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

Hello, everybody, and I appreciate you being with us today for the earnings call covering the 2nd quarter of 2024. Prior to starting, please note that certain remarks on this call are not historical facts and might be considered forward-looking statements. The factors that may lead actual outcomes to differ materially from what W. P. Carey anticipates are described in our SEC filings. A web replay of this conference call will be accessible through the Investor Relations portion of our site, wpcarey.com, and it will remain archived there for roughly 1 year; you can also locate copies of our investor presentations and other associated materials there. With that said, I'll now hand things over to Jason Fox, our Chief Executive Officer.

Appreciate that, Peter, and hello everybody on this morning's call. Today I'll give a quick rundown of a few recent developments, though my main comments will center on the investments we've been making and how those position us against the updated guidance we provided. Joining me this morning is Toni Sanzone, our CFO, who'll walk through the specifics of our second quarter results, guidance and balance sheet. Our President, John Park, and Brooks Gordon, who leads Asset Management for us, are also here to field questions. Before we get going, I want to take a moment to recognize that our President, colleague and friend, John Park, is departing, leaving W. P. Carey following 37 years. John has been a vital part of our management team, and his perspective and imagination were central in turning W. P. Carey into the top net lease REIT that it is now. Yesterday we announced AFFO per share of $1.17 for the second quarter, up versus the first quarter, and we expect it to rise further across the back half of the year as we keep putting cash to work in new investments. At this point, every property in our office sale program has been disposed of, aside from a single remaining asset, which sits under a binding contract with a December closing scheduled. Now that this program is finished, I'm happy to report that we realized pricing in line with the blended average cap rate in the high single digits and brought in total gross proceeds slightly below $800 million, with both figures matching what we told you to expect when our office exit strategy was announced. In the second quarter, we took care of both of our 2024 bond maturities, bringing in more than $1 billion of new unsecured debt via bond issuances in Europe and the U.S. alike, landing tight spreads over their benchmark rates and yields that were appealing compared with where bond pricing has sat for the past few years. The pricing on both bond deals also looked appealing next to the yields we've seen on new investment opportunities. Our liquidity is higher than it has ever been, with a $2 billion revolver that's almost completely undrawn, along with cash produced by the NLOP spin-off, on-balance sheet office sales, and the U-Haul disposition. Putting the significant capital we've accumulated to work in new investments stays our number one priority, even though we'll keep earning a fairly high return on that cash in the interim. Beginning in the third quarter, the accretive effects on AFFO from redeploying that cash into new investments will be far cleaner, absent the impact of office asset sales and with our interest expense reset after the recent bond refinancings. One longer-term source of liquidity is our equity stake in Lineage, which, as a lot of you are aware, priced its IPO recently. We rank among its bigger investors, something that resulted from multiple sale leasebacks we completed with Lineage back when it was only getting off the ground. With the stock trading where it is now, the value of our equity position comes to slightly less than $400 million after promote. The fact that their IPO priced successfully makes clear we'll have an exceptionally distinctive and strongly accretive capital source, which we'd anticipate putting back to work across the coming few years, depending on when Lineage chooses to settle with pre-IPO investors. Until then, we anticipate Lineage beginning to distribute cash dividends on a more consistent basis, and those will pass through into our AFFO. Turning to what we're doing on the investment side. Though the deal market offered up some appealing possibilities in the first 6 months, more lately things have struck us as rather quiet, as sellers fixate more and more on possible rate reductions as the trigger that would bring fresh sale leasebacks to market, or else explore other options in the financing markets in hopes that rates will decline. Certain deals have stepped aside given today's pricing, since sellers lacking an urgent need for capital frequently choose to hold off; we keep finding new opportunities to invest spanning a variety of cap rates, with our attention on transactions carrying going in cash cap rates in the 7s and occasionally reaching the 8s. Thanks to the appealing bumps we can secure across lengthy lease terms, that works out to average yields and unlevered IRRs comfortably into the 9s, a level high enough above our spot cost of capital to justify transacting, even though no fresh debt or equity is required from us to finance deals in this year. So far this year, we've finished investments adding up to $641 million, at an initial weighted average cash cap rate of 7.7% and an average yield of a bit more than 9%. Our investment volume for the first half featured $293 million in deals that closed in the second quarter, at comparable weighted average cap rates and average yields. Warehouse and industrial properties made up the overwhelming majority of investments in both periods. Deals that closed in the second quarter sat almost completely in North America, producing a fairly balanced split between North America and Europe for what closed across the first half; we kept securing favorable rent escalations. Roughly 60% of the investment volume closed in the first 6 months carried rent bumps linked to inflation. The bulk of those consisted of CPI capped rent escalations, with the typical CPI cap placed at approximately 4.5%. Fixed rent bumps applied to about 40% of our first half investment volume, averaging roughly 3% per year. A little more than half of the deal volume closed in the first half was made up of acquisitions of existing leases, coming from the closed portion of the portfolio deal with Angelo Gordon. Ordinarily, sale-leasebacks account for the overwhelming majority of our deals. Still, we'll pick up portfolios of existing leases whenever their structures and terms match our standards. This portfolio illustrated that well and represents an investment volume source we intend to pursue further. Right now, our pipeline adds up to more than $200 million in investments. We anticipate closing half of that in the coming 30 to 60 days, and that includes the rest of the portfolio acquisition I referenced a moment ago. Two of the bigger deals we had been chasing this year, together worth over $300 million, have just dropped out of our near-term pipeline. That's not typical, and it's disappointing, particularly because of when it happened. Still, during diligence we found critical problems that we simply couldn't resolve. New deals keep getting added, sure, but this puts a drag on how fast we invest as we head into late summer, a period when transaction activity usually slows down. As I said before, on margin, certain sellers want more clarity around rate cuts before they proceed with sale leasebacks. Should the Fed cut rates in the third quarter, that would probably push them to move, giving a boost to what is normally a strong fourth quarter. There's also some indication that brokers have recently been doing more BOVs — broker opinions of value — and we've found that tends to be an early signal of deals headed to market. So although we're cautiously optimistic that deal activity will improve, pinpointing the exact timing is very difficult, and that obviously shapes how many deals get done across the rest of the year. Because of this, we're bringing down our expectations for investment volume, which carries through to our full year guidance, as Toni will explain in more detail; and with that, I'll hand the call to Toni.

