Item 7. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.
Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding our financial statements and the reasons for changes in certain key components of our financial statements from period to period. This item also provides our perspective on our financial position and liquidity, as well as certain other factors that may affect our future results. The discussion also breaks down the financial results of our business by segment to provide a better understanding of how these segments and their results affect our financial condition and results of operations.
The following discussion should be read in conjunction with our consolidated financial statements in Item 8 of this Report and the matters described under Item 1A. Risk Factors. Please see our Annual Report on Form 10-K for the year ended December 31, 2021 for discussion of our financial condition and results of operations for the year ended December 31, 2020. Refer to Item 1. Business for a description of our business.
Significant Developments
Board of Directors Change
On December 12, 2022, we announced that Ms. Elisabeth Stheeman, age 58, was appointed to our Board. Please see our Current Report on Form 8-K filed on December 12, 2022 for additional information.
Financial Highlights
During the year ended December 31, 2022, we completed the following (as further described in the consolidated financial statements):
Real Estate
CPA:18 Merger
On August 1, 2022, we completed the CPA:18 Merger (Note 3).
•We acquired full or partial ownership interests in 42 properties in the CPA:18 Merger (including seven properties in which we already owned a partial ownership interest), substantially all of which were triple-net leased with a weighted-average lease term of 7.0 years, an occupancy rate of 99.3%, and an estimated ABR totaling $81.0 million. We also acquired 65 self-storage operating properties and two student housing operating properties totaling 5.1 million square feet. The related property-level debt was comprised of non-recourse mortgage loans with an aggregate consolidated fair value of approximately $900.2 million with a weighted-average annual interest rate of 5.1% as of August 1, 2022.
•We issued the following to CPA:18 – Global stockholders as part of the merger consideration: (i) 13,786,302 shares of our common stock of approximately $1.2 billion, (ii) $3.00 per share of cash consideration totaling approximately $423.3 million, and (iii) cash of $0.1 million paid in lieu of issuing any fractional shares of our common stock.
•Lease revenues and operating property revenues from properties acquired in the CPA:18 Merger were $42.7 million and $39.2 million, respectively, for the year ended December 31, 2022.
•We recognized a Gain on change in control of interests of $33.9 million in connection with the CPA:18 Merger during the year ended December 31, 2022, of which $11.4 million was attributable to our Real Estate segment and $22.5 million was attributable to our Investment Management segment.
Investments
•We acquired 23 investments totaling $1.2 billion (Note 5, Note 6).
•We completed six construction projects at a cost totaling $148.1 million (Note 5).
•We funded approximately $89.5 million for a construction loan to build a retail complex in Las Vegas, Nevada, during the year ended December 31, 2022. Through December 31, 2022, we have funded $193.2 million (Note 8).
•We committed to fund six build-to-suit or redevelopment projects totaling $20.3 million. We currently expect to complete the projects in 2023 (Note 5).
Dispositions
•We disposed of 23 properties for total proceeds, net of selling costs, of $234.7 million (Note 16).
•In January 2022, WLT redeemed in full our 1,300,000 shares of its preferred stock for gross proceeds of $65.0 million (Note 9).
•In October 2022, we received $82.6 million in cash proceeds as a result of certain private real estate funds’ acquisition of all outstanding shares of WLT common stock. As of the date of acquisition, we owned 12,208,243 shares of WLT common stock. Upon completion of this transaction, we have no remaining interest in WLT (Note 9).
Financing and Capital Markets Transactions
•In April 2022, we increased the Term Loan to £270.0 million and the Delayed Draw Term Loan to €215.0 million, thereby increasing the total capacity of our Senior Unsecured Credit Facility to approximately $2.4 billion. We used the approximately $300 million of proceeds from this increase in the capacity of our Unsecured Term Loans to partially repay amounts outstanding under our Unsecured Revolving Credit Facility (Note 11).
