W. P. Carey Inc. (NYSE:WPC) Q3 2023 Earnings Call Transcript

W. P. Carey Inc. (NYSE:WPC) Q3 2023 Earnings Call Transcript November 3, 2023

W. P. Carey Inc. misses on earnings expectations. Reported EPS is $0.00058 EPS, expectations were $1.32.

Operator: Hello. And welcome to W. P. Carey’s Third Quarter 2023 Earnings Conference Call. My name is John, and I’ll be your operator today. All lines have been placed on mute to prevent any background noise. Please note that today’s event is being recorded. After today’s prepared remarks, we will be taking questions via the phone line. Instructions on how to do so will be given at the appropriate time. And I will now turn today’s program over to Peter Sands, Head of Investor Relations. Thank you, Mr. Sands. Please go ahead.

Peter Sands: Good morning, everyone. And thank you for joining us this morning for our 2023 third quarter earnings call. Before we begin, I would like to remind everyone that some of the statements made on this call are not historic facts and may be deemed forward-looking statements. Factors that could cause actual results to differ materially, W. P. Carey’s expectations are provided in our SEC filings. An online replay of this conference call will be made available in the Investor Relations section of our website at wpcarey.com, where it will be archived for approximately one year and where you can also find copies of our investor presentations and other related materials. And with that, I’ll hand the call over to our Chief Executive Officer, Jason Fox.

Jason Fox: Thank you, Peter, and good morning, everyone. On this earnings call, in addition to discussing our third quarter results, we want to take the opportunity to provide an update on our recently announced strategic plan to exit office, including the progress we’ve made over the last six weeks and how we would be better positioned for growth going forward. I’ll also discuss how the significant amount of liquidity coming back to us puts us in an exceptionally strong capital position and touch upon what we’re seeing in the transaction market and how we’re approaching new investment opportunities as a result. I’m joined this morning by our CFO, Toni Sanzone, who will review the third quarter and our expectations for the remainder of 2023, as well as our preliminary expectations for 2024 AFFO and the resetting of our dividend to reflect our strategic exit from office.

John Park, our President; and Brooks Gordon, our Head of Asset Management, are also on the call to take questions. Starting with our strategic exit from office, which accelerates the approach we’ve been taking over the last eight years or so to reduce our office exposure and will effectively take it down to zero over the next few months. I’m pleased to say that on November 1st, we completed the spin-off of Net Lease Office Properties, which we’ll refer to as NLOP on this call. As a result, assets representing about two-thirds of our office ABR are now owned by NLOP. W. P. Carey has no ownership interest in NLOP and as a separate publicly traded company, NLOP will make its own public disclosures, including updates on its progress with asset sales.

We’re also making good progress selling the office assets that remain on our balance sheet, which we are referring to at the Office Sale Program. So far, we’ve completed sales of four office assets under this program, totaling $143 million in gross proceeds, including the Telefónica assets sold during the third quarter. We have signed contracts on another roughly $500 million. This includes our largest office asset net lease to the Spanish Government, which remains on track to close in January and is sailed back to the tenant for approximately $350 million. In total, we have closed or have transactions in place on over 90% of assets in the program based on gross proceeds, giving us confidence that the vast majority of on-balance sheet office sales will be completed by early 2024.

We’re pleased with the progress we’ve made to-date, particularly given the remaining 10%, which we are actively working on selling, represents less than 1% of our total ABR. As a result, by early 2024, we will have a higher quality portfolio with some of the strongest metrics in the net lease sector. Just over 60% of ABR will come from warehouse and industrial assets. The weighted average lease term will remain over 11 years on a portfolio maintaining strong geographic diversification, with over half of ABR generated by assets with rent escalations tied to inflation. We will continue to have among the strongest names for rent growth in our peer group, both from CPI-linked leases and higher fixed rent escalations. Proactively exiting our office exposure over a short period of time also ensures we won’t face a drag in our earnings over multiple years or the risks associated with large lease expirations and increased vacancies driven by declining demand for office.

Our view is that the leasing market, financing market and investment sales market for the office sector will all remain under pressure and that office assets will see worse outcomes going forward than they’ve seen in the past, which will be particularly impactful on a single-tenant office portfolio with a declining weighted average lease term. These factors all contributed to our conviction addressing office more proactively, while it still has a reasonable amount of lease term remaining and to provide investors a cleaner and clearer path for earnings growth on our core portfolio. As I look ahead, W. P. Carey will be better positioned for growth. The quality of our cash flows will be enhanced through better end-of-lease outcomes, including fewer vacancies, higher overall releasing spreads, reduced down times and carrying costs and lower CapEx requirements.