Thanks, Jason, and good morning to all of you. AFFO for the second quarter of 2024 came to $1.17 per share, and the sequential gain from the first quarter was driven mainly by reduced G&A expense, the wrap-up of the Hellweg rent abatement in the first quarter, and increased other lease-related income, partially offset by disposition activity in the first half, including the sale of the U-Haul portfolio, which had been our largest tenant. First-half dispositions came to slightly more than $1 billion, of which $152 million closed in the second quarter, among them the final Marriott operating hotels designated for sale; in July we sold two more office assets, and a single asset accounting for only 45 basis points of ABR is under a binding contract with a closing set for no later than December, marking the last sale in our office disposition program. We also finished selling three of the four vacant Prima Wawona assets, with one of those closing in July. Now to the portfolio, beginning with same-store rent growth. During Q2, rent growth on a contractual same-store basis came in at 2.9% compared with the prior-year period. Leases that move with CPI escalations continue to land in the mid-3% area, while those with fixed escalations sit slightly higher than 2%. Looking at the whole year, we expect contractual same-store rent growth to land at an average of about 2.8%. On a comprehensive same-store basis, rent growth was down 40 basis points relative to last year. The main driver of the difference from the contractual figure is the impact this quarter from the assets we discussed on our earlier earnings call — specifically the Prima Wawona lease rejection, the period of build-out ahead of the Samsung lease starting, and the Hellweg rent restructuring, which kicked in during Q2. You'll continue to see those impacts show up in overall same-store growth, but they won't be as pronounced during the back half of the year, which means we're looking at flat same-store growth for the entire year. Our watch list remains at about 5% of ABR — there hasn't been much movement since our last earnings call, and we didn't bring on or lose any significant tenants. For rent collections, we landed just over 99% in Q2 as well as the first six months, and nothing notable changed with our cash basis tenants. As for the bad debt figure baked into our AFFO guidance, it still accounts for rents we haven't collected; a small group of tenants, both current and former, still owe us money, and we're continuing to chase down those balances. Based on where things stand and how we expect the timing to play out, our guidance bakes in roughly $0.03 to $0.04 of AFFO coming back in the back half of the year. When we re-leased space during Q2, we ended up capturing 116% of the prior rent overall, and that activity added 6.5 years to our weighted average lease term while only touching 50 basis points of ABR — the gains came from favorable re-leasing spreads on industrial and retail properties. At quarter-end, the portfolio's weighted average lease term stood at 12 years, which remains among the best in the net lease space, and occupancy held strong at 98.8%. On top of that, Q2 brought in $9.1 million of other lease-related income, largely tied to deferred maintenance and other settlement payments. We're still expecting that line item to fall in the range of the low to mid-$20 million range. In Q2, nonoperating income reached $9.2 million, which consists of $5.9 million in interest on cash and $3.3 million in realized gains from currency hedges, bringing first-half nonoperating income to $24.7 million. The cash we keep in the U.S. is earning roughly 5.3% on average right now, and that basically covers the interest expense tied to our recently issued U.S. bonds until we put that cash to work in new investments. At this point, we expect full-year nonoperating income to land somewhere between $45 million and $50 million, subject to the timing of when cash gets deployed. Operating property NOI reached $21.8 million in Q2, an increase of $1.5 million versus Q1, which puts operating property NOI for the first half at $42.1 million on an AFFO basis. Looking year-over-year on a same-store basis, operating self-storage NOI is down 4.2% through the first 6 months, and for the full year we assume it declines by 5% to 6%, a reduction from our original guidance assumption of roughly flat