Good afternoon. my name is John Kim with BMO Capital Markets. It is my pleasure to be hosting or moderating this presentation with W. P. Carey, celebrating its fiftieth year pretty soon, as a real estate company. With us today, Jason Fox, CEO, Jeremiah Gregory, with the company as well. I think we're gonna go through with, like, a presentation and an overview to begin with, and then we'll go into Q&A.
I'll just, you know, take a minute to give a quick overview. I'm Jason Fox, CEO of W. P. Carey. Jeremiah Gregory is with me, who heads up capital markets for us. Yes, we are celebrating several anniversaries actually, in 2023. The company was founded 50 years ago. We became a public company, actually 25 years ago, 1998, and we also began investing in Europe for the first time 25 years ago, when we pioneered sale-leasebacks in the European markets. Today, we're one of the largest owners of net lease real estate and among the top 20 REITs in the index, with a market cap of around $15 billion. Actually, I just checked. It's exactly $15.00 billion as of today. We are a diversified net lease REIT.
We own a highly diversified portfolio across geographies, tenant industries, and property types, with a primary focus in North America and Northern and Western Europe, and the largest concentration of our real estate assets are industrial, with retail, the next largest asset class after that. The portfolio as of the end of the first quarter of this year was comprised of 1,400 net lease properties that generate about $1.4 billion of ABR. We have a weighted average lease term of approximately 11 years. 62%, so just a little bit under 2/3 of our portfolio, is from properties in the U.S., with a little bit over 2/3 from those in Europe. Again, that's primarily Northern and Western Europe.
As I mentioned, we're primarily focused on acquiring industrial real estate in the U.S., with industrial and retail in the European markets as well. Currently, industrial represents a little over 50% of our portfolio at this point in time. We run our investments teams out of New York and London. We have a proactive asset management approach, with a team here in the U.S. and a team based out of Amsterdam in Europe that runs our European operations. We have an investment grade balance sheet, recently got upgraded by both S&P and Moody's to BBB+ and Baa1. And we really have a successful track record of investing in net lease across many cycles over our 50-year history, with a focus on downside protection and growth going forward.
With that, let me turn back to you, John, and you can fire away some questions.
You talked about diversification that you have by asset type and geography. Can you just talk a little bit about the benefits of that model, where are you seeing the best opportunities as far as investments on a risk-reward basis?
Yeah, look, diversification is, you know, beneficial on the downside protection. We have no kind of over allocation to any one industry or geography, and that's great in an environment like we're, you know, heading into or have been in, with a slowing economic environment. On the growth side, you know, we have a wider funnel. We have a, you know, more opportunities to choose from on how we allocate our capital. This is both across property types as well as geographies. You know, we currently have one of the lowest top 10 tenant concentrations amongst the net lease peer group at about 18% of our ABR, and no single tenant is more than, I think, 2.7% of our portfolio.
You know, the benefits are really on, you know, finding the best opportunities and, when Europe is slow, like it is right now, we are over allocating in the U.S. You know, when we see opportunities pick up and maybe we can be opportunistic in the European markets, you know, we'll find some there as well.
Can you talk a little bit about the cap rate differential and your spread to your cost of capital?
Yeah, sure. Between the geographies or just generally? Yeah. Right now we're seeing better opportunities in the U.S. Cap rates have expanded more here than they have in Europe. You know, just to give some examples or some historical context, run rate for us on cap rates, you know, going back kind of two to three years, was in and around 6% for going in cap rates. The fourth quarter of 2022, that expanded to about 6.8%. Year to date, we've done about $750 million of new transactions at a weighted cap rate of around 7.2%. That, in our, you know, in our judgment, is kind of indicative of where, you know, the markets have gone. We're still able to generate spreads that make sense for us.
We have a cost of capital that works in this environment, and, you know, our balance sheet is really well positioned to take advantage of these rising cap rates. In terms of spreads, you know, we think of things in two different ways. Number one, accretion is important. We're very mindful of whether or not a new transaction is gonna generate some day one earnings accretion for us, and that's something we focus on. Perhaps more important, though, is a focus on the spreads to our cost of capital with regards to an unlevered IRR. That's mainly because a going-in cap rate doesn't always tell the full picture for us, especially given the types of lease structures that we're able to negotiate in our sale-leasebacks.
