W. P. Carey Inc. (NYSE:WPC) Nareit REIT Week: 2024 Investor Conference June 5, 2024 2:45 PM ET
Company Participants
Jason Fox - Chief Executive Officer
Jeremiah Gregory - Managing Director and Head of Capital Markets
Conference Call Participants
Brad Heffern - RBC Capital Markets
Brad Heffern
Everybody. Thanks for joining this session. I'm Brad Heffern, I'm the net lease analyst for RBC Capital Markets, and I'm pleased to be here with W. P. Carey today. We have to my left, Jason Fox, CEO; and Jeremiah Gregory, Managing Director and Head of Capital Markets.
Obviously, I have a list of questions prepared, but we'll leave time for Q&A at the end or if you have something pressing, feel free to raise your hand as well.
So Jason, for those not as familiar with W. P. Carey, can you just give a brief introduction of the company?
Jason Fox
Yes, certainly. And thank you all for attending today. So W. P. Carey, we're one of the largest public REITs within enterprise value of approximately $20 billion and an equity market cap of a little over $12 billion. We've been investing primarily or almost exclusively in net lease for over 50 years at this point in time. We celebrated our 50th anniversary last year. We've been a public REIT since 2012.
We currently own about 1,300 net lease properties that generate approximately $1.3 billion of ABR. We've always had a diversified approach among only a few internationally diversified REITs, about two-thirds or call it, 63% of our ABR is in North America, with the balance of the remainder spread across Northern and Western Europe.
We generally have a focus on generating earnings growth through a combination of both accretive investments as well as built-in rent escalations within our portfolio. We do invest in single-tenant, mission-critical predominantly industrial and warehouse properties that makes up a little under two-thirds of our ABR as well as retail, which makes up a little bit over 20% of our ABR.
Currently, we are on pace with an investment guidance of about $1.5 billion to $2 billion of deal volume for this year. I mentioned contractual increases also kind of helped buoy our growth. We have among the highest contractual same-store rent growth within the net lease sector. This year, expected to be around 3% for the year, with about half or 54% of our ABR from leases tied to inflation or CPI-based increases, which is also a sector leader.
Balance sheet, we're conservatively levered with ample liquidity. We'll talk about that, I'm sure, in some of our questions. Currently investment-grade rated Baa1 by Moody's, BBB+ by S&P. These are recent upgrades over the past 12 months or so. So that's a nutshell. And happy to get Q&A.
Question-and-Answer Session
Q - Brad Heffern
Yes. Perfect. So starting maybe with the investment environment, how do things look currently? And can you compare the environment in the U.S. compared to Europe?
Jason Fox
Yes. It's a good environment for us right now. I would say we are predominantly sourcing deals through sale-leasebacks. They're quite attractively priced today in the current market, and they're very attractive to corporates who are looking for pathways to raise capital. This is typically a hallmark of how we transact, I would say, over the past three or four years, upwards of 80% of our deal flow is through sale-leaseback. So a good environment for that, environment where there's been credit dislocation, I think that's beneficial for us as well. And so we're quite competitive right now.
In terms of Europe versus the U.S., if you look back over the past I guess, through 2023, back into 2022, we've been much more active in the U.S., I think that we've seen some meaningful credit dislocation across Europe, maybe that peaked in the fall of 2022 and kind of a reference point for that. Credit spreads were quite wide. Base rates were quite wide, which led to a freezing of the transaction markets. We were getting bond quotes at that point in time to issue eurobonds around 7%. I think if you fast forward to a couple of weeks ago, and Jeremiah will go into some details on this, we did issue a eurobond at 4.25%. And so you can kind of see the changes in the macro environment in Europe, which really has led to a much more increased activity across Europe.
I think it starts with sale-leasebacks. That's maybe the first part of the market to come back when you think about real estate transaction activity, especially across the net lease space. Spreads have come in some. I think that's led to a more dynamic market where sellers that had been on the sidelines in Europe are now looking to transact. The bid-ask spreads have come in quite a bit. And we've been very active.
I think if you look at year-to-date through our earnings call, about 70% of our new investments were in Europe. I think adding to some recent deals that we announced, that's probably about 50% in Europe right now and contrasted that with 2023, Europe was maybe 10% to 20% of our total deal volumes. So we're seeing much more activity there, interesting spreads and the pricing, a good dynamic for us right now. I think maybe one data point to point to is that 4.25% bond that we issued, that's about 150 basis points inside of where we could issue U.S. bonds right now, yet initial cap rates or cash cap rates for European deals are roughly in line with what we're seeing in the U.S. So we are able to pick up meaningful spread in Europe relative to the U.S. I think that the market tends to be less competitive. Generally, we've always had more pricing power. But I think in an environment like we're currently in here now, it's an interesting place to be.
