W. P. Carey Inc. (WPC) Q3 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the W. P. Carey Third Quarter Financial Results Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kristin Brown. Please go ahead.

Thank you, Maureen. Good morning, and welcome, everyone, to our Third Quarter Earnings Conference Call. Joining us today are W.P. Carey's President and CEO, Trevor Bond; and Chief Financial Officer, Katy Rice. Today’s call is being simulcast on our website, wpcarey.com and will be archived for 90 days. Before I turn the call over to Trevor, I need to inform you that some statements made on this call are not historic fact and may be deemed to be forward-looking statement. Factors that could cause actual results to differ materially from W. P. Carey's expectations are listed in our SEC filings. Now I'd like to turn the call over to Trevor.

Thanks, Kristin. Thanks, everyone, for joining us today. It was a strong quarter, and I'll discuss some of the highlights and our investment outlook before turning the floor over to our CFO, Katy Rice. First, our adjusted funds from operation was $1.03 per share for the quarter, bringing us to $3.09 per share year-to-date. Second, we raised our annualized dividend by 2.4% to $3.44 per share, which represented our 50th consecutive quarterly increase. And third, despite some uncertainty with respect to the macro environment, we've already exceeded the goals we had set initially for a combined investment volume, and we crossed the $1 billion mark by the end of the third quarter, which, I think, is a first for us. That figure masks somewhat our current attitude of caution towards the investment environment for net lease assets within the United States, the competition for which has grown more intense, and I'll be discussing our views on that in a moment. But first, more detail on our volume. We structured $429 million of investments on behalf of the managed REITs during the third quarter. And subsequent to the quarter close, we structured an additional $180 million, adding about $1.1 billion of new investments to assets under management for the year-to-date through October 31. $498 million of that came in the first half and the balance was from July 1 through October 31. Also we acquired one property on behalf of W.P. Carey Inc. in the quarter for approximately $63 million, bringing our total for the year to about $249 million for the public REIT and a combined $1.4 billion for the entire W.P. Carey Group, including all managed REITs. The CPA programs activity this quarter came from 4 different net lease transactions and some self-storage deals. Two of the net lease deals were discussed on our last call in August, including a logistics facility in Poznan, Poland leased to H&M, which is one of the world's largest clothing retailers, and also a new research and development facility in the Netherlands for Royal Friesland, which is one of the world's largest dairy companies. In August, we also closed on State Farm's operations center in Austin, Texas, which was valued at about $116 million and also a $15 million auto dealership in the Dallas area. We also purchased 4 self-storage facilities for CPA:17 during the quarter, which totaled about $20 million. And the W. P. Carey balance sheet acquisition was a building in Manchester, England, which is leased to the U.K. tax authority. Another highlight for the quarter was the closing on September 15 of Carey Watermark Investors with a total equity raise of $582 million. Carey Watermark, as most of you know, is our separate nonlisted REIT wholly dedicated to the hotel industry with a distinct subadvisor and Board of Directors, all of whom have extensive industry experience and all of whom serve on the independent investment committee. CWI was an important contributor to W.P. Carey's revenues in the third quarter. We concluded 2 purchases: first, the Fairmont Sonoma Mission Inn & Spa in Napa Valley, California, which I discussed on the last earnings call; and also the 400-room Marriott City Center in downtown Raleigh, North Carolina. Also subsequent to the quarter's close, we purchased Hawks Cay Resort, which is the largest destination resort in the Florida Keys. CWI has an active pipeline, and because we continue to believe there are good opportunities in the hotel sector, we recently filed a registration statement for a follow-on offering of up to $350 million, which we expect to launch in the first quarter of next year. As I've mentioned on past calls, our Investment Management activity in both the hotel and storage sectors demonstrates our commitment to enhancing the revenues from and the value of our Investment Management platform by selectively adding new products silos over time. It's worth emphasizing, given that there are different business models to compare ours with and we're not all alike, it's worth noting that all the revenues from W. P. Carey's Investment Management segment, including our captive broker-dealer, Carey Financial, flow entirely to the benefit of our shareholders. To turn now to the macro environment and the current investment climate. The cap rates for the net lease transactions I have mentioned, including for the managed REITs, varied widely as you'd expect given the diversity of product type, industry and geography. The range of initial cap rates for the quarter was 6.4% to 9%. That's not a meaningful proxy for the entire net lease market, however, because these transactions were executed in markets as diverse as the U.K., Poland, the Netherlands and Texas with a diverse group of tenants and industries as well. But I will say that from W.P. Carey's point of view, the