[WPC stock] WP Carey Q4 2020 Earnings Call (2/12/21)

Thank you, Peter, and good morning everyone. 2020 was a year unlike any other in W.P. Carey's almost 50-year history. Throughout the economic upheaval produced by the worst global pandemic in over a century, our portfolio has proven itself to be exceptionally resilient. After stalling mid-year, market activity continues to accelerate, and as we look ahead to 2021, we're extremely focused on increasing our investment volume, supported by substantial liquidity, proven access to capital, and a robust near-term pipeline. On today's call, I'll briefly recap 2020, including our recent investment activity, what we're currently seeing in the transaction market, and how we're building on the deal momentum we saw in the fourth quarter. After that, I'll hand it over to Tony Sanzone, our CFO, who will briefly review our results, key aspects of our portfolio and balance sheet, as well as our 2021 guidance. Tony and I are joined this morning by our President, John Park, and our Head of Asset Management, Brooks Gordon, who are available to take questions later in the call. Given the enormous impact the pandemic has had on our daily lives, I'd like to start by acknowledging our employees and say how proud I am of the way our entire team has adapted and continues to perform to the highest standards. I'd also like to mention a recent ESG accomplishment that we're very proud of. In January, W.P. Carey had the honor of being one of just a few REITs added to the 2021 Bloomberg Gender Equality Index, which recognizes companies showing leadership in advancing women in the workplace and a commitment to transparency in gender reporting. In recapping 2020, I'll start with our balance sheet positioning and capital markets activity, which support our ability to increase our investment volume in 2021. One of the first significant steps we took in 2020 was to renew our credit facility. Strong demand in the bank market for our credit allowed us to increase its size and improve our pricing, duration, and other terms. Maintaining ample liquidity ensures we have the flexibility to raise capital when market conditions are favorable rather than out of necessity. So when equity markets moved sharply lower from late February through to late March and volatility reached extreme levels, we remained extremely well positioned with a $1.8 billion revolving credit facility that was almost entirely undrawn, very limited near-term mortgage maturities, and no bonds maturing until 2023. Once equity markets stabilized, regaining much of their initial losses, we took the opportunity to further enhance our balance sheet with a forward equity offering in June, locking in our ability to match fund acquisitions accretively with well-priced equity. In October, we successfully completed a senior unsecured notes offering. Strong demand allowed us to significantly upsize the deal and issue U.S. bonds at our tightest ever spread to the benchmark 10-year Treasury rate, which at the time was also the lowest coupon rate ever for a 10-year net lease bond. Our balance sheet strength was coupled with superior portfolio performance. Since the start of the pandemic, we've reported our rent collections on a monthly basis, which were consistently in the high 90% range for the second half of 2020, ranking among the best in the net lease sector as well as REITs generally. This is a direct result of our approach to net lease investing, characterized by deep credit underwriting focused on mission-critical properties leased to large tenants operating in recession-resilient industries. It also reflects the protections built into our leases and the effectiveness of our asset management team. During the initial stages of the pandemic, transaction markets slowed significantly in both the U.S. and Europe. We also paused external acquisitions as we focused on preserving financial flexibility. Market activity soon rebounded, however, and by the third quarter, our pipeline returned to pre-pandemic levels, and we ended the year with renewed momentum, closing just over half of our 2020 external acquisitions during the fourth quarter. Turning now to our fourth quarter investment activity in more detail, we completed investments totaling $310 million during the quarter with a weighted average cap rate of 6.4% and a weighted average lease term of 21 years. This activity brought our total investment volume for 2020 to $826 million at a weighted average cap rate of 6.5% and a weighted average lease term of 20 years, helping maintain an overall portfolio weighted average lease term of 10.6 years. The majority of our 2020 acquisitions were sale-leasebacks, which generally allow us to negotiate better contractual release terms compared to secondary market deals. To give context to the 6.5% average cap rate on our 2020 investments, it's important to also consider the attractive embedded growth we achieve. In the large majority of our deals, about three-quarters of our 2020 deal volume had fixed rent increases with a weighted average increase of 2.4% annually, with the remaining 25% having rent increases tied to inflation. I'll touch upon two of our fourth quarter transactions in more detail, both of which were in industries that have performed well during the pandemic. In early November, we announced the roughly $100 million sale-leaseback of a 27-property supermarket portfolio located in northern Spain and the Balearic Islands with Arosky, which is one of the largest supermarket chains in Spain and an existing tenant of W.P. Carey. The portfolio is primarily located in dense residential neighborhoods with limited local competition. Strict planning laws and licensing requirements create significant barriers for new entrants, thereby increasing the inherent