Brad Heffern
Okay. And earlier this week, you gave an update on your volumes year-to-date. Can you talk through that as well as your overall expectations for 2024?
Jason Fox
Yes, sure. So we did issue a press release on Monday after the close, updating the market on our deal volume for the year. The headline number was $700 million of year-to-date deal activity. It's really comprised of three components: deals that are fully closed at this point in time, including half of a portfolio of net lease assets that we recently went under contract with Angelo Gordon to buy. So half we closed, the other half of the assets in that portfolio will close, I would say, imminently over the coming weeks more as a processing question. So effectively, those are done deals.
And on top of that, we have about $70 million of construction projects. These are namely build-to-suits or expansions kind of underway within our portfolio that we'll deliver this year. We include that in transaction activity or volume once the buildings are complete and the rent begins. So you add all those up, and that's kind of the headline, $700 million year-to-date.
On top of that, we characterize our pipeline as being greater than $300 million. I would say the $300 million is deals that are at advanced stages that we have a high degree of confidence and that will close maybe over the coming quarter or so, and there's a pipeline beyond that as well. But maybe the main kind of takeaway is that in total, we have visibility into about $1 billion of deal volume just five months into the year, which, as I mentioned earlier, keeps us well on pace for the $1.5 billion to $2 billion of deal volume within our guidance this year.
I think on top of that, our fourth quarter tends to be the most active for the year. It's not every year it happens, but most years, we tend to do a disproportionate share of new investments in the fourth quarter as we approach year-end. So I think there's reason to be optimistic. Again, we don't have the visibility to know what's going to happen at the end of the year, but we're on a good pace right now. And I think, importantly, cap rates have held up. I think we've generally been targeting cap rates in the 7s, both in the U.S. and Europe. I think that perhaps the pipeline is more in the top half of that range right now. So we are generating really interesting spreads relative to cost cap.
And I think the last point, and maybe we'll get into this some as well, is the liquidity positioning. We're sitting on a lot of cash, which gives us -- we've effectively prefunded our pipeline for the year and gives us a lot of confidence and believe to transact right now.
Brad Heffern
Okay. And what types of proper -- or what property types are you targeting? And is there a difference between Europe and the U.S.?
Jason Fox
Yes. It's still predominantly, I would say, industrial sale-leasebacks are probably the biggest driver at this point in time. This is both logistics assets, as well as light manufacturing, things like food production may come into play as well. I think historically, our retail allocation has mainly been in Europe, where we've seen better pricing dynamics, less competition, better long-term fundamentals. There's a -- I think the stats that we've seen are there's 9 times more retail square feet per capita in Europe and in the U.S. But there's -- really, there's fewer buyers, which adds to a better pricing dynamic.
I think more recently, we've shifted some of that interest are maybe added to that interest in the U.S. We've built a retail net lease team in the U.S. We expect to take some market share there. I think that there's been some consolidation in the net lease space with some of the M&A activity that's happened. I think also the 1031 market has slowed given fewer exits from say, multifamily, reinvesting or 1031 into retail net lease. I think there's some better dynamics in the U.S. that makes us interesting.
So while I would still expect industrial to be the -- probably get equal weight or higher weighting relative to its kind of two-third of mix in our current portfolio, I think there's opportunities to add some U.S. retail for that as well.
Brad Heffern
Okay. And you mentioned cap rates briefly. How have they trended of late? And then what's your expectation for how they look for the balance of the year?
Jason Fox
Yes. I would say cap rates at the beginning of the year, our expectation is that they stabilize. And I think that contributed to maybe transaction activity picking up again. That was particularly the case in Europe, where things have been quite volatile. I referenced where our new issuance bond yields would be as an indication that they've come in quite a bit.
In the U.S., I think it's a little bit of a different story. We've seen more choppiness around 10-year treasuries. Obviously, there's been some uncertainty around Fed cuts and the timing of that, if at all, for this calendar year. It feels like that while we had stabilization in the first quarter, there's an argument -- and maybe even some compression, I think there's an argument that maybe they're staying where they are and maybe a slight uptick depending on the property type.
But I think generally speaking, we're diversified. We're looking at a range of assets, as well as geographies. The cap rates do range. Our target remains in the 7% to 8% range. There are some outliers above or below that. I think importantly, what needs to be factored in or consider when you think about going in cap rates as the bump structures, they're also part of these transactions. I think that's something that it's always been very important to us. So going in cap rate in the mid-7s for us typically also factors in either an inflation-based increase, which is maybe more prominent in Europe right now or annual fixed increases.