They, you know, primarily all have, you know, built-in annual rent increases. Our current portfolio has over 50% are indexed to inflation. You know, those that aren't indexed to inflation have healthy, you know, fixed rent increases. For us, it's more important to look at either an unlevered IRR or an average yield and compare that to our cost of capital. In the current environment, despite the, you know, rising, you know, cost of debt and where equities have traded, you know, we're still within a zone that we've been historically in terms of generating spreads, and a lot of that has to do with cap rate expansion, but also the type of bonds we're able to negotiate.
On the sale-leasebacks, just can you talk about why this is increasing recently as far as that pipeline of transactions? What are sellers looking for? Are they looking for maximizing price on the sale or having an affordable rent that helps them in their business going forward?
Yeah, I mean, to start with the second question first, I mean, sellers are focused on the economics primarily, so it's optimizing their occupancy costs. You know, one of the big drivers of why companies do sale-leasebacks is because they have a use of proceeds. And really, this is a, for us, I would say 90%+ of the deals that we've sourced over the last number of years have been either sale-leasebacks or build-to-suits, which have a similar structure in which our counterparty on a transaction is ultimately our tenant. And there's a lot of benefits to that. What drives sale-leasebacks are use of proceeds.
During growth environments like we saw, you know, say, in 2021 and even into 2022, there's a lot of correlation with M&A activity, where sale-leasebacks are, you know, part of the capital stack in a buyout or other corporate transactions. I think as we find ourselves in a slowing economic environment or even a recession, I think sale-leasebacks are equally beneficial to corporates, but maybe for different reasons. I think it's more gonna be a source of proceeds to be used for, you know, getting ahead of debt maturities, maybe as a alternative to other sources of capital like debt or equity. The use of the proceeds is key, and, you know, the...
Where we see ourselves in sale-leasebacks right now is perhaps, you know, maybe the most constructive environment that I've seen in the 20+ years I've been doing this. You have really two factors playing into that. Number one, when companies are looking at generating a use of proceeds, they look at their alternative ways to raise capital. Currently, where we focus, which is just below investment grade, you know, call it the BB-type credits, the high yield markets, leveraged loan market, have gotten very expensive. You know, call it high single digits or even into double digits of where their borrowing costs could be. A sale-leaseback, call it in and around 7% or 7%+, is quite competitive, even when you factor in the meaningful bumps we're able to negotiate.
you know, this is about as competitive as sale-leasebacks have been in a long time relative to other corporate capital opportunities. I think secondly, the competitive environment for sale-leasebacks are competitors that we've historically faced when looking at sale-leasebacks, have primarily been the, you know, private equity real estate, the net lease arms of some of the big asset managers like KKR or Carlyle or Angelo Gordon, or others. They typically target returns based on higher leverage transactions, and they're mainly using mortgage debt to achieve their leverage. Debt's gotten a lot more expensive. Mortgage financing, especially in the 60%+ range, has moved a lot more than investment grade bonds have, which is, you know, how we're funding, you know, our deals at this point in time.
Our competition are either, you know, outbid because they're not competitive or they can't actually even, you know, find mortgage financing that works for them. It's a good spot for us, both from a supply standpoint, but also from a competitive environment.
One of your big transactions this year is the Apotex acquisition, sale-leaseback, primarily based in Canada. Can you just give some color behind the transaction? Was it sourced from their sponsors, I think SK Capital, and whether or not this could lead to other transactions with either the sponsor or with the company?
Yeah, this is a good example of, you know, I would say this is a pretty typical sale-leaseback for us. I mentioned earlier that during growth environments, sale-leasebacks can support M&A activity. You know, this is a deal that we've been working on or had been working on for several months at this point in time. It was in support of a buyout. A company called SK Capital, which is a New York-based private equity firm, was buying Apotex, a family-owned business in a leveraged buyout, and the sale-leaseback was a meaningful component of the capitalization of the company. You know, I think the transaction itself checks a lot of boxes for us when we think about credit. Apotex, for those that know it, is the largest generic drug manufacturer in Canada.
