Earnings Call Transcript - WPC Q3 2021

Operator, Operator

Hello, and welcome to W. P. Carey's Third Quarter 2021 earnings conference call. My name is Brock 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'll be taking questions via the phone line, instructions on how to do so will be given at the appropriate time. 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 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 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 will 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 say our third quarter results keep us on pace to deliver strong year-over-year AFFO growth. We continue to see strong deal momentum during the quarter for 2021, set to be a record year for investment volume. Having already surpassed our full-year investment volume for all prior years and establishing a new phase of externally driven growth for W.P. Carey. We're also entering a period of higher internally driven growth with inflation ticking up in recent months and generally expected to last longer than originally anticipated. W.P. Carey is uniquely positioned to benefit. Higher inflation had a positive impact on our same-store growth during the third quarter, especially for leases tied to uncapped CPI. However, it is really just the start, with the bulk of the impact occurring over the next few quarters. Consequently, we believe W.P. Carey currently offers one of the best combinations of external and internal growth across the net lease sector supported by the strength of our near-term pipeline, ample liquidity, and continued access to well-priced capital, in addition to providing an attractive dividend yield. This morning I'll focus my remarks on these aspects of our growth, and Toni Sanzone, our CFO, will take you through the details of our results for the quarter, guidance, and balance sheet positioning. Toni is now joined by our President, John Park, and our head of asset management, Brooks Gordon, who are available to take questions. Starting with growth through acquisitions. During the third quarter, we completed about $200 million of investments primarily into Class A warehouse properties in the U.S. at a weighted average initial cap rate of 6.2%, bringing our total deal volume for the first nine months of the year to $1.2 billion at a weighted average initial cap rate of 5.9% and a weighted average lease term of 19 years. This is among the longest for new investments across the net lease sector. Our ability to structure these deals with long lease terms and strong rent increases averaging over 2% translates to an average annual yield of over 7%, a metric that we believe better captures the prolonged accretion we're achieving. It's also meaningfully more attractive than that of most of our net-lease peers, who tend to be investing in shorter-term leases, lower, or even no bumps. In addition to entering a new phase of externally driven growth, we're also entering a period of higher internally driven growth with one of the best-positioned net lease portfolios for inflation. One of the key benefits of our focus on originating sale leasebacks is our ability to directly negotiate the lease structure, including the rent bumps. As a result, we've constructed a portfolio in which 60% of ABR has rent increases tied to inflation. During many years of low inflation, our rent growth was driven by leases with fixed rent increases. But with inflation picking up in recent months, we expect leases tied to inflation to drive rent growth and strongly outpace the 2.3% average fixed rent bump we saw for the third quarter. Inflation began to flow through to rents during the third quarter, although on a relatively small portion of our portfolio. Leases with CPI-linked rent increases that went through scheduled rent adjustments during the quarter experienced rent increases averaging 3.3%. The vast majority of CPI-linked leases that did not bump during the third quarter are scheduled to do so over the next nine months, adding about 100 basis points to our same-store rent growth based on current inflation forecasts. Taking it from about 1.5 percent to about 2.5 percent. Higher same-store growth is especially valuable in an environment where investment spreads are expected to continue to compress. And if inflation runs higher or for longer than currently anticipated, we would expect to see additional upside. Turning to the market environment and our pipeline. During the quarter, we saw a continuation of many of the dynamics that have driven the transaction market in recent quarters, with continued cap rate compression, both in the U.S. and Europe, largely fueled by private capital. Warehouse industrial remains sought-after asset classes in both regions, and logistics assets are traded at especially tight cap rates in Europe. While these trends look set to continue, heightened M&A activity is spurring a steady flow of deals, in part driven by the attractive valuation arbitrage that exists for private equity investors between the multiples at which they acquire businesses and real estate values. More broadly, M&A activity is expected to continue at record levels, which is positive for the supply of sale-leaseback opportunities. From a top-down perspective, we continue to focus predominantly on warehouse and industrial assets, which comprised about three quarters of our deal volume through the end of the third quarter. Moving the ABR we generate from these property types 40 basis points higher to 48.7%, while the proportion of ABR we generate from office properties has continued to decline. So far in the fourth quarter, we've completed an additional $41 million industrial investment and we expect to maintain a strong pace of activity into year-end, including $100 million of capital investments and commitments scheduled for completion during the fourth quarter. Our pipeline remains strong and includes a handful of larger portfolio deals that are working towards closings around year-end. This is reflected in our investment volume guidance range, which we're maintaining at $1.5 to $2 billion. Depending on the number of deals that come to fruition and their eventual timing, it could take us to the top end. Lastly, I want to briefly mention our recent green bond offering. We are proud to have successfully completed our inaugural green bond issuance earlier this month, with the proceeds allocated to new and existing eligible green projects. This was a major milestone demonstrating our commitment to ESG, and we note that we have one of the best ESG profiles in the net lease peer group. We were the first net lease REIT to provide an annual ESG report to the market, which we've been publishing since 2019. We were the second net lease REIT to issue a green bond, and the first to do so in the U.S. We were very pleased with the execution, achieving one of the tightest ever spreads for net lease REIT on a 10-year bond offering. It also allowed us to further diversify our investor base to include ESG-focused investors, which we hope will continue to be a source of capital for W.P. Carey as we acquire more eligible buildings and seek opportunities to redevelop existing properties to enhance their sustainable characteristics. In closing, we remain focused on creating value for our investors through both accretive investment opportunities and the rent growth built into our leases, offering potential additional upside from sustained higher inflation. We expect our recent pace of investment activity to continue in 2022. As a result, we believe W.P. Carey currently offers one of the best combinations of external and internal growth across the net lease sector, plus one of the most compelling dividend yields at around 5.5%, supported by our stable cash flows, the strength of our pipeline, ample liquidity, and continued access to well-priced capital. And with that, I'll pass the call over to Toni.