U.S. market has gotten more competitive as more capital has flowed into the net lease sector. When, back in May, the likelihood increased that the Fed would begin tapering quantitative easing and the bond markets responded by raising the 10-year to 3% and REITs generally experience a so-called correction, it was our expectation that cap rates in the U.S. would and should begin to widen. But that doesn't appear to have happened. And in fact, it seems, and this is anecdotal based on our own experience in marketed transactions, the opposite has happened, especially in the investment grade segment. It's not surprising that the easier a deal is to underwrite, the more bids it will attract. In short, it's been a good time to be a seller, and as proactive asset managers, we intend to take advantage of that. But it's been a less good time to be a buyer, in the U.S., that is. We're staying disciplined because it's important to us that acquisitions are not only accretive in the first year, but also going forward. For us, that means that the leases must contain contractual rent increases and it means that the short-term rollover/residual risk needs to be carefully considered and that the price per foot and the rent per foot don't veer too far from market. Unfortunately, we continue to find attractive transactions that don't fit into the box for other net lease buyers for a variety of reasons, and we have to work harder to underwrite these, but that's what we do. The landscape in Europe has remained more positive from a buyer's perspective, and we continue to see solid risk-adjusted returns over there, which explains why much of our volume in the third quarter was in Europe where we still get, in most cases, leases that adjust upwards according to the local inflation indexes. So despite the more competitive environment, we still believe we can deploy the ample capital we raised to grow assets under management as well as our own balance sheet, which brings me to the topic of growth and specifically how we intend to achieve it. There's been a lot of consolidation activity in the net lease sector and often we're asked about our own plans with respect to that. Clearly, our #1 priority now is to close on our proposed merger with CPA:16, which we announced back in July and which we still expect to close in the first quarter of 2014. But of course, it is still subject to the approval of both W. P. Carey and CPA:16 shareholders. If the merger closes, however, it's our expectation that we would raise the dividend to $3.52 per share at a minimum. And aside from the benefits of scale and liquidity, that should obviously be the primary goal and litmus test for any merger. That is, will it help us grow our AFFO, and therefore, our dividend. And when we've asked that same question with respect to the many external acquisition opportunities presented to us over the past 12 months, the answer has been no. And if it's not going to be accretive, we're priced attractively based on fundamentals, why should we do it? We don't believe that growth and scale alone will enhance shareholder value unless it leads to sustained AFFO per share growth. The cause-and-effect relationship between increased size and AFFO per share growth is not axiomatic nor do we think that size alone will result in a higher valuation for W.P. Carey. There are other necessary ingredients and those are what we're trying to focus on. Among those other ingredients are: first, conservative leverage and a predictable, reasonable cost of debt, and Katy will get into our balance sheet strategy more in a moment. Another important success factor is manage -- fostering management debt as well as maintaining and communicating clear alignment of interest between management and shareholders. Also we think our share value will grow if we continue to enhance the value of our wholly captive Investment Management platform. And finally, we think that the market will award higher multiples to the REITs that are able to demonstrate not just external, but also internal growth, which we intend to achieve in 3 different ways. First, through growth in our base rents that occurs due to contractual increases in the leases either through fixed bumps or increases tied to inflation indexes, as is the case with the majority of our leases. Clearly, this increase will be offset by reductions in rent that we experience sometimes when old leases roll over. But our lease expiration in the next few years are manageable and we expect early next year to be able to provide you with guidance as to our specific forecast with respect to how this trade-off will apply to our AFFO. Second, we intend to grow our revenues by continuing to increase assets under management. Because we have global coverage and expertise, we have exposure to a much deeper, broader pool of opportunities, which enables us to pick and choose and also to better diversify risk notwithstanding a competitive U.S. climate. Third, we intend to grow W.P. Carey's own balance sheet one purchase at a time for as long as our cost of capital is attractive relative to the opportunity set, which still is the case. This way of growing is admittedly slower than acquiring large portfolios, but we think it's more likely to lead to AFFO accretion, which will, in turn, lead to enhanced shareholder value. That said, clearly, we believe that if the market goes through a period of correction and the bulk premiums that we're seeing begin to decline and if sector consolidation starts to make fundamental sense, then we think we'll be as well positioned as anyone else to play a role. And now, I'll turn the microphone over to Katy.

