Earnings Call Transcript - WPC Q1 2021

Operator, Operator

Hello, and welcome to W. P. Carey's First Quarter 2021 Earnings Conference Call. My name is Jesse and I will 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. I will now turn today's program over to Peter Sands, Head of Investor Relations. Mr. Sands, please go ahead.

Peter Sands, Head of Investor Relations

Good morning everyone. Thank you for joining us this morning for our 2021 first 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 from 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 pass the call over to our Chief Executive Officer, Jason Fox.

Jason Fox, CEO

Thank you, Peter, and good morning everyone. I'm pleased to report that many of the positive trends we saw in the fourth quarter of 2020 have continued into 2021. We've had a very strong start to the year on several fronts. First, we're already on pace to exceed our initial expectations for investment volume in 2021 and our near-term pipelines are strong, perhaps even stronger than it's ever been with over $500 million of active deals at an advanced stage, much of which we expect to close during the second quarter. Second, we delivered industry-leading rent collections throughout the pandemic and continue to have high confidence in how our portfolio will perform going forward, especially in a macro environment where the US and global economies are expected to improve as COVID cases decline and business activity rebounds. Third, we executed on two significant bond issuances during the first quarter, highlighting our access to very attractively priced capital, locking in record low coupons in both the US and Europe and refinancing the majority of near-term debt maturities with our next meaningful maturity now scheduled in 2024. In the past week, we were also placed on positive outlook by Moody's, which reflects the positive trajectory of our business and balance sheet and gives us confidence that we will continue to have access to attractively priced capital going forward. Fourth, we raised equity through our ATM, accretively funding our recent investment activity and modestly deleveraging compared to where we ended the fourth quarter. We also still have equity proceeds available through the equity forward we raised in 2020. So plenty of flexibility in how we fund our investment activity over the remainder of the year. The combination of closed investments, our active pipeline, strong portfolio performance, and raising capital at attractive spreads on new investments has allowed us to raise our AFFO guidance for 2021. Toni Sanzone, our CFO, will discuss our guidance raise along with our results for the quarter and balance sheet activity. Toni and I are joined this morning by John Park, our President; and Brooks Gordon, our Head of Asset Management. During the first quarter, we completed $214 million of investments comprising $149 million of acquisitions and $65 million of completed capital projects. Our first quarter investments had a weighted average initial cap rate of 6.6% and like virtually all of our investments provide built-in rent growth averaging 2.25% for those with fixed increases which occur over long lease terms averaging 23 years. Reflecting our diversified approach, our first quarter investments span most of our core property types though the bulk of our deals continue to be in industrial and warehouse which currently comprise about half of our portfolio on an ABR basis. I'll touch upon a few of the more notable deals from the first quarter. In February, we completed the $75 million sale-leaseback of two packing, production, and distribution facilities net leased to Primo Wawona the leading vertically-integrated grower, packer, and shipper of seasonal high-value summer fruit in the US. If you like peaches, there's a roughly one in three chance the last one you ate was processed in these facilities. The properties are strategically located in proximity to the tenant's farmland in California Central Valley and represent the majority of its storage, processing, and distribution operations, a significant portion of which is cold storage. The tenant has invested significantly in the facilities, underscoring their criticality and their triple net lease, under a master lease for a 25-year term with fixed annual rent increases. During the quarter, we also completed the $52 million build-to-suit of a new industrial R&D facility in Germany, net leased to American Axle, which is a global Tier 1 supplier of automotive components and systems, including electric drive technologies. The facility is strategically located in a prime industrial park near the Frankfurt Airport and triple net leased for a 20-year term with rent increases tied to German CPI. Since quarter end, we've completed three additional acquisitions, totaling $186 million, the majority of which relates to our second significant investment over the last six months in grocery retail. Specifically in early April, we closed the $119 million sale-leaseback of three hypermarket properties located in Southern and Central France, which rank among the tenant's top-performing sites. They're triple net leased to Casino, one of the largest food retailers in the world. From an ESG perspective, this was also an opportunity to invest in a tenant committed to transitioning to renewable energy. The properties are on a long-term master lease with rent increases tied to French CPI. Including the transactions we completed in April, our investment volume year-to-date totals $400 million. In addition to accretive acquisitions, a meaningful contributor to our future growth comes from the rent increases built into our leases, a significant portion of which is tied to inflation. Given renewed expectations for higher inflation, I'll take a moment to provide a little extra detail on our rent escalations. 