Exiting office will also enable our sector-leading internal growth to have a greater impact on our overall AFFO growth. In addition, the significant amount of capital that has and will continue to come back to us over the next several months uniquely positions us within the net lease space. In aggregate, the combination of settling our equity forwards, the cash distribution received at execution of the spin-off, asset sales under the Office Sale Program, along with the upcoming exercise of the U-Haul purchase option and other dispositions is expected to generate around $2 billion of liquidity. We will also start retaining more cash as a result of resetting our dividend. Based on our revised investment volume expectations for the remainder of 2023 and our current assumptions for 2024, we don’t expect a need to issue new capital in the near-term.

It could potentially go to the end of 2024 without having to access the capital markets if they remain unfavorable, even if we temporarily repaid our 2024 debt maturities with cash. The significant pool of dry powder we have gives us a meaningful competitive advantage on new deals, especially versus net lease peers that may become capital constrained if they’re unable to access the capital markets or their cost of capital remains too high. Looking further ahead, we have additional sources of capital, such as our investment in Lineage Logistics and potential operating property sales, which could provide even more of a runway to fund accretive investments should capital market conditions remain unattractive over an extended period of time. Turning now to the transaction environment and how we’re approaching new investments as a result.

The current environment for sale leasebacks continues to be one of the most interesting I’ve seen in my career. High yield debt and other financing alternatives are constrained and generally very expensive, making sale leasebacks the most attractive source of capital. In addition, the capital market backdrop remains volatile, creating uncertainty over the pool of buyers able to raise and deploy capital accretively. Competition has thinned out, especially from buyers using mortgage financing. We are seeing less capital chasing deals. Coming out of summer, we had a substantial pipeline with around $500 million of new investments at various stages of execution and at cap rates generally in the low-to-mid 7s. After steadily rising over the summer, interest rates moved sharply higher in late September, bringing deal pricing even more into focus.

We began more actively exerting our pricing power, pushing cap rates higher to better reflect the current capital market environment. Specifically, we repriced most of our live deals to cap rates in the mid-to-high 7s and even into the 8s, providing unleveraged returns in the high single digits and into the low double digits. Deals are therefore taking longer to negotiate and close as sellers either adjust to or are unwilling to accept higher pricing. That translated to a very slow third quarter, with investment volume totaling just $40 million and lower expectations for overall 2023 investment volume. Looking ahead, we have a strong bias towards deploying capital into new investments, although we are taking a balanced approach, recognizing that macro factors, including the trajectory of interest rates, also matter.

For sale leasebacks in particular, where sellers are motivated to transact through a specific use of proceeds and face a lack of attractive alternatives, we believe pricing will adjust quicker than in other parts of the net lease market. As transaction cap rates gradually move higher, we will allocate capital when we see appropriately priced opportunities. We will continue to press for higher cap rates, knowing we’re exceptionally well positioned to deploy more capital as sellers adjust their expectations. And for the types of transactions we focus on, we will be competing against a shrinking pool of buyers who can raise and deploy capital. Currently, our pipeline stands at over $400 million, with many deals back on track and heading towards closing, most of which we expect to close around year-end.

Additionally, we have a handful of large portfolio deals at relatively early stages. And with that, I’ll pass the call over to Toni.

Toni Sanzone: Thank you, Jason, and good morning, everyone. For the 2023 third quarter, we generated total AFFO of $1.32 per diluted share. The $0.04 decline versus the second quarter primarily reflects certain non-recurring items, which added to our AFFO in the prior period. Contractual same-store rent growth was 4.2% for the third quarter, 80 basis points above where it was a year ago and expected to remain around 4% during the fourth quarter, as we continue to see the lag in CPI-linked rent increases flowing through our leases. Comprehensive same-store rent growth for the third quarter was 3.5%. During the third quarter, rent recapture on releasing activity was 81% overall, primarily driven by restructurings on three of our four movie theater properties, which fall within the other category and comprise an insignificant proportion of our overall portfolio.

The one office asset that renewed during the quarter is now part of NLOP. Going forward, we expect to see improved rent recapture metrics driven by our exit from office, although it can vary from quarter to quarter with limited releasing activity. Turning to our 2023 guidance, we’ve lowered and narrowed our AFFO guidance range to between $5.17 per share and $5.23 per share, based on full year investment volume of between $1.3 billion and $1.5 billion, having closed almost $1 billion of investments year-to-date. As a reminder, when we announced our strategic exit from office in late September, we reset our 2023 AFFO guidance range to reflect its expected impacts. The updated guidance we’ve announced today lowers the midpoint of that range by $0.02 to $5.20, mostly to reflect greater uncertainty over the timing of deal closings as we push for higher cap rates on the active deals in our pipeline, as Jason discussed.

