It's been a tough couple of years for companies owning and operating commercial real estate properties. Rising interest rates have led to growing refinancing costs for those in the industry, with specific property types under intense pressure.
One commercial real estate investment trust (REIT) navigating these challenging times is W.P. Carey (WPC -1.70%). W.P. Carey is one of the largest REITs in the U.S. and is known for its long history of growing its dividend payout. However, that 26-year streak recently ended as the company strategically decided to shore up its balance sheet and look toward a better future.
While investors don't like to see a dividend payment cut, in W.P. Carey's case, the move could be the best for its long-term growth prospects. Here's what you need to know.
W.P. Carey has a wide range of properties and is exiting this higher-risk property type
W.P. Carey owns properties across the United States and Europe with a simple objective: To lease properties on long-term contracts with built-in rent escalators to produce steady cash flows. As of the third quarter, its portfolio had 1,472 properties across 26 countries with a 98.9% occupancy rate.
The company's portfolio is well-diversified, with no property type making up more than one-third of it. Industrial properties make up 30% of its holdings, while warehouses (24%), retail (17%), and office (15%) round out its top holdings.
Although W.P. Carey is quite diversified, earlier this year, management decided to eliminate its office properties entirely. The move is likely intelligent, given the challenges office property owners face.
Office properties have come under increasing pressure due to work-from-home or hybrid work arrangements that first emerged during the pandemic shutdowns. Not only that, but companies have been cutting jobs through significant layoffs, reducing the amount of office space companies need. According to the National Association of Realtors, office vacancy rates are a record-high 13.3%. Banks are growing hesitant to lend to the sector because of the increased risk to these property types.
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W.P. Carey's recent plan accelerates its exit from office properties
The process of W.P. Carey reducing its office property exposure has been ongoing over the past several years. Eight years ago, office properties accounted for 30% of its annualized base rent (ABR). Most recently, these properties account for just 15% of ABR. The company was taking a patient approach to eliminating its office holdings, but the recent uncertainty in the space had CEO Jason Fox pushing a plan that "vastly accelerates" W.P. Carey's exit from office.
On Nov. 1, the company completed a spinoff of 59 of its higher-quality holdings into a company called Net Lease Office Properties. W.P. Carey shareholders earned one share of Net Lease Office Properties for every 15 shares of W.P. Carey stock held, with cash paid in place of any fractional shares. The company will sell the remainder of its 87 office assets, which it hopes to complete by January 2024.
Why W.P. Carey's exit from office could set it up for long-term success
This strategic move to exit office properties was painful in the short term but could prove to be an intelligent decision over the long haul. By eliminating its office assets, W.P. Carey could improve the quality of its portfolio by eliminating high-risk properties and reinvesting those proceeds into higher-quality properties, such as industrial or warehouse assets.
The move should help W.P. Carey enhance the quality and stability of its earnings while also improving the credit quality of its portfolio. Industrial properties include warehouses, distribution centers, factories, and manufacturing facilities. These properties are well-positioned because of the ongoing consumer demand for e-commerce, which increases demand for warehouses and distribution centers.
According to a report by Mordor Intelligence, the global e-commerce market is projected to grow at around 15.8% annually through 2028, and more industrial properties will be needed to accommodate this growth.
Here's how W.P. Carey's dividend payout changed
As part of W.P. Carey's exit from office properties, the company also announced that it would reset its dividend policy to a more sustainable long-term level. According to CFO Toni Sanzone, the reset will allow it to retain more cash flow to put into other income-producing properties, which should support further dividend growth following the reset. The company will target a pro forma adjusted funds from operations (AFFO) payout ratio of 70% to 75%. This year, its payout ratio hovered around 80%.
The company recently announced a quarterly dividend payment of $0.86 per share, representing a 20% decrease from its previous payment of $1.071 per share. The move also ends the company's 26-year streak of growing dividend payments.
WPC Dividend data by YCharts
Is W.P. Carey a buy?
W.P. Carey is shoring up its balance sheet, focusing on quality, and looking to grow its portfolio. Aside from selling office properties, the company expects U-Haul to buy back self-storage properties it currently leases, which could generate another $470 million in proceeds.
Additionally, it stands to benefit from the potential IPO of Lineage Logistics. W.P. Carey holds a sizable investment in Lineage Logistics, valued at around $400 million. If Lineage Logistics has a successful IPO, W.P. Carey could cash in on its stake and have even more capital to reinvest in income-producing properties.
W.P. Carey made the difficult but necessary move of exiting its office assets and resetting its dividend payment to a more sustainable level. However, the company is well-positioned and should have plenty of capital to put to work on higher-quality properties, which is why I think the REIT is a solid dividend stock for investors to buy and hold.