They have a roughly a 30% market share. We view them as critical Canadian pharmaceutical infrastructure in many ways. You have moderately leveraged balance sheet as part of the buyout. You know, I think importantly, the real estate, another piece of the transaction that we focus on, is how does it fit into the operations of the company? The portfolio that we acquired, comprised about 90% of the operating assets, really generated about 90% of the revenue for the company, so highly critical. We structured it on a master lease. These were 11 properties. We structured on a master lease, which provides, you know, meaningful downside protection. Cherry picking is something that you're at risk for with individual leases on a master lease. In a restructuring, you're not permitted to do that.
While we don't think a restructuring is likely for this company anytime soon or at all, we do structure our transactions with that in mind. The real estate itself is quite strong. These were or are advanced manufacturing and R&D facilities for this company. They are infill Toronto, one of the tightest industrial markets in North America, with low single-digit vacancies. You know, very well located. You know, the basis at which we acquired these were probably somewhere less than half of replacement cost. You know, I would say we pretty much checked every box in this. On top of that, it was a deal where the private equity firm was depending on us to provide a meaningful portion of their financing.
I think that it was, you know, a fair pricing that we put on the table, but something where we had some pricing power, and, you know, they depended on us as part of the capital stack. SK Capital is a great firm. We're looking at more deals with them. We expect to do more deals with them in the future. It's a relationship business, as, you know, a lot of things are. You know, I think that's one of the things that we provide, probably more than anyone else, is certainty of execution, and in this environment, that's pretty important.
Would you say that the cap rate you acquired at that is reflective of the market, or did you get a hot, slightly higher yield?
Yeah, look, I mean, when we source sale-leasebacks, one of the benefits is that there are fewer competitors that have the track record to, you know, complete bios, especially one this large. This was close to $500 million on a sale-leaseback basis. We don't think there are other bidders on this. We think it was market pricing from how we price sale-leasebacks, where we get, you know, I would say anywhere from 50 to 100 basis points of incremental yield relative to where net lease typically trades, you know, from a third-party landlord, you know, in the secondary market. Did the cap rate. Well, we don't disclose specific cap rates. It's within our target range right now of a high six cap rate into the sevens.
As I mentioned earlier, our weighted average cap rate for the year was 7.2%. This was a big part of our year-to-date volume at this point, so you can get a sense for where that cap rate, you know, would've settled out. I think importantly, and I mentioned this earlier, it had meaningful bumps. These were 3% fixed increases, which probably lag the market, but that certainly impacts, you know, our total economics and how we price a deal, and it's, you know, the economics are primarily driven by, you're going in cap rate and the lease bumps. You know, the lease term, in this case, it was 20+ years.
I think I asked you this on the earnings call, Apotex is paying U.S. rent.
Yes, U.S. dollar. Yep.
How important was that for you? Or are you willing to take currency risk?
Yeah. We do have, you know, currencies other than the U.S. in this deal, really, I think probably almost all the Canadian deals that we've done have been U.S. dollar. There's ways to hedge currencies. There's ways to, you know, borrow in Canadian dollars if we wanted to. For this one, the company has a lot of U.S. dollar revenue, and we don't think it's a mismatch from a corporate standpoint. Ideally, you know, we pay our dividends in dollars. We trade on a U.S. stock exchange. Ideally, when there's a situation where we can do a U.S. dollar-denominated deal, we will, and that's the case here.
One of the differentiating factors of W. P. Carey is the amount of CPI-linked rent increases that you have. Can you just provide an update as to what % of your portfolio is CPI-linked, and how are you viewing inflation in Europe versus U.S.?
Yeah, sure. It's about 57% of our portfolio is indexed to inflation. Importantly, about 2/3 of that amount is uncapped CPI. We're really seeing, you know, the tailwinds, you know, flow through to our earnings as well. You know, even within the fixed component, which is the other 43%, it's sizable. I think on average, historically, we've seen about 2% fixed increases across our portfolio, which tends to be perhaps double what's typical in the net lease world. That is why we emphasize that going in cap rates don't tell the whole story in terms of spreads and accretion.