•On May 2, 2022, we established a $1.0 billion ATM Program, under which we may issue shares directly or defer delivery to a later date through our ATM Forwards (Note 13).
•We issued 2,740,295 shares of our common stock under our prior ATM Program at a weighted-average price of $80.79 per share, for net proceeds of $218.1 million (Note 13).
•We settled our remaining Equity Forwards by delivering 3,925,000 shares of common stock for net proceeds of $284.3 million (Note 13).
•As of December 31, 2022, we had approximately $530.0 million of available proceeds under our ATM Forwards (Note 13).
•On September 28, 2022, we completed a private placement of (i) €150 million of 3.41% Senior Notes due 2029, which have a seven-year term and are scheduled to mature on September 28, 2029, and (ii) €200 million of 3.70% Senior Notes due 2032, which have a ten-year term and are scheduled to mature on September 28, 2032 (Note 11).
Investment Management
•Upon completion of the CPA:18 Merger (Note 3), we ceased earning advisory fees and other income previously earned when we served as advisor to CPA:18 – Global. During the year ended December 31, 2022, through the date of the CPA:18 Merger, such fees and other income from CPA:18 – Global totaled $17.9 million. Investment Management fees and other income are expected to be minimal going forward.
Dividends to Stockholders
We declared cash dividends totaling $4.242 per share, comprised of four quarterly dividends per share of $1.057, $1.059, $1.061, and $1.065.
Consolidated Results
(in thousands, except shares)
Years Ended December 31,
Net income from Real Estate attributable to W. P. Carey 591,603 384,766
Net income from Investment Management attributable to W. P. Carey 7,536 25,222
Net cash provided by financing activities 57,887 557,048
Supplemental financial measures (a):
__________
(a)We consider Adjusted funds from operations (“AFFO”), a supplemental measure that is not defined by U.S. generally accepted accounting principles (“GAAP”) (a “non-GAAP measure”), to be an important measure in the evaluation of our operating performance. See Supplemental Financial Measures below for our definition of this non-GAAP measure and a reconciliation to its most directly comparable GAAP measure.
Revenues
Real Estate revenue increased in 2022 as compared to 2021, primarily due to higher lease revenues (substantially as a result of property acquisition activity and rent escalations, as well as the net-leased properties we acquired in the CPA:18 Merger on August 1, 2022 (Note 3), partially offset by the impact of the weakening euro and British pound sterling) and higher operating property revenues (primarily from the operating properties we acquired in the CPA:18 Merger on August 1, 2022 (Note 3)), partially offset by lower other lease-related income (Note 5).
Net Income Attributable to W. P. Carey
Net income attributable to W. P. Carey increased in 2022 as compared to 2021. Net income from Real Estate attributable to W. P. Carey increased primarily due to a lower loss on extinguishment of debt (Note 11), non-cash unrealized gains recognized on our investment in common shares of WLT (Note 9), and the impact of real estate acquisitions, partially offset by higher interest expense and the impact of the weakening euro and British pound sterling. In addition, we recognized non-cash unrealized gains on our investment in shares of Lineage Logistics during both the current and prior year (Note 9). Net income from Investment Management attributable to W. P. Carey decreased primarily due to an impairment charge recognized on goodwill within our Investment Management segment (Note 9). In addition, we recognized a gain on change in control of interests during the current year in connection with the CPA:18 Merger (Note 3).
AFFO
AFFO increased in 2022 as compared to 2021, primarily due to investment activity and rent escalations, higher other lease-related income (on an AFFO basis), and the accretive impact of the CPA:18 Merger (Note 3), partially offset by the impact of the weakening euro and British pound sterling and higher interest expense.
Portfolio Overview
Our portfolio is comprised of operationally-critical, commercial real estate assets net leased to tenants located primarily in the United States and Northern and Western Europe. We invest in high-quality single tenant industrial, warehouse, office, retail, and self-storage (net lease) properties subject to long-term leases with built-in rent escalators. Portfolio information is provided on a pro rata basis, unless otherwise noted below, to better illustrate the economic impact of our various net-leased jointly owned investments. See Terms and Definitions below for a description of pro rata amounts.