Historically, those fixed increases have been in and around 2%. I think since inflation has increased over the past couple of years, we've been able to push the fixed increases embedded in our leases to average in and around 3%. So pretty substantial contributor to the economics of the deal than just the going in cap rates. And I know that typically, when we see spread comparisons from one REIT to the next, there's typically quotes around going in cap rates, but we certainly have a keen focus on the bump structures as well, which we still get good accretion in the first year.
But importantly, we'll have ongoing build in growth within the portfolio going forward, which I would maybe characterize as higher quality growth and growth that you generate through external investments and spread investments since that's a little bit less unknown.
Brad Heffern
Okay. You built up a significant amount of liquidity through the recent office exit. How big of an advantage is that for you in the current and then how do you plan to deploy that?
Jason Fox
Yes. Maybe I'll start, and I'll pass it to Jeremiah to talk about kind of sources in use. Look, it's a big advantage from a transaction standpoint. We typically have a cost of capital that's competitive. But because we have an execution history, and we can point to substantial liquidity. We're an all-cash buyer. That is our counterparties great confidence that we can transact. And so it's an intangible, I think it's really important, especially in a market in which capital availability and access to capital is inconsistent at best.
I think it's an important component of how we win deals. It also helps us give us confidence in continuing to invest in the current environment and have conviction that we're finding interesting deals in a choppy market. And for all practical purposes, we've prefunded our pipeline for the year.
Jeremiah Gregory
Yes. I mean just to add to what Jason is saying, I mean during the first quarter, we were at around $1 billion of cash on the balance sheet. He's discussed a lot about our view of the investment climate. And so for us, the focus on deploying that capital is really into new investments. It does allow us to look really throughout this year and to hit our investment guidance without having to address the equity markets.
As far as another thing that's been on certain investors' minds is our debt maturities this year. And so we do -- in the first quarter, we had two bonds that were maturing. One of those bonds, we've already paid off. We used cash on the balance sheet to pay it off, but we would expect to kind of replenish that cash through another issuance later in the year.
The other bond we have maturing is in July, it's a eurobond. We've already been in the eurobond market. Jason alluded to it. We recently did a EUR650 million offering, and that accounts for the EUR500 million maturity we have plus some excess proceeds. So to kind of tie it back as far as the cash that we have on the balance sheet. That's primarily our thought for capital allocation is that's going to new investments, and we think that, that will be deployed this year.
Brad Heffern
Okay. And then longer term, you have some additional unique sources of capital like the stake in Lineage as well as the operating self-storage portfolio, how do those play into your thinking?
Jason Fox
Yes. I mean it just provides alternative source of capital and maybe less reliance on the capital markets, and that's important in an environment like this. You mentioned Lineage, that's an investment that we helped see the company 10-years ago. And as part of some original sale-leasebacks, we were able to make an equity investment into the operating company. That now stands at about a $400 million investment on the balance sheet, kind of cash in around $50 million. So it's been a good investment over the 10-year period.
But maybe most importantly, it's a great source of capital for us right now. It's currently paying a dividend of less than 1%. Really, it's a tax dividend, if anything else. So what that means is it's a very accretive source of capital for us. When we do have the opportunity to get a liquidity event, which we expect sometime in the coming quarters, I think there's an expectation that Lineage will go public. That will give us an opportunity to begin accessing that capital. And you think about the magnitude of the accretion we can generate, if we're investing in the mid-7s on going in cap rates against a current dividend yield for that asset at less than 1%, we can pick up kind of 600 basis points to 700 basis points of spread. So quite meaningful growth embedded in our portfolio embedded in that investment that should be realized over the coming years.
You mentioned self-storage. We kind of think of that as a similar bucket in many regards. It's an asset class that we've been in for a long time. It's something that we've acquired as it was investments that came through the CPA:18 merger that we did a couple of years ago. We now own, I think it's 80 to 90 operating self-storage assets that generate approximately $70 million of NOI. So pick a number, something over $1 billion worth of asset value there. It's non-core to us.
I think if you look at over the past 10-years at any point, self-storage cap rates have been lower, if not meaningfully lower than where net lease properties have traded at least the ones that we're investing through sale-leasebacks. And that's the case now. We think we can pick up meaningful spread there if we think that's the best way to fund deals. There's nothing urgent to do there. I think that we, again, feel it as it gives us optionality. If we think that we don't like our stock price or the bond markets are choppy, this is just another pathway to generate some liquidity.