year-over-year. Once we factor in the completed sale of that Marriott property I referenced earlier, NOI from all operating properties should now land between $81 million and $85 million for 2024. Now on to expenses. During the second quarter, G&A costs reached $24.2 million. That's $3.7 million lower than what we saw in Q1, and the main driver there was timing. With that, our first half figure comes to $52 million. Looking ahead, we've brought down our expectation for full year G&A expense, and we're now projecting somewhere in the range of $98 million to $101 million. Turning to non-reimbursed property expenses, those amounted to $13.9 million in Q2. That figure covers carrying costs on properties sitting vacant prior to being sold, as well as on the Samsung asset before its lease began. Across the whole year, we expect nonreimbursed property expenses to land somewhere between $44 million and $48 million. On an AFFO basis, tax expense totaled $7.6 million, and that includes some onetime benefits connected to resolving tax-related matters. Looking at the entire year, we expect taxes calculated on an AFFO basis to land somewhere in the range of $37 million to $41 million. Turning now to our guidance. Per Jason's earlier comments, our forecast for full year investment volume is being brought down, with the new expected range sitting between $1.25 billion and $1.75 billion, and beyond that, we're anticipating reduced NOI coming out of the self-storage portfolio we operate. Because of this, our AFFO guidance range is being lowered by $0.02 at the midpoint, putting it at $4.63 to $4.73 per share. Should Lineage choose to pay out any dividends during the latter half of 2024, that could potentially counteract part or all of the cut we're presently observing in our AFFO guidance; at this point, we aren't factoring in any extra dividends from Lineage within our 2024 AFFO guidance; we'll seek additional detail regarding their dividend policy moving forward and offer any revisions to our AFFO expectations as needed. Turning next to our capital markets activity and balance sheet positioning. The second quarter was a busy one for us on the capital markets side, with roughly $1.1 billion in unsecured notes issued. In May, we completed a Eurobond issue worth $650 million with a 4.25% coupon, taking advantage of cheaper rates in Europe. After that, in June, we sold USD 400 million in bonds with a 5.375% coupon. These issuances went well, in our view, with pricing at 160 and 130 basis points over the relevant benchmarks. Since Q1 closed, we have retired $1 billion in maturing bonds — specifically a $500 million U.S. bond paid off in April and a EUR 500 million bond settled in July. We have no further bond maturities in 2024, and only $61 million in mortgage debt is due during the second half. So far this year, the bond issuance and repayment activity we've completed has extended how long it takes our debt to come due on a weighted average basis by nearly twelve months, and it keeps our maturity schedule nicely staggered. During Q2, our liquidity went up even more, and we ended the quarter with $3.2 billion, which includes a revolver that's basically untouched with $2 billion available plus more than $1 billion of cash. That said, as I mentioned before, we ended up drawing on a portion of those funds afterward to pay off the bond that came due in July. For Q2, our weighted average interest rate remained fairly low at 3.1%, and for the rest of the year we expect it to land in the low to mid-3% range on average. Looking ahead, the refinancing of our bonds that have matured should push interest expense higher during the second half of the year. That increase will be partly countered by greater interest income, though that benefit will shrink as we put the capital to work in fresh investments. At the close of the second quarter, leverage stood at roughly the same point it reached at the conclusion of the first quarter. Our debt-to-gross assets figure came in at 41.7%, still comfortably inside the low to mid-40s target range. Net debt-to-EBITDA registered 5.4x, staying beneath the bottom of the mid- to high 5x target range, even as we keep expecting it to move back up into that range across the back half of the year as more capital gets deployed into new investments. With that said, I'll now return the line to our operator so we can take your questions.