We disposed of six properties during the third quarter for gross proceeds of $148 million, bringing dispositions for the first nine months of the year to $196 million. Disposition volume for 2023 is anticipated to total between $450 million and $550 million, including up to $300 million of sales under the Office Sale Program. ABR totaled $1.46 billion at the end of the third quarter. With the completion of the NLOP spinoff, our ABR was reduced to $1.31 billion and is expected to be further reduced to $1.25 billion upon completion of the office sale program in early 2024. Operating NOI for the third quarter totaled $24 million, mostly comprising $17 million from our operating self-storage portfolio and $6 million from our remaining operating hotel properties.

During the third quarter, our disposition activity included sales of three Marriott operating hotels for $49 million, with another three sales completed in October, totaling $46 million. We currently expect NOI from all operating properties to total between $91 million and $94 million for 2023, taking into account the timing of the sales of the operating hotel properties and slower NOI growth within our operating self-storage portfolio. Other lease-related income totaled $2.3 million for the third quarter, bringing it to about $21 million year-to-date. For the full year, we expect this line item to total between $22 million and $25 million, which has been adjusted to exclude expected termination income on assets that are now part of NLOP. Moving to expenses.

Non-reimbursed property expenses totaled $13 million for the third quarter and $31 million year-to-date. As a reminder, during the second quarter, we recognized a one-time benefit from the reversal of a property tax accrual, totaling $6.3 million. For the full year 2023, we expect non-reimbursed property expenses to total between $41 million and $43 million. Tax expense, which primarily relates to foreign taxes on our European portfolio, was $9.4 million for the third quarter and $33 million year-to-date on an AFFO basis and includes a one-time expense of $3.3 million in the second quarter, resulting from a tax audit in Europe. For 2023, we expect cash basis taxes to total between $43 million and $45 million. G&A was $23 million for the third quarter and is expected to total between $96 million and $98 million for 2023, a reduction of $1.5 million from the midpoint of our previous range, which reflects better visibility on the timing of certain expenses given where we are in the year.

We will receive fees and reimbursements from NLOP for acting as its external manager. Specifically, asset management fees will start at an initial annual rate of $7.5 million, declining as NLOP’s assets are sold and a $4 million annual administrative reimbursement, which will remain flat over time. For the fourth quarter, we expect to receive asset management fees and reimbursements totaling approximately $2 million, both of which will be reflected as revenue, with no impact on our G&A expense line item. Interest expense totaled $77 million for the third quarter and our weighted average interest rate remained at 3.3% at quarter end. Interest expense is expected to decline by $8 million to $10 million in the fourth quarter, reflecting the impact of the NLOP spin-off and our Office Sale Program.

This is driven by the cash proceeds we received from the NLOP distribution, the settlement of equity forwards and asset sales. We’ve assumed any excess cash after reducing our revolver and funding new investments earns interest income at a rate of almost 5% over the near-term. Turning now to 2024. This morning, we announced preliminary 2024 AFFO guidance of between $4.60 per share and $4.80 per share, reflecting the full year impact of the NLOP spin-off and the estimated impact from the expected completion of our Office Sale Program early in the year, combined with a preliminary outlook on the overall investment environment, disposition activity and our liquidity positioning. Starting with the spin-off, the impact of the assets that were contributed to NLOP is about a $0.50 per share decline in AFFO on a full year basis, based on their ABR, less property expenses, mortgage interest expense and income taxes.

Similarly, the completion of asset sales under the Office Sale Program early next year is expected to result in an approximate $0.27 decline in our 2024 AFFO per share. During 2024, we also expect to receive a total of approximately $0.04 per share in asset management fees and reimbursements for managing NLOP. When thinking about 2024 earnings, it’s important to also take into consideration our cash positioning and the deployment of the various sources of capital we’ve received and expect to receive in the coming months, which will serve as a meaningful offset to the decline in AFFO associated with our exit from office and should therefore be viewed along with our anticipated net investment activity and capital markets activity in 2024.