Thanks, Trevor, and good morning, everyone. I'd like to review our financial results for the third quarter, walk you through our portfolio metrics and then finish up with a discussion of some of our balance sheet initiatives for the remainder of the year and the coming quarters. Let's start with our earnings. Our third quarter earnings were fairly consistent quarter-to-quarter with both Q1 and Q2. However, the year-to-year comparison is not really meaningful as it reflects the impact of the CPA:15 merger, which we completed in September of 2012. Our real estate segment revenue increased modestly with the addition of approximately $2 million of lease revenue from our Q2 acquisitions, which totaled $113 million. Our Investment Management revenues were up 53% quarter-over-quarter due primarily to the increase in structuring revenues we earned from investing approximately $429 million on behalf of our managed funds. As we've mentioned in the past, you should expect significant quarterly variability in the Investment Management numbers, particularly in the structuring revenues, which are dependent on our acquisition volumes in the managed funds. In addition, the Investment Management income is taxable. So our quarterly tax liability, which is difficult to forecast, creates variability as well. As we reported this morning, our AFFO in Q3 was $1.03 per diluted share. We had a robust fundraising quarter for our hotel fund, Carey Watermark, and this is reflected in the higher dealer manager fees and reimbursed cost from affiliates quarter-to-quarter. We completed our fundraising in September, having raised a total of $582 million of equity. We also began fundraising for CPA:18 this quarter with a target equity raise of $1 billion. From a balance sheet perspective at the end of the quarter, our debt-to-total growth assets was 42% and our net debt-to-adjusted EBITDA was 4.6x. We do not have any significant debt maturities for the remainder of 2013. But in 2014, we have 8 mortgage loans maturing, which total approximately $273 million. As of September 30, the weighted average cost of our nonrecourse debt was 5.2% and our overall cost, including amounts outstanding on our line, was 4.4%. We're in the process of recasting our senior credit facility and expect to have a new larger facility in place towards the end of the year or early in the first quarter. We continue to have several hundred million dollars of capacity on our line for additional acquisitions. At the end of the quarter, the WPC Group, which includes WPC Inc., as well as our 4 managed funds, had a total AUM of $15.8 billion. Now let's review our WPC portfolio metrics. As of September 30, our portfolio consisted primarily of 421 net lease properties with 39.4 million square feet leased to 125 different tenants with 31% of our lease revenue coming from investment grade tenants. Approximately 70% of our contractual minimum base rent is from properties that are located in the U.S. and 30% is from our international investments. At the end of the quarter, our portfolio occupancy was 99%, and our weighted average lease term at the end of the quarter was 8.7 years. In Q3, we completed the acquisition of an office building in Manchester, England for $63 million. The property is leased to the U.K. government. As part of our proactive Asset Management program, we selectively sell properties that no longer meet our investment goals. In the third quarter, we sold 3 small properties for a total of $8 million. We do not have any lease maturities through the remainder of the year. And in 2014, we have 12 leases expiring, representing approximately 3% of the portfolio revenue. We are actively working on each of these tenants to assess their needs and formulate a game plan. In most cases, we expect the tenants to renew. However, we do expect some of these properties to become vacant and are working on alternative outcomes, including leasing the property to a new tenant or selling to or joint venturing with a local entrepreneurial developer who can reposition the property. As we announced in July, we expect to complete the proposed merger with CPA:16 sometime in the first quarter. The combined company is expected to have an equity market cap of approximately $6.5 billion and a total enterprise value of approximately $10 billion. As I mentioned on our last 2 calls, we expect to have greater access to a variety of capital sources to fund our growth and lower our cost of capital. In the coming quarters, as our secured debt rolls off, we plan to build an unencumbered asset pool in anticipation of becoming an unsecured borrower. A new larger revolving credit facility, which we expect to have in place late in the year or early 2014, will be an important component of our plan. We expect this shift to take 12 to 18 months and will be dependent on the timing of our investment volume and the expense involved in prepaying certain secured debt obligations. As we announced earlier in the quarter, we increased our quarterly dividend by 2.4% to $0.86 per diluted share or $3.44 per share on an annualized basis. Finally, with respect to our earnings forecast for the remainder of the year, we expect the first 3 quarters to be reasonable proxies for Q4. We have a few potential acquisitions that may close towards the end of the year or may slip into 2014. So there may be some variability with respect to our Investment Management structuring revenue and our tax liability in Q4. And with that, let me open it up to questions.

