With the stock market hitting record highs day after day, many value focused investors are understandably nervous about investing new money at this time.
Fortunately, there are still a few industries where high-yield dividend investors can turn to for generous, secure, and growing dividends.
One of these is Real Estate Investment Trusts, or REITs; the easiest way for dividend investors to gain exposure to real estate. Many REITs have sold off in recent months as rising interest rates have made them relatively less attractive investments.
W.P. Carey (WPC) converted to REIT status in 2012 and has seen its stock price decline 18% since early August. However, the company proven itself a master at growing long-term investor income and wealth over time.
In addition to its high 6.6% yield, the company is a dividend achiever that has paid uninterrupted dividends since 1998 and increased its dividend annually for 18 consecutive years.
With the recent pullback in its share price, let’s take a closer look at W.P. Carey for consideration in our Conservative Retirees portfolio.
Founded in 1973, W.P. Carey is one of the oldest REITs in the world and a pioneer in the sale/leaseback model of triple net REITs.
Essentially W.P. Carey raises capital from investors and then purchases freestanding real estate from companies, who then sign long-term (i.e. 20 to 25 years) rental agreements to pay rent to W.P Carey for the use of those properties.
Companies are willing to do this because they are able to monetize the value of their real estate in a tax-efficient manner by getting upfront capital, and they can deduct 100% of rent from their income statements, boosting earnings.
Another appeal of the business model is that these are triple net leases, meaning the tenant is responsible for maintenance, taxes, and insurance. In other words W.P. Carey only has to buy the properties and then sit back and collect rent.
This creates a low overhead business model in which the REIT generates high adjusted funds from operations, or AFFO (REIT equivalent of free cash flow and what funds the dividend), which must be paid out to investors for tax reasons in the form of generous, secure, and growing dividends.
But what specifically makes W.P. Carey a standout in the world of sale/leaseback triple net leases?
However, as you can see below, W.P. Carey offers investors far more global diversification, with just over one third of its properties located overseas.
More importantly, its 910 properties are spread out over far more REIT sectors, including hot growth markets such as warehouses, which are experiencing strong growth due to the rise of e-commerce and the growing need for more fulfillment centers.
Source: W.P Carey Annual Report
This greater regional and industry diversification means that W.P Carey enjoys very stable and predictable cash flow, which makes it a sleep well at night, or SWAN stock.
Finally, the third major difference between W.P Carey and its peers is that in addition to owning a global portfolio of rental properties, it operates a highly successful investment management division.
In fact, since inception, the REIT’s investment management division has generated 11%, net of fees, compound annual returns for its investors.
Such strong performance explains why W.P Carey has $12.2 billion in assets under management, up 16% compared to Q3 of 2015.
The company’s non-traded REIT management division not just provides the REIT with future potential growth opportunities, but also fast-growing and lucrative management fee revenues (up 35% year-over-year) that made up 20% of the REIT’s total revenue in the most recent quarter and 8% of AFFO over the last year.
The key to any long-term investment is quality management. W.P Carey has built its business around a long-term focus of acquiring quality properties around the globe at opportunistic prices and slowly but surely growing its cash flows in a disciplined manner.
It’s important to remember that because W.P Carey operates as a hybrid of a traditional equity REIT as well as a private equity fund, its growth in revenue, cash flow, and dividends can be lumpy.
Source: Simply Safe Dividends
That’s because management likes to recycle capital, which means selling properties that have become overvalued when they generate good internal rates of returns and then reinvesting that cash into other, more attractively priced assets.
For example, thus far in 2016 W.P Carey has sold off $618.1 million in properties, at an average cap rate of 7%. In total, the REIT was able to achieve internal rates of return of over 20% annually on the sales of its properties this year.
More important than W.P Carey’s individual quarterly or annual results is the fact that management is constantly working to manage its property portfolio with an eye on tenant quality, credit risk, and cash flow stability.
For example, in the past year W.P Carey has managed to not just raise its occupancy to one of the highest levels in the industry (99.1%), but also to extend the weighted average lease term from 8.9 years to 9.4.
Better yet, the amount of lease expirations in 2017 and 2018 has fallen from 10.6% of annual base rent to just 3.4%, meaning that the REIT’s cash flow is becoming even more stable and reliable over time.
All of which means higher dividend security for income investors, far more than the current high-yield might otherwise indicate.
While W.P Carey is a high-quality REIT, nonetheless it has a few key risks for investors to keep in mind.
The first risk is that W.P Carey, because of its hybrid REIT/private equity structure, has a slightly above average leveraged balance sheet, especially relative to pure retail triple net REITs such as Realty Income and National Retail Properties.
|REIT||Debt / EBITDA||EBITDA / Interest||Debt / Capital||S&P Credit Rating|
|National Retail Properties||4.86||4.59||37%||BBB+|
Sources: Simply Safe Dividends, Morningstar, FastGraphs
Of course REITs in general, due to their business model (in which at least 90% of earnings must be paid out as dividends), have high debt loads, and W.P Carey’s debt is far from dangerous levels, as seen by the company’s investment grade credit rating.
However, in a rising interest rate environment, rolling over that debt is likely to put increasing pressure on its interest coverage ratio and could slow the rate of future dividend growth.
Speaking of rising interest rates, investors need to keep in mind that as rates rise (they are up about 0.7% since November 8th), there could be additional growth headwinds for REITs.
Not necessarily because of rising debt capital costs (management has proven it can grow consistently even during much higher rate environments), but because REITs need to frequently raise equity growth capital from investors. W.P. Carey’s diluted shares outstanding have more than doubled since it converted to a REIT in 2012, for example.
Source: Simply Safe Dividends
The problem is that over the