Specifically, our current projections assume investment volume of $1.5 billion for 2024, weighted more towards the back half of the year. We view this as a very preliminary estimate for directional purposes as opposed to a target given the dynamic environment and expect to have a more refined view and formal range when we issue guidance in February. Expected dispositions during 2024 fall into four main buckets. First, the remaining roughly $100 million [ph] of office asset sales under the Office Sale Program, the bulk of which comprises the Spanish Government portfolio sale, which is under contract and expected to close in January. Second, the exercise of the U-Haul purchase option in the first quarter, which we currently estimate will generate about $470 million in gross proceeds.

Rent from the U-Haul portfolio in 2024 prior to its sale is expected to be $9.7 million. Third, potential non-core operating property dispositions of up to $100 million, including one Marriott hotel sale and the possibility of selling a student housing operating asset. And lastly, going forward, we expect normal course net lease dispositions of between $100 million and $300 million annually. Given the timing of the U-Haul and Spanish Government transactions, 2024 disposition volume is heavily weighted to the first quarter of the year. It’s important to note that our preliminary 2024 guidance makes certain simplifying assumptions and the specific timing of both acquisitions and dispositions over the course of the year may have a meaningful impact on our AFFO.

We have two bonds totaling $1 billion maturing in 2024, as well as approximately $220 million of mortgage debt. Taking into account the estimated $2 billion of capital inflows we expect, our guidance assumes we have sufficient capital and liquidity to fund our anticipated investment activity and repay our 2024 debt maturities without needing to access the debt markets until late in the year and that we may not need to raise equity capital at all in 2024. In terms of other assumptions, I want to reiterate that we expect contractual same-store rent growth to remain strong in 2024, averaging about 3% for the full year. For the bulk of the remaining line items impacting AFFO, beyond the impact of NLOP spin-off and completion of the Office Sale Program, our preliminary 2024 guidance assumptions are relatively in line with 2023.

We expect to provide additional color and details with our fourth quarter earnings in February when we announce our formal guidance for the year. Moving now to our capital markets activity and balance sheet positioning. In conjunction with the NLOP spin-off, we settled our remaining equity forwards in October, issuing 4.7 million shares, generating aggregate proceeds of $384 million. This was equity we originally raised at a gross price of over $83 per share, which for technical and legal reasons, we decided to settle ahead of the spinoff. As Jason discussed, with around $2 billion of capital expected to come back to us through early 2024, we remain exceptionally well positioned to fund acquisitions and manage our upcoming debt maturities. We therefore continue to have significant flexibility in when and how we access the capital markets, enabling us to look for favorable windows of opportunity to do so.

We are maintaining our leverage targets to low — of low-to=mid 40s on debt-to-gross assets and mid-to-high 5 times on net debt-to-EBITDA, although we do expect to be in the low 5s on net debt-to-EBITDA going into 2024 and potentially for much of the year. As we deploy capital into new investments, we expect leverage to gradually increase back into our target range. I also want to note that we remain on track to recast our $1.8 billion credit facility by the end of this year, pushing out the maturity on a significant portion of the total debt we have maturing over the next couple of years. The final topic I want to discuss this morning is our dividend. On our office exit announcement call a few weeks ago, we noted that after spinning off NLOP, we intended to reset our dividend, reflecting both the impact of exiting office on our AFFO and a lower targeted AFFO payout ratio, enabling us to retain higher cash flow going forward, which can be accretively reinvested to further drive AFFO growth.

We anticipate a one-time dividend reset during the fourth quarter to achieve these goals, subject to our Board’s approval. Our dividend is expected to reflect a payout ratio in the low-to-mid 70% range, more in line with that of our peer group and helping contribute to an improvement in our cost of capital. We expect that to translate to a one-time reduction of approximately 20% in the fourth quarter, compared to our most recently declared dividend. From there, the intention is to grow the dividend in line with our AFFO growth, which we anticipate will result in higher dividend growth than in recent years. In closing, having completed the NLOP spin-off and making strong progress selling the remaining office assets on our balance sheet, we’re confident we will have exited the vast majority of our office exposure by early 2024, better positioning us for growth.

And with roughly $2 billion of capital coming back to us, we believe we’re exceptionally well positioned to continue investing through 2024, especially if cap rates continue to move higher and capital market conditions remain unfavorable. And with that, I’ll hand the call back to the Operator for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] And the first question comes from the line of Eric Wolfe with Citi. Please proceed with your question.

Eric Wolfe: Hey. Good morning. For the 2024 AFFO guidance, it sounds like there is some dilution associated with the timing lag between when you sell the properties and reinvest the proceeds, just given the back half waiting that you mentioned in terms of investments. So, I was hoping you could quantify it just so we can understand what AFFO would look like more on a run rate basis after you redeploy the proceeds?