Portfolio Summary
As of December 31,
Number of net-leased properties (a) 1,449 1,304
Weighted-average lease term (in years) 10.8 10.8
Operating Properties
Number of operating properties: (b) 87 20
Number of self-storage operating properties 84 19
Number of student housing operating properties 2 —
Number of hotel operating properties 1 1
Occupancy (self-storage operating properties) 91.0 % 95.3 %
Number of countries (c) 26 24
Years Ended December 31,
Acquisition volume (in millions) (d) $ 1,265.5 $ 1,627.9
Construction projects completed (in millions) 148.1 88.2
Average U.S. dollar/euro exchange rate 1.0540 1.1830
Average U.S. dollar/British pound sterling exchange rate 1.2373 1.3755
__________
(a)We acquired 35 net-leased properties (in which we did not already have an ownership interest) in the CPA:18 Merger in August 2022 (Note 3).
(b)We acquired 65 self-storage properties, one student housing property, and one student housing development project in the CPA:18 Merger in August 2022 (Note 3).
(c)We acquired investments in Belgium during the year ended December 31, 2022. We acquired an investment in Mauritius in connection with the CPA:18 Merger in August 2022 (Note 3).
(d)Amount for the year ended December 31, 2022 excludes properties acquired in the CPA:18 Merger (Note 3). Amounts for the years ended December 31, 2022 and 2021 include $19.8 million and $217.0 million, respectively, of sale-leasebacks classified as loans receivable (Note 6). Amounts for the years ended December 31, 2022 and 2021 include $89.5 million and $103.7 million, respectively, of funding for a construction loan (Note 8).
Net-Leased Portfolio
The tables below represent information about our net-leased portfolio at December 31, 2022 on a pro rata basis and, accordingly, exclude all operating properties. See Terms and Definitions below for a description of pro rata amounts and ABR.
Top Ten Tenants by ABR
(dollars in thousands)
OBI Group (a) Do-it-yourself retail properties in Poland 26 22,266 1.6 % 7.8
Nord Anglia Education, Inc. K-12 private schools in the U.S. 3 20,981 1.5 % 20.7
__________
(a)ABR amounts are subject to fluctuations in foreign currency exchange rates.
(b)ABR for this tenant includes $16.1 million from a lease that expired in January 2023. Upon lease expiration, these properties were converted from net lease properties to operating properties.
Portfolio Diversification by Geography
(in thousands, except percentages)
Region ABR ABR Percent Square Footage (a) Square Footage Percent
United States
South
Midwest
East
West
International
Portfolio Diversification by Property Type
(in thousands, except percentages)
Property Type ABR ABR Percent Square Footage (a) Square Footage Percent
__________
(a)Includes square footage for any vacant properties.
(b)Other properties within South include assets in Louisiana, Arkansas, Oklahoma, and Mississippi. Other properties within Midwest include assets in Iowa, Missouri, Kansas, Nebraska, South Dakota, and North Dakota. Other properties within East include assets in Maryland, Connecticut, West Virginia, New Hampshire, and Maine. Other properties within West include assets in Utah, Oregon, Colorado, Washington, Nevada, Hawaii, Idaho, New Mexico, Wyoming, and Montana.
(c)Includes assets in Lithuania, Mexico, Finland, Belgium, Hungary, Mauritius, Slovakia, Portugal, the Czech Republic, Austria, Sweden, Japan, Latvia, and Estonia.
(d)Includes automotive dealerships.
(e)Includes ABR from tenants with the following property types: hotel (net lease), education facility, laboratory, specialty, fitness facility, research and development, student housing (net lease), theater, funeral home, restaurant, land, and parking.
