After building an impressive track record of regular dividend growth, W. P. Carey (WPC -1.70%) has chosen to reset its business in a major way. Although the company focused on the spinoff of office properties when it announced the big overhaul, passive income investors paid more attention to an anticipated dividend cut. W. P. Carey's story has changed and that makes net lease peer Realty Income (O -0.17%) a better choice for most income investors.
The big letdown from W.P. Carey
Up until now, real estate investment trust (REIT) W. P. Carey has increased its dividend every year since its 1998 initial public offering. It increased it during the 2000 dot-com crash, the Great Recession, and the coronavirus pandemic bear market. Management had a slide dedicated to its dividend consistency in its investor presentation, specifically stating that it has a "conservative and stable payout ratio."
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But that record is about to be torn asunder, as the REIT looks to exit the office sector in one fell swoop. It has been working toward this end slowly for several years, but for some reason the urgency of the exit has suddenly increased. W. P. Carey's plans include selling some office assets from the portfolio and spinning the rest off to shareholders in a taxable distribution. That new company will be managed by W. P. Carey and will, effectively, exist to sell the properties it owns.
Diversification has long been one of the factors that separated W. P. Carey from its peers. And while there's nothing wrong with exiting the office sector, it will reduce diversification to some degree. Office properties make up about 16% of rents. That's a very large percentage, so it pretty much requires a dividend cut. Most investors, myself included, probably would have preferred a slow wind-down without a dividend cut even if it meant minimal dividend growth for a stretch of time.
The question now is what to expect from W. P. Carey after the overhaul. It's too soon to tell. In fact, there's no clear expectation regarding where the dividend will settle other than broad guidance that the adjusted funds from operations (FFO) payout ratio will be targeted to a range of 70% to 75%. Until there's more clarity, investors will be better off with a company that's known for being a little more boring. Realty Income is a great alternative.
Realty Income is dedicated to dividends
When it comes to commitment, Realty Income has really put its name on the line, trademarking the tag line "The Monthly Dividend Company." It has increased its dividend annually for 29 consecutive years. Like W. P. Carey, it is a net-lease REIT, which means that its tenants pay for most property-level operating costs.
Although Realty Income's yield is currently lower than that of W. P. Carey, that's a comparison based on W.P. Carey's pre-cut dividend. That said, the downturn in the REIT sector has pushed Realty income's dividend yield up to more than 6%, which is toward the high end of its recent history. That suggests that the shares are cheap today.
Data source: YCharts
The biggest difference between the two REITs is the broad focus of their portfolios. W. P. Carey has material industrial/warehouse exposure and Realty Income leans heavily toward retail assets. In some ways the two companies complement each other quite well with regard to sector diversification, which is one of the reasons I had owned them both. In fact, unlike most U.S. REITs, the pair both have notable foreign exposure.
If you are looking to own just a single net-lease REIT, given the pending dividend cut at W. P. Carey, most income-focused investors should probably err on the side of caution and go with Realty Income instead. At the very least, investors should wait until after the taxable office spinoff and the final announcement on the dividend cut before jumping aboard W. P. Carey.
Trustworthy versus rebuilding trust
At the end of the day, W. P. Carey isn't a bad REIT. I sold it because I don't want to get involved with the taxable office spinoff. I'll probably buy it again after the spinoff and dividend cut because its portfolio compliments my holdings in Realty Income so well. And I believe that W. P. Carey will work quickly to start rebuilding trust with investors (which means getting back to dividend growth ASAP.)
If I were looking to buy a net lease REIT today, however, there would be no question that I would pick Realty Income first. Realty Income continues to prove it is a trustworthy passive income stock and it seems unlikely that it will blow that trust up anytime soon. On that front, it is worth noting that Realty Income spun off its office assets not too long ago, but didn't have to cut its dividend.
