W. P. Carey (WPC +0.70%) ended an era last year. The real estate investment trust (REIT) reduced its dividend by nearly 20%, ending a quarter century of annual increases. It made the move following its decision to enhance its real estate portfolio and financial profile by exiting the office sector and resetting its payout ratio to a lower level.
The REIT believes this transition will pay big dividends in the future. It should put it in the position to grow its adjusted funds from operations (FFO) faster, giving it the fuel to quickly rebuild its dividend (which still yields an attractive 6% after the recent cut). That faster growth should boost the company's valuation, creating more value for shareholders over the long term.
NYSE: WPC
Key Data Points
The great reset
W. P. Carey's management team discussed the company's transitional phase on its recent fourth-quarter conference call. CEO Jason Fox commented:
Exiting office over a short space of time has reset the baseline from which we will grow AFFO without the headwinds associated with owning office assets. Since our announcement, office fundamentals have remained under pressure while our multiple has expanded, reinforcing our conviction in the strategy and benefiting our cost of equity, making us more competitive on deals. We're able to achieve wider investment spreads, thereby enhancing our ability to generate AFFO growth.
The company's strategic decision to quickly exit the office sector, which represented more than 15% of its annual base rent (ABR) before the announcement, has had a significant impact. On the plus side, the REIT was able to get some value for properties in a sector that is currently under a lot of pressure. The company's valuation has already gotten a boost by removing that weight.
However, the move came at a cost. W. P. Carey's adjusted FFO is falling to a new baseline as it sells off those properties. Its adjusted FFO declined from $5.29 per share in 2022 to $5.18 last year and is on track to fall to a range of $4.65 to $4.75 per share in 2024. That declining adjusted FFO and a decision to be more financially conservative led the REIT to reset its dividend. It's now paying $0.86 per share each quarter ($3.44 annualized), which will put its dividend-payout ratio in the range of 72% to 74% this year. That's down from its prior level of $1.07 per quarter ($4.28 annually), which gave it an 83% payout ratio. The REIT's higher payout ratio held back its ability to grow its dividend and portfolio since it didn't retain much cash to invest in new properties.
Growing faster in the future
W. P. Carey believes that its strategic decision to exit the office sector and reduce its dividend-payout ratio will put it in a stronger position to grow faster from its new baseline level.
CFO Toni Sanzone commented on the factors driving this view on the call, stating:
2024 is a transitional year, primarily reflecting the execution of our office exit strategy and establishing a new baseline from which to grow our AFFO going forward. We believe we're very well positioned to generate FFO growth over both the near term and long term, supported by an improving investment environment, a strong balance sheet, and an exceptional liquidity position, as well as the embedded rent growth within our portfolio of high-quality, primarily warehouse and industrial net lease assets.
The CFO highlighted several catalysts that should drive faster adjusted FFO growth from its reset baseline. A notable one is the embedded rent growth of its portfolio going forward. With office properties no longer a drag, the company will benefit from the strength of its industrial-focused portfolio (59% of its ABR), which benefits from leases that tie rates to inflation (56%) or grow at a fixed rate.
In addition, the REIT has lots of financial flexibility to acquire properties with stronger growth profiles than offices. It's getting a big cash infusion from its office sales (and a tenant's repurchase of some of its self-storage properties). Meanwhile, it will retain more cash after paying dividends, giving it additional money to make new investments. These new properties should grow its adjusted FFO per share at a faster rate in the future.
That bodes well for the reset dividend. The CFO stated on the call, "Going forward, the intention is to grow our dividend in line with our AFFO." The REIT will go from increasing its dividend at a slower pace compared to its slower-growing adjusted FFO to a much faster pace since its adjusted FFO growth rate should be faster in the future with the dividend following it higher.
Attractive total return potential
W. P. Carey's decision to exit the office sector should pay off for shareholders over the long run. It positions the company to grow its adjusted FFO and dividend at a faster rate off its reset baseline. It should also take the pressure off its valuation. These factors put the company in a position to potentially produce attractive total returns in the coming years. That makes it look like a compelling investment right now.
