2023-05-02 17:20:14 ET
Summary
- W. P. Carey reported strong earnings with particularly interesting transaction activity.
- The company is growing and trading at a multiple slightly below fair value.
- WPC makes sense to me here as an income or total return play.
As part of standard ongoing due diligence for the companies we own I listen to the earnings conference calls and read through the supplementals. After a few dozen of these each quarter, the numbers start to swirl around a bit with the main takeaways being which industries and individual companies are performing better or worse than expected. Occasionally, however, there is a that piece of data that is so unexpected that it stands out in the sea of earnings calls.
W. P. Carey (WPC) delivered the shock with the following statement in its earnings release :
"Year to date, the Company completed investments totaling $743.5 million, including $177.8 million during the 2023 first quarter and $565.7 million subsequent to quarter end."
If you have been following real estate, you know that transactions have been just about frozen for the last 6 months. Bidders are demanding high cap rates to reflect the higher interest rate environment while sellers are still trying to sell at the 5% cap rates of a year ago.
In most sectors, there is a spread of 100 to 300 basis points between buyers and sellers and nobody wants to budge. Thus, transactions volumes are severely depressed.
So how is WPC on pace for a multibillion-dollar acquisition volume this year?
Well, one way to do it would be to just pay up for what sellers are asking, but WPC is averaging 7.2% cap rates per Jason Fox's commentary on the call .
"Our investments year-to-date were completed at a weighted average cap rate of 7.2% and a weighted average lease term of 21 years, in line with our core focus, virtually all were industrial sale leasebacks, including 3 industrial portfolios, each over $50 million"
This high cap rate is particularly impressive given the 21 year lease term and industrial properties. Other REITs looking to acquire such properties are not able to buy at 7.2% cap rates as similar properties on the market are listed at cap rates of around 5.5%. Further, it remains difficult to source financing even if one can find an acquisition target.
Well, there are 2 key aspects of WPC which enable it to still source accretive transactions when almost nobody else can:
- Sale-leaseback origination expertise
- Access to cheap Euro debt
Rather than looking at marketed deals, WPC transacts directly with operators of properties by originating sale-leasebacks. This would be a property that is currently owned by the tenant rather than another landlord. WPC works with the tenant to structure a deal that is mutually agreeable to both parties. The tenant gets an immediate infusion of capital while WPC gets a nice property, a long lease, and a favorable cap rate.
Part of the value offered by WPC is that it can close quickly and in cash which removes contingencies related to property level financing. With a market cap of $15.5B, WPC can also do larger transactions than most such as its $468 million sale leaseback with Apotex, a large Canadian pharmaceutical company.
The reasonably high 7.2% cap rates are made accretive to WPC because they are a global company with access to much cheaper Euro debt.
On April 24th, WPC announced a 500 million Euro term loan with accordion up to 750 million Euros. The cost of the loan was 80 basis points over EURIBOR but WPC used swaps to fix it at 4.34%.
That makes quite a nice spread to the 7.2% cap rate acquisitions.
While the rare ability to accretively grow externally in this environment is intriguing to me it does not single handedly make WPC a buy. Let us take a look at organic growth, valuation and risk profile.
W. P. Carey overview
WPC has been around for a long time, over which it has amassed a diversified portfolio comprising 176.1 million square feet.
Most of its sale leasebacks started with terms of around 20 years, but since they have done this continuously for a long time, the weighted average remaining lease term is about 10.9 years. Tenant credit metrics at 31.6% investment grade are fairly consistent with peer triple nets.
One of the areas where WPC's leases have really shined over recent quarters is that they have strong escalators with more than half linked to CPI.
Given the high inflation as of late, organic growth rate has increased.
Steady revenue growth has facilitated steady dividend growth which makes WPC a rather popular stock.
At times, WPC's popularity has caused it to trade a bit overvalued. Since the Fed hikes, however, dividend focused investments in general have fallen which has brought WPC back down to an attractive pricing range.
WPC stock valuation
The triple net sector has highly visible cashflows due to the contractual nature of revenue. In my opinion, this makes valuation even more important as a factor because there is less room for error in mathematically estimating fair value. Overall, the sector is trading a bit on the cheap side right now with an average price to 2023 AFFO of 12.9X.
WPC is trading slightly above the sector average at 13.4X AFFO and I believe such a premium is warranted given its larger size, superior escalators and what I believe will be above sector growth for the next few years. It could also be given a bit of a premium for its below average debt.
Within triple net there are a few different categories:
- Free standing retail
- Diversified (industrial with a bit of office and retail)
- Casino
- Convenience stores
Within retail I like Spirit Realty (SRC) as its properties are almost indistinguishable from retail peers but its valuation is much cheaper.
In diversified I like WPC and Broadstone Net Lease (BNL), and own both. BNL is quite attractive on the valuation front while WPC brings the growth.
VICI (VICI) remains the best casino play, in my opinion, but it is trading at close to fair value even after its strong earnings report.
WPC risk profile
In this section I want to discuss what the market is looking at as risky and what I view as risky.
17% exposure to office is likely at least partially responsible for WPC's now cheaper valuation. Any mention of office seems to terrify the market right now.
WPC
Despite being an office bear, there are 2 mitigating factors that make me significantly less worried about WPC's office exposure:
- Much of their office is in Europe which has a much better office outlook
- Very long lease terms
Instead, I am more worried about WPC's 84 self-storage properties. Rental rates in self-storage are above a sustainable level and high new supply growth is poised to pull both rental rates and occupancy down. At roughly 5% of annual base rent, it won't destroy the company, but weakness here could slow growth in AFFO/share.
The bottom line
Overall, WPC is a solid company and trading at a reasonable valuation. I think it will mildly outperform the market over the long run.
For further details see:
W. P. Carey Is Transacting In The Untransactable Market