I wanted to ask about those 2 transactions that dropped out of the pipeline. Could you talk a bit about what attracted you to them? And then what sorts of critical problems caused them to drop out of the pipeline? I'm just trying to get a better grasp of what's happening with the deal environment and the risks or other things that could affect whether transactions get completed.

Yes, absolutely. Yes. And obviously, that is the largest shift compared with where things stood in June, the last time we discussed the pipeline and guidance, and it's had the greatest effect on our revised range. So those 2 transactions had originally totaled more than $300 million. For the bigger one of the 2, I believe we found what I'd describe as a critical problem during the later phases of diligence. The owner didn't know about it, and it was impossible to resolve it in time. When something like that occurs, I'd describe it as uncommon and beyond our control. I'd say it's highly atypical for that to happen when our transactions have progressed this far. So of course, we're unhappy that they weren't able to cross the finish line, and right now we're working on refilling our pipeline with fresh opportunities; but I don't view it as a signal of anything structurally broken in the transaction markets; these should be seen as, once again, atypical given this point in the transaction, and I'd have to describe them as one-offs.

Understood. Then, to follow up — looking at where things stand right now, you've achieved significant movement on the dispositions, be it office or certain other categories, and at this point the guidance for acquisition volume has been lowered. But is this sort of a — does the approach now turn toward offense when it comes to locating deals, pursuing deals aggressively, and simply deploying that capital you've got available? I'm just attempting to grasp the narrative change and the strategic change as of today, plus what we ought to anticipate across the next several quarters?

Yes, definitely. I believe that's how we'd describe it. On the strategic side, we've already handled a portion of the heavy lifting with last year's office spin. That is — at this point the office sale program has concluded. And clearly, the U-Haul transaction represents a major capital source, yet selling off a portfolio that large was also a burden. And we've now also paid off our two bond maturities during this year and reset our interest expense. So yes, we're now in a solid position. When it comes to seeking new opportunities, we're definitely on the offense. We're sitting in a very strong liquidity position which — that's going to help us lean into deals; and so at this point we need to see transaction activity increase. And given where we are right now, sort of late summer, this is the summer law. It's particularly noticeable in Europe. So at the moment we lack as much visibility into the transaction markets and sort of the dynamics around that, but by the end of summer in September and certainly October, we'll have a better sense of what the end of the year looks like.