[Operator Instructions] Our first question is Sheila McGrath, Evercore.

Trevor, I was at the NYU conference recently and it seemed the consensus view that investment opportunities right now are best in Europe. I was just wondering if you could talk about your views there and also how you take into account the additional risks of investing in Europe.

Well, I think we've maintained that posture really for the last several years even through some of the periods of perceived crisis in the euro and peripheral eurozone. So I would concur with whatever conclusions were reached by those participants. We haven't really stopped our efforts over there. With respect to the risks, clearly, the one that would be foremost on most people's minds at any given point would be the currency risk. And we have, as many of the participants on the call know, actively hedged against our euro risk for a number of years and recently took advantage of increased strength in the euro to push out our forward contracts even further, I think, to about 6.5 years out at attractive rates. And so -- and that's been the strategy all along, in periods of weakness of the dollar to enhance our hedging with respect to the euro. And the rest of it, I think, we mitigate the risk by having people on the ground in Europe. We have a fully staffed office in Amsterdam, which we've talked about on other earnings calls, more than 20 people fully functional across all areas that are important. And I think that gives us the ability to quickly get over to any potential areas of problems or meet with tenants on a regular basis and stay in front of them to make sure that we're on top of their needs. That's in addition to our investment office in London.

Is -- but Trevor, is there a rule of thumb in terms of how much cap rates that you look at -- you want to see a differential versus the U.S.?

I don't think so. I think we look at each individual investment on its own and based on its own risk and do factor in that hedging that I mentioned. And I would say that pound for pound, we do see a differential. It's not based on a quota that we have set ahead of time.

Okay. And then just quickly, on the go-shop provision expired during the quarter and the document, the S-4, revealed that there were 2 potential bidders and in both cases, they requested WPC waive fees. I just wanted to know your thoughts on that, kind of those bidders and your view on waiving fees, et cetera.

Well, I think it was an easy decision for us to make to not waive fees that we had earned. And I think it would have been against the interest of all of our shareholders to do so. So I'm not sure what more I can say other than that wasn't a commercially reasonable request.

Okay. Last question, just on CPA:18 in terms of the capital raised in the quarter, are you pleased with those volumes? I know that others in the sector have much bigger volumes that they report their raise. I just wondered, are you happy with that kind of magnitude, and how we should think about the ramp-up of raising CPA:18?

