W.P. Carey (WPC -1.70%) is one of the most diversified landlords you can find. However, the shares have been hammered over the past year, underperforming the average real estate investment trust (REIT) and its closest-sized net-lease peers. And yet the generous 6.5% dividend yield is obviously quite attractive. What's going on, and what is W.P. Carey doing to get back on track?
The business model works
W.P. Carey has a very long history in the net-lease market. Net leases require tenants to pay for most property-level operating costs. In fact, it was one of the first companies to popularize net-lease sale/leaseback deals as a way for companies to raise and use capital for other purposes, such as expanding their operations. It was also one of the first to bring the net-lease model to Europe, entering that market well ahead of net-lease giant Realty Income (O -0.17%).
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On top of being an industry leader, W.P. Carey also is one of the largest REITs in the net-lease sector, with a market cap of almost $14 billion. While Realty Income's $38 billion market cap dwarfs that figure, W.P. Carey is still roughly twice the size of the No. 3 name in the sector, NNN REIT. Scale comes with some advantages, such as being able to easily access the capital markets and taking on deals that are just too large for smaller players.
Meanwhile, W.P. Carey is one of the most diversified net-lease REITs. It has exposure to industrial, warehouse, office, retail, and self-storage assets. And nearly 40% of its rents come from outside the U.S. That gives it a lot of levers to pull as it looks for profitable investments.
Here's the proof of the model: The company has raised its dividend every single year since its initial public offering in 1998. This is not a fly-by-night company; it is one that has a strong history and a business foundation that peers can't match (even Realty Income doesn't have the same level of diversification).
The two big guns are getting more similar
There's an interesting thing here, though. A few years ago, as hinted above, Realty Income followed W.P. Carey into Europe. That market is still just beginning to embrace the net-lease model, so Realty Income is basically taking W.P. Carey's lead as it looks to expand. That's a flattering statement about W.P. Carey's business model.
W.P. Carey appears to be returning the compliment, just more slowly. Realty Income bought VEREIT several years ago and then spun off all of the office assets it owned into Orion Office (ONL 0.31%). The logic is pretty simple.
Office assets tend to be very large, so a vacancy can leave a big hole in a company's rent stream. Releasing vacant space or renewing a lease with the same tenant can require significant capital investment to upgrade the property. Finding new tenants for what are often highly specific assets can take a long time.
Realty Income basically decided to get out of the riskiest net-lease asset class it owned. The late-2021 spin off of Orion also let Realty Income avoid the pain caused by the lingering work-from-home shift left over from the coronavirus lockdowns. W.P. Carey isn't getting ready to spin off its office properties, even though the high rent it gets from that exposure -- 17% of its total -- has been one of the reasons behind its relative underperformance. Investors are worried about the risks of having so much office exposure. But W.P. Carey is, slowly, following Realty Income's lead.
Chief Executive Officer Jason Fox noted during the second-quarter conference call that five years ago office was around 30% of the rent roll. So W.P. Carey has been slowly reducing its exposure, partly by adding more to other property types. And he explained that the long-term goal is to get that figure to zero, just like Realty Income. That said, he didn't provide any time frame, so it could be a very long glide path.
That's not shocking because W.P. Carey tends to be very methodical in its approach. Why get out of a good property that's still performing well just because it's an office? However, investors looking at the REIT's office exposure and fretting should recognize that the long-term goal is to reduce this exposure, just like Realty Income did. In other words, it may not be the problem that some on Wall Street think it is. And there's really little harm in W.P. Carey trying to carry out a slow and orderly exit.
Give W.P. Carey a second look
W.P. Carey is not your run-of-the-mill net-lease REIT, given its size, diversification, and strong dividend history. The yield today is among the highest in the group, and comparable to those of the largest players. If you have been avoiding the REIT because of its office exposure, which is not immaterial, you might want to step back and think longer term. Yes, it is problematic today, but the goal is for office to become less and less important over time. And given W.P. Carey's long and successful history, giving management the benefit of the doubt probably is a good bet.
