

W.P. Carey: Higher Dividends for Over 20 Consecutive Years

W.P. Carey (WPC) was founded in 1973 by Bill Carey, who helped to pioneer the triple net lease and sale-leaseback REIT business model. W.P. Carey went public in 1998 as a master limited partnership but converted to a REIT in 2012.

Today the REIT owns over 1,100 properties located in 25 countries around the world. W.P. Carey's portfolio is broadly diversified across tenants (over 300, none greater than 4% of rent), industries (over 25), property types (industrial, office, retail, storage), and geographies (37% of sales are outside of the U.S., primarily in Western and Northern Europe).
Source: W.P. Carey Investor Presentation
The company also used to manage more than $13 billion in non-traded REITs under its asset management business, which historically generated close to 20% of its adjusted funds from operations, or AFFO (similar to free cash flow for REITs).

However, in 2018 W.P. Carey announced a $5.8 billion all-stock buyout of one of its largest funds, making the company a virtual pure-play net lease REIT, as opposed to one that also manages large private real estate funds. 

All of the remaining funds have been closed to new money and are scheduled to be sold at a profit or rolled up into W.P. Carey between 2019 and 2023. These funds are paying about $22 million per year in management fees, accounting for roughly 2% of the W.P. Carey's total revenue.

W.P. Carey has paid increasing dividends for 20 consecutive years and is on track to become a dividend aristocrat in 2023.

Business Analysis
Bill Carey was one of the pioneers of the triple net lease and sale-leaseback business model in real estate. Specifically, W.P. Carey would buy a free-standing property from a tenant and then lease its back to them over a very long time period, usually 20 to 25 years. The tenant would gain immediate capital from the property sale while being able to continue to use the asset. 

The company structures these contracts as triple net leases, meaning the tenant pays all insurance, taxes, and maintenance costs. This creates a profitable and very stable source of cash flow, with inflation protection created by annual rental escalators tied to the inflation rate (99% of W.P. Carey's leases contain annual escalators).

However, W.P. Carey has several differentiating factors that make it unique compared to many of its U.S.-based peers. For example, the company is far more diversified by property type and industry, with relatively little retail exposure (18% of rent). 

This is because Bill Carey was a large believer in a highly diversified property type portfolio, meaning that the REIT focuses more on industries such as office buildings, industrial properties, and warehouses.

Another differentiator is W.P. Carey's large exposure to international markets, mostly in Europe (35% of sales). Management has long believed that the U.S. retail property market is overbuilt (which has since proven true), and so the company has focused on more profitable opportunities abroad. 

W.P. Carey has invested in Europe for nearly 20 years, giving it the experience to know which deals make sense and which to pass on. That's a big advantage for the REIT because of the long learning curve created by the highly localized nature of the countries and industries in which it operates.

Finally, W.P. Carey's asset management division has been a great source of long-term growth. This is because it primarily invests in non-publicly traded properties which have higher cash yields (due to lack of liquidity) and generally can only be done by experienced management teams with deep industry contacts.

However, going forward, W.P. Carey has decided to focus on its core triple net lease business and gradually shut down its asset management division. The company will roll up some of the triple net lease properties in its asset management portfolio, absorbing them into itself to create a nice short-term catalyst for growth.

W.P. Carey has actually pursued this strategy in the past, specifically in 2013 when it purchased one of its property portfolios for about $4 billion. In 2018 the REIT bought out CPA 17, its largest privately managed real estate fund, which added about 400 new properties to its portfolio. 

CPA 17 represented about 50% of the REIT's private property fund portfolio, so this acquisition is a major step towards W.P. Carey's goal of converting to a simpler business structure that will hopefully result in a higher valuation multiple.

Management believes that in the past the confusing nature of its mixed business model (direct ownership of property plus asset management) raised its cost of equity by keeping its price-to-cash flow valuation multiple below that of other triple-net REITs like Realty Income (O) and National Retail Properties (NNN). 

If successful, W.P. Carey's lower cost of capital would further increase the number of profitable property acquisitions and redevelopment projects the REIT could pursue. However, the company's management team has shown a strong dedication to disciplined acquisitions, very much focused on quality over quantity.