Portfolio Diversification by Tenant Industry
(in thousands, except percentages)
Industry Type ABR ABR Percent Square Footage Square Footage Percent
__________
(a)Includes automotive dealerships.
(b)Includes ABR from tenants in the following industries: media: broadcasting and subscription, aerospace and defense, wholesale, media: advertising, printing, and publishing, oil and gas, utilities: electric, environmental industries, consumer transportation, forest products and paper, electricity, and real estate. Also includes square footage for vacant properties.
Lease Expirations
(dollars and square footage in thousands)
__________
(a)Assumes tenants do not exercise any renewal options or purchase options.
(b)Includes ABR of $16.1 million from a tenant (Marriott Corporation) with a lease that expired in January 2023. Upon lease expiration, these properties were converted from net lease properties to operating properties.
(c)Includes ABR of $38.8 million from a tenant (U-Haul Moving Partners, Inc. and Mercury Partners, LP) that holds an option to repurchase the 78 properties it is leasing in April 2024. There can be no assurance that such repurchase will be completed.
Rent Collections
Through the date of this Report, we received from tenants over 99.3% of contractual base rent that was due during the fourth quarter of 2022 (based on contractual minimum ABR as of September 30, 2022).
Terms and Definitions
Pro Rata Metrics —The portfolio information above contains certain metrics prepared on a pro rata basis. We refer to these metrics as pro rata metrics. We have a number of investments, usually with our affiliates, in which our economic ownership is less than 100%. On a full consolidation basis, we report 100% of the assets, liabilities, revenues, and expenses of those investments that are deemed to be under our control or for which we are deemed to be the primary beneficiary, even if our ownership is less than 100%. Also, for all other jointly owned investments, which we do not control, we report our net investment and our net income or loss from that investment. On a pro rata basis, we generally present our proportionate share, based on our economic ownership of these jointly owned investments, of the portfolio metrics of those investments. Multiplying each of our jointly owned investments’ financial statement line items by our percentage ownership and adding or subtracting those amounts from our totals, as applicable, may not accurately depict the legal and economic implications of holding an ownership interest of less than 100% in our jointly owned investments.
ABR —ABR represents contractual minimum annualized base rent for our net-leased properties and reflects exchange rates as of December 31, 2022. If there is a rent abatement, we annualize the first monthly contractual base rent following the free rent period. ABR is not applicable to operating properties.
Results of Operations
We operate in two reportable segments: Real Estate and Investment Management. We evaluate our results of operations with a primary focus on increasing and enhancing the value, quality, and number of properties in our Real Estate segment. We focus our efforts on accretive investing and improving portfolio quality through re-leasing efforts, including negotiation of lease renewals, or selectively selling assets in order to increase value in our real estate portfolio. Through our Investment Management segment, we expect to continue to earn fees and other income from the management of the CESH portfolio until it reaches the end of its life cycle. Refer to Note 17 for tables presenting the comparative results of our Real Estate and Investment Management segments.
Real Estate
Revenues
The following table presents revenues within our Real Estate segment (in thousands):
Years Ended December 31,
Real Estate Revenues
Lease revenues from:
Net-leased properties acquired in the CPA:18 Merger 36,040 — 36,040
Income from direct financing leases and loans receivable 74,266 67,555 6,711
Operating property revenues from:
Operating properties acquired in the CPA:18 Merger 39,193 — 39,193
Lease Revenues
“Existing net-leased properties” are those that we acquired or placed into service prior to January 1, 2021 and that were not sold or held for sale during the periods presented. For the periods presented, there were 1,108 existing net-leased properties.
For the year ended December 31, 2022 as compared to 2021, lease revenues from existing net-leased properties increased due to the following items (in millions):
__________
(a)Excludes fixed minimum rent increases, which are reflected as straight-line rent adjustments within lease revenues.
(b)Primarily related to (i) straight-line rent adjustments and (ii) write-offs of above/below-market rent intangibles.