Yes, we are pleased with it. We still have dry powder to deploy from CPA:17 roughly, and this is an order-of-magnitude estimate, about $215 million net of deals that we've already committed to or that we expect we'll have to provide capital for build-to-suit opportunities, et cetera. So we still have some money to invest from 17, which closed back in December. So actually it was helpful to have somewhat of a pause in our fundraising. One of the biggest concerns that we would ever have is maintaining the equilibrium between the capital that we're raising and the investments, the pipeline that we're seeing. And right now, we're in pretty good equilibrium. With respect to our rankings in any lead tables, that's of no concern to us whatsoever. It's never our goal to be the top fundraiser. It never has been because, I think, that exposes one to the risk of what do you do with all that money if you're not seeing the opportunities that you like.

Our next question is Paul Adornato, BMO Capital Markets.

Trevor, just to follow up on Europe, is there an upper limit as to how much exposure you'll have to Europe in any of the funds?

There is no upper limit in terms of what the prospectus discussed and what we described to investors. I think a prudent investor's going to look at concentration risk, as you know, Paul. So we'll keep an eye on that. And if it became what we thought to be too much concentration risk in Europe, then we would back off. We did back off somewhat in 2011 because we weren't quite seeing the returns that we wanted and we felt it was getting a little high. But given the opportunities that we're seeing now, we haven't wanted to slow down.

Okay, great. And Katy, you mentioned in terms of the lease expirations next year that there might be a couple of vacancies. Was wondering if you could perhaps quantify the vacancies versus renewals and perhaps give us a little bit more color on those assets?

Yes, in the 2014 maturities, obviously they're sort of somewhat spread throughout the year. But our Asset Management team has been in active dialogue with each of those tenants, really beginning this year as we forecast out sort of where we're going to be. So we have a fairly detailed plan in place for each of those. But I don't have the breakout on exactly what we think we're going to be selling versus re-leasing for you.

Okay. And I guess from a bigger picture perspective, to Trevor, I appreciate the kind of tone of caution that you have expressed on this call. But was wondering if, as you look out over the entire net lease landscape, since you do have a specialized fund in Carey Watermark, if there were other kind of niche areas within the net lease universe that might be either appropriate for a specialized fund or just inclusion in your existing funds?

Well, and also we are a prominent player now in the storage sector, as I've mentioned. I mean, in terms of we're nowhere near the big 4 public REITs, of course. But in terms of the scale of the operation and the size of our portfolio, we're in the top 10 in terms of owner-operators, managers of storage. So that's something that we do in the context of the CPAs. And right now, we have no immediate plans to expand our portfolio -- our product offerings, but we are looking at other opportunities. I just wouldn't want to comment on it right now in this call.

Our next question is John Wollershin [ph], UBS.

Two things. When do you imagine the vote for CPA:16 will occur?

We believe pretty early in 2014, I think.

It's going to slip to the first quarter?

Well, it's an ongoing process and it's not a 1-day event, as you probably know. It extends over a period of time. And so just to be prudent, I think it's safe to think of it as ending early in the first quarter.

Okay. And if you just look at the private REIT space, they've raised a lot of capital this year. Do think there's maybe some investor fatigue? Are you guys concerned about that as you think about ramping up to CPA:18?

No. I don't think we're concerned at all that we will be able to raise the full amount, which is $1 billion of the offering. We're not concerned. And we're not concerned about the other side of it, although I should say that we're always focused on it, which is that equilibrium that I mentioned, can you deploy the capital that you've raised. In terms of investor demand, I don't see that abating because the investors in that particular segment of the non-traded REIT space are people who want rising income and these are good income products for that type of investor. And notwithstanding comments about the rise of interest rates and what's happened in the bond market, the alternatives for many investors haven't really become more attractive with all this talk of tapering, et cetera. Where else can you get these kinds of yields? But I think that, that dynamic will continue.

[Operator Instructions] Our next question is Dan Donlan, Ladenburg Thalmann. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: Trevor, I might have missed this. I was waiting to get on the call for a couple of minutes listening to Rigoletto, so that was enjoyable. But just in terms of raising net lease capital, how do you think that's going to be different with ARCP and Cole potentially being combined as an entity. Do you think that it's one less competitor? You might be able to raise more than you would have otherwise if those 2 had been separate entities? Or what's your thought process there?

