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

Good morning all, and welcome to the W. P. Carey general session. I'm Jim Kammert with Evercore ISI, and I'm pleased to have the opportunity to moderate today's general session for Carey. Just to make sure I'm sure they'll introduce themselves and tell you a little bit more about the preamble of the company. But to my immediate left is Jason Fox, CEO of W. Carey. And to his left is Jeremiah Gregory, Head of Capital Markets and Strategy for the company. So maybe -- I don't know, Jason, do you want to give a quick overview of Carey and then we get into Q&A? And obviously, if you have questions, please come to 1 of the mics and we invite your participation.

Yes. Yes, sure. And thanks, Jim, for monitoring today, and thank you all for joining us this morning. Hopefully, many are or maybe all of you know a little bit about W. P. Carey. We're the second largest net lease REIT breaking in the top 25 of all REITs in the RMZ by market cap. Our current market cap is about $14 billion with an enterprise value of about $22 billion. We've been investing in net lease for over 50 years at this point in time, founded back in 1973. And we've been investing in Europe now for over 25 years as well. We primarily invest in single tenants net lease properties, industrial and warehouse as well as retail properties. These are all triple net, triple net leased to a variety of tenants in a variety of industries with a target for very long terms. We do have a diversified approach which is a bit unique to us. This is by tenant, by industry, property type and geography, as I mentioned, and this does offer good downside protection that's proven out over many cycles over the last 50-plus years, but it also provides a wide funnel of investment opportunities from which we can grow. As I mentioned, we're in both the U.S. and Europe, about 2/3 of our portfolio is in North America with the vast majority of that in the U.S. and the remaining 1/3 is in Europe. This is predominantly in the developed countries in Northern and Western Europe. We feel we offer investors a unique combination of both growth and downside protection. And I know we'll get into this on with Jim, but our AFFO growth comes from really two drivers. And this is also a bit unique given the percentage of our growth that can come from same-store bumps. And obviously, as a net lease REIT, we also drive growth through investing externally. And all this is supported by an investment-grade balance sheet, where rated BBB+ by Moody's. BAA, one on stable outlook from S&P, well laddered debt maturities with our next bond not due until 2026 and we take care of maturities this year. And then importantly, it's something that we -- I'm sure we'll talk about have emphasized on recent calls. We do not need to access any capital markets this year to fund our investment program. We have a big noncore portfolio of assets that we plan to sell this year is predominantly operating self-storage is not core to our net lease platform. So let me pause there, Jim and let you dig in some details.

Great. Thank you for the review. And maybe going back, Jason, you notice of your diversified global footprint and you have a pretty broad investment appetite, maybe you could just spend a little time telling us where you are for Carey in terms of your pace this year and where you're seeing the opportunities and perhaps the type of returns you're seeing on those various buckets?

Yes. I mean the investment market is quite stronger now for us. I think that there's been expectations as we've come into this year and into the first quarter that tariffs could have an impact on investment activity. And I still think that's possible. There's certainly the potential that the uncertainty around tariffs could slow things down. But as of now, we've seen very little impact on deal activity. In fact, we feel things are accelerating as we get into the summer. And a lot of that is driven by companies needs for sale leasebacks and we talked about some of that as well. We are targeting deals in terms of pricing that you asked about across the 7s, a relatively wide range, but we do have a diversified approach. Generally speaking, we expect to be in the mid-7s on an average on a cap rate basis, which is roughly where we were last year. It's where we are year-to-date, and it's also roughly where our pipeline is. So despite the uncertainty in the world and a little bit of volatility in the bond markets, we've seen some stability on cap rates, which does help fuel activity per share.

Great. And what would that translate to? I know you put out a range of guidance for our anticipated investment for the year, but how is that trending? And if you have any updates there, it might be helpful for the audience.

