WP Carey Inc (WPC) 2017 Q4 法說會逐字稿

Hello, and welcome to W. P. Carey's Fourth Quarter 2017 Earnings Conference Call. My name is Diego, and I will be your operator today. (Operator Instructions) Please note that today's event is being recorded. (Operator Instructions)

I will now turn today's program over to Peter Sands, Director of Institutional Investor Relations. Mr. Sands, please go ahead.

Good morning, everyone, and thank you for joining us today for our 2017 fourth quarter earnings call. 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 1 year.

And with that, I will hand the call over to our Chief Executive Officer, Jason Fox.

Thank you, Peter, and good morning, everyone. I'm joined this morning by our President, John Park; our CFO, Toni Sanzone, who will review our results and guidance; and our Head of Asset Management, Brooks Gordon.

2018 marks a number of milestones for W. P. Carey: our 45th anniversary, our 20th year as a public company and we have just completed our 20th year of rising dividends. It is also my first year as Chief Executive Officer, and therefore, an opportune time to outline how I view our business and our strategy going forward.

W. P. Carey was a pioneer of net lease investment and is among the largest and foremost REITs operating in this area of the market. We see virtually every deal brought to market, and many that aren't, giving us unparalleled market insight.

As I've discussed on previous calls, 2017 was another year of sustained strength for commercial real estate markets, both in the U.S. and Europe. This was undoubtedly positive for the value of our existing portfolio and a favorable environment for dispositions. In fact, we may look back at 2017 as the pricing peak for the current cycle. Given this market backdrop, we maintained our investment discipline and elected to be a net seller for the calendar year.

Looking ahead, given historically low cap rates and late cycle sentiment, we expect sellers to become more motivated, allowing buyers to regain some leverage. Coupled with the outlook for higher interest rates, we anticipate a more favorable acquisition environment in 2018, which is reflected in our guidance.

We also view the recent U.S. tax reforms as supportive of corporate sale-leaseback activity, which often competes with debt financing, given the limitations placed on the deductibility of interest compared to the full deductibility of rental expense.

In addition to growth through new acquisitions, we also generate growth internally through rent increases written into our leases, which is especially important during times of rising inflation. During 2017, inflation picked up in both the U.S. and Europe, which was reflected in our same-store rent growth of 1.7% on a constant currency basis, up from 1.1% for 2016.

At year-end, 68% of our annualized base rent, or ABR, came from leases with built-in rent escalators linked to inflation. I believe that among net lease REITs, we have the highest percentage of ABR coming from leases tied to CPI, and we are, therefore, the best positioned to benefit from higher inflation.

The outlook for global economic growth, low unemployment in the U.S. and a declining jobless rate in Europe suggest that inflation will continue to rise over the near to medium term. Last week's higher-than-expected headline CPI of 2.1% reflects the strength in the U.S. economy, although it does increase the likelihood that the Fed will raise rates more quickly.

Diversification is another way that we've differentiated from our peers. I firmly believe in the benefits of diversification for the net lease asset class. We have a long track record as a prudent allocator of capital over multiple real estate cycles, proactively adjusting our portfolio composition by selling into strength when we believe markets are mispriced and buying into weakness when we see opportunity. It also insulates our portfolio from disruptions in a particular area of the market.

2017 provided an excellent example of the benefits of diversification as the threat to traditional retailers from e-commerce became a focus for REIT investors. We exited the majority of our U.S. big-box assets in 2011 well before the cracks in the market were widely recognized and had maintained an underweight exposure to retail, which at year-end represented only 17% of total ABR, with de minimis exposure to properties we view as being at high risk from near-term disruption. Over that time, we have allocated capital towards more attractive risk-reward investments such as warehouse and industrial assets, which represent 44% of total ABR.

Diversification also allows us to allocate capital to the geographies offering the best risk-adjusted returns and spread opportunities, although we also balance this with the benefits of scale. In 2017, we opportunistically divested investments in Malaysia and Thailand, exiting markets where we lack a path to scale. And over the course of 2018, we plan to exit investments in other noncore countries, refining our focus on North America and Europe.