Well, again, to repeat something I'm not sure whether you heard, but it's not our desire or our goal to actually raise more than we're currently raising. So that with respect to an increase in market share, it might be possible. It won't factor into our AFFO growth forecast at all. If we were to double our capital, which we don't intend to do, it wouldn't necessarily change our growth estimates because our growth estimates are based on what we think we can reasonably deploy in a good risk-adjusted way. So even if that merger was to result in a larger market share for us, I don't think it would have a significant impact on our business. And with respect to what it does to the combined volume of those 2 platforms, those 2 fundraising platforms, which are quite formidable, I will admit, no question about it, I really couldn't say. I don't know how that will play out. I don't know how management intends to integrate an internally-managed owned platform with a relationship outside the REIT with externally-managed platforms. I don't know how that's going to -- and I'm sure that their management will have a strategy that they can communicate, but I can't comment on it. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: Sure. I was just more or less just curious if you thought that might up your market share in which case you might see more capital coming in than maybe what you expect. But going back to the $65.6 million that you raised for CPA:18, when -- over what time frame did you raise that?

The fund is in operation for a few months now. It was a slow ramp-up. We did sign on our largest dealer, broker-dealer, fairly recently, only about 1 month ago, 1.5 months ago. And so, as I say, we don't expect that we'll have any problem with the fundraise for CPA:18.

Dan, what's typical is in the early months we're still working on signing agreements and getting through their due diligence. So it's usually a slower ramp, which is fine with us. As Trevor mentioned, we have dry capital, dry powder in CPA:17 to deploy. And then, as is typical, as you get towards the end date, there is sort of a flood of capital, which is what we experienced recently with CWI. So I think we're -- as Trevor mentioned, we're not concerned about it at all and I think it will dovetail nicely with, hopefully, our ability to deploy the capital in a responsible way. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: Absolutely. I guess, historically, what has been kind of the monthly run rate for these funds? Is it something around $30 million to $40 million a month or...

It varies widely and it has exceeded that by a large margin in the closing months for CPA:17, for instance. Once the close approaches, it becomes...

It's not linear.

Yes. It's not linear, that's right. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: But you would expect probably a pretty large inflow into the fund in back half of the first quarter into the second quarter as some of your potential CPA:16 investors roll out and maybe choose to go into CPA:18 versus potentially the whole W. P. Carey stock?

Yes, that could happen. But now, I think, we're fringing on areas where, because it's a public registration statement, I can't comment any more on the sales pace or what might stimulate sales or whatnot. Sorry about that. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: No, perfectly understood. And then just kind of last question, bigger picture, Trevor. I mean, you guys have been doing sale-leasebacks for 40-odd years now. Just kind of curious how you see the environment on the sale-leaseback side, not necessarily third-party owned properties now versus where you have another prior interest rate cycle. I mean, do you feel like there's just a lot of volume coming direct from people that own real estate and have owned real estate for a number of years? Or what's your view there?

Well, I think, that you're speaking to the supply of opportunities. And this year it seems as if the supply of opportunities, particularly in the retail space, has been already generated -- already negotiated lease deals, so done by a third party. We think that as the economy continues to expand globally that you will have more companies that start to see sale-leaseback as an attractive alternative form of capital raise as opposed to debt, for instance. And we think that they'll have more confidence and more intention to actually utilize that because they'll have more of a need for it. So over the past few years, sale-leasebacks have been done, for the most part, to delever. And going forward, we think that the sale-leasebacks will be done by corporate owners in order to expand as well, particularly here in the U.S. So that's why I feel that the supply of opportunities will eventually expand and hopefully enough to accommodate the increased inflow of capital into the space. We're certainly seeing that abroad and we think it'll continue.

Having no further questions, this concludes our question-and-answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.