value of these proven sites. The portfolio is triple net leased under three 20-year master leases with rent increases tied to Spanish CPI. As we look to accelerate our external growth, this transaction exemplifies our ability to make substantial investments into areas like essential retail, especially in Europe where there's less competition. From an ESG perspective, I'm pleased to say this transaction was also an opportunity to expand our investment in a tenant committed to sustainability through a variety of initiatives, including minimizing the environmental impact of its logistics and transportation operations. In combination with the existing warehouse and retail properties in our portfolio, their net lease to Arosky now comprises 1.6% of total ABR, placing it among our top 10 tenant list. As a result, Advanced Auto Parts, which is one of our largest investment-grade tenants, now sits just outside the top ten. The other transaction I'll highlight is a further example of a follow-on investment with an existing tenant in an off-market transaction. In December, we completed a $23 million investment in a distribution facility in Utah that is leased to Orgill, the world's largest independent hardware distributor. The modern facility serves as a key distribution center strategically located along Interstate 15. We also committed to an additional investment of approximately $20 million for a 430,000 square foot expansion, which is scheduled for completion in 2022. The facility is triple net leased with fixed increases for a 20-year term that resets upon completion of the expansion. Warehouse and industrial properties comprised about two-thirds of our fourth quarter investment volume and three-quarters of our total investment volume for 2020, resulting in those categories edging higher to represent a combined 47% of total ABR at year-end. During the fourth quarter, we also capitalized on a very unique and attractive opportunity to increase our investment in the privately held equity of Lineage Logistics, the world's largest temperature-controlled industrial REIT. We've been investing in the cold storage industry for over 20 years, a business we long ago recognized as having the potential to transform the way perishable food is distributed. In connection with several sale-leasebacks with Lineage, we made our first investment in its equity in 2011 within CPA 17, which had an original cost basis totaling $28 million and is currently marked at $195 million based on Lineage's most recent equity raise. While we remain long-term holders of net lease cold storage assets, Lineage's desire to buy back certain properties allowed us to opportunistically enter into what was essentially an asset swap with them during the fourth quarter, exchanging two cold storage facilities for an additional approximately $95 million equity stake in the company. This brought the total value of our equity investment in Lineage, including the mark on our original investment, to approximately $300 million, the large majority of which was established at a significantly lower basis. In addition, Lineage recently paid its first dividend, which Tony will discuss in the context of our 2021 guidance. Given Lineage's rapid growth and the trading multiples of its publicly traded REIT peers, we expect our investment to further increase in value, thereby creating additional value for W.P. Carey shareholders, which can be harvested should Lineage go public over the next few years. Turning to the market environment and pipeline, after slowing dramatically mid-year, transaction volume in the U.S. accelerated during the second half of 2020 as investors came off the sidelines on the back of vaccine developments and a favorable interest rate backdrop. Cap rate compression continued, particularly for industrial and essential retail properties, driven by a flight to quality and historically low interest rates. In Europe, initial expectations of pent-up demand for sale-leasebacks in the second half of the year did not materialize, in part due to the alternatives that government programs provided. 2021 has started with a different tone, however, and we're seeing increased interest in sale-leasebacks by companies, which is also the case in the U.S. While there is also no shortage of capital chasing deals in Europe, especially for food retail and industrial, we remain competitive there, which is reflected in both our recent deal closings and growing pipeline. Looking ahead, we expect market activity in both regions to accelerate in 2021, supported by low interest rates and increased economic activity on the back of government stimulus, as well as hopes that the vaccine rollout will boost economic recovery. Cap rates are likely to remain low in both regions, although possibly tempered by the prospect of inflation and ultimately higher interest rates in the U.S. While the potential for repeal of 1031 tax-free exchanges has garnered a great deal of interest and could affect overall market activity, it's not a critical part of our business and we don't expect it to impact our deal flow. As I mentioned, the transaction momentum we saw in the fourth quarter has extended into 2021. Year-to-date, we've completed investments totaling $203 million, comprising three acquisitions and two completed capital investment projects. We currently have an additional $102 million of capital projects scheduled for completion this year, and we also have a very active near-term pipeline with over $300 million of investments that are at an advanced stage, including deals where we have a purchase agreement in place. Given that we're still in February, we're confident in our ability to meaningfully increase our investment volume relative to recent years. And with that, I'll hand the call over to Tony.