It's important to bake in, you know, the built-in rent growth, and especially when you get to our size, you know, having, you know, really strong internal growth, is a great supplement and maybe big driver in addition to externally driven growth. In terms of the current opportunity set, obviously, inflation has become more of a conversation for our sale-leaseback counterparties. It's more of a discussion. I think in Europe, it's been more customary. More of our inflation base increases are in Europe. I mentioned earlier, about 1/3 of our ABR is in Europe, but about half of our CPI base increases, are there as well, so it's a little overweighted.
I think in terms of new transactions right now, as I said, it's more the conversation than, you know, while we may not be getting uncapped CPI as much in this current environment, you know, when we do get CPI that is capped, these caps have gotten higher. We've also added floors, and the floors are at higher levels, where we might have been floors in the 1%-2% range with caps in the, you know, 3%-3.5% range. Our floors are probably more around 2%, and our caps are going to be more in the, you know, 3%-5% range at this point in time. Even though we're not, I said, getting uncapped CPI all the time like we have in the past, it's still flowing through.
Importantly, it's flowing through to our fixed increases. I mentioned earlier that historically, we've been closer to 2%. Our year to date, for our year-to-date deal volume, the weighted average fixed increase is 3.0%. Again, you know, something that's meaningfully higher than we've had historically and probably a, you know, multiple of our competitors. What does that mean in terms of growth? We provided this disclosure on our earnings. Our Q1 contractual same-store growth was at 4.3%. We expect 2023 to be at 4%. Again, you know, multiples above the net lease peers.
We've also provided a forecast for 2024 as well, which we expect our contractual same-store increase to be around 3%, and that assumes that inflation is at 2% by the end of 2024. To the extent that it takes longer to get there, or we're at something higher than 2% by the end of next year, then we would expect our same-store growth to be higher. A lot of this is the lag effect. Not all of our leases bump on an annual basis, some every two, three, or five years. We're going to see this effect for years to come. It's also the formulas that we use tend to lag inflation by three or four months.
You know, the bumps that are happening right now is going to be based on inflation, you know, from, you know, call it February, you know, January, and December.
Another unique characteristic of W. P. Carey is, post your CPA:18 merger, you do have some operating asset exposure in hotels and self-storage. I think you provided guidance that's about $100 million of NOI. Do you feel comfortable with that amount of operating income? If you could just provide an update on-
Yeah, sure.
Those portfolios.
Yes, there's really two groups of operating assets. The largest of them is operating self-storage assets. As part of the CPA:18 merger, we acquired, I would say, the bulk of those 84 operating self-storage properties. This was last year. The other component of the operating portfolio are some operating hotels, and it's primarily the 12 Marriott hotels that had been under lease with Marriott for the past, roughly 30 years, that, you know, just expired, and those are now franchised operating hotels as opposed to, you know, net lease investments. Instead of receiving rent directly from Marriott, we're receiving the NOI that these operating hotels generate. Actually, there's a pickup in earnings from that because there was coverage at these hotels. To your question, are these something that are long term?
You know, the operating assets are of an asset class that we've been investing in for quite some time. In fact, we first invested in self-storage, where we did a large sale-leaseback with U-Haul back in 2004, and helped them fund their exit from bankruptcy by, you know, buying some of their best storage assets. We learned about the business, and through some fund vehicles that we had, namely CPA:17 and CPA:18, we did acquire a number of operating assets. I think the way we look at this is, you know, long term, we'd like to be a pure player, as close to possible, as a pure play net lease company. I think that we have a lot of options with the self-storage assets.
We did do a conversion of a number of properties from operating assets to net lease with Extra Space, four, three and a half years ago now. I think that's certainly an option, whether it's Extra Space or another counterparty, there's a way to, you know, to put a lease in place with these properties and generate some maybe more visible, stable cash flows. You know, by and large, we like the asset class. It has a lot of the same characteristics that we like about net lease. Stable cash flows through, you know, various economic environments, low CapEx. You have the ability to raise rents on a monthly basis, so in effect, you have an inflation hedge, much like we have with our net lease portfolio.
You know, there are reasons of why we're comfortable owning operating assets in some part as well. I think, look, lastly, the option is always to sell some of these assets. I think, over the past two years, when storage was producing, you know, 20%+ same-store growth, we wanted to continue to watch these stabilize at maybe a more moderate or historic growth level that we're seeing now. To the extent that selling storage is the best way to fund new net lease deals, that's certainly an option that we would consider. I think right now we have, you know, well-priced capital, and I think Jeremiah can touch on, you know, some of our balance sheet, if that's of interest. You know, it's something that we can always do.