You mentioned that fewer people are willing to sell right now, since everyone is sort of holding out for rate cuts. Could you give us some detail on how the level of competition for deals has moved in the U.S. and in Europe? And in the back half of the year, where do you think competition will increase?

Yeah, so yeah, I'd say the transaction markets have been somewhat quiet lately. I think the reason for that might be some pausing that took place related to expectations around Fed rate cuts; competition, I'd say, has been creeping up in both the U.S. and Europe, perhaps a touch more in the U.S., and I think that is creating some downward pressure on cap rates. And again, that may be somewhat more the case in the U.S. than in Europe, though I would anticipate a bit of the same in Europe too, particularly since borrowing costs have moved. So yeah, I believe greater competition will drive cap rates lower. We can take advantage of that in our pricing a bit; we said that we hold a lot of liquidity, and while it does earn 5% in cash, we're eager to deploy it, and we can definitely create some accretion versus cash, and also versus where we are able to issue capital at this point. So competition exists, it always has, and I expect it will rise somewhat once the cost of capital sort of resets to wherever the Fed lands.

All right. Then about that investment you made to grow the storage base — I realize it's a pretty modest outlay. But could you give us a bit of detail on what made you feel at ease with the underwriting, especially considering the difficulties the storage sector has been dealing with when it comes to rental rates? And perhaps also some wider perspective on how you view the industry overall?

Yeah. When I think about it — it was small. I'm trying to recall whether that was a tuck-in deal or an expansion of a property we already owned. But what matters, I'd say, is that storage transactions essentially move through the very same underwriting steps we apply to net lease. They have to produce the appropriate spreads relative to our cost of capital. We can likely count on long-term growth that exceeds what net lease would deliver, yet they still must have the sort of underlying return fundamentals that suit us. I can't recall the precise details of that deal, but I believe it was either an expansion of a property we already held or a tuck-in for properties in a market where we already operate.

So, Jason, I suppose I'd like to confirm my grasp of a few of those remarks — from what I hear, certain sellers are holding out until interest rates decline, and you brought up possibly even pushing on price somewhat. You brought up cap rates, the mid-7s, and I believe even as high as the 8 range. Going forward, ought we to view those as dropping, perhaps to the low 7s, or whatever it takes for deals to get done? How are we meant to approach that?

Yes. That's a solid question, and it's definitely fluid. What I'd say is that at present, we're generally aiming at cap rates — cash cap rates within the 7s, which, because of how our bump structures work, would usually translate into an average yield within the 9s. So pricing of that sort is acceptable to us. Given that we're holding as much liquidity as we currently have, I believe that for the right deal, we could likely go under that range, particularly since we have a tendency to transact across a wide spread of cap rates; so a few will land higher within that range too. Still, I think for the right asset, particularly those carrying greater growth built into the leases, we're at ease being somewhat more aggressive than the 7.7 average cash cap rate that was reported this quarter or, I should say, year-to-date.

All right, and one more question from me. Regarding that 5% of ABR sitting on the watch list — does any portion of it involve any of the top 25 tenants that you could identify for us?

Sure, Brooks, would you like to handle that?

Absolutely. Yeah. Like Toni said, the watch list stays really steady from one quarter to the next. And as we've talked about on earlier calls, most of it comes from Hellweg and Hearthside, which we've gone over before. Those two make up roughly 2/3 of the watch list, and both are top 25 tenants. But they're the only 2, and the rest of the list has stayed really steady, again at about 5% of ABR.

So, once more, how does Hearthside fit into that 5%?

That's right. They also appeared in the quarter before this one.