I think there's also options, Brad, to maintain ownership of those assets but convert them into a net lease model. We did that with Extra Space several years ago at this point, They're a top 10 tenant of ours. I think there's a blueprint that we now have in place, and we can do that again. So I would say with that $1 billion-plus portfolio, there's lots of options. I don't think we need to do all of it at once or all of it in one direction. I think there's ways to be flexible on how we look at that.
And there's other sources of capital that we think of that are beyond kind of the typical net lease capital source. I mentioned those two. We also have a construction loan at around $260 million on a development project in Las Vegas with a partner that's complete. It's almost leased up. It's been a very successful project. We'll have an option to buy into the equity of that project or some net lease units at our preference. But I think importantly, we'll also get refinanced out of that construction loan.
When we did the deal back in 2021, 6% interest rate was looked interesting relative to the 5 caps that we are investing in, in industrial assets. I think fast forward to today, 6%, when that gets refinanced, is going to provide some good positive spread when we reinvest it if we're finding deals into the mid-7s. That's another pocket of capital. I mean there's a couple of other things to talk about as well, but all told, I think you can add those up to probably close to $2 billion of additional incremental capital that if the need arises, we have a lot of flexibility.
Brad Heffern
Okay. You talked about the European -- or the euro-denominated bond offering at the 4.25% coupon. It's obviously meaningfully inside where you could get U.S. debt today. Can you just talk about how access to that European debt market plays into the cost of capital and how you think about investment spreads on deals in Europe versus the U.S.?
Jeremiah Gregory
Yes. I mean we've been issuing in Europe and the U.S. really for our entire history as an unsecured borrower. So that goes back about 10-years now. We have multiple bonds out in both markets, and we do have kind of a couple of philosophical points about how we issue. We tend to over lever. We always do over lever or overweight, I would say, euros in our debt structure. So if about one-third of our assets, one-third of our rents are European and euro-denominated, it's more like half of our debt is in Europe, and that provides us a hedge. It's a very efficient hedge, both on the asset level and also on our cash flows.
And importantly, over the last decade, that's also been -- it's been more attractively priced debt as well. So it's brought down our weighted average cost of debt and our weighted average cost of capital accordingly, if you think about kind of the cost that we're taking for our overall investments.
Historically, it's probably been around 100 to 200 basis points inside of U.S. debt where we can do euros. That fluctuates certainly in the last couple of years. There's been some periods of fairly meaningful distortion. There's even been periods where euro debt was more expensive than U.S. debt, but what we've seen in the last quarter or two is it's kind of settled into more of what we would say is the long-term average. We're back to about maybe right around 150-basis-point differential for euro issuance versus U.S. issuance.
So I think it's an important -- it's yet another kind of important channel we have for raising capital. It helps us keep our cost of debt down. It helps us be even more efficient and more opportunistic on the balance sheet. As far as spreads in Europe versus the U.S., there's a wide range of cap rates that we do, both in the U.S. and Europe. I think Jason has covered some of this. So it's maybe -- in some ways, it's more deal-specific than region-specific in terms of differences we see in cap rates.
So I think for the most part, at least in this environment, we're picking up almost all of that benefit on the debt side when we do euro deals. So you can imagine we're doing deals in kind of similar yields and similar IRRs in Europe to the U.S., but we're funding that in part with that, and that debt is priced 150 basis points lower. So I think the spread environment in Europe right now is clearly even more attractive than in the U.S. and where we can generate the best spreads.
Brad Heffern
Okay. In recent years, you've undergone some significant strategic changes. You exited the asset management business. Most recently, you've exited office. Can you give an update on where you are with that office exit and what that looks like?
Jason Fox
Yes, sure. So as Brad mentioned, we did separate ourselves from office through both the spin as well as what we've characterized as an office sale program. These are office assets that we did not include in the spin. And instead had a plan to sell those over the near term. And it was around an $800 million office sale program at the beginning. We're effectively all the way through it at this point in time.
I think 95% of that -- of those expected proceeds are either closed or under binding contract to close with the vast majority of it in that closed category. And that remaining 5% are assets, I think, that are almost all under contract and in kind of the diligence phase. So for all practical purposes, we've completed our exit from office, completed the office sale program as well.
We got good execution, I think. When we first announced this program back in September, I think the big round number that we disclosed was we think it's around an $800 million sale program. I think since that time, the office market has deteriorated, available financing has gotten worse. I think expectations for the fundamentals continue to deteriorate. Yet I think our execution is still going to be within 2% or 3% of that target sale. It's kind of a high single-digit cap rate is where we guided to, and we think that's the execution.
So it's been a successful program. I think at this point in time, where we sit today, our office ABR is probably in and around 1%. So the office sales program is largely done, and I think that we're well positioned because of that.
