Dividend stocks can be an excellent source of passive income in your portfolio. W.P. Carey (WPC -1.70%), one of the world's largest real estate investment trusts (REITs), has been an excellent dividend stock for investors. For more than 26 years the REIT has raised its dividend payout to investors, making it a stellar source of income and investment appreciation. If you invested in the REIT two decades ago, your returns would have far outpaced those of the S&P 500.
W.P. Carey has been a solid performer for years, but can it keep winning? Let's dive into the business, near-term headwinds, and whether this REIT stock is the right fit for your portfolio.
W.P. Carey generates steady, consistent revenue through its leases
W.P. Carey owns and leases commercial real estate to companies all across the US. and Europe. At the end of last year, its portfolio comprised 1,449 properties in 26 countries. The company's goal is simple: to lease properties long-term with built-in rent escalators to produce steady and stable cash flows, letting it raise its dividend annually.
W.P. Carey uses sale-leaseback transactions to do this. In these transactions, it acquires a company's real estate and leases it back to them. Companies prefer to lease their properties because it allows them to use their capital more effectively and focus on their core business.
W.P. Carey uses long-term, triple-net leases that require tenants to pay all the costs associated with operating and maintaining the properties. These leases are preferable because the REIT doesn't bear any responsibility for operating the properties, requiring less management while generating a consistent revenue stream. Tenants benefit, too, by having more control over their properties while paying a lower rental rate.
Image source: Getty Images.
REITs like W.P. have struggled in the past year. Here's why.
REIT stocks have struggled over the past year as the industry has faced some headwinds. Over the past year and a half, the Federal Reserve has aggressively raised interest rates to fight inflation, which reached its highest level in more than 40 years.
Since March 2022, the federal funds rate (the overnight lending rate for banks) went from near zero to 5.25%. Higher interest rates have made investors more cautious about REITs, leading to a sell-off in good stocks such as W.P. Carey. Interest rates have an inverse relationship with prices, so when rates rise, it tends to decrease the value of properties. Higher interest rates also increase the cost of borrowing, making the cost of funding to produce further growth more expensive for REITs.
Not only that, but concerns have emerged about the commercial real estate market. Specifically, investors are concerned about the refinancing of office loans. Office properties have been under pressure since beginning of the pandemic, which led many companies to adopt work-from-home and hybrid-work arrangements. As a result, many companies are slashing their office space, and banks are more hesitant to lend to this sector. According to Moody's Analytics, nearly 90% of commercial mortgage-backed securities office loans maturing in 2023 will face refinancing challenges.
Why W.P. Carey is well-positioned to withstand headwinds
W.P. Carey has a diverse mix of properties across sectors, with office buildings making up about 17% of its total portfolio. These office properties are spread across the U.S. and Europe, helping to reduce any geographic risk if a few particular regions struggle.
It also has properties in the industrial sector (27%), warehouse (24%), and retail (17%), that provide diversification to its portfolio. Robust trends for industrial and warehouse properties should help those segments hold up better than others in commercial real estate.
One thing to keep an eye on for W.P. Carey is its debt maturities. By 2025, 44% of its total debt will mature, creating a need to refinance in the coming years. If interest rates stay elevated, it could squeeze the spread between its cap rates -- the rate of return in real estate investing -- and the cost of capital.
If interest rates stay elevated over the coming years, it would likely be because inflationary pressures persistent. W.P. Carey could prove resilient if that's the case, since 57% of its leases have rent increases linked to the consumer price index (CPI), while 40% of its rents increase at a fixed rate.
ABR = annualized base rent. Image source: W.P. Carey.
Its diversification and valuation make it an intriguing stock
REITs like W.P. Carey face near-term headwinds from the unknowns regarding the commercial real estate sector. However, given the sell-off in the stock over the past several months, the cheap valuation of W.P. Carey stock makes it an appealing buy.
History also suggests the recent sell-off could be a good buying opportunity. S&P Global did a study and found that in six periods when the 10-year U.S. Treasury Bonds rose significantly, REITs performed as well as or better than the S&P 500 four times.
W.P. Carey is well diversified across industries and geographies and should have no problem maintaining its dividend payout -- making the REIT a solid buy today, especially for investors looking to generate income from their portfolios.