99% of our ABR is generated by leases with some form of built-in rent increases. 61% of ABR comes from leases tied to inflation. So if we enter a period of sustained inflation, we remain very well positioned for it to flow through as incremental rent growth. Of our leases with rent increases tied to inflation, the majority, representing 38% of total ABR, is based on uncapped CPI with the largest category being those tied to US CPI. The other 23% of ABR that's tied to inflation includes leases with floors and/or caps, which we refer to as CPI-based. Within this category, the average floor is around 1.5% on an annualized basis and the average cap is approximately 3%. In an inflationary environment, if our 3% caps become relevant, it would likely mean that we would be achieving substantially higher same-store rent growth than we are today. For now, however, the floors continue to be more relevant than the caps, as drivers of annual growth in our leases. Finally, 35% of ABR is generated from leases with fixed rent increases, where the average increase is approximately 2% on an annualized basis. Rent increases generally occur annually, so over time will flow through to rents. Given the profile of our rent escalations, we believe we are well positioned as net lease REITs for inflation. Turning to how we're positioned in the current environment. In the US, with economic indicators trending positive on the back of a vaccine-led recovery, we're seeing strong deal flow across almost all property types, the exception being office, where sellers seem to be taking a wait-and-see approach, given the significant rise of work-from-home during the pandemic. Industrial assets continue to be aggressively pursued by a wide range of buyers but it remains a very deep and diverse sector and we continue to find plenty of accretive opportunities as our recent transaction momentum demonstrates underpinned by our cost of capital. As the manufacturing sector continues to gather strength in the US, it should support growing interest in sale-leasebacks as a means of freeing up capital to be redeployed in company's core businesses. In Europe, while competition also remains strong for industrial assets, our significantly lower cost of debt in the region results in spreads that are generally 50 to 100 basis points wider than for comparable assets in the US. Food retail, particularly grocery, has proven to be a resilient sector during the pandemic and has seen further cap rate compression, especially in the US, driven by a flight to quality. We generally prefer retail in Europe, where there's lower retail square footage per capita, higher barriers to entry, and less competition. As our recent sizable investments in retail grocery illustrate, we have good access to deals in the sector, successfully executing on top-performing stores. A recent market theme in Europe has been the record amounts of real estate being sold by companies, as they look to shore up their COVID-impacted balance sheets. As the market leader for sale-leaseback transactions in the region, this is a positive trend that expands our addressable market and we're confident in our ability to capture our share of deals. Before I conclude my remarks, I want to briefly touch on spreads and our ability to continue generating growth, even in an environment where cap rates remain tight. Our cost of debt has become increasingly efficient in recent years. In Europe, we issued nine-year bonds during the first quarter, with a coupon below 1%. And in the U.S., we issued 12-year bonds with a coupon in the low twos. In addition, our investments continue to have attractive built-in growth. And we originate leases that tend to be the longest in the net lease sector. We believe it's important for investors to understand not only the day one accretion from our going-in cash cap rates but also the average yield we are achieving over lease terms of 20 years or more with strong annual rent bumps. For an investment within the initial cap rate in the mid-6s, the average yield over 20 years with 2% annual rent bumps is approximately 8%. In closing, through a combination of the deals we've closed to date, the capital projects and commitments scheduled to complete this year, and a near-term pipeline that's the strongest we've seen in many years, we're on track for a record year for deal volume, supported by favorable cost of capital, substantial liquidity and the flexibility to access capital markets opportunistically. And with that, I'll pass the call over to Toni.

