Written by Sam Kovacs
I'm sure that most of you have heard the news, W. P. Carey (NYSE:WPC) is exiting offices, and resetting (a fancy word to say cutting) its dividend as a consequence.
The market didn't take well to this, with WPC's share price plunging 15% since the news.
Neither did it fare well with some Seeking Alpha authors who have qualified management of "turning sour" or suggesting that they no longer "sleep well at night" holding WPC.
WPC currently trades at $53.26 and based on our estimate of the incoming dividend cut, has a forward yield of about 7%.
Is the spin-off a good idea? How bad is it really?
Let's unpack all of this.
Here are the details of the spin-off and sale of office assets:
First, here is a summary of the strategic plan which involves a spinoff of 59 properties and a sale of 87 properties:
- Majority of office assets to be spun-off into a publicly traded REIT, Net Lease Office Properties (NLOP), contributing to about 10% of current ABR.
- NLOP to pursue its business strategy independently, focusing on value realization for its shareholders.
- Expected to enhance W. P. Carey’s credit profile and earnings growth with improved cost of capital.
- Some office assets retained and to be disposed of in the near term, mainly international assets.
- Assets under the program represent about 5% of total ABR.
- Targeted for sale by end of the year.
Realty Income (O) decided to dispose of their office portfolio in 2021.
That was much better timing than WPC's disposals which seem to be happening at a questionable time, when office valuations are low.
One must first ask: why leave offices at all?
The corporate office space is forever changed, and likely will never recover to what it was.
The poor cash spreads that office REITs have witnessed on renewals are a clear testament to this.
I've commented in the past over WPC's gradual reduction of its office exposure over the past few years from 30% in 2015 to 16% at the end of Q2 2023.
I viewed this reduced exposure as smart and compelling, but I must say, they're late to the game with the exit.
While WPC's exit of offices makes sense, this is a move which would have been more timely if made in 2021.
We can't go back in time, and this is what it is.
But why would they go for a hybrid exit of a spin-off and a sale?
Let's compare the numbers of the offices being spun-off versus the offices being sold.
The offices being spun off represent $141 million in annual base rent, from 8.7 million square feet. This is about $16 in rent per square foot.
The offices being sold brought in $77 million from 6 million square feet, or $12.8 per square foot.
If we take out property expenses and taxes, this goes down to $15.4 per square foot for the spun-off portfolio, and $11 per square foot for the sold properties.
From a top line perspective the spun-off properties are actually more profitable.
But we need to look beyond that.
The spun-off properties have a weighted average lease term of 5.7 years versus between 9 and 10 years for the offices being sold.
The vast majority of the offices spun-off have fixed rent escalators, versus mostly CPI linked on the sold properties.
The shorter weighted average lease term is likely what is at play here: a potential buyer will be looking at what spread he could renew the leases and the numbers are likely not good. If they were WPC would sell rather than spin-off a debt straddled company.
But to say that they are dumping all their bad assets in the spin-off and selling the rest isn't true.
They are selling mostly their European office assets, and spinning off mostly their US based assets.
The conclusion that WPC is spinning off worse office properties, is therefore hasty and unfounded.
What are the consequences of exiting offices?
Having exited offices, WPC will be comprised of industrial properties, essential retail and self-storage properties with a weighted average lease term above 11 years.
The company will generate between $5.18 and $5.26 in AFFO and payout 70 to 75% as a dividend.
This suggests an annual dividend of $3.6 to $3.9. Let's meet in the middle and call it $3.75.
WPC currently pays $4.284 in annual dividends, meaning that we are looking at a dividend cut of 9% to 16%, with a 12.5% cut as the mid point.
This is what the DFT Chart for WPC would look like, after the dividend cut: effectively reversing the past 7 years of dividend growth.
Even with the dividend cut, WPC would yield about 7.1% at the current price going forward.
Interestingly enough, WPC's share price is now at the same level it was at its lowest in 2016, despite now having a portfolio of assets in subsectors which I like a lot more (industrial/self storage/essential retail).
Management pointed out that the transaction should drive a rerating of WPC's AFFO multiple, which at 11.9x AFFO, was below peer averages of about 14x AFFO.
And I believe that is fair. WPC's portfolio is comprised of strong assets backed by a competent management team.
If WPC were to trade at 13x its go forward AFFO, it would be priced at $67.6 and yield 5.5%, which would be slightly below its 10 year median yield of 5.8%.
A $65 price target for WPC is therefore quite conservative I believe. It will of course take time, as sentiment is poor among REITs and even poorer at the stock level post spin-off.
The stock's momentum is appalling, it has strong downside momentum.
There is no saying where the stock will ultimately bottom, as it hasn't shown signs yet of bottoming, and it will likely be targeted as an option for tax-loss harvesting in the 4th quarter.
The consolation, is that you're getting the spinoff, which is worth 10% of WPC's ABR. This is an extra $3-$5 worth of assets which you can expect to get per share, at least.
This has been discarded as 0 value which I don't believe is fair.
Let's wrap it up.
So while the market has reacted badly, and while I agree it can be perceived as distasteful, and yes the timing was bad with the market in a "fear mode on" phase where REITs are going down more than the rest, but I do not believe that:
A. this is a bad thing long term.
B. the sell off is justified
C. there is any reason to dump WPC.
In fact, I'll be topping up our position to bring down our average cost, while leaving room to add at lower prices.
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