Proactive asset management also plays a central role in our strategy, and 2017 was no exception. In a year during which we opted to be less active as a buyer, we were able to maintain a weighted average lease term of close to 10 years and achieved strong rent recapture with minimal tenant improvements. At the same time, we reduced our near-term rent expirations and lowered vacant space, ending the year with close to full occupancy.

Given the size and composition of our portfolio, proactive asset management also provides us with a meaningful pool of follow-on opportunities through which we can create significant value by investing discretionary capital into existing assets. The Astellas transaction we announced yesterday was an excellent example of this. Such deals typically offer above-market yields and enhance the overall quality of our portfolio by extending lease term, modernizing assets and increasing criticality, which also increases the likelihood of renewal.

In addition to our investment in asset management activities, there are other ways that we are building a more valuable company. The most important step we took during 2017 was our strategic decision to exit retail fundraising and ultimately the Investment Management business altogether, moving us towards a simpler business with more predictable and higher-quality income streams. We believe that, over time, this will further enhance our cost of capital, allowing us to grow earnings at a faster pace through accretive investments.

In closing, I would like to briefly comment on the current capital markets environment. Despite the recent volatility in equity markets, which is weighed on REIT stocks, we believe W. P. Carey is very well positioned for 2018 and beyond. We have managed our balance sheet conservatively with limited near-term maturities and currently have over $1 billion of availability on our credit facility. We also have a sizable disposition pipeline that provides us with the flexibility to make new investments without an immediate need to issue equity.

Cap rates for our investments in recent years averaged over 7%, primarily because of the structured nature of our investments, our diversification and our track record of sourcing high-yielding off-market transactions. As a result, we are able to make accretive investments with equity issued at a range of multiples.

Lastly, fears over the Fed's trajectory for interest rates in response to rising inflation have been a key driver of the recent underperformance for net lease REITs. With close to 70% of ABR coming from leases linked to CPI, W. P. Carey has a built-in hedge against inflation, a differentiating factor among net lease REITs that we believe is underappreciated by investors.

And with that, I'll hand the call over to Toni.

Thank you, Jason, and good morning, everyone.

This morning, we announced AFFO per diluted share of $1.31 for the fourth quarter, representing a 7.4% increase over the year ago quarter. For the full year, AFFO per diluted share was $5.30, representing a 3.5% increase over $5.12 per share for 2016.

Our results for the year demonstrate our commitment to maximizing long-term shareholder value as we increased earnings while improving both the quality of our portfolio and the composition of our revenue stream. Our revenues reflect the short-term impact of our decision to be a net seller over the last 2 years during highly competitive market conditions as well as our continued shift away from onetime structuring fees. However, that impact has been outweighed by the positive ongoing benefits of an improved cost of debt and a lower overall cost structure.

During 2017, we declared distributions totaling $4.01 per share, completing our 20th year of rising dividends while maintaining a conservative payout ratio of 76% for the year. In combination with our stock price performance, shareholders earned a total return of 23.8% for the calendar year, significantly outperforming the MSCI US REIT Index.

Turning to the portfolio. At year-end, our owned portfolio was comprised of 887 properties, covering roughly 85 million square feet net leased to 210 tenants with a weighted average lease term of 9.6 years. ABR for all leases in place at the end of the year totaled $681 million.

Investment activity for the year totaled $96 million, including $64 million of completed capital projects at a weighted average cap rate of 7.5% and a weighted average lease term of 20 years. As of year-end, we've committed to fund 8 capital investment projects related to both existing assets and new build-to-suit transactions for a total of $148 million, of which $36 million was funded during 2017. We expect to complete $100 million of these projects during 2018, which is included in our guidance. We have provided additional disclosure on these projects in our supplemental report on Page 22.