Yes, sure. So as of our last earnings call, we had announced $450 million of deals done year-to-date, and that was through the end of April. On top of that, we also have a little over $100 million, $120 million of what we call construction and process that will deliver this year. And once it delivers and begins generating rent, we'll count that towards our deal volume. So in total, we have visibility at this point in the year into $570 million of deal volume. That's against the guidance, initial guidance to start the year between $1 billion and $1.5 billion. So we're trending quite well. If you look at annualizing the year-to-date components we're probably certainly in the top of our guidance range, perhaps even at the top of the range. I think there's reason to be optimistic that continue to see activity at levels that we're currently experiencing. I think there's a good chance that we can be even above our range, and we'll talk about that as we get closer to our next earnings call at the end of July, but we like the activity levels, and we think that's going to help track the growth this year.

Great. And one point you made was you're targeting initial -- that's initial cash yields in the mid this call for whoops and giggles, but with your escalators on your long-term leases, what does that translate to in terms of a GAAP or average return?

Yes. It's a good question and one that every opportunity I like to emphasize because I think we're quite unique in the net lease space given the size of the bumps that we have built within our portfolio. The contractual increases that are embedded into all of our leases. When you factor in our going in cap rates in the mid-7s plus bumps that tend to be in the mid- to high 2s and in many cases, it's the current environment above 3%. That's on a fixed side. We're also getting still substantial I would say the majority of what we're doing in Europe are CPI-based increases. So you factor all that in, we look at it as an unlevered IRR or an average yield through the life of the leases in the 9s. So quite substantial. When we think about spreads, we look at both year 1 accretion, but it's also very important that we think about what these average yields over the life of the lease are compared cost of paper how we're funding deals. And this is important. I mean, we see -- if you want to compare it to kind of across the space, you can think of this as a bit of a GAAP cap rate. So our GAAP cap rate, not technically gap because inflation is treated but effectively, GAAP cap rate is something north of 9%, which is quite substantial. And that's what helped drive the internal growth that I mentioned in the beginning.

All right. And maybe if we put Jeremiah the spot, but you just mentioned some of your cost of capital thinking about how you can borrow in Europe as well as in the U.S. And then obviously, we can kind of all do the math and the implied cap rate of the equity, but your implied equity for our modeling is below the mid-7s. So that's accretive. Maybe a little more amplification on the debt side, too, because I think that's a little unique for Carey in terms of their flexibility and access to debt.

Yes. I mean we invest in both the U.S. and Europe. And accordingly, we've funded that with bonds U.S. and Europe. And so we do overweight euro bonds in our capital structure, which is relatively consistent with what other international REITs have been doing. So even though about 1/3 of our investments in Europe is probably more like half of our debt and Euro debt is, for the most part, been 100 to 200 basis points cheaper than U.S. debt. So the impact that that's had, if you look at our weighted average cost of debt, it's right around 3%. We think that's the lowest we're certainly one of the lowest in the entire net lease sector on a blended basis. And if you look at what we could do new deals on, we could do maybe mid-5s in the U.S., but it's probably closer to 4% in Europe right now. And so even funding new you can see how that kind of then average blends us down to a cheaper cost of debt than if we were just funding in the U.S.

And it's an important point to note, the bandage we have invest in multiple markets this past year, there's a lot more activity in the U.S. I think Europe is still kind of recovering from a lot of the volatility. Going back to 2021 when rates were effectively 0 and they rose even more sharply than they did in the U.S. bid-ask spreads had been wide for buyers and sellers on the things that we've been looking at in Europe, probably the last couple of years. And Europe has been underweighted. And that's been the case to start the year. About 80% of our deals start the year have been in the U.S. or North America and 20% in Europe. But as we look forward to our pipeline, we're starting to see a lot more activity in Europe. And I'd say the pipeline, depending on how far out we go, we're seeing as much as at least 50%, maybe as much as 2/3 of our portfolio -- of our pipeline right now is in Europe. See how that plays out? But I think that's it's interesting to see, especially since when you think about what Jeremiah mentioned about how cheaply we can borrow in euros relative to U.S. dollars. We're generating wider spreads. Cap rates in Europe going in cap rates are roughly in line with what we're seeing in the U.S., maybe a little bit inside depending on the market. Again, it's a wide range given the number of countries we're investing in. But our cost to borrow is probably 150 basis points inside of where we can borrow in U.S. dollars, which we're generating meaningful spreads over there. And as someone who's been investing in Europe for the past 25 years, we have a real distinctive advantage. We have a team of 50 people on the ground in Amsterdam. They run our operations. So we have a real platform there. Tax accounting, cash management, compliance, asset management, all the functions that you typically see in a REIT, we have on the ground in your staff by Europeans, the countries, the cultures, the markets, and that's important. And then in London, we have our investments team closer to the capital markets, which are going to be more prominent in London and sourcing they are staffed by Europeans to speak probably a dozen languages amongst the group that is a big advantage for us given how long we get there.

