W. P. Carey Inc. REIT

Hello, and welcome to WP Carey's first quarter 2022 earnings conference call. My name is Jessie, and I will be your operator today. All lines have been placed on mute to prevent any background noise. Please note that today's event is being recorded. After today's prepared remarks, we will be taking questions via the phone line. Instructions on how to do so will be given at the appropriate time. I will now turn the program over to Peter Sands, head of investor relations. Mr. Sands, please go ahead.

Good morning, everyone. Thank you for joining us this morning for our 2022 first quarter earnings call. Before we begin, I would like to remind everyone that some of the statements made on this call are not historic facts and may be deemed forward-looking statements. Factors that could cause actual results to differ materially from WP 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 wpcary.com, where it will be archived for approximately one year, and where you can also find copies of our investor presentations and other related materials. And with that, I'll pass the call over to our Chief Executive Officer, Jason Fox.

Thank you, Peter, and good morning, everyone. The strong year-over-year AFFO growth we reported this morning reflects both our sustained higher investment activity and inflation beginning to more meaningfully flow through to our rents. Our CFO, Tony Sanzone, will cover our earnings in more detail and give an update on our portfolio, balance sheet, and guidance. It's been over a decade since we've seen any real upward pressure on cap rates, so I'll focus my remarks this morning on the current environment, including the impact of higher interest rates and inflation. I'll also review our recent investment activity and pipelines. and give a brief update on our acquisition of CPA 18 as we move towards closing that transaction. And in light of the conflict in Ukraine, I'll touch upon the continued strong performance of our European portfolio and expectations moving forward. Tony and I are joined this morning by John Park, our President, and Brooks Gordon, our Head of Asset Management, who are available to take questions. Plenty to get through, so let's jump right in, starting with the broader environment, particularly the impact of higher interest rates on cap rates and investment spreads. With 10-year Treasury rates up about 100 basis points since early March and 150 basis points compared to much of 2021, the long-term cost of debt for all net lease REITs has moved meaningfully higher. Cap rates, on the other hand, generally react to rising rates on a lag, typically measured in quarters rather than weeks. While our cost of debt has undoubtedly moved higher, there are several mitigating factors that benefit our overall cost of capital and allow us to continue investing at sufficient spreads. First, it's important to remember that we were very active in the capital markets during 2021, raising almost $1.5 billion in debt capital, proactively pre-funding almost all of our debt maturities through the end of 2023, locking in an attractive cost of debt when it's significantly lower than current market interest rates. Second, our cost of equity has improved meaningfully since late February, with our stock currently trading around its highest level since late 2019, before the onset of COVID. Given our capital structure and commitment to running conservative leverage, a lower cost of equity is generally more impactful to our overall cost of capital than a higher cost of debt. Similarly, from a competitive standpoint, we expect higher interest rates to more negatively affect higher leveraged private equity buyers. Third, As we've consistently said, the spreads we generate on new investments are not driven solely by initial going and cap rates. The contribution to our earnings over time is better represented by the unlevered internal rate of return or average yields we generate on our investments, which factor in the favorable rent growth we typically achieve over long lease terms. And because over 99% of our AVR comes from leases with embedded rent growth, the majority of which is tied to CPI, we continue to feel good about the all-in returns we are earning for our investors relative to our cost of capital. In fact, for investments with rent increases tied to CPI, higher expected rent growth in the near term may partly compensate for a higher cost of debt. Finally, while we've always expected that changes in cap rates would lag interest rates, we are starting to see signs of upward pressure on cap rates. But it's important to remember that most of the movement in interest rates that transaction markets are reacting to happened relatively recently, really over the last six weeks. And while deal cap rates will eventually respond to higher interest rates, it's too early to say exactly how much and over what timeframe to reach an equilibrium. So far, we've seen cap rates move incrementally wider on new deals being priced and a handful of deals in the market being repriced. In some cases, this has resulted in them coming back to market or coming back to WD carry. And today, we would also price them at wider cap rates. During transitional periods in the market, like we're currently experiencing, sellers are more focused on execution risk. Our strong reputation for providing certainty of close therefore gives us a competitive edge and also tends to result in our transacting at better yields. With that as the market backdrop, I'll turn now to our recent investment activity. Year-to-date, we've completed investments totaling $415 million, with a weighted average cap rate of 6%, and a weighted average lease term of 21 years. Our investments were predominantly sale-leasebacks, giving us the ability to directly negotiate lease terms, including rent escalations. We continue to take a diversified approach, although we remain focused on warehouse and industrial, which represent about half of our portfolio. We're also maintaining our focus on essential retail in Europe, as well as exploring segments of U.S. retail. Our office exposure continued to decline incrementally, trajectory we expect to continue given our underweight stance towards this asset class. Turning to our pipeline, in addition to the $415 million of investments we've completed year to date, we continue to see strong deal momentum. Currently, we have over $400 million of deals in