These investments are expected to generate additional ABR, increase criticality, add to lease terms and enhance the overall quality of the assets. As Jason mentioned, the size and composition of our portfolio, in conjunction with our strong tenant relationships, enables us to source a significant pool of investments internally, which have become a more meaningful part of our overall investment activity.

During the fourth quarter, we also disposed of 5 properties for $59 million, bringing total dispositions for 2017 to $192 million.

Through our asset management activities in 2017, we maintained a weighted average lease term of close to 10 years with minimal leasing costs, and we've made meaningful progress addressing our near-term lease expirations. We also lowered vacant space by approximately 700,000 square feet, eliminating vacant carrying costs and bringing occupancy to 99.8%.

Touching briefly on our Investment Management segment. The simplification of our business is now being reflected in our financial statements, and we continue to see improvement in the quality and stability of our revenue stream. Revenues from Investment Management, excluding reimbursable costs, totaled $110 million for 2017. Asset management fees comprised $70 million or about 2/3 of the total while onetime structuring revenues were $34 million for the year.

Looking ahead, with structuring revenue now limited to capital recycling within the managed funds, we expect those onetime fees to further decline and make up about 10% to 20% of Investment Management net revenue.

Moving on to expenses. We've made meaningful and sustainable changes in our cost structure over the last 2 years, reflecting the elimination of costs associated with nontraded retail fundraising as well as other significant operational efficiencies. For 2017, G&A expense totaled $71 million, down $11 million or 14% from the prior year, with the full year impact of these reductions to be reflected in 2018.

We have also executed on our commitment to maintain a strong and flexible investment-grade balance sheet, which is reflected in both interest savings and strong balance sheet metrics. During 2017, interest expense declined by $18 million or 10% compared to the prior year as we continued replacing mortgage debt with unsecured borrowings. Our weighted average cost of debt for the year declined to 3.6%.

During the year, we repaid mortgage debt with a weighted average interest rate of 5.5%, reducing our consolidated secured debt to gross assets to 13.4%, down from almost 20% a year ago. We have ample liquidity through cash and available capacity on our credit facility. Our near-term debt maturities are very manageable with $198 million due in 2018 and $51 million in 2019 on a pro rata basis. Furthermore, our limited near-term debt maturities and moderate use of floating-rate debt limits our exposure to interest rate volatility.

Turning now to our guidance. As outlined in this morning's earnings release, for 2018, we expect to generate AFFO per diluted share of between $5.30 and $5.50, with about 80% generated by our core Owned Real Estate business. This range assumes acquisitions for W. P. Carey's balance sheet of between $500 million and $1 billion and dispositions of between $300 million and $500 million.

We want to stress that these are not targets but represent levels we view as achievable based on expected market conditions and current visibility into our pipeline. It also reflects our current asset management plans, the timing of which can significantly impact AFFO.

We've provided our assumptions for G&A expenses, which we expect to fall between $65 million and $70 million for the year.

To wrap up, despite a decline of nearly $60 million in onetime structuring revenues since 2015 and market conditions leading us to be a net seller over the last 2 years, we were able to grow AFFO on an average of 3% by lowering our borrowing costs and simplifying our business, allowing us to reduce expenses, both benefits that will remain in place in 2018 and beyond.

Looking ahead, we believe we are well positioned to drive long-term shareholder value through accretive investments, the generation of opportunities within our existing portfolio and same-store growth driven largely by inflation.

And with that, I will hand the call over to the operator to take questions.

(Operator Instructions) Our first question comes from Todd Stender with Wells Fargo.

With the acquisition guidance, this is all on balance sheet, is that correct, the $500 million to $1 billion?

That is correct. That's all on balance sheet.

Okay. And how about the -- there's $148 million of capital projects. Is that included in that number?

Yes, it is. That's part of our total investment for the year.

Okay. And then the -- just looking at the project, the Astellas Institute for Regenerative Medicine, so that's an existing property of yours. It's an office building that you're converting. What are you -- what would you expect the cap rate change to be if -- once it's fully stabilized, if you're looking at a life science -- well, I guess, it's still office, but what do you think the -- with the credit upgrade potentially, what do you think the change in cap rate would be?