Right. And we touched upon it in both your investing and then the organic growth. But can you just -- just a little bit more clarity on what are your representative escalators per your -- because you really have two main themes, industrial/manufacturing assets. And then about -- that's about 60% of the assets, if I'm not mistaken, another 20% is retail. How were those organic escalators compare just to give folks a general sense, and you're probably going to sort of invest in those ratios prospectively.

Yes. So I mean, historically, we've always experienced higher bumps in our deals. I think there's a good reason for that. We source most of our transactions through sale-leasebacks, which means that they can kind of write the terms of had downside protections in there. We can pick cherrypick assets within a portfolio construction with master leases, all these things have great benefits for downside protection. On the growth side, we can also type of box we want to have. It's part of the broader economics. So you might have a little bit of a lower going-in cap rate in exchange for higher bumps, but that's important to us that we continue to have growth within the portfolio. So that we're a little bit less reliant on external growth, something that we often always control given the volatility and the transaction activity. So historically, we've probably been in the low 2s more recently over the last 3 years since inflation has ticked up. We've seen an increase in the types of pumps that we can negotiate when we're completing sale leasebacks. A lot of that is clearly driven by inflation. We do have inflation increase in the U.S., they're more difficult to get now, as you would expect. But instead of getting inflation, we're able to negotiate higher fixed increases. Historically, it was in the 2% to 2.5% per year range over the last couple of years, it's been more in the 2.5% to 3.5% range, with the average fixed bumps over the last couple of years on new deals around 3%. So that really drives these average yields growth over the long term. I think the portfolio as a whole, we're expecting kind of low to mid-2s for contractual increases this year when you think about adding a little bit of leverage within the model that's going to provide probably half of the growth that we target to generate on an annual basis, which is going to be significantly more than probably all of the peers.

I would agree you look at our net lease coverage. One thing you mentioned, call my attention was downside protection. That's great. You get 2% to 3% escalators. But are you concerned that your rents outpace the profitability or the economics of the property the occupant, maybe you talk about coverage ratios are endemic in your portfolio to give the audience a sense of that?

Yes. I mean we're generally targeting bumps that correspond to our expectations for market increases that particular asset in that particular market, for instance, in some of the stronger markets on the West Coast, that's where we've been getting the 3.5% and even 4% increases. Our industrial properties we bought in the Toronto market, which is perhaps the strongest industrial market in North America. Those also have higher bumps. And we think the market is going to track those bumps. And that's the goal. We want to be within the realm of markets so that at the end of lease terms or if there's scenarios we need to retune the building, we can go to a market tenant if we have to and maintain those cash flows. What was the second half?

So what is like the coverage ratios? And then also don't a lot of your tenants put a fairly decent amount of their own capital in that kind of gives you comfort that there will be around here for the lease turn.

