Surging inflation has been causing a lot of worry among investors this year. It's driving up costs, eating into the earnings of a growing number of companies.
However, while inflation is hurting most companies, it's benefiting others. One company that's getting an inflation-driven boost is real estate investment trust (REIT) W.P. Carey (WPC 0.55%). Because of that, it's a good hedge for investors who are worried about inflation.
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An inflation-driven rental income boost
W.P. Carey recently reported its first-quarter results. The diversified REIT grew its adjusted funds from operations (AFFO) by 10.7% per share. That outpaced the current inflation rate, which surged by 8.5% in March, its fastest pace in four decades.
A big driver of W.P. Carey's inflation-beating growth is its rental contract structure. The REIT primarily owns single-tenant properties triple-net leased (NNN) to tenants. That lease structure makes the tenant responsible for maintenance, building insurance, and real estate taxes, insulating the REIT from rising costs.
Meanwhile, many of its rental contracts have escalation clauses that increase rental rates based on inflation. Currently, 58% of its annualized base rent has inflation-linked contractual rate increases, including 38% completely uncapped to inflation's rise. In addition, most of its remaining contracts provide fixed rental rate increases.
Because of that, "inflation [is] beginning to more meaningfully appear in our same store rent growth," according to CEO Jason Fox in the first-quarter earnings release. The company's overall same store annual base rent was up by 2.7% in the first quarter, an acceleration from the sub-1.8% growth it delivered each quarter last year.
A secondary growth driver
In addition to inflation, acquisitions are another factor helping drive W.P. Carey's AFFO growth. The REIT invested a record $1.73 billion in expanding its portfolio last year. These new additions are providing meaningful near-term rental income growth with long-term upside. All the leases securing those deals feature fixed rental escalations averaging 2.3% annually or rent increases linked to inflation. Because of that, they'll supply the company with a steadily rising income stream for years to come.
Meanwhile, W.P. Carey has continued to acquire more real estate this year. It has already signed deals to invest $415.4 million on new property additions. That has it on pace to invest another $1.5 billion to $2 billion into expanding its real estate portfolio in 2022. In the first-quarter earnings release, CEO Jason Fox noted that even with interest rates rising, the company continues to "see strong deal momentum with an active, growing pipeline," with investment yields well above its cost of capital. Because of that, these future deals should provide a further boost to AFFO per share as it closes them.
That growing portfolio will enable W.P. Carey to take even greater advantage of real estate inflation. In addition to its inflation-driven rental income boost, the values of its properties should rise since investors typically value commercial real estate based on the income it can produce. Meanwhile, inflation is driving up the replacement cost of buildings, making existing ones more valuable.
A great REIT to reduce inflation's impact
W.P. Carey's lease structure makes it relatively inflation-proof. Tenants are responsible for escalating costs, while contractual clauses push rental rates higher. On top of that, the value of the company's steadily expanding portfolio rises with inflation.
Meanwhile, W.P. Carey provides investors with a really attractive dividend that currently yields more than 5%. It has a long history of steadily growing that payout, helping offset some of the impact of inflation on its income stream. Combine that with its capital appreciation potential, and this REIT should provide investors with inflation-beating total return, making it a great hedge in today's environment.