Sure, this is Brooks. I can give a little color on the Astellas transaction. It was an excellent deal. It's a 250,000 square-foot office outside of Boston. It had a remaining lease term of about 8 years, but the tenant was under-utilizing -- the existing tenant under-utilizing the property. And we recognize the life sciences market strength in the Boston area, so we have -- we're investing approximately $50 million to fully convert that to a state-of-the-art life sciences facility. We have an executed 18-year lease with Astellas. We can't share the exact cap rate. But in rough terms, the rent is going to more than double there. So we think it's a great outcome. It's got very attractive lease term, an excellent credit. I think it's a really good example of how we can proactively invest in the portfolio, change of use of the building and have a very attractive return on capital.

Will there be lab space in the building or it's really just a headquarters, so it's remaining office?

No, it's a life sciences lab and R&D.

Okay. So you've got to outfit it with -- your HVAC and plumbing, that's got to change?

Correct, that's a portion of the investment.

Okay. Just, I guess, last question. How much capital still needs to be invested in the CPA funds that hold net lease assets? Is there anything left that you'd have to invest in net lease assets in 2018?

Initial capital has all been invested across all of the funds, but there is always expected to be some level of capital recycling. But I think as I mentioned in my remarks, we do expect the structuring revenue from that to fall off fairly significantly. So I think even coming down more than 50% from this year's level is a reasonable expectation.

Our next question comes from Chris Lucas with Capital One Securities.

I guess, just a couple of questions on some of the guidance assumptions. I guess, as it relates to the acquisitions, first of all, are there particular geographies that are more attractive at this point? And on the dispositions, are those all identified at this point? Or how are you thinking about the cadence of dispositions since that's something you control a little bit more than on the acquisition side? Maybe a little help on both of those topics.

Right, sure. Chris, let me take the first one, and I'll let Brooks talk about dispositions. In terms of markets and asset types that we're looking at, it's generally -- I would say, across the board, it's spread between the U.S. and Europe, perhaps even a little bit more weighted towards Europe, at least our near-term pipeline for that matter. We're seeing some better spread opportunities over there right now. In asset classes, I would say that less so asset classes; but in terms of structure, the majority of these deals are going to continue to be sale-leasebacks and build-to-suits where we'll add a lot of value in the front end by putting together a lease, putting into place the structure that's optimum for us, whether it's lease term or rent increases. So I think you'll continue to see that. We're able to source our deals more through sale-leasebacks and build-to-suits than on the secondary market. Brooks, why don't you talk about dispositions?

Sure. So first, some color on the disposition guidance. Again, it's about $300 million to $500 million expected. In terms of geographies, it's roughly split between -- evenly between noncore regions that we are seeking to exit, Europe and North America, it's about 1/3 each. Transaction types, it's about 2/3 what we would call opportunistic, with the balance being managing residual risk. Property types, it's probably about 60% industrial, 30% retail and 10% other. And these are early in the year estimates at this point. And so in terms of timing, we expect that kind of mid to back half of the year.

Okay. And I guess, on the dispositions, just to understand, are there any tenant right offers or calls that they have on assets that are part of this pool?

Not in -- there's 2 small purchase options, which aren't material in this coming year. The only material purchase options we have are The New York Times building, which we've discussed in the past, and that will be exercised in December of 2019; and then the U-Haul portfolio, which is in 2024.

Okay. And then just on the balance sheet, your sup indicates that you're at the 5.5x net debt-to-EBITDA at this point. What's the comfort level in terms of leverage levels that you're willing to get to in terms of the amount of leverage you're willing to take? Is it -- can you give us a sense as to what that is?

Chris, we're comfortable with the level -- current leverage metrics. We believe that we could be anywhere between mid to high 5s.