Toni Sanzone, CFO

Thank you, Jason. And good morning, everyone. During the third quarter, we continued to make good progress towards our full-year guidance, with our results showing steadily increasing lease revenues and the continued decline in interest expense. For the quarter, we generated total AFFO of $1.24 per diluted share, driven by real estate AFFO of $1.21, representing 8% year-over-year growth. Our third-quarter results build on the momentum we established during the first half of the year for investment volume, reflecting the new phase of external growth Jason referred to, but also demonstrating the quality of our portfolio due to continued strength of our rent collections and a growing contribution from rent escalations. We continue to expect that we will complete record investment volume in 2021, totaling between $1.5 and $2 billion. Accordingly, we're also maintaining our full-year AFFO guidance range of $4.94 to $5.02 per share, including real estate AFFO of between $4.82 and $4.90 per share, representing over 5% annual growth at the midpoint. Turning to our same-store rent growth. Contractual same-store rent growth, which reflects the rent growth built into our leases was 1.6% year-over-year, a 10 basis point increase over the second quarter. However, as Jason discussed, higher inflation is just starting to flow through to rents. Within this metric, our same-store growth from leases tied to uncapped CPI was 50 basis points higher than it was for the second quarter. Comprehensive same-store rent growth, which is based on pro-rata rental income included in AFFO, increased 90 basis points over the second quarter to 2.9%, primarily reflecting COVID-related recoveries and restructurings over the past 12 months, in addition to the positive impacts of inflation on rents. Among our other key portfolio metrics, occupancy increased 40 basis points during the quarter to 98.4%. We ended the quarter with a weighted average lease term of 10.6 years, and a top 10 concentration of 20.5%, among the lowest in the net lease sector. Third quarter dispositions totaled $30 million, bringing total dispositions for the first nine months of the year to approximately $130 million. Based on our current visibility into the timing of certain sales, we are maintaining our expectations that total disposition activity for the year will fall between $150 and $250 million. Moving to our capital markets activity and balance sheet. We've demonstrated ample access to well-priced debt and equity this year, issuing about $2.2 billion of long-term and permanent capital, supporting both our increased pace of investment activity and the refinancing of higher-cost mortgage debt with lower-cost unsecured debt, as well as further enhancing our credit profile and demonstrating our commitment to ESG. During the third quarter, we settled equity forward agreements on 2 million shares for net proceeds of $147 million. This occurred close to the end of the quarter, so it will be fully reflected in our fourth quarter diluted share count. In August, we executed our second equity forward for the year, pricing a public offering of 5.2 million shares, including the full exercise of the underwriter's overallotment option, enabling us to match fund acquisitions with approximately $400 million of equity raised at a gross price of $78 per share. Currently, we have the ability to settle the remaining 7.2 million shares under forward sale agreements for anticipated net proceeds of about $540 million. Turning to our debt capital. As Jason discussed, we're proud to be among the first net lease REITs to issue green bonds. In October, our inaugural green bond offering raised $350 million at a coupon of 2.45% with a 10-year maturity, with an amount equal to the net proceeds to be allocated to eligible green projects in accordance with our Green Financing Framework, a copy of which appears on our website. Approximately 70% of the proceeds have already been allocated to existing green investments. We were able to upsize the transaction and priced at our tightest spread to date for a U.S. dollar denominated bond, reflecting both strong support for our credit and incremental demand created by our ability to access ESG-focused investors. Year-to-date through today, we've issued unsecured notes totaling $1.4 billion with a weighted average interest rate of about 1.7%, inclusive of the green bond issued after quarter-end. During that same year-to-date period, we've prepaid secured and unsecured debt totaling $1.3 billion with a weighted average interest rate of 3.5%, including about $300 million of secured mortgage debt subsequent to quarter-end, which had a weighted average interest rate of 4.4%. The combination of our green bond issuance and mortgage repayments occurring after quarter-end extends our weighted average debt maturity from 5.3 years to 5.7 years, and reduces our secured debt as a percentage of gross assets from 4.2% to under 3%. We currently have no bond maturities until 2024, and we remain on positive outlook for Moody's. Our key balance sheet metrics remain strong, ending the third quarter with a debt-to-gross assets ratio of 40.4%, which continues to be at the low end of our target range of mid-to-low 40s. Net debt to EBITDA was 5.9 times at the end of the third quarter, also within our target range of mid-to-high 5 times, and meaningfully lower if we factor in the proceeds from shares to be settled under outstanding equity forward agreements. While we expect the proceeds from our outstanding equity forwards to be primarily used to fund new investments, they nonetheless provide us with additional flexibility in managing our balance sheet. Our cash interest coverage ratio continues to trend positively, ending the quarter at 5.7 times, among the strongest in the net lease peer group, steadily increasing as our weighted average cost of debt has declined through debt refinancings. At the end of the third quarter, our weighted average interest rate was 2.6%, a significant decline from 3% a year ago, reflecting the continued improvement in our cost of debt and generating substantial year-over-year interest savings. Our liquidity position also remains very strong, ending the third quarter with total liquidity of approximately $2.2 billion, including $1.5 billion of availability on our revolving credit facility, cash on hand, and net proceeds available under equity forward agreements, ensuring we're well-positioned to continue executing on ideal pipeline and accessing the capital markets opportunistically. To sum up, we're pleased with our results for the third quarter, including the progress we made towards our full-year guidance and the pace of our investment activity. We remain well-positioned for continued higher growth, both externally and internally driven, given our active pipeline and sector-leading same-store growth profile, all of which is supported by the strength and flexibility of our balance sheet. And with that, I'll hand the call back to the Operator for questions.

