Inflation is insidious, slowly eating away at the value of money over time. Although inflation is running hot today, it is almost always present and normally so slow that the hit to your buying power goes unnoticed. W.P. Carey (WPC -1.70%) has noticed and was prepared in advance for today's sharp inflation spike.
Here's how this real estate investment trust (REIT) protects itself -- and its shareholders -- from rising prices.
A simple but powerful model
From a big-picture perspective, W.P. Carey doesn't do anything particularly unique. It is just one of many REITs that use the net lease model. This means it owns properties that it leases to single tenants, and those tenants are responsible for most property-level operating costs. Although any one asset is high-risk, since there's only one tenant, across the company's over 1,440 properties, the risk is pretty low. Notably, tenants have to deal with increasing costs for things like property maintenance.
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What's a little more unique about W.P. Carey is its focus on sale/leaseback transactions. This means that it is buying a property directly from a company that then turns around and becomes the lessee of the asset. This is important because it means that W.P. Carey is creating the lease and, thus, it gets to set the lease terms. That gives it a huge amount of control, including with regard to contractual rent increases.
Added to that, W.P. Carey also spreads its investments around in a way that few of its competitors replicate. For example, roughly 38% of its rent comes from outside the United States. And its portfolio includes industrial (27% of rent), warehouse (24%), office (17%), retail (17%), and self-storage (5%) assets. This allows the REIT to put cash to work where it sees the best opportunities for high returns and also allows it to avoid overly competitive areas of the market where lease terms aren't attractive.
And, to add a little more nuance to the picture, W.P. Carey is also willing to work with lower-quality tenants. Such tenants often have to provide more financial information to prospective landlords in sale/leaseback deals, allowing W.P. Carey to further fine-tune its leases. Weaker companies also tend to accept more stringent lease terms since it is generally harder for them to access cash.
All in, the REIT has a fairly unique approach in the net-lease REIT sector.
The inflation benefits
The first thing to notice with W.P. Carey is that there are a lot of moving parts. However, it has increased its dividend every single year since its 1998 initial public offering. That's roughly a quarter of a century of dividend increases, a record that a company simply can't achieve without a successful business model. The average annual dividend increase over the past decade, meanwhile, was about 4.5%.
That figure may seem modest given the high rate of inflation today. However, inflation has historically averaged closer to 3%. So over time W.P. Carey has grown the buying power of the dividends it pays to shareholders. A key piece of that ability, meanwhile, is found in its ability to dictate the terms of its leases.
To put a figure on that, nearly 60% of the REIT's leases include rent escalations that are tied to inflation-driven benchmarks. The increases roll in over a period of time since each lease is signed at a different time and, thus, annual escalators kick in at different points of the year.
But the end result is pretty impressive, with the company's same-store rent growth more than doubling over the past two years. In the first quarter of 2021, same-store rents increased by 1.6%, and in the first quarter of 2023, they rose by 4.3%. By comparison, peer and industry giant Realty Income's (NYSE: O) same-store rent increased just 0.2% year over year in the first quarter of 2023.
Clearly, W.P. Carey has some embedded hidden strengths in its business model that set it apart from the pack.
Ready in advance
What's really important to understand here is that W.P. Carey didn't just start caring about inflation. The results shareholders are benefiting from today are based on policies and approaches that have been in place for decades. Diversification by geography, property type, and tenant quality and a keen focus on leases that protect W.P. Carey from inflation and maximize long-term returns are simply part of the company's DNA.
And that is why conservative dividend investors should be looking at this stock and its generous 6.3% dividend yield today, even as the stock pulls back in the face of raging inflation and rising interest rates.