“Recently acquired net-leased properties” are those that we acquired or placed into service subsequent to December 31, 2020 and that were not sold or held for sale during the periods presented. Since January 1, 2021, we acquired 48 investments (comprised of 192 properties and six land parcels under buildings that we already own) and placed three properties into service.
“Net-leased properties acquired in the CPA:18 Merger” on August 1, 2022 (Note 3) consisted of 38 net-leased properties, which contributed five months of lease revenue, depreciation and amortization, and property expenses during the year ended December 31, 2022.
“Net-leased properties sold or held for sale” include (i) 23 net-leased properties disposed of during the year ended December 31, 2022; (ii) three net-leased properties classified as held for sale at December 31, 2022, one of which was sold in January 2023 (Note 5, Note 18); and (iii) 24 net-leased properties disposed of during the year ended December 31, 2021. Our dispositions are more fully described in Note 16.
Income from Direct Financing Leases and Loans Receivable
For the year ended December 31, 2022 as compared to 2021, income from direct financing leases and loans receivable decreased due to the following items (in millions):
Operating Property Revenues and Expenses
“Operating properties acquired in the CPA:18 Merger” on August 1, 2022 (Note 3) consisted of 65 self-storage properties and two student housing properties, which contributed five months of operating property revenues, depreciation and amortization, and operating property expenses during the year ended December 31, 2022.
“Existing operating properties” are those that we acquired or placed into service prior to January 1, 2021 and that were not sold or held for sale during the periods presented. For the periods presented, we recorded operating property revenues from 11 existing operating properties, comprised of ten self-storage operating properties (which excludes nine self-storage properties accounted for under the equity method) and one hotel operating property. For our hotel operating property, revenues and expenses increased by $4.9 million and $2.8 million, respectively, for the year ended December 31, 2022 as compared to 2021, reflecting higher occupancy as the hotel’s business recovers from the ongoing COVID-19 pandemic.
Other Lease-Related Income
Other lease-related income is described in Note 5.
Operating Expenses
Depreciation and Amortization
For the year ended December 31, 2022 as compared to 2021, depreciation and amortization expense for net-leased properties and self-storage operating properties increased primarily due to the impact of net acquisition activity (including properties acquired in the CPA:18 Merger (Note 3)), partially offset by the weakening of foreign currencies (primarily the euro and British pound sterling) in relation to the U.S. dollar between the periods.
General and Administrative
All general and administrative expenses are recognized within our Real Estate segment.
For the year ended December 31, 2022 as compared to 2021, general and administrative expenses increased by $7.1 million, primarily due to higher compensation expense, increased professional fees resulting from the CPA:18 Merger, and higher travel costs.
Property Expenses, Excluding Reimbursable Tenant Costs
For the year ended December 31, 2022 as compared to 2021, property expenses, excluding reimbursable tenant costs, increased by $2.9 million, primarily due to due to tenant vacancies during 2021 and 2022 (which resulted in property expenses no longer being reimbursable) and property expenses incurred on acquisitions since January 1, 2021 (Note 3).
Impairment Charges
Our impairment charges are described in Note 9.
Stock-based Compensation Expense
For a description of our equity plans and awards, please see Note 14. Stock-based compensation expense is fully recognized within our Real Estate segment.
For the year ended December 31, 2022 as compared to 2021, stock-based compensation expense increased by $8.0 million, primarily due to changes in the projected payout for performance share units.
Merger and Other Expenses
For the years ended December 31, 2022 and 2021, merger and other expenses are primarily comprised of costs incurred in connection with the CPA:18 Merger (Note 3) and/or reversals of estimated liabilities for German real estate transfer taxes that were previously recorded in connection with mergers in prior years.