our pipeline at an advanced stage and about $175 million of capital projects or other commitments scheduled to complete in 2022. That gives us good visibility into about $1 million of investment volume. still relatively early in the year, and we continue to add to our pipeline at a healthy pace, making excellent progress towards our guidance range of $1.5 to $2 billion for full-year investment volume. Our expectations on full-year deal volume are, of course, before the impact of our proposed $2.7 billion acquisition of CPA 18, which is expected to add about $2 billion of assets after approximately $700 million of anticipated dispositions. Our announcement on CPA 18 was, in many ways, the most significant event of the first quarter, providing an excellent opportunity to add high-quality assets we know very well that are well aligned with our existing portfolio, with minimal balance sheet impact, as well as essentially concluding our exit from investment management. As we said at the time of our announcement, we expect it to be immediately accretive to our real estate AFFO by around 2%, largely offsetting the earnings we will lose from no longer managing CPA 18. with attractive embedded upside through its self-storage portfolio. Since announcing this transaction, it's been positively received by investors in our conversations with them who are widely recognizing these benefits. In terms of the progress update, I'm pleased to say the 30-day go-shop period ended at the end of March with no competing proposals, and we anticipate a closing date in early August pending the approval of CP18 stockholders and other customary closing requirements. The contemplated $700 million of asset sales primarily student housing and office assets, also remain on track, both in terms of our timing and pricing expectations. The sales processes well underway. Turning now to the more meaningful impact that inflation is having on our rents. We continue to believe we're better positioned than any other net lease REIT to capture higher inflation through rent growth. It's 58% of our AVR having rent escalations tied to CPI. On an AVR basis, 40% of our assets with rent increases tied to CPI went through scheduled rent increases during the first quarter, with an average increase of 4.5%. It's important to keep in mind that the 4.5% is capturing the year-over-year impact of fourth quarter CPI. And with inflation currently running at around 8% in both the U.S. and Europe, we'd expect to see significantly higher rent growth in 2022 and even more significant impact in 2023. We view this as especially valuable in the current environment, perhaps underappreciated by REIT investors, given that it has no cost of capital associated with it and has the potential to provide a prolonged tailwind to earnings, even after inflation begins to decline. And of course, if inflation expectations continue to move higher and for longer, you would expect to capture additional upside. Lastly, we're closely tracking the implication of the war in Ukraine, both in terms of potential impacts on our tenants and the transaction market. From a portfolio perspective, we have very limited assets in Eastern Europe, which are entirely within NATO countries, and we have no properties in Ukraine itself, or Russia for that matter. Within Eastern Europe, our assets are largely in Poland, primarily OBI, one of Europe's largest do-it-yourself operators, and a strong German-based multinational credit. To date, we've not really seen any impacts on our tenants' ability to pay rent, stemming from the Ukraine conflict, either in Eastern Europe or Europe more broadly. whether from higher energy prices or supply chain disruptions. That could change, however, as the war continues. If there are significant economic disruptions, which would likely have a global impact, we remain well positioned for them. We view our tenant experience during COVID, during which we remain the sector leader in rent collections, as the best indicator of our expectations. During the first quarter, we collected over 99.7% of rent due for the portfolio overall and 99.9% for Europe. Similarly, we have not yet seen any meaningful impacts on transaction activity in Europe. Putting the business aspects to one side for a moment, I'm going to also say we're committed to supporting the humanitarian relief efforts in the region and have made a donation to the American Red Cross, which is giving much-needed support to displaced Ukrainian civilians. The WP Carey Foundation has also matched our donation two to one to help further its impact. In closing, We believe we're set up very favorably for the current environment for several key reasons. We have a well-positioned investment-grade balance sheet with about $2 billion of total liquidity and proven access to capital at a cost of capital that we believe will continue to provide sufficient spread to our investment opportunities, even as cap rates lag interest rates. Currently, both S&P and Moody's have us on positive outlook, which could provide incremental benefits to our cost of capital, even in a challenging capital markets environment. After a record investment volume in 2021, we continue to see strong deal momentum and an active growing pipeline with good visibility into about $1 billion of investments, including investments completed year to date. We're making excellent progress towards the $1.5 to $2 billion of deals embedded in our guidance. In addition, we are confident in closing our acquisition of CPA 18, which adds about $2 billion of assets that will be immediately accretive to our real estate AFFO. with additional upside in its self-storage portfolio. Strategically, this transaction also simplifies our business, concluding our exit from investment management. Finally, and perhaps most importantly in the current environment, we believe we're the best position NetLease reached for inflation, given our embedded rent growth and high proportion of ABR tied to inflation. We're achieving record same-store growth in 2022, which is expected to continue if inflation remains high. And to the extent investors are concerned about uncertainty in the market and a possible recession, we also offer unique downside protection through our diversified approach and a roughly 5% dividend yield, supported by high-quality cash flows and sector-leading rent collections during COVID. And with that, I'll pass the call over to Toni.