Yeah, good. Chris has been with us for I think probably about 10 years now, and he's been leading transactions over there for quite some time. So it is a new title that we've given this year, and he'll still report back across the pond to Gino. But to your question, yeah, we are seeing a pickup in Europe. I think 2020 was a little slow. We started off the year with a deal in Europe and we ended the year with the Arosky deal that we talked about earlier, but not much in between. And we've seen things pick up a little bit more in Europe. Again, it's one of the benefits of being diversified across asset classes and industries but also geographies. We have an opportunity to provide incremental growth by doing deals in different regions, and we hope that continues to pick up.

Right, sure. The 75% of fixed increases is a little bit higher than what we've done in the past, and sometimes it comes down to negotiations. We do like having a portion of our leases anchored with fixed increases. I think right now it's about a third of them are fixed increases, with about two-thirds of our total ABR indexed to inflation. Out of that two-thirds, about 40%, maybe a little over 40%, is uncapped, with the remaining 20% to 25% having some kind of cap and floor. To your last question, the CPI base typically has some kind of cap and floor. In some cases, it might even have a multiple of CPI capped at some level. Brooks, I don't know if you have any data on what those caps and floors look like.

Just to clarify one point there, on the uncapped CPI, there are floors in there as well. In some cases there may be floors, but uncapped, by definition, you don't have limits on the upside. And virtually all of these CPI leases, and I don't think you're suggesting it's going to go in this direction, but there is an implied floor of 0% in virtually all of the CPI leases.

Yeah, certainly cap rates have continued to trend down. If you look at industrial properties specifically, and that's where we're focusing a lot of our new investments, we're back to probably well inside of pre-COVID levels at this point, maybe even by 50 to 100 basis points. That's the broader market, of course. We're probably flat to maybe where we were in the fourth quarter. But we've talked previously, we look at deals across a wide range of cap rates, and we think we can do creative transactions into the low fives and maybe even sub-5% cap rates, depending on the rent increases that are embedded in the lease. These would be for higher quality logistics properties, maybe like the Persentius deal or the Orgill deal that we closed last year, both of which are warehouses. But we also still have a good pipeline of deals with cap rates into the sixes and even in the sevens. These are our typical sale-leasebacks where we can drive some incremental yield through how we source these transactions and in the structuring. And then we also look at a lot of deals within the industrial asset class but maybe outside core logistics, such as light manufacturing. We've been doing some food production facilities which are highly critical and non-discretionary products being produced. We mentioned cold storage, some R&D, all property types that we've had success targeting and ones where we think we can generate some incremental yield. You mentioned earlier that our 2020 weighted average cap rate was around 6.5%. I think we'd be probably in that zip code for 2021, perhaps trending slightly lower given where the markets are, but also depending on the mix of the types of properties we acquire. Lastly, cap rates don't always tell the whole story. Unlike maybe many of our peers, our leases have meaningful contractual rent increases, so headline cap rates for us are going to produce higher spreads to our cost of capital potentially given those built-in bumps.

You're welcome.

I think our expectation is that we're going to be doing a meaningful portion of that, probably the vast majority, as sale-leasebacks. We have great relationships with our tenant base for follow-on deals, within the brokerage community. We source deals through private equity sponsors in many cases; they're follow-on deals with their portfolio companies. And you're right, there's correlation with M&A, and I think that's part of the reason why we have and would expect to continue to see some uptick in sale-leasebacks. And we're also seeing build-to-suits, though, and that's a similar structure in many ways. A couple of those build-to-suits might be more structured as takeouts upon completion, so not technically a sale-leaseback, but I think you'll see a lot of the deal flow that comes in will have the same benefits that we get out of sale-leasebacks.