If we think that selling storage is the best way to fund net lease, we'll certainly do it. My guess is that we'll do all the above. You know, we'll probably convert some, we'll probably sell some, and we may hold some that ultimately could be sold or converted as well.
It's probably worth noting that the Marriott Hotel portfolio, that is targeted for sale.
Yeah.
In 2023. Don't necessarily have visibility on exactly what the pricing or the exact timing is. On our guidance, we've assumed that those hotels. You know, we get the NOI from those hotels throughout the end of the year. We are targeting those for sale this year. We expect those to be disposed of, you know, we won't be owning operating hotels as part of the portfolio.
It's a good point to make, you know, we've talked in some detail there. There are 12 Marriott assets. Nine of them, we expect to sell by end of the year. Three of them, we expect to continue to operate as we entitle them for a higher and better use. We have one right on Newark Airport. It's likely gonna be industrial, A+ location, right on the airport. We have a Courtyard Marriott in Torrey Pines in San Diego, that's got, you know, new lab development all around it. We think we can add density there, and we would likely either do a build-to-suit for a tenant or sell to a lab developer, but that's the highest and best use.
The third one is prime location in Irvine, California, which could be multifamily, it could be creative office, it could be industrial, it could be R&D. If it's industrial or R&D, we could do a build-to-suit there, but in all likelihood, you know, we would sell to a developer once we have it entitled.
Across all of your geographies and asset types, and including some of your operating assets, what are your views on a recession? You know, when Are you seeing any signs of stress today, you know, in your portfolio? What are you know, forecasting as far as how you operate your business going forward?
Yeah.
What do you think is gonna happen?
I mean, look, we're built for a recessionary environment. I think that the portfolio is diversified. I talked about that earlier. We have a long weighted average lease term of over 11 years. Occupancy is in the high 90s. You know, despite having just 30% of our ABR and investment grade, we were the market leader in collections throughout COVID. You know, quickly in May and June, we were collecting 98% and 99% of our rents. Maybe that's the most important part is, you know, what's the performance? You know, we think we're great at credit picking and structuring.
You know, ultimately, we do have some tenants to get upgraded over time into investment grade, which is why we have a portion of that. I think that's a good litmus test for us. You know, it's also a good environment to be opportunistic. I think when there's, you know, weakness in, in, you know, we have some operating or some pricing leverage, especially when we're well capitalized like we are right now, it's something that, you know, we think that, you know, we fare quite well. When we look at our credit watch list, it's quite benign. You know, the peak in COVID, we call it our heightened watch list, which are defined as companies that have a reasonable likelihood of a payment default. Within COVID, it peaked at 4%.
The trough between them and now is, you know, around 1%. Right now we're sitting at around 2.5%. It's important to note, you know, even during COVID, when we had a 4% heightened watch list, we were still collecting 98%, 99% of our rents. When you have critical operating assets on master leases, even in restructurings, we tend to get paid in whole. Just because it's on a heightened watch list, doesn't mean that it ultimately results in a payment default. That's how we, you know, kind of monitor our portfolio. No big themes within the portfolio. When you think about the typical areas that net lease have run into trouble, theaters. You know, 20 basis points of our ABR is in theaters.
It's on our watch list. You know, restaurants, we have one restaurant on our watch list. That's under 10 basis points. You know, we have a department store, it's a logistics asset. Frankly, if our tenant defaults and we can terminate that lease, we're under market, and there's gonna be upside there. It's a pretty benign list, and even a lot of the details when you kinda dig into it, there's no themes and there's, you know, there could be some good outcomes at the same time.
Any questions from the audience?
How are the higher interest rates and your financing going forward? You know, what's kind of the plan there? Do you have enough rental increases in the existing leases to cover the higher interest costs maybe the way forward?
Yeah. The question was about higher interest rate environment.
Yeah.
Yeah.
I think that you're going to be either refinancing or getting new financing, and obviously have a higher cost.
Right. Yeah, I'm just repeating the question for the audience that's not here in person. The question is about higher interest rates and how that flows through to our business and impacts it. Jeremiah, you want to touch on balance sheet and how we manage that?