Okay. And then last question for me, just on the cadence of acquisitions and dispositions. Is there any -- you mentioned the dispositions more back-end loaded. Is that also true on the acquisition side as well?

No. On the acquisition side, I think our guidance, based on the pipeline that Jason highlighted, is really spread more evenly throughout the year.

Our next question comes from Sheila McGrath with Evercore.

Yes. I'm sorry if you already touched on this on multiple calls, but is there any material change to the burn-off of the asset management fees since you first announced the wind-down? I'm just wondering how asset management impact in 2018 will be versus your original expectations.

Sure, yes, Sheila. The asset management fees are relatively stable while we continue managing our existing funds. So I think it's fair to look at Q4 as a run rate. There's certainly movements possible with NAV changes, but those wouldn't be material.

Okay. And then how should we think about CPA:17 in terms of potential timing? I think it was mentioned in their prospectus that they were already discussing with their board strategic alternatives. So if you could just give us an update on that.

Sure. Really can't comment on potential M&A activity. But with regards to the portfolio, our thoughts are no different than what we've conveyed in the past. We're a natural buyer of those assets. We're well positioned to do it, but we'd underwrite it just like any other deal. And at the same time, we're also comfortable continuing to actively manage those assets until there's a liquidity event for those shareholders. And really, ultimately, the decision lies with the independent director. So when we have more concrete updates, we'll provide you with those.

Sheila, I would add that at current pricing, we'd be very cautious about issuing significant amount of equity for M&A or any significant transactions.

Okay, that's helpful. I was actually going to ask on that. But the net lease -- stocks really have gotten penalized with this sharp interest rate change, even though interest rates are certainly still low. I just wondered if you could talk historically about your business in terms of rising interest rates. Do you get more deal flow? And then also just your guidance and plan in terms of where your share price is.

Yes, sure. I mean, yes, REITs are being affected, that's obvious. But we think we're in a better position than most REITs to really deal with this pullback in the equity markets. We talked about our balance sheet. It's managed conservatively. We redid our credit facility and term loan last year, so we're now equipped with over $1 billion of availability. We also, as Brooks mentioned and I mentioned in the prepared remarks, that we have a sizable disposition pipeline. So we have flexibility to make new investments really without issuing equity in the near term. But in terms of how we've looked at this historically, I mean, we have this diversified investment strategy. So we really can choose to allocate capital either into asset classes or geographies where we're seeing higher yields. If you note over the last couple of years, cap rates on our investments have averaged over 7%. So we don't necessarily need to issue equity at high multiples to generate accretion. But we're certainly cognizant on where our equity is trading now, and we'll be very cautious about anything with regards to issuing new equity. But it really comes down to what the market opportunities are. I think it's also important to note how we run our business. And I highlighted this earlier that we have a very high percentage of our leases that are indexed to inflation. So we think we're going to outperform on a same-store growth rate relative to our peers, especially as inflation rises. And I think really that's one of the big drivers of interest rates. And then we also can generate a lot of growth internally. Apart from just the inflation-based increases -- Brooks talked about Astellas. That's a good example of how we're able to proactively manage our portfolio. The types of assets that we buy, especially in manufacturing and distribution, and the fact that we do sale-leasebacks and actively seek to acquire excess land when we buy these deals, they really lend themselves well to expansion opportunities. And we can put more capital to work. It tends to be at a much higher yield than where it would trade in the market given that it's truly proprietary deal flow. But it also helps us improve the quality of the portfolio, too. So interest rates, ultimately, we think, are going to lead to some higher cap rates. Of course, there's a lag, but we do think we're well positioned.

Our next question comes from R.J. Milligan with Robert W. Baird & Co.

This is Will Harman on for R.J. Most of our questions have already been asked, but just wanted to go back to acquisitions and dispositions. What cap rate ranges are you expecting to transact this year? Could you just provide a little bit color around that?