Toni Sanzone, CFO

Thank you, Jason, and good morning everyone. This morning we reported AFFO of $1.22 per diluted share and real estate AFFO of $1.19 per share. We had a strong first quarter on all fronts, with our investment activity and debt refinancings positioning us well to raise our earnings expectations for the remainder of the year. And as Jason mentioned, we have over $500 million of active deals in our near-term pipeline. Our portfolio continues to perform consistently well, as it has since the start of the pandemic, with first quarter rent collections at 98% of ABR. The number of tenants with rent disruption remains very small and manageable, with no new themes to report. During the first quarter, we had one retail tenant in Europe partially pay rent as a result of a temporary lockdown. And we excluded the unpaid portion totaling $2.9 million from AFFO, in line with our continued conservative approach to revenue recognition. We're actively pursuing this rent and would only recognize it in revenue and AFFO once there is more certainty of collection. As a reminder, we had no significant rent receivable from 2020, and minimal rent deferrals. The few deferrals we did have were part of broader lease restructures, where the deferred rent amount is now reflected in current ABR and the tenants have resumed paying rent. Overall, our collection rate remains very strong and on track with our expectations for the year, with April collections in line with the first quarter. As such, going forward, we will be reporting rent collections on a quarterly basis. Turning to same-store rent growth, comprehensive same-store rent growth which is based on pro-rata rental income included in AFFO was negative 0.6% year-over-year, in part reflecting the fact that the prior period was pre-COVID. As we've previously noted, this metric will move around from quarter-to-quarter, especially as COVID-related disruptions and rent recoveries flow through the period-over-period comparisons in our results. For the full year, we expect our comprehensive same-store rent growth to be in line with our pre-COVID growth rates. Contractual same-store rent growth which reflects the average rent increases in our leases was 1.6% year-over-year, a 10 basis point increase over the fourth quarter, driven primarily by a rent escalation for Advanced Auto, which has moved back into our top 10 tenant list, as a result. Leasing activity for the quarter was primarily comprised of five-year lease extensions on properties leased to Obi, a do-it-yourself retailer in Europe, extending the maturities from 2024 to 2029 with full rent recapture on $14 million or 1.2% of ABR and no capital outlay. On a trailing eight-quarter basis, we've recaptured 95% of the prior rent which relates to 11.5% of ABR and added 7.2 years of incremental lease-term while spending just $1.44 per square foot on tenant improvements and leasing commissions. Moving on to our balance sheet activity, the first quarter was a busy quarter for our capital markets activity, raising over $1 billion in well-priced, long-term and permanent capital. In February, we issued $425 million of 12-year senior unsecured notes, at a coupon of 2.25%, representing a 108 basis point spread to the benchmark treasury. Also in February, we issued €525 million of nine-year unsecured notes, at a coupon of 0.95%, representing a 110 basis point spread to the benchmark. I'm pleased to say both of these bond issuances were executed at our tightest spreads and lowest coupons to date, demonstrating continued strengthening of our credit profile. Proceeds from these offerings were primarily used to prepay approximately $400 million of mortgages with a weighted average interest rate just over 5% and for the early redemption of €500 million bond, which carried a 2% coupon and was scheduled to mature in 2023. In addition to taking advantage of favorable market conditions and getting ahead of a rising interest rate environment, we effectively reduced refinancing risk by addressing the majority of our debt due before 2024, while extending our weighted average debt maturity from 4.8 to 5.9 years. In addition, we further advanced our unsecured debt strategy, reducing secured debt as a percentage of gross assets to 4.6%, down from 7.2% at the end of the fourth quarter and increasing our unencumbered ABR to 87%. Locking in these long-term rates also resulted in an overall reduction to our weighted average cost of debt by 20 basis points to 2.7%, which is expected to generate annualized interest savings of approximately $17 million. Since the debt repayments occurred closer to the end of the first quarter, we expect to see the interest savings start to flow through earnings more meaningfully beginning in the second quarter. On the equity side, during the first quarter we tapped into our ATM program issuing just over two million shares of common stock at a weighted average price of $70.26 per share, raising net proceeds of $140 million. So far in the second quarter, we've issued just over 443,000 shares at a weighted average price of $71.67 per share, raising additional net proceeds of approximately $31 million. We continue to have the flexibility to settle approximately 2.5 million shares under forward agreements in 2021 for anticipated net proceeds of approximately $160 million. From a leverage perspective, we ended the first quarter with debt-to-gross assets of 41.2% and net debt to adjusted EBITDA of 5.9 times, which does not factor in the additional equity we have available to issue under forward agreements. We continue to target debt-to-gross assets in the low to mid-40% range and net debt to adjusted EBITDA in the mid to high five times. Our successful execution raising capital this quarter has bolstered our already strong balance sheet with over $1.8 billion credit facility virtually undrawn at the end of the quarter, ensuring we remain extremely well-positioned to execute on our investment pipeline and retain significant flexibility on when we decide to access the capital markets. Turning now to our 2021 guidance. As announced this morning, we've raised our AFFO guidance range by $0.06 at the midpoint, driven primarily by the strong momentum in our investment activity year-to-date both in terms of volume and pace as well as by the interest savings we will generate from the debt refinancing activity I discussed earlier. We've increased our investment volume range to between $1.25 billion and $1.75 billion, which always includes capital investments and commitments scheduled to complete this year. Our expectations for disposition activity remain unchanged at between $250 million and $350 million for the year. Year-to-date disposition activity has generated about $93 million in proceeds including $79 million that closed in the second quarter. Our guidance continues to assume uncollected rents of between 1% and 2% of ABR. We continue to expect G&A expense for the full year to fall within our original range of $79 million to $83 million. And I'll note that our first quarter G&A generally trends higher than other quarters due to the timing of payroll-related taxes and is therefore not a run rate for the rest of the year. Embedded in our AFFO guidance is $9.7 million of cash dividends generated by other real estate investments, which we spoke about on our last earnings call. In January, we received a $6.4 million dividend on our common equity investment in Lineage Logistics, which we assume will be the only distribution we receive from Lineage this year. And in April, we received $3.3 million of preferred stock dividends on our investment in Watermark Lodging Trust, reflecting the amount due for the prior four quarters. These dividends will be the primary components of a new line item on our income statement called non-operating income. Taking all of this together, for the full year, we currently expect total AFFO of between $4.87 and $4.97 per share, including real estate AFFO of between $4.74 and $4.84 per share. In closing, we remain focused on growth. Our strong start to the year and robust pipeline put us on a path to deliver our highest annual investment volume since converting to a REIT. Furthermore, our balance sheet is well positioned for rising rates, with no significant maturities until 2024, and we have one of the best positioned net lease portfolios with embedded rent growth especially for an inflationary environment. And with that, I'll hand the call back to the operator for questions.

