W. P. Carey (WPC -1.70%) recently revealed plans to strategically exit the office sector. The move will enable the diversified real estate investment trust (REIT) to focus on real estate sectors with better long-term demand dynamics. That should enhance the quality of its portfolio and rental income.
Here's a look at the diversified REIT's strategy to exit the office sector and how that will impact its 7.1%-yielding dividend.
Hastening its exit
W. P. Carey unveiled a two-part strategy to exit the office sector by early next year. It plans to spin off 59 office properties into Net Lease Office Properties (NLOP), a separate publicly traded office REIT. The company plans to sell the remaining 87 office properties it retains. It expects to complete the spinoff by early November and close the sales of its remaining office properties by January.
The company is taking a similar approach to Realty Income (O -0.17%), which exited the office sector in 2021. It spun off substantially all its combined office properties following its merger with VEREIT, creating Orion Office REIT. That move enabled Realty Income to focus on retail and industrial properties while Orion managed the legacy office portfolio.
A meaningful change
W. P. Carey has been steadily reducing its exposure to the office sector over the years. Offices supplied 30% of its annual base rent in 2015. That has fallen to 25.5% in 2018 and 16.1% this year. The spinoff of NLOP will further reduce its office exposure to 5.8%, while the sales program will bring it down to zero by early next year.
The transaction will further shift the company's portfolio toward industrial and warehouse assets. It believes that this move will enhance shareholder value, driven in part by a rerating of its stock trading multiple:
Data source: W. P. Carey.
As that slide shows, W. P. Carey believes it will fetch a higher trading multiple by exiting the office sector, given the higher average market trading multiples of peers like Realty Income without office exposure.
The company believes that the move will have several other benefits. It should enhance its growth profile, increase its earnings stability, improve the overall quality of its portfolio, and further strengthen its balance sheet.
Hitting reset on the dividend
Office properties currently contribute a meaningful amount of rental income. Because of that, W. P. Carey's cash flow will take a hit. As a result, it expects to reset its dividend following the office sector exit.
It plans to target a dividend payout ratio between 70% and 75% of its adjusted funds from operations (FFO). That's down from its current level of around 80% and closer to Realty Income's dividend payout ratio (76.5% of its AFFO in the second quarter). That lower payout ratio will allow it to retain more cash to invest in higher-returning property investments.
The dividend reset will mark a big change for W. P. Carey. The REIT has increased its dividend every year since its public market listing in 1998. While W. P. Carey investors will see a decline in their dividend income, payments from NLOP will help mute some of that impact. That new office REIT intends to make distributions to investors from its operating cash flow and future asset sales.
Meanwhile, W. P. Carey will likely increase its reset payout at a faster rate. Given its higher payout ratio, it has been giving investors modest raises (about 0.2% per quarter). By retaining more cash to fund new investments, it could grow its earnings faster, which could support a higher dividend growth rate.
The end of an era
W. P. Carey is accelerating its exit from the office sector. It plans to sell off a big chunk of its office assets while spinning off the rest to shareholders. That move will enhance its portfolio and balance sheet, which could boost its valuation.
However, the company plans to reset its dividend in the process, allowing it to retain more cash to invest in new properties across higher growth sectors like industrial and warehouse. While that move makes sense, it's disappointing to see the company's long dividend growth streak come to an end. Hopefully, W. P. Carey will quickly rebuild the dividend by growing it at a faster rate after exiting the office sector.