Toni Sanzone: Yeah. Thanks for the question, Eric. I think, we really do view 2024 as a new baseline for us. I think you highlighted the timing of the dispositions. That’s really weighted really towards the very front part of the year and so we will see some impact in Q1, maybe a slightly higher Q1 there. But I think the expectation is really to deploy that capital from there and to grow on that baseline. I would say that with that vast majority of the office sales and U-Haul, for that matter, being out of that, the run rate really gets reestablished early in the year. So this is effectively how we’re viewing it from which we can grow going forward.

Eric Wolfe: Okay. So as you said, so that means that the sort of estimate you put out would imply that if we’re trying to model in 2025, you can model a more normal growth rate off of that, not a sort of more inflated growth rate, if you will, just because as you redeploy the proceeds, maybe you’re holding something in cash. As you sell it at 5%, you redeploy it at 7.5%, 8%. You would expect that there would be a little bit of improvement in growth, I would think, through the year. But it sounds like you’re saying that this is sort of a normal baseline from which we can then grow into 2025.

Toni Sanzone: That’s the right way to think about it. I think we do expect that growth in 2025 and beyond to be more normalized and that is coming off of the 2024 base year, which, again, has some ins and outs from a timing perspective, but for all intents and purposes is our new baseline.

Eric Wolfe: Okay. Thank you. And then the second question, just on the $500 million that’s under contract today that will likely close, I think you said, in the early part of next year. Just curious if there are any sort of conditions that need to be met before these close, are there sort of contingency financing — financing contingencies, they have to achieve a certain level of financing at a certain rate. Just wondering what needs to happen before that $500 million can close.

Jason Fox: Brooks, you want to take that?

Brooks Gordon: Yeah. Sure. This is Brooks. The bulk of it, as Toni mentioned, is the transaction of the Spanish Government portfolio and that’s under a binding contract. Several other assets also under binding contracts. So it’s a mix. But when you look at closed transactions plus what’s under binding, that’s about 65% of the total plan and then there’s an incremental chunk under contract and transactions in progress. And as Toni mentioned, there’s a small sub piece we’re still working on, but over 90% of that is transactions in progress.

Eric Wolfe: Okay. All right. Thank you.

Operator: And the next question comes from the line of Greg McGinniss with Deutsche Bank. Please proceed with your question.

Greg McGinniss: Hey. This is Greg with Scotiabank. Jason, how much are you hoping to get — how much are you hoping to see cap rates expand from here? What do you consider appropriately priced? And what would you need to see in order to start maybe increasing 2024 investment guidance? Is that more a function of cap rates or transaction availability?

Jason Fox: I mean, it’s a little bit of both. I think they certainly go together. I mean, we’ve seen cap rates come up over the last, call it, the last quarter to where we’re comfortable transacting, I would call it, mid-7s into the high-7s. I think that feels comfortable for us right now. There’s not a lot of market comps out there looking backwards, so it’s hard to peg where the market is right now. But it feels like it’s probably come up 50 basis points and that’s a pretty comfortable place for us to invest. But look, it’s volatile. I mean, look, we — you go back a month and it was a pretty sharp increase up until three days ago and now we’re seeing a bit of a rally in treasury. So it’s hard to predict, of course, but we have a lot of liquidity.

We’re sitting on $2 billion of capital that’s coming in the door over the near-term and so there’s a bias to put the money to work and we think where we’re seeing cap rates right now, especially in conjunction with, say, leasebacks where we have some pricing power, we think that’s a good place to be.

Greg McGinniss: Sorry. And so are you expecting further cap rate expansion from here? As you…

Jason Fox: Look, as of a couple days ago, I would say, yes, we would have expected to see some increasing cap rates over time. And look, I think, the dynamics with cap rates, it’s — on the way up, cap rate movements tend to lag interest rates, and obviously, we had a pretty meaningful move over a short period of time, but not withstanding this week. So disciplined buyers like us tend to push for higher yields and sellers hold out hope. Ultimately that leads to bid-ask spreads kind of widening and the pattern we’ve seen this year is that sellers ultimately move. And I think that’s what we’ll continue to see going into next year, but with this recent rate movement back downward, hard to predict, of course. I think if treasuries settle at the levels they are today and maybe gradually move lower, think there’s a sustained move lower, then I don’t think we’ll see increases next year. But we may not need to in order to do more deals, if that’s the case.