Operator, Operator

Thank you. Our first question is coming from the line of Harsh Hemnani with Green Street. Please proceed with your question.

Harsh Hemnani, Analyst

Thank you. I just wanted to ask in light of yesterday's deal of Realty Income acquiring VEREIT, do you feel like the competitive landscape will change with Realty Income entering continental Europe and whether that will make it more difficult or competitive for you to get deals there?

Jason Fox, CEO

Hey, good morning. Yes, I don't think it really changes anything. Certainly, they're now a larger net lease REIT, but they've been making progress moving towards Europe, the UK first, and based on what we read that they say Europe next. And it's a big market over there. It's as large if not larger than the United States, and is actually a higher percentage of owner-occupied real estate, so the sale-leaseback market is even deeper. Generally, we don't compete directly with them in the US. There's probably a little bit more overlap with what we do in Europe, but I don't think this changes things. And if anything, I'll say that anything that brings attention to the net lease space, maybe in particular a diversified model within the net lease space and one that includes geographic diversification, I think that's a positive from my point of view.

Harsh Hemnani, Analyst

Thank you. And then another one for me. Can you talk about the occupancy declines on a sequential basis in the past two quarters? What is driving this? And then can you talk about what you're expecting going forward? I know you don't provide guidance on this but just your outlook would be helpful.

Brooks Gordon, Head of Asset Management

Sure. Vacancy did tick up slightly. It's a few properties, I think, five over that period that have come off lease. Not really any trends in there; pretty anecdotal. We do expect occupancy will tick back up to in the 99% range. Over the course of this year, there's a lot of activity in process active deals on roughly 30% of that vacant square footage and good prospects on the balance. So that will go up and down in any given quarter, but we would expect it to remain in that 99% range in the long run.

Harsh Hemnani, Analyst

Okay. Thank you.

Brooks Gordon, Head of Asset Management

You're welcome.

Operator, Operator

Thank you. Our next question is coming from the line of Joshua Dennerlein with Bank of America. Please proceed with your question.