Regarding how many deals you're doing, by the close of Q2 you're about midway to the bottom end of your guidance; you also made clear that Q3 is slow, with sellers holding off. Competition has increased. So my question is why you wouldn't lower the guidance further? Given what you've already closed this year, what makes you confident about reaching the middle of that range?

Yes, of course. Let me give a quick summary. Once you include the remaining capital projects we anticipate closing this year — roughly $40 million or so — we stand at approximately $700 million in deal volume; beyond that, our pipeline is what I'd describe as above $200 million. It spans different phases. My expectation is that most of it, likely no less than half, will close during August and September; that provides us with sight lines to approximately $1 billion in investments as things stand, or at least that's our current position. That figure is definitely below what we'd prefer. And as we see it, the primary cause is those two deals I referenced before that fell out of our pipeline. So yes, there's still work ahead in the back half of the year; we hold a tremendous amount of liquidity. Our inclination is to deploy capital. As I just noted, we can push harder on pricing for the appropriate deals. There are indications that market activity will strengthen once summer ends. I noted that BOV activity has risen, which usually serves as something of an early signal for deal activity. I believe Fed rate cuts could contribute to that as well. Additionally, bear in mind that Q4 is generally our biggest and busiest period; on average, based on roughly 10 years of history, around 35% of yearly deal volume happens during the fourth quarter. So we can't yet see year-end deals, and attention will shift there more in September and October. But yes, I believe — we believe that range is correct. It's a range that's fairly wide because of uncertainty, yet we consider it the suitable range, and we'll continue seeking ways to deploy capital.

Okay, I understand. Then regarding Lineage, based on what you said, it sounds as though you don't have much clarity about when you could actually start monetizing it. Is that the right way to read it? And after that, when could you gain that clarity?

Yes, I'd say that's an accurate way to describe it. Lockups exist. An outside date sits at 3 years, yet we anticipate there will be periodic, or perhaps routine, chances for liquidity during the settlement period, though it's largely up to the sponsor's discretion, so we lack complete visibility there. I believe they're motivated, in all probability, to clear away any overhang. Still, we don't have much visibility into it. I'd say that's accurate.

So you brought up that 5% of ABR sitting on the watch list, but can we dig into how the remaining portfolio performed quarter over quarter? In other words, across these businesses more broadly, are you noticing the lower-end consumer coming under more pressure?

Brooks, is there anything you...

No, there aren't any significant patterns I'd call out. What I'd say is that the watch list serves as a solid signal of where risk is more severe. Once more, let me remind everyone that this isn't meant to show what we anticipate in terms of a default — it's simply those tenants we feel deserve extra scrutiny. There are definitely some pressures facing consumers in different areas, yet that hasn't carried over into our tenant pool, apart from those tenants we've already flagged on the watch list.

All right, and for the second thing, perhaps returning to how the self-storage properties we operate are performing. You lowered the guidance to a decline of 5% to 6% compared with a year earlier, whereas during our previous conversation it was unchanged. And it seems to me that the softness in self-storage has been widely recognized. So I'm wondering why the guidance wasn't reduced sooner, and what shifted from one quarter to the next?

Toni, do you have any — any perspective on that?.

Yeah. I'd say — regarding how things have gone during the first half of the year, we've been examining on a month-by-month basis the way the portfolio has performed. And I believe it has kept demonstrating a softening pattern. Generally, there have been optimistic signals in the market regarding possible interest rate cuts. As of right now, we simply aren't witnessing that materialize. So at this moment, I think our guidance truly rests on what we're observing flow through our portfolio right now. I think optimism still exists out there for the back half of the year broadly when it comes to self-storage, and we're hopeful that could mean some upside for us compared with where we've marked it. But I think we feel good about where we've marked it at this point in the year.

Correct. Beyond that, figures like these typically come out of the budgets our operators supply to us, so they're definitely a major factor in how we approach what gets modeled and what goes into our guidance.