Operator, Operator

Thank you. We will now take questions. Please hold on while we collect them. The first question today comes from Brad Heffern of RBC Capital Markets. Please go ahead with your question.

Brad Heffern, Analyst

Thanks. Good morning, everybody. I was wondering if you could do a quick walk on the ABR quarter-over-quarter. I would have expected it to be up at least some just given the same-store growth and the acquisitions, and it didn't look like there was a big roll down in the releases or anything like that. So any color you can give there?

Jason Fox, CEO

Okay. Sure. Thanks, Brad. Is your question more about inflation kind of rolling through or more specific to ABR numbers? Maybe it's the latter. Toni, you can talk about but if it's the former, I can jump in around inflation.

Brad Heffern, Analyst

Yes, it's more just the ABR. I mean, it was 12:20 about last quarter and this quarter so I'm just curious, why didn't it go up more?

Toni Sanzone, CFO

The bulk – I've got it. I think the bulk of the activity on ABR is certainly coming from the acquisition activity to a smaller extent on the same-store growth. But I think I'm not sure what you're missing here, and we did sell some vacant assets, so there was some vacancy between this time last year and now that's running through the year-over-year ABR. So I don't think there's any other material movers there outside of the acquisition activity and the same-store growth.

Brad Heffern, Analyst

Okay. Got it. And then any update on the process with the CPA team?

Jason Fox, CEO

Yeah. I think the only update is there is some disclosure by the CPA team, maybe a couple of months back that essentially says to fund is considering liquidity alternatives. And we, as its advisor, have presented various options, including a potential combination with us. But this is really just the start of the process and really not unexpected since CPA team's liquidity kind of guidelines from its perspective is approaching early next year. But other than that, there's really nothing due to update. Ultimately, if this is going to be a process that's run by its independent directors and they'll have ultimate discretion as well.

Brad Heffern, Analyst

Okay. Thank you.

Operator, Operator

The next question is from Harsh Hemnani of Green Street. Please proceed with your question.

Harsh Hemnani, Analyst

Thank you. I wanted to talk about what you're seeing on the European side. You mentioned you've mentioned in the past that the sale leaseback market there has been strong, but I guess we didn't see anything sourced from that during this quarter. Or is there something we should be expecting in the pipeline from Europe in the fourth quarter?