Yes. They're both very good points. Especially on the manufacturing side, there's significant tenant investment in our buildings. We're buying the base building at a typical basis for an for an industrial building. tenants tend to have a lot of investment. They have overhead cranes that have significant value, but that's something that the tenant had put in for higher power, maybe higher floor loads to the extent it's a food production, you have clean room space, you may have cold storage space or boxes within boxes. And these could be multiples tenant investment could be multiples of what we've put in the building. And this, you asked about, can our rents become bigger than maybe the tenant would like given the bumps that are embedded in our leases. And one of the things -- one of the big benefits of doing sale leasebacks is we can really dig into the underwriting. Our counterparty on the sale is also going to be our long-term credit or a long-term tenant, which allows us to dig in on dairy underwriting. And when we're looking at manufacturing, is one of the criteria we look at to help assess criticality is what is the site level contribution of EBITDAR. And most companies do track and report at least internally, P&Ls on a production plant level. And so we don't get in all of our deals, but I say most of the underwriting we do and in many of them, we're also getting ongoing reporting. It's a big range depending on the business. But on average, typically call it, 5x to 15x probably, on average, closer to double digits. Is this going to be the coverage that the facility produces in terms of EBITDA relative to our rents. So said differently, the rents are a pretty small input into the broader scheme of the tenants' operations. However, they're the most critical. Without our real estate that has all of their expensive equipment that's been invested without that, they can't operate. So in many cases, we view ourselves as the senior most creditor companies with good collateral.

Very good. Maybe take a pause, I'd like to get into some sources of capital discussion, but do we have any questions from the audience that people would like to pose?

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Yes, sure. So on sale leasebacks, one of the other benefits is we can dictate long lease terms and tenants are usually more than happy to provide longer lease terms, especially if there's an economic benefit to them, which there can be, we may be willing to price things a little bit more aggressively for longer lease terms. But they also, maybe more importantly, we want to make sure they can control these properties for a long time, given how important they are. So I would say typical lease terms for us and sale leasebacks and building suits are 15 to 25 years. And if I look back over the last 5 years, I would say most of these deals are probably at least 20 years. We're able to get that. We probably average over 20 years in terms of these terms. So as a lot of visibility into our cash flows going forward as a lot of downside protection. One of the questions we get asked a lot is industrial market, in a market like L.A. that has some difficulties. And are you guys feeling that? And we do own some properties in that market, but we have very long lease terms. So while there might be cycles in which there's dips in rents have dropped in occupancies come down. We don't feel those because we ride right through them with their term leases. In terms of the underwriting, in practice, we have perpetual capital. So generally speaking, when we like your assets, we're not selling them. On an underwriting basis, we're typically using some kind of spread to our going in cap rates it's maybe around 100 basis points. But it's maybe more of a kind of a DCF of kind of a lease term going out. And that's going to be the long lease term. That's going to be the bigger driver and some residual cap rate.

Thank you for the question. Any others before we -- Great. Well, so you have a nice pipeline. We're getting nice organic growth. Tony, she's not here, your CFO, how are you going to pay for all this? What are some of your primary sources of capitalist here? You mentioned on the intro as you feel you're well positioned for '25, in particular, from a capital sourcing, no need for equity issuance.

Yes, we're very well positioned this year. I mean we've talked about this pretty regularly over the past couple of quarters. We have through some legacy M&A, we have a substantial portfolio of operating self-storage assets. Currently, right now, that portfolio generates, call to $55 million of NOI, so substantial size portfolio. So our expectation, our plan for this year is to fund our investment activity with the sale of what we're calling our noncore operating assets it's predominantly self-storage. It's not entirely self-storage, but that's what we plan to do. And we look at it historically, certainly, probably over the last 10 years, maybe longer, self-storage has always traded well inside where net lease cap rates are, certainly where we've been buying net lease. And so there's an expectation this year that we can sell noncore operating assets, by the way, which also simplifies our business, operating self-storage is not something that we've expected to hold long term. It's been a bit of a rain day pocket for us. We think this is a good time to lean into sales to help fund our deals. We do expect to generate at least 100 basis points of spread between where we sell our noncore assets and where we're reinvesting into net lease. And I say at least, that's the number we're talking about. I think we have expectations to do better than that. Let's see how the markets shake out. But for us, that's going to be some of the cheaper capital that lease space to invest if you think about maybe it's around 6%, maybe it's inside of that. But again, it's going to be at least 100 basis points from where we expect to reinvest and think that's important to emphasize. It's not just the self-storage also to the extent we continue to think that funding new investments with asset sales is the best way to do it. And our equity is not far off and Jeremiah can talk about that. But we do think that these noncore assets in a better way to go. We have other pockets of money as well. We have a construction loan that we sourced not in 2021, that's yielding 6%. That's likely get to get repaid this year. It's a $260 million loan on a highly, highly successful development in Las Vegas. So that's also very cheap capital to get back. We can go into it if it's interesting, we also own a chunk of lineage. We helped seed that company back in 2010 with some sale leasebacks and at 1.09% of the operating company. Our stake in that company is worth about $250 million or now, which is down from where it was for those of you that follow the lineage, but it's still a substantial stake paying a dividend in the mid-4s. So again, very cheap capital to reinvest selling something that's yielding in mid-4s, reinvesting into the mid-7s, it's going to generate a lot of accretion for us going forward.

