What to Do With W.P. Carey Following Surprise Dividend Cut
W.P. Carey (WPC) surprised investors this morning by announcing it would divest its entire portfolio of offices (15% of rent) by early next year through a mix of asset sales and a corporate spin-off, causing shares to drop by around 8% today.
Despite raising the REIT's payout just one week ago, management also informed investors it would rebase the dividend in response to this loss of cash flow, likely beginning with the fourth-quarter payout that is typically announced in early December.
W.P. Carey didn't provide specific financial guidance other than noting the REIT would target a 70% to 75% payout ratio.
Our attempt at modeling the REIT's 2024 cash flow, adjusted for these pending transactions, suggests a headline dividend cut of around 20% could be in the cards.
That lost income could narrow to around a 10% to 15% reduction if shareholders sell the stock they'll receive in the office REIT spin-off, called Net Lease Office Properties (NLOP), and reinvest the proceeds back into W.P. Carey.
However, that estimate could change depending on how the spin-off is valued, where WPC shares are trading later this fall, and where WPC sets its new dividend level.
The spin-off is expected to close around November 1st of this year, and WPC shareholders will receive stock in the new company proportionate to their current ownership.
Our attempt at modeling the REIT's 2024 cash flow, adjusted for these pending transactions, suggests a headline dividend cut of around 20% could be in the cards.
That lost income could narrow to around a 10% to 15% reduction if shareholders sell the stock they'll receive in the office REIT spin-off, called Net Lease Office Properties (NLOP), and reinvest the proceeds back into W.P. Carey.
However, that estimate could change depending on how the spin-off is valued, where WPC shares are trading later this fall, and where WPC sets its new dividend level.
The spin-off is expected to close around November 1st of this year, and WPC shareholders will receive stock in the new company proportionate to their current ownership.
We plan to continue holding our shares of W.P. Carey in our Conservative Retirees portfolio and expect to sell our stake in NLOP, reinvesting the proceeds in WPC shares. We will provide another update as the spin-off draws closer.
Recognizing the upcoming dividend cut, we are temporarily downgrading W.P. Carey's Dividend Safety Score from Safe to Unsafe until the payout has officially been reduced.
Once the rebased dividend is in place to reflect the office property divestitures, we anticipate returning W.P. Carey to a Safe rating.
Recognizing the upcoming dividend cut, we are temporarily downgrading W.P. Carey's Dividend Safety Score from Safe to Unsafe until the payout has officially been reduced.
Once the rebased dividend is in place to reflect the office property divestitures, we anticipate returning W.P. Carey to a Safe rating.
As straight shooters, we have added W.P. Carey's pending dividend cut to our Dividend Safety Score system's real-time track record with a Safe rating.
While that public blemish stings, it pales in comparison to the regret we feel from missing this projected dividend reduction for our members.
While that public blemish stings, it pales in comparison to the regret we feel from missing this projected dividend reduction for our members.
This announcement caught many by surprise, including us. W.P. Carey had gradually reduced its office portfolio from over 30% of rent five years ago to 15% today and provided no hints that an immediate separation from all of these properties was desirable or even a consideration.
This part of the REIT's portfolio had continued delivering stable performance with occupancy above 95%, an average remaining lease term extending through the back half of this decade, and a diverse mix of mostly investment-grade tenants.
W.P. Carey's dividend was also reasonably covered with an 80% payout ratio, and the balance sheet was in good shape with a BBB+ credit rating (leverage is expected to remain unchanged following these transactions).
Had management chosen to defend the dividend, which had been increased every year since W.P. Carey went public in 1998, we estimate the REIT's payout ratio would have hovered near 90% in 2024, a level it touched several years ago.
This part of the REIT's portfolio had continued delivering stable performance with occupancy above 95%, an average remaining lease term extending through the back half of this decade, and a diverse mix of mostly investment-grade tenants.
W.P. Carey's dividend was also reasonably covered with an 80% payout ratio, and the balance sheet was in good shape with a BBB+ credit rating (leverage is expected to remain unchanged following these transactions).
Had management chosen to defend the dividend, which had been increased every year since W.P. Carey went public in 1998, we estimate the REIT's payout ratio would have hovered near 90% in 2024, a level it touched several years ago.
The company's payout ratio could have headed towards 85% rather quickly too since W.P. Carey will have around $1.5 billion of cash coming in from spin-off proceeds, office sales, and a forward equity sale. This money can be used to buy properties or reduce debt to improve cash flow.
That said, W.P. Carey will move forward with a portfolio that tilts even more toward industrial buildings and warehouses (over 60% of rent), all while maintaining an enviable 99% occupancy rate and favorable lease maturity schedule (average remaining lease term of 12 years).
Furthermore, the firm's bolstered cash reserves will provide more flexibility to finance growth opportunities and add a layer of security for the rebased dividend, which should enjoy better growth prospects thanks to a lower payout ratio and no more exposure to office properties.
While we would have preferred to see W.P. Carey continue to methodically reduce its office exposure through incremental property sales each year and keep the dividend intact, we appreciate the firm's sound portfolio and stable outlook. This still seems like a good business to own for the long haul.
Touching briefly on the upcoming spin-off, NLOP, this newly formed REIT will take on about 60 office properties, accounting for around 10% of W.P. Carey's rent. These properties have an average remaining lease term of just shy of six years, an occupancy rate of 97%, and over 60% of tenants rated investment-grade caliber.
These tenants include reputable companies like KBR (12% of rent), Blue Cross Blue Shield (9%), JP Morgan Chase (6%), and FedEx (4%).
While this represents a solid portfolio compared to some of its office REIT peers, NLOP has no intentions to grow its business. Instead, the company will liquidate its properties over time using rental income and proceeds from property dispositions to reduce debt and pay dividends to shareholders as the REIT winds down.
Overall, W.P. Carey's surprising announcement is disappointing news for income investors in the near term. But unlike most dividend cuts, which can be a signal to exit a business with lasting troubles, this looming reduction does not seem like an indictment against W.P. Carey's quality or long-term outlook.
Once the initial disappointment of this cut fades, management is hopeful W.P. Carey's stock can grow into a higher valuation multiple that reflects its even stronger business mix.
Time will tell, but we plan to hang onto our shares and will provide additional updates on the diversified REIT when the spin-off gets closer.