Yes, sure. In the U.S., we're targeting deals in the mid to high 6s and well into the 7s, and that's really what we've been able to accomplish over the last couple of years. I would say Europe -- depends on the country and can vary pretty widely, but on the low end of that range, Europe might be 25 basis points lower, again depending on deal specifics, length of lease term, et cetera. But yield there, they're trending downwards. But given the borrowing costs, we're still able to be accretive and make attractive spreads on those investments. Brooks, you want to talk a little bit about dispositions?

Sure. Timing and mix is certainly going to be a key factor in exit cap rates. But I think the right way to think about it is it's going to be largely in line or somewhat tighter than our acquisition pipeline. But again, a little too early to say on specific deal execution.

And then just with retail, you mentioned reducing some of your retail exposure. Is that primarily in the U.S.? Or is that a mix of U.S. and Europe?

This is actually primarily in Europe. We don't really own much retail in the U.S.

Our next question comes from Nick Joseph with Citigroup.

Just going back to guidance. What percentage of 2018 AFFO is from Investment Management? I know in 2017, it was about 20%. It looks like in the fourth quarter, it was just above 20%.

It is roughly 20%. I think that would be the high end of it still for 2018. As I mentioned, sort of we have 2 key fee streams left. We have the asset management fees, which again, you can look at Q4 as your run rate; and the structuring revenues, which are dropping fairly significantly from the prior years.

And so what's 2018 guidance assume for structuring revenues?

We haven't really given a range there, I think because the capital investing or the recycling on behalf of the funds could vary. But what I did say in my prepared remarks were that, that component of the revenue streams would be about 10% to 20% through 2018.

That component of the Investment Management revenue streams.

Right, of the Investment Management stream.

And then for The New York Times building, the purchase option in December 2019, what's the assumed cap rate on that given the rent bumps, I guess, over the next 2 years?

Sure. So again, as we've discussed on prior calls, that's kind of always been in our intent and expectation that they would buy that property back in December of 2019, which is year 10 of the lease. So that's a $250 million fixed-price purchase option. There's also fixed rent bumps on that lease, so that will be about an 11% yield on the ABR at the time. And when all is said and done, it's been a very attractive, well-performing investment for us. It will be about a 20% IRR over that 10-year hold period with a very low risk profile.

And then just maybe finally, just same question but on the U-Haul purchase option. I know it's a few years out, but what would be the cap rate on that?

That one is more of a market-determined number, so it's not -- we're not able to predict the cap rate as of now.

Our next question comes from John Massocca with Ladenburg Thalmann.

So if you look at Page 33 of the sup, your leasing spreads on renewals and extensions were down 4.7%. What would your same-store NOI growth had been -- or same-store rent growth had been if you include that?

I can tackle that one. That's not a number we've disclosed. And as you know, our same-store analysis is really focused on unchanged assets in the period. So it's unfortunately not a metric we have handy.

That's fine. What -- it was obviously one large retail lease that kind of was the bulk of that. Can you refresh my memory on what that was?

Sure. So we did a -- it's actually the first tranche of a proactive investment with our tenant, Hellweg, in Germany. So it's a portfolio of do-it-yourself stores. So we extended to a new 20-year lease the first chunk of that. The second chunk, so the rest of the portfolio, actually closed in January. So now that entire lease term is 20 years. And we invested about $15 million for some expansions and renovation work with the tenant as well. So a very attractive outcome for that portfolio.

And the stuff on subsequent had kind of a similar re-leasing spread?

No, that's actually a positive number. So all in, it's a positive leasing spread. But again, it's split between quarters. So unfortunately, it doesn't show up in this particular quarter.

Understood. And then kind of maybe more of a housekeeping question. The G&A guidance, does that include stock comp expense?

No, it does not. That's cash-based G&A.

(Operator Instructions) At this time, I'm not showing any further questions. I'll now hand the call back to Mr. Sands.

Thank you for your interest in W. P. Carey. If you have further questions, please call Investor Relations on (212) 492-1110. That concludes today's call. You may now disconnect.

Thank you. All parties may disconnect. Have a good day.