Yeah, we've been underweight office for quite some time, and it's trended that way. If you look back maybe four or five years, our percentage of ABR was a little north of 30%. At this point, it's down in the low 20s, and I would expect that trajectory to continue that way, partly as we continue to overweight industrial, but also I think office is something that we will do on occasion. I'd probably characterize it more as opportunistic, where it will require longer lease terms, stronger credits. We generally underwrite those conservatively, especially these end scenarios. For a lot of those reasons, we're not generally competitive given our underwriting, so I don't think you'll see much change there because of the pandemic. We'll remain underweight.

Yeah, sure. We just did the Arosky transaction in the fourth quarter that we went through in some detail earlier, and that's a follow-on deal with a tenant that we've had a long-term relationship. It's now in our top ten, and we'd like to do more grocery. In the U.S., we are interested as well. I think we're probably more focused on doing portfolio deals where we can get critical mass and structure on master leases to provide some more long-term protection. In the U.S., I think the fundamentals are probably not quite as favorable as they are in Europe. The U.S. tends to be a little bit more oversupplied with less barriers for new development compared to Europe. There's also lots of competition in the U.S. chasing the same deal. So I think that we have better economics with less competition, and we generate better spreads given the low cost to borrow. So we would expect to look to do more deals there, probably more biased towards Europe for those reasons I mentioned, but we hope to find some good opportunities in the U.S. as well.

Yeah, I think it's a good point. It's becoming incrementally more competitive, but we still feel like we have a real advantage in that space. Incrementally more competitive, but it's still a much smaller universe of buyers compared to the broader net lease market. A lot of the deals will be limitedly marketed where execution is still kind of the highest priority. Obviously pricing is important as well, but pricing doesn't matter if there's no deal that closes. So I think we still have an advantage there. A lot of the deals we've done recently, for instance the Arosky deal, that was a purely off-market deal. We're not aware that others had any conversations with the company. A lot of that is because of our reputation in Europe, but in that case also it was an existing tenant and we've had good execution with a number of sale-leasebacks with them in the past. But I think your point is well taken. There are perhaps more players in the sale-leaseback market than there have been, say, five years ago.

That was not an option. They approached us. As many people know, they are now a REIT, so they have some motivation to own more of their properties than to lease them. We've done a number of sale-leasebacks with Lineage, especially early when the company was just being formed. So that was something that they approached us, and we've had conversations with them for several years now. It felt like this was the right time to do it given that they were aggressively valued from the disposition side, but also we really see a lot of value in increasing our investment in the operating company. For starters, we're very bullish on cold storage and we've been so for quite some time, maybe dating back over 20 years when we first began acquiring temperature-controlled warehouses. And we're even more bullish on Lineage: number one market share globally, probably by a wide margin, great management team, top-notch sponsorship in Bay Grove, and they have really proven their ability to grow. So it was more opportunistic than anything else. And second question about options: we've talked about U-Haul before. That is something where they have an option at the end of the 20-year lease term in 2024. Occasionally there are options in leases. I think most of them are structured as a greater of fair market value and some amount greater than our original purchase price, so we can capture the upside in most cases. The U-Haul one is a little different; it was a fixed price based on the original purchase price grown by inflation over the 20-year period. So that's the meaningful one that's in our portfolio, and we've talked about that before.

It's a good question. Certainly that capital is competitive to sale-leasebacks. I think companies can fund their capital needs through a number of options, but one of course is a sale-leaseback where they can unlock any capital that's tied up in their real estate. So it's probably competitive in some ways, but I also say that the low interest rate environment we're in right now, which is what's driving the high-yield markets lower, maybe it's more impactful on sale-leasebacks where companies can really lock in historically low interest rates or low rental rates for 20-plus year periods. And the other merits of a sale-leaseback still apply: it's permanent capital, no debt that needs to be repaid. In our opinion, companies should optimize their balance sheet, and that does not include owning real estate. Our cost of capital is set up to own a diversified portfolio of real estate. Corporates are better off unlocking that capital and reinvesting it into their core business and generating a more appropriate return for their shareholders that way.