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WP Carey’s Strategy for Regaining Wall Street’s Confidence
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WP Carey’s Strategy for Regaining Wall Street’s Confidence

After 24 years, from WP Carey (NYSE: WPC) the streak of annual dividend increases was about to hit a major milestone. However, the real estate investment trust (REIT) did something that didn’t seem to make sense — it cut its dividend just months before hitting 25 consecutive annual dividend increases. Investors weren’t happy, but WP Carey is hard at work trying to prove that this downgrade was really just a reset. Here’s why this high-yielding REIT is still worth buying.

What’s wrong with desks?

The fact that WP Carey is a net leasing The REIT is an important factor to consider in its decision to exit the office sector. Net lease assets are generally single-tenant properties. Although the tenant is responsible for most of the expenses at the property level, the big risk for the landlord is that the tenant does not renew the lease when it ends. Given the troubled state of the office sector post-coronavirus, single-tenant risk to net office rental assets is particularly high at this time.

Scissors cutting a hundred dollar bill in half.Scissors cutting a hundred dollar bill in half.

Scissors cutting a hundred dollar bill in half.

Image source: Getty Images.

What’s interesting about office properties is that they often require material investment in the asset at the end of a lease. The first reason for this is the size of the assets, which are often much larger than a single-tenant retail store. Also, the existing tenant will usually ask for upgrades to entice them to stay. If the property is vacated, there will certainly be significant costs to upgrade the office and to convince a new tenant to move in. Such expenses will most likely be necessary if the office owner decides to sell as well. So office properties are one of the higher risk types of net lease properties.

Sensing the market shift, Real estate income (NYSE: O) decided to divest its office properties a few years ago. However, Income Realty is about four times larger than WP Carey. The shedding of office properties, which represented a relatively small percentage of its rents, had little impact on this REITs business because the property type just wasn’t that important to his business. Offices accounted for 16% of rents at WP Carey before the decision to exit the property type.

A dividend reset had to be done at WP Carey

There is no way a REIT can suddenly give up 16% rent and not cut the dividend. But it is important to remember that this was a strategic decision designed to improve WP Carey’s long-term prospects. The rest of the portfolio is, for the most part, performing reasonably well. The REIT was simply looking to change its business in a more positive direction. That’s why WP Carey started raising its dividend again in the quarter after the cut. In fact, it has increased the dividend every quarter since the cut.

It is effectively an effort to demonstrate to investors that the cut was not made from a position of weakness. It was just a reset, as the REIT immediately returned to the quarterly growth cadence that existed before the cut. Now that the office is out of the portfolio, the REIT can operate from a stronger position. Investors should not miss the signal here; management makes a statement.

WPC chartWPC chart

WPC chart

WPC given by YCharts

After resetting the lower dividend, the REIT could have simply changed the dividend model (perhaps let it languish at the same level for years) and no one would have batted an eye. But he didn’t do that. WP Carey chose to resume the same dividend model that existed before the reduction.

What is also notable is that the exit from the office sector has left WP Carey with cash which it plans to invest in new properties. This will expand the business and give it the means to continue growing its dividend over the long term. However, timing is a problem. Buying new properties is a process that can take months and sometimes more than a year. It can’t prove it’s growing again as easily as it can prove it’s dedicated to returning shareholder value through a growing dividend.

Listen to WP Carey’s obvious signals

It was probably a better choice to reset the dividend before reaching 25 annual increases than it would have been to reset the dividend after reaching that milestone. That doesn’t make the dividend cut any easier to swallow, but it does help explain the seemingly odd timing. Now, the fact that WP Carey is already raising its dividend again is a very good sign. This will become more apparent over time as he spends the cash generated from leaving the office on new properties. However, long-term income investors should probably take the company’s early dividend signal to heart and buy this 6.2% yielding REIT while Wall Street expectations are still clouded by the cut. The dividend reset effectively hides the positives that are increasingly exposed.

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Reuben Gregg Brewer has positions in Realty Income and WP Carey. The Motley Fool has positions and recommends Realty Income. The Motley Fool has a disclosure policy.