I think one thing just -- and Jason, on the self-storage, what's the reasonable bandwidth of total proceeds, I don't think we went over to. So because you have a guidance of $500 million to $1 billion of asset sales or capital recycling as total dollar proceeds. You talk about the construction loan, it's 260. Just trying to put bookends on that.

The investment guidance is $1 billion to $1.5 billion disposition guidance right now is to $1 billion, which is a pretty big range, of course, especially for disposition guidance within the net lease space. But we have a lot of assets we can choose from. And so we'll size our dispositions based on our needs from the investment side. I mentioned that self-storage, we have $50 million to $55 million of NOI associated with that portfolio. We currently have half of that in the market right now, so call it, $27 million, $25 million to $27 million of NOI that's in the market. We are -- we've grouped into 3 sub portfolios, we think sizing it, call it, big round numbers, $150 million for each portfolio. We think that's sized appropriately to attract the deepest pool of reputable buyers and these buyers will span from some of the public REITs have expressed interest some of the private platforms that have scale are interested in even some of the players who have raised dedicated self-storage funds in the utilized third-party management platforms have also had interest. It wouldn't surprise me if we see some combination of those types of buyers buying these pools. But it's -- it's a deep pool. And to the extent our investment volume increases, we can lean into more self-storage sales that we like, but we also have the sources that I mentioned earlier between the construction loan on could be refinanced this year. We're not anticipating the line just something that we have liquidity this year, maybe not even next year. There is a pre-IPO investor like us, there's a lockup until 2027. But it's still a pocket of capital that we know at some point will be complicit. And by the way, we also generate free cash flow for a year. So we feel pretty confident that even as we go up through the top end of our guidance range on investments that we have plenty of capital access to plenty of count to support that investment activity.

Are there opportunity questions from the audience? Please?

Leaseback you can [indiscernible] that market the [indiscernible] free up cash and monetization of some of the real state assets that sit there [indiscernible].

The question was, do we do any sale leasebacks in Japan. Our focus right now is our two platforms, which is North America and in Europe. So is not something that Asia is not something that we're targeting now. I think there probably are opportunities there, but we want to focus our efforts where we have a big platform on the ground. And we're -- we're not considering opening up a platform in Asia at this point.

Great. Anyone else, it's a lot of good news, but we do have to dress on occasion, you have some tenant hiccups and maybe you refresh or bring us up to speed, you kind of dealt with two of the three, there were sort of the known problem children, if you will, this year and maybe an update on the third, which is kind of ongoing.