Other Income and (Expenses), and (Provision for) Benefit from Income Taxes
Interest Expense
For the year ended December 31, 2022 as compared to 2021, interest expense increased by $22.3 million, primarily due to (i) $20.1 million of interest expense incurred from August through December 2022 related to non-recourse mortgage loans assumed in the CPA:18 Merger (Note 3), (ii) higher outstanding balances and interest rates on our Senior Unsecured Credit Facility, and (iii) five senior unsecured notes issuances totaling $1.7 billion (based on the exchange rate of the euro on the dates of issuance for our euro-denominated senior unsecured notes) with a weighted-average interest rate of 2.1% completed since January 1, 2021, partially offset by (i) the weakening of foreign currencies (primarily the euro and British pound sterling) in relation to the U.S. dollar between the periods and (ii) the reduction of our mortgage debt outstanding by prepaying or repaying at or close to maturity a total of $892.9 million of non-recourse mortgage loans with a weighted-average interest rate of 4.8% since January 1, 2021.
The following table presents certain information about our outstanding debt (dollars in thousands):
Years Ended December 31,
Weighted-average interest rate 2.7 % 2.6 %
The weighted-average interest rate for our debt instruments as of December 31, 2022 increased to 3.0% as compared to 2.5% as of December 31, 2021, and is expected to be further impacted by rising interest rates over the next year.
Other Gains and (Losses)
Other gains and (losses) primarily consists of gains and losses on (i) the mark-to-market fair value of equity securities, (ii) extinguishment of debt, and (iii) foreign currency exchange rate movements. The timing and amount of such gains or losses cannot always be estimated and are subject to fluctuation. All of our foreign currency-denominated unsecured debt instruments were designated as net investment hedges during the years ended December 31, 2022 and 2021. Therefore, no gains and losses on foreign currency exchange rate movements were recognized on the remeasurement of such instruments during those periods (Note 10).
The following table presents other gains and (losses) within our Real Estate segment (in thousands):
Years Ended December 31,
Other Gains and (Losses)
Gain on repayment of secured loan receivable (b) 10,613 — 10,613
__________
(a)We make certain foreign currency-denominated intercompany loans to a number of our foreign subsidiaries, most of which do not have the U.S. dollar as their functional currency. Remeasurement of foreign currency intercompany transactions that are scheduled for settlement, consisting primarily of accrued interest and amortizing loans, are included in other gains and (losses).
(b)We acquired a secured loan receivable with a fair value of $23.4 million in our merger with a former affiliate, Corporate Property Associates 17 – Global Incorporated, in October 2018 (“CPA:17 Merger”), for which the outstanding principal of $34.0 million was fully repaid to us in September 2022 (Note 6). Therefore, we recorded a $10.6 million gain on repayment of this secured loan receivable.
(c)This insurance receivable was acquired in the CPA:17 Merger.
(d)Amount for the year ended December 31, 2021 is related to the prepayment of mortgage loans (primarily comprised of prepayment penalties totaling $45.2 million) and redemption of the €500.0 million of 2.0% Senior Notes due 2023 in March 2021 (primarily comprised of a “make-whole” amount of $26.2 million related to the redemption) (Note 11).
Gain on Sale of Real Estate, Net
Gain on sale of real estate, net, consists of gain on the sale of properties that were disposed of during the reporting period. Our dispositions are more fully described in Note 16.
Non-Operating Income
Non-operating income primarily consists of realized gains and losses on derivative instruments, dividends from equity securities, and interest income on our loans to affiliates and cash deposits.
The following table presents non-operating income within our Real Estate segment (in thousands):
Years Ended December 31,
Non-Operating Income
Earnings (Losses) from Equity Method Investments in Real Estate
Our equity method investments in real estate are more fully described in Note 8. The following table presents earnings (losses) from equity method investments in real estate (in thousands):
Years Ended December 31,
Earnings (Losses) from Equity Method Investments in Real Estate
Existing Equity Method Investments:
Earnings from Harmon Retail Center 1,051 1,108 (57)
Equity Method Investments Consolidated after the CPA:18 Merger (Note 3):
Earnings from Fortenova Grupa d.d. (d) 136 1,542 (1,406)
__________
(a)Increase is primarily due to higher occupancy and unit rates at these self-storage facilities.
