The commercial real estate sector is under the microscope. Central to investor concerns are high interest rates, with market participants slamming commercial real estate loan breaks.
The shares of W. P. Carey (WPC -0.12%) a commercial real estate company, are down 30% since the start of 2022. Real estate investment trusts (REITs), in general, have struggled with higher interest rates, especially those with higher-risk holdings, such as office properties. W. P. Carey recently said it would eliminate its office assets. Yet its 8% dividend yield looks tempting. However, before you add shares of W. P. Carey, here's what you should know.
1. W. P. Carey has a diversified real estate portfolio across industries
W. P. Carey is one of the world's largest REITs. At the end of last year, its portfolio included 1,449 properties in 26 countries. These properties span industries, including industrial, warehouse, retail, and office (for now).
As a REIT, W. P. Carey must pay out 90% of its income as dividends to shareholders. Its tax treatment is why REITs can make attractive income stocks to hold in retirement accounts like IRAs. During the past decade, W. P. Carey has been a reliable dividend stock whose dividend yield has averaged 5.5%.
2. Rising interest rates have been a boon to the REIT
The real estate industry has faced significant headwinds for more than a year, with high interest rates as the culprit. Since March 2022, the Federal Reserve has raised its benchmark interest rate from roughly zero to 5.5%.
Rising rates have a couple of effects on real estate investments. For one, prices tend to have an inverse relationship with rates, so when interest rates rise, property values fall. REITs also use leverage to boost returns. Higher interest rates raise these companies' borrowing costs, which can weigh on the bottom line.
Rising interest rates also make banks more reluctant to lend in riskier commercial real estate segments. Specifically, they are concerned about office properties, which have been under pressure since the pandemic began in 2020 and the shift to work from home. CBRE Group, one of the world's largest real estate companies, believes that office property values will take twice as long to recover as they did from the 2008 Great Recession and that they will be a shrinking part of commercial real estate portfolios in the future.
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3. It will spin off some of its riskier office holdings
W. P. Carey has made progress in reducing its office real estate exposure. Five years ago, office properties represented 30% of its annualized base rent (ABR). In the second quarter, these properties were 16% of its ABR. However, the company decided it would accelerate its exit from office properties, eliminating all of these assets in the next few months.
The company will reduce its office exposure in two ways. First, it will spin off 59 of its highest-quality office assets into a publicly traded company called Net Lease Office Properties (NLOP). Shareholders will receive shares of the new REIT on a pro-rata basis when it closes in early November. After that, it will sell its 87 remaining properties, aiming to complete the sales by January next year.
Chief Executive Officer Jason Fox says the company can "achieve a lower cost of capital and be better positioned for long-term value creation for our shareholders" by eliminating its office assets.
4. Its 26-year streak of raising dividends will come to an end
W. P. Carey has been a reliable dividend stock, raising its annual payout for more than a quarter-century. However, the company says its accelerated exit from office properties will help "reset its dividend policy" -- in other words, a reduction.
The REIT will target a pro forma adjusted funds from operations (AFFO) payout ratio of 70% to 75%. Last year, its payout ratio was around 80%. Chief Financial Officer Toni Sanzone said the company's goal is to "reset the payout ratio at a level that we feel comfortable with and one where we can retain a higher amount of cash flow."
W. P. Carey will continue to face near-term headwinds
W. P. Carey has been a solid dividend stock, and its exit from its office assets is likely a good long-term move that will help it focus on more reliable investments.
However, dividend investors never like to see a company slash its payout, and there are concerns that a quick exit from office properties may not be the best move. The stock has taken a beating since the announcement last month, falling by more than 16%, and will likely face pressure as it spins off NLOP and sells the remainder of its office properties in the coming months.