Jason Fox, CEO

Yeah, sure. So year-to-date, we've done about 30% of our deal volume in Europe. A lot of that is driven by sale-leasebacks and some large deals that we've talked about previously, like the casino grocery deal we did in France and the JLR deal, the Jaguar, Land Rover deal we did in the UK. Keep in mind summer in Europe tends to slow down as a lot of people are on vacation during July and August, so it's not atypical for the summer months to have a little bit of a lull. And it has picked up. I think about half of our pipeline for the remainder of the year is in Europe. So I think you'll see that activity pick up as we come to the end of the year.

Harsh Hemnani, Analyst

Great. That was it from me. Thank you.

Jason Fox, CEO

Okay, you're welcome.

Operator, Operator

The next question is from Greg McGinnis of Deutsche Bank. Please proceed with your question.

Greg McGinnis, Analyst

Hey, good morning. The first quarter, Realty Income announced its Carrefour deal in Spain, and then you were doing grocery deals in Spain at the end of last year as well, which leads me to two questions. First, and I realize we've covered the topic of Realty Income in Europe in the past, but does this deal represent the start of maybe more head-to-head competition that you might be seeing with them? And two, were you looking at those assets as well? Or maybe has your history with Carrefour kept you away?

Jason Fox, CEO

We did see that deal. There are some reasons it wasn't a fit for us, but I won't go into those details. More broadly with Realty Income, they may be expanding into continental Europe beyond just the UK. Generally, Europe has less competition, and there are very few pan-European REITs, so even with Realty Income's entry into Europe, competition remains significantly lower than what we experience in the U.S. It's also important to note that it's a large market. There's an estimated $4 to $5 trillion of owner-occupied corporate real estate, with some reports suggesting it could be as much as $8 billion. That's our adjustable sale leaseback market, which is substantial. Keep in mind that we have had an established platform there for over 20 years, building relationships and a network in cities like London and Amsterdam. We will continue to be active in Europe. Regarding Realty Income's actions, while they will introduce some additional competition, I believe there are investor perception benefits that may outweigh this increased competition. Europe is largely seen as a competitive advantage for us, though it’s also less familiar to U.S.-based investors. If Realty Income's increased ownership of European assets helps investors feel more comfortable with Europe, I think that’s beneficial for us. Ultimately, it's a significant market. We typically don't operate in the same areas as them, but we may overlap more in Europe. However, if they start to resemble W.P. Carey more closely, I don't think that would negatively impact our position or valuation.

Greg McGinnis, Analyst

Okay. Fair. Thank you. And then on rent growth, I appreciate your opening comments there in terms of negotiations on rent growth. I was just hoping you could expand on that a little bit. Has the type of escalator that you include in leases changed much over time? Or maybe during this inflationary period? And then why might a lease be fixed for CPI base? Is that just underlying credit quality or what are the other factors?

Jason Fox, CEO

The ease of negotiating inflation-based increases varies based on market conditions and the overall view on inflation. It is more challenging now to negotiate CPI-based leases compared to the past. However, it's important to note that we still believe we are in a strong position regarding leases related to inflation. Sixty percent of our annual base rent on a $20 billion asset base includes CPI increases, which will drive same-store growth in this higher inflationary environment. While there is a lot of focus on inflation now, we have prioritized inflation protection for many years, even when inflation was low. We are pleased to see the advantages of this approach coming to fruition. Currently, year-to-date deal volume has favored fixed increases, with about one-third being inflation-based and two-thirds fixed. We are comfortable with this as fixed increases provide a solid foundation regardless of inflation. Our pipeline remains healthy, with over 50%, possibly close to two-thirds, of our deals in the pipeline being inflation-based, partly due to a greater number of deals in Europe where including inflation increases is more customary.

Greg McGinnis, Analyst

Right. Okay. And then just on the potential pipeline, could you give us some sense for the size of the portfolio investments under review? Do you need to close on all the deals under negotiation to hit the high end of the guidance range? And then how likely is it that some of these deals slip into Q1?

Jason Fox, CEO

Yes. So the pipeline continues to build. As with any pipeline, there are deals at various stages. Some we would expect to close in the coming weeks, some of which there's still work to do on them and may take closer to the end of the year, and some of those may even flip into January. So it's really hard to predict where we sit right now, especially when we're transacting through sale leasebacks predominantly. But we feel good about the range. I think if some of our larger transactions come together, there's probably an interesting opportunity to get to the top end of that range. But I think it will depend on where some of these fall and how we progress through some of the deals.

Greg McGinnis, Analyst

Great, thanks so much.

Jason Fox, CEO

Yep, welcome.

Operator, Operator

The next question is from Joshua Dennerlein of Bank of America. Please proceed with your question.