Brad Heffern
Okay. And then I'll ask one more and we'll go to Q&A from the audience. Because of the office exit, 2024 is a bit of a transition year for you where you're sort of setting a new baseline. Can you talk about how you expect to be positioned going forward post the exit?
Jason Fox
Yes. I mean, look, post the exit, our portfolio is clearly stronger. We're about two-third industrial. I think I mentioned before, 63% industrial spread out between Europe and the U.S., the bulk of the majority of the remainder is retail. So these are mainstream, kind of what we view as very strong, high-quality net lease assets to own. So we'll end the year in 2024 with a stronger portfolio.
We view 2024 as kind of the new baseline from which to grow. And we talk about our earnings guidance out there. We think that's the right number from which to start. There's been some ins and outs this year within the portfolio. But generally, that's a good baseline from where to start.
I talked earlier about the internal growth that we can generate. We also talked about the spread investing we can do on the external front. I think combined, we see a pathway going forward to, call it, mid-single-digits earnings growth when you combine those two factors. And when you layer on top of that a 6% plus dividend yield, there's certainly a pathway, maybe an expectation that we can generate double-digit -- low double-digit total shareholder return. And that's before any kind of multiple re-rating, which we think we can get, we can share that kind of growth. So I think we're very well positioned. And as we mentioned earlier, lots of liquidity to execute on external growth plan at the same time.
Brad Heffern
Okay. Any questions from the audience? Yes.
Unidentified Analyst
[Technical Difficulty]
Jason Fox
Yes, sure. So I would say historically, simultaneously closes on M&A is a minority of our PE backed sale-leasebacks. It does happen. And I think that when it is needed and occasionally, depending on how big of a component the sale-leaseback is the capitalization of the company, it may be an important component of an M&A deal. In those cases, we have a lot of pricing power because you can imagine the degree of execution and how important that is, it's just at a different level than a refi or something that's done in the ordinary course of business.
So we welcome those opportunities. But it is another moving part and sometimes it's not a big enough component to have it part of the transaction itself. So when I think about our pipeline right now or the deals we've done to date, I think it's very few fall into that category. We do have some PE sponsored transactions. We think it's -- the PE firms tend to look to optimize capital structure. We've always made the arguments that a company doesn't need to own their real estate. They can still maintain control of their core critical operating real estate through long lease terms as well as renewal options and the triple net lease structure really enables the company to maintain all operational control as well.
So that's a part of the business model. I think maybe the context here is the leverage in the current environment. So that's part of our sensitivities. I mean I think that we certainly are very focused on what leverage levels look like, what coverages may be, what their plan is to kind of grow out or to pay down debt over time. I think that's all part of the investment thesis.
And I think maybe equally important is the downside protection in our lease structure. We tend to put assets on master leases. We tend to focus on highly critical real estate. So balance sheet restructurings we want to avoid. But when we have critical operating assets on master leases. We tend to fare very well even with restructures, which is not a common element within our portfolio, but it's something that we certainly structure in case we run into those events.
Unidentified Analyst
[Technical Difficulty]
Jason Fox
Yes, the question is around hedging our FX exposure. Jeremiah, you want to take that?
Jeremiah Gregory
So you're correct that the primary component or the first component of it is the over levering and the over weighting of our debt. And that, like I mentioned, that gives us a hedge on the asset value as well as the sort of excess interest expense. So it's providing -- eroding kind of the net euro-denominated cash flow. So the way to think about that from a percentage standpoint on NAV, if about 1/3 of our assets and rents are coming in Europe, it's probably more like only 10% to 15% of an NAV value. So obviously, currency movements have much lower impact as a result on our NAV.
On the cash flow side, we do, in addition to kind of having that benefit effectively of the additional euro interest expense. We also do cash flow hedging on the net cash flows. And so we do that out 5 years. It's very programmatic, meaning we're just sort of layering in every quarter, and we're going out 5 years to put some kind of math around that as well. Based on our kind of analysis if the FX -- if the euro moved down 20%, and it did that in a day against the U.S. dollar, and then it stayed at that level for a full year, so a very radical move and one that persists throughout the year. We think with our hedges in place, that's maybe a 1% to 2% impact on AFFO.
So I think that the intuition is when the euro strengthens, that's a very mild tailwind to W. P. Carey earnings. If the euro is weakening, that's a very mild headwind to W.P. Carey earnings. For the most part, that's not even something that would be kind of picked up in our overall earnings though. And even in these kind of larger moves it's maybe pennies per share.
Brad Heffern
That's all the time we have. Thank you.
Jason Fox
Great. Thanks, everyone.
