tenant risk that continues over time?

I'll begin. Brooks can chime in regarding the way we're looking at things moving forward across the portfolio. I suppose the brief response would be no; our business model and our underwriting process are things we feel good about. The emphasis is on acquiring top-tier real estate and, crucially, on working with businesses whose credit we have confidence in. Our target sits just under investment grade; in our view, that represents the ideal place to put money to work in net lease. We're able to set the terms, be it escalations in rent, the length of leases, additional stipulations, or covenants contained in those leases. And then, quite significantly, as we noted regarding Hearthside, this also applied in the JoAnn's situation: we purchase real estate that is extremely critical. That matters greatly to how a tenant operates. And regardless of a restructuring occurring, as happened with JoAnn's, rent kept being paid the whole time, and they came out of bankruptcy with no interruption. Such is our business model. We have performed quite strongly, and through many decades and countless economic cycles our portfolio has done quite strongly as well; so no, I believe the same approach remains in place. That said, credit is something we constantly keep in sharp focus. We devote, I'd say, most of our hours to underwriting transactions, speaking with tenants, grasping their standing in the market, sitting down with management; but yes, our business model suits us.

All right. My apologies; and one last item, mostly so we can learn something. Regarding how leases get renewed, at what point does that usually happen? I'm simply looking at the top 10 disclosure. FM Logistic appears to have its expiration at the close of next year. At what time would a renewal normally be seen happening?