Yes, sure. I mean one of the things that we've been doing over the past probably quarters, we provided a lot more disclosure around our portfolio. I think we're the only net lease REIT has expanded the top tenant list to 25. We used to disclose the top 10 list. Now we disclosed the top 25 list, and we want to make sure that we provide updates on any changes to the tenant quality, especially within that top 25 since that's going to have the biggest impact on the portfolio. So over the last year, we have been talking about 3x Jim, as you mentioned, and let me touch on the first two quickly because those are pretty easy on the part side, which is a very large kind of the largest contract snack-food manufacturer in North America. They've experienced some credit weakness inflating some other headwinds on labor costs, et cetera. And they've been a leveraged company. So they went through a bankruptcy about a year ago is when they entered bankruptcy, they recently exited. Our thesis on that investment from the very beginning, which held true is that we held their most important operating assets with very high site level coverage, as we talked about earlier, that meet up a majority of their production in their sales. All of this held on a master lease, predominantly one master lease that provides also on protection. So as we expected, they needed our facilities, they paid rent on time throughout the bankruptcy process and when they exited bankruptcy, they continue to pay rent at 100% and affirm the leases for all the facilities. It's a bit of a test case -- a case study on our model. We don't have defaults that often. But when we own critical operating assets and we have it fall this is the outcome. Would we tend to get 100% of our rents because the company needs to continue. It's a big company, $5 billion in sales. They have a blue-chip customer list, all the big consumer packaging companies like Procter & Gamble and Kraft, Heinz, et cetera. So this was an outcome that wasn't surprising to us, but it was a technical default given the bankruptcies that we talked about is pretty substantially. The second one is a company called True Value, which I'm sure all of you know from the branding on the hardware space, they went through a difficult period. A lot of it was the pull forward from -- of demand coming out of COVID and then the void that left when all that demand was pulled forward, and they restructured and sold themselves to a company called, Do It Best, which is a competitor of theirs in the hardware store distribution network. And to be clear, do it best entry value. They're not retailers. They don't own stores, they own distribution and they sell into or they distribute into many independent hardware stores. But do invest, took over 6 of our leases, 6 of the 9 warehouses that we had leased to true value rents with the staggered maturities of around 7 years. So good assets with a good credit paying rent at 100% of rents we had previously. The three that they need needed less. We're allowing them to terminate those leases at the end of this month of June. And we think we have good leasing prospects for that it may take a little bit of time. We do have good buyers for those. So it's likely that we'll sell those assets relative but they're paying 100% of rent on those assets until those leases expire and then we'll reposition them. So that situation is resolved. All of that had been baked into our guidance for the year. There's really no impact on earnings. And then lastly, Hellweg is a big to yourself retailer in Germany, who has had financial struggles as well. And they continue to. The German economy is not as strong as they or we would like it to be. So we've approached this, but we want to reduce our exposure to healing. And I think this is something that I'm really impressed about at the speed and execution we've seen out of our asset management team. We've sold 4 assets out of our 5 million we've agreed to take back stores which we want to do from Hellweg and retenant those with competitors, we have a lot of interest. So we feel that by the end of this year, we'll have them out of our top 10 list by the end of next year with continued lease terminations and retenanting with competitors who really want the space as well as some asset sales. We think we'll have them out of our top 25.

Great. It's very well done. To Lilly to the last second. I think our 30 minutes is up, unless we're going to have the last minute. I would just want to thank the audience -- It's John.

[indiscernible] in the sale leaseback will spread in the mortgage cost or cap rate may face.

I mean we don't use secured debt, but we can talk about kind of the relationship there. I mean this math would be we're executing deals in the mid-7s. And I think mortgage financing is probably -- it could be close to a 200 basis point spread. So if you think about mortgage borrowing costs, it's probably in the low 6s. As Jeremiah and I mentioned, we're not funding our deals with mortgage financing, we're using bonds. We can borrow much cheaper than that. We're probably generating from a spread to where our kind of weighted average cost of debt is it's probably more like 250 basis points. that's different. I think our competitors are probably inside of $150 million is the number you mentioned.

Yes. So a follow-up question on that. Would that imply the Carey's cost of funding, is year-year to private strategy out there [indiscernible].

Yes. Yes, absolutely. Which is a competitive advantage. And look, the other part of that is we don't rely on mortgage financing, which adds another kind of moving part to a transaction. We're not a cash buyer. We can be quite competitive in the markets right now relative to a lot of the private buyers that are in that.

Great. Thank you, Jason. Thank you, Jeremiah. Thank you for your questions.

Thanks, Jim.