Yeah. I mean, I'll just talk broadly about the balance sheet and how it's set up. I mean, we certainly assume that we're gonna continue financing new investments on a leverage-neutral basis. That means, you know, more equity than debt. You know, that's how we've financed historically. That's how we'll continue to finance going forward. You know, on the debt side, you know, I think we have bonds, you know, coming due, like many large REITs. You know, in any given year, we have some bonds coming due. Our first bond that comes due is April 2024. That's a U.S. bond. It's at a 4.6% interest rate.
We would assume there would be some, you know, some leakage, you know, some headwinds from rising interest expenses, but perhaps, you know, not as meaningful, at least on these near-term financings, as people might think. You know, I think, you know, for the most part, we're looking wherever we can to, you know, lock in long-term cost of debt and, you know, not, you know, be in a position where we have, you know, meaningful headwinds in any given year from interest rates. I think, you know, where interest rates are today, I think probably for all REITs, there's a little bit of a headwind there as you work through your refinancings. For us, we have a very well-laddered maturity schedule as well.
It's gonna have to play out really over the next 10+ years. You know, that, you know, where rates go and where we do refinancings kind of every year from here on, is gonna really drive it over time. You know, any one bond is probably not gonna, you know, have a huge impact on our overall weighted average cost of capital. We're certainly, you know, we're setting up, and we're expecting, and when we do planning, you know, we assume rates are gonna be at this higher level. I think importantly, when we make new investments, you know, we're looking at investments that could be funded with, you know, debt at these levels or equity, where it's trading.
The last thing I'll just mention on our equity, you know, I mentioned that's gonna be majority of our capital structure. We are very, very well positioned right now on the equity side, where we're sitting on close to $400 million of equity forward that was raised in the mid-to-low 80s, so about average price of $83 a share. That's obviously well above where we're trading today, and that gives us a really good ramp when we think about deploying capital and using capital over the rest of 2023. That helps give us a lot of confidence. That, I guess, in addition to our $1.8 billion revolver, which allows us to, you know, be opportunistic in terms of how we fund things.
We would never look at the revolver as permanent capital, but it does help us manage the capital markets and going into the bond markets at the right time.
Stock has declined from about $90 to about $70 in the last few weeks. A lot of equity, a lot of things... Where do you think the disconnect is?
Do you want me to repeat the question?
Yeah, go ahead.
Sorry. Your stock price has come down from $90 to around $70. Where do you think the disconnect is between your performance and the market reaction?
Yeah, we do think there's a disconnect, you know, I think all, you know, REITs may say the same thing, but, you know, this is a buying opportunity in our mind. I mean, there's a disconnect because when you think about what drives net lease performance, it's about growth, and we're very well positioned from an internal growth standpoint. We don't need to do as much external growth, deal volume as many of our peers, because we have the internal growth driving a big portion of that. As Jeremiah mentioned, we're very well set up from a balance sheet perspective to take advantage of the rising cap rate environment.
You know, and frankly, where we position ourselves for a recession, I think that's something that we've proven that, we perform quite well during down cycles. When you layer on top of that, a 6% dividend yield, you know, we think that it's an opportunity to acquire quality at a, at an interesting opportunity right now.
We're running over time, so I'm just gonna ask you one last question.
Sure.
You got to answer it in less than a minute. Do you think there will be M&A in the sector, in the net lease sector? Where does W. P. Carey stand in that?
Look, there are 20-25 net lease REITs, many of which are below, you know, seven or even, you know, $5 billion at that point. I think there'll be fewer net lease companies maybe a year from now, that we probably should see some M&A activity. A lot of it's gonna be dictated by, you know, the diversion in cost of capital, mainly, you know, equity multiples. We are diversified. I think that puts us in a good position to look at a lot of different companies. We certainly have an appetite for growth. You know, portfolio quality really matters. The spreads matter. You know, clearly, you have to pay a premium for M&A, so it's not just kind of headline numbers right now.
You know, we want to grow, and we want to do it in a smart way. I think it's an opportunity and an option for us, but we'll have to see how things play out.
Okay. With that, I want to thank everyone for attending the session.
Great. Thanks, everyone.