One of the key differentiating factors behind W.P. Carey's (WPC +0.27%) business model is that it has a material presence in Europe. Historically, the net-lease competition in the region has been minimal. But Realty Income's (O +0.21%) increasing scale in Europe is changing that equation. Yet W.P. Carey believes the change will be a good one.
A big opportunity
While the U.S. net-lease real estate market is fairly well developed, Europe is only beginning to embrace this style of property ownership in a big way. A net lease requires the tenant to pay most of the operating costs of the properties it occupies. Very often a net-lease transaction is a way for a tenant company to raise cash by selling a property without having to give up the use of that property, given that the company will often immediately sign a long-term lease, usually with built-in rent hikes.
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It's really best to think of these deals as financing transactions. The seller gets cash it can use for growth or to strengthen its balance sheet. The net-lease real estate investment trust (REIT) buyer gets a long-term tenant and earns the difference between its cost of capital and the rents it charges. It's pretty close to a win-win. W.P. Carey has been doing this for decades in Europe with minimal competition. In fact, even with Realty Income entering Europe, there's still only three major U.S. publicly traded players in the market.
So this is something of an emerging region with modest competition. But, interestingly, Realty Income believes the European market is twice the size of the U.S. net-lease market. So there's potentially a huge opportunity here.
Not afraid of the giant
W.P. Carey, with a nearly $15 billion market cap, is one of the largest names in the net-lease arena. But it pales in comparison to Realty Income's $40 billion market cap. When the industry giant starts to venture into one of your key property markets, you would think a little concern might be in order. But that doesn't seem to be the view that Chief Executive Officer Jason Fox is taking, given his comments during W.P. Carey's third-quarter 2021 earnings conference call.
When asked specifically about Realty Income's expanding presence, he noted the size of the market, which could be as large as $8 trillion, suggesting that there's plenty of room for more competitors. He also explained that competition is fairly light in what is really still an emerging net-lease market. And he noted that the two REITs don't actually compete head to head all that often. Nothing overly shocking in any of that.
But here's the most interesting thing. W.P. Carey has been operating in Europe for about two decades and has a well-established presence in the region. It has proven to the market that it is a reliable partner, which is important for European customers. In fact, Realty Income has been pleasantly surprised by how well it has been received, highlighting the partnership aspect of its deals. Yet, even after 20 years or so, while W.P. Carey has found success in the region, it still hasn't really gotten the word out about the opportunity there. Which is why CEO Fox noted:
With regards to Realty Income, yeah, they will add some incremental competition, but I think there are investor perception benefits that may even outweigh that increased competition. Europe, I think, is largely viewed as a competitive advantage for us, but it's also less familiar to U.S.-based investors. So to the extent, Realty Income's increase in ownership of European assets helps investors get more comfortable with Europe. I think that's a good thing for us.
In other words, having the net-lease industry bellwether expanding into Europe will help investors get more comfortable with the 35% or so of W.P. Carey's portfolio that's in the region. And that could help to close the valuation gap that has long existed between W.P. Carey and Realty Income. To put a number on that, W.P. Carey's dividend yield is 5.3% while Realty Income's is 4.1%. That spread isn't unusual, but it could easily tighten if investors finally start to see the benefits of having material exposure to Europe.
Time for another look
If you have checked out W.P. Carey because of its relatively high yield but have held off because of its foreign exposure, you might want to reconsider. Indeed, with industry giant Realty Income starting to look more and more like W.P. Carey geographically, it may not be long before investors reconsider, in a positive way, the valuation they attach to European property exposure. On Wall Street, perception matters a lot --and W.P. Carey looks like it's due for a rethink.