W.P. Carey only works with tenants who are on strong financial footing and are at low risk of falling into financial distress. Focusing on mission-critical assets and implementing lease escalations are additional priorities.
Source: W.P. Carey Investor Presentation
Management's focus on top quality properties and conservative capital allocation have helped W.P. Carey enjoy some of the industry's best occupancy rates, a key factor in generating a safe and steadily rising dividend over the years. Even during the Great Recession the REIT's occupancy never dipped below 96.6%.
Source: W.P. Carey Investor Presentation
The company has also worked to extend the length of its average lease term to 10.2 years and has nicely staggered its lease expiration schedule. No more than 7% of its annual rent expires any given year through 2023, which results in cash flow that is even more stable and reliable over time.
Source: W.P. Carey Investor Presentation

W.P. Carey's diversification, quality tenants, and prudent use of debt have earned the company a BBB investment grade credit rating from Standard & Poor's. This helps keep the REIT's borrowing costs reasonably low. As a result, W.P. Carey can pursue more growth opportunities without reaching for yield by purchasing lower quality properties leased to tenants who might default on rent during a recession.

With a stable and conservative payout ratio below the industry average, relatively low cost of capital, diversified property portfolio, and strong balance sheet, W.P. Carey seems like a safe bet for dependable income and moderate dividend growth in the years ahead.

Key Risks
While W.P. Carey possesses a number of fundamental strengths, there are nonetheless several risks to keep in mind.

First, W.P. Carey's international properties, while providing valuable diversification, also create currency risk. Specifically, a strengthening dollar reduces the cash flow generated in local currencies when it's brought back to the U.S. for accounting purposes.

Of course, W.P. Carey's management team is well aware of this risk and generally uses hedging to minimize its currency-induced cash flow fluctuations. So while currency risk is something to keep in mind, it's not a big concern for long-term investors.

A larger concern might be that W.P. Carey's largest property growth (which has fueled most of its dividend growth over time) has come from acquiring its managed non-traded portfolios at highly favorable terms.

Once W.P. Carey is out of the REIT asset management game, it will have to rely on more gradual property growth, usually one property at a time. The firm's disciplined approach to acquisitions also means that its growth rate could slow in the future.

For now, that doesn't appear to be the case, with the REIT acquiring $940 million in new properties in 2018 at average cash yields of 7%. The average lease duration on these properties was 20 years. 

W.P. Carey's business model is shifting, but the company deserves the benefit of the doubt. Importantly, the REIT's long-term management track record is impressive, and CEO Jason Fox has been with the REIT for 12 years. In that time he's been responsible for over $10 billion in acquisitions. In other words, investors should remain confident in the REIT's long-term growth, although it's hard to say what the ultimate pace will be. 

Finally, interest rates are always a factor to consider when investing in any REIT. However, the interplay between interest rates and REIT share prices is more complex than many investors initially think.

For one thing, the rate sensitivity of REITs varies over time and by industry, meaning that it can be surprisingly difficult to accurately predict how rising long-term interest rates will affect prices and yields.

In general, there is an inverse correlation between price volatility and interest rate sensitivity. In other words, the least volatile REIT industries, such as triple net lease REITs, can also be the most sensitive to interest rates.

That's because the same long-term leases that ensure strong cash flow predictability (and dividend security) also mean that these REITs have more inflation sensitivity given their bond-like qualities (slow growth, annual rent escalators could fail to keep pace with inflation). 

However, there are two important things to keep in mind. First, because WPC negotiates rental escalators on a property-by-property basis (no master leases) and 64% of its contractual rent increases are linked to CPI, its inflation sensitivity (and thus rate sensitivity) is lower than most of its triple-net lease peers. 

The second and most important issue to consider about interest rates is that they don't usually threaten the long-term growth rate of the REIT or its dividend. Simply put, REITs like W.P. Carey have experienced management teams that know how to carefully tune their capital structure to keep their costs of capital lower than the cash yields on new investments.

In other words, W.P. Carey has grown steadily for more than 40 years, during which management has proven itself capable of navigating all types of economic and interest rate environments, including when 10-year Treasuries yielded 16.5%.

While rising interest rates can cause W.P. Carey's share price to fluctuate, perhaps even significantly, they seem unlikely to threaten the company's long-term earnings power. 

Closing Thoughts on W.P. Carey
With a time-tested management team, strong global property portfolio, financially healthy tenants, and cash flow secured by rental agreements as long as a quarter century, W.P. Carey represents a high-yield, quality REIT that appeals to many conservative income investors.

The company has increased its dividend every year since going public in 1998, and W.P. Carey's business model seems likely to continue that trend for the foreseeable future.


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