(b)Increase is primarily due to higher rent collections at these retail properties, where certain rents were previously disputed and subsequently collected.
(c)Loss for 2021 is primarily due to the adverse impact of the COVID-19 pandemic on WLT’s operations. We recorded losses from this investment on a one quarter lag. This investment was reclassified to equity securities at fair value within Other assets, net on our consolidated balance sheets in January 2022 (Note 9).
(d)Amount for 2021 reflects our proportionate share of a gain recognized on the sale of one of the properties in this portfolio.
(Provision for) Benefit from Income Taxes
For the year ended December 31, 2022 as compared to 2021, provision for income taxes within our Real Estate segment decreased by $7.3 million, primarily due to (i) deferred tax benefits totaling $3.5 million recognized during 2022 related to the release of valuation allowances on certain foreign properties, (ii) trade taxes of $1.8 million recognized during 2021 as a result of the completion of a tax review on a portfolio of properties in Germany, and (iii) tax benefits of $0.7 million recognized on certain foreign properties during 2022 as a result of a tax court ruling.
Investment Management
We earn revenue as the advisor to the Managed Programs. For the periods presented, we acted as advisor to the following Managed Programs: CPA:18 – Global (through August 1, 2022), CWI 1 and CWI 2 (through April 13, 2020), and CESH. Upon completion of the CPA:18 Merger on August 1, 2022 (Note 3), the advisory agreement with CPA:18 – Global was terminated, and we ceased earning revenue from CPA:18 – Global. The CWI 1 and CWI 2 Merger closed on April 13, 2020, and as a result, CWI 2 was renamed Watermark Lodging Trust, Inc., for which we provided certain services pursuant to a transition services agreement, which was terminated on October 13, 2021 (Note 4).
We no longer raise capital for new or existing funds, but we currently expect to continue managing CESH and earn the various fees described below through the end of its life cycle (Note 1, Note 4).
Revenues
The following table presents revenues within our Investment Management segment (in thousands):
Years Ended December 31,
Investment Management Revenues
Asset management and other revenue
Reimbursable costs from affiliates
Asset Management and Other Revenue
During the periods presented, we earned asset management revenue from (i) CPA:18 – Global (prior to the CPA:18 Merger) based on the value of its real estate-related assets under management and (ii) CESH based on its gross assets under management at fair value. For 2022, we received asset management fees from (i) CPA:18 – Global in shares of its common stock through February 28, 2022; effective as of March 1, 2022, we receive asset management fees from CPA:18 – Global in cash in light of the CPA:18 Merger, which closed on August 1, 2022 (Note 3), and (ii) CESH in cash. Asset management revenues from CESH are expected to decline as assets are sold.
Operating Expenses
Impairment Charges — Investment Management Goodwill
Our impairment charges on Investment Management goodwill are more fully described in Note 9.
Other Income and Expenses, and (Provision for) Benefit from Income Taxes
Earnings from Equity Method Investments in the Managed Programs
The following table presents the details of our earnings from equity method investments in the Managed Programs (Note 8) (in thousands):
Years Ended December 31,
Earnings from equity method investments in the Managed Programs:
Distributions of Available Cash from CPA:18 – Global (a) $ 8,746 $ 7,345
Earnings from equity method investments in the Managed Programs $ 13,288 $ 8,820
__________
(a)As a result of the completion of the CPA:18 Merger on August 1, 2022 (Note 3), we no longer recognize equity income from our investment in shares of common stock of CPA:18 – Global or receive distributions of Available Cash from CPA:18 – Global.
(b)The increase for the year ended December 31, 2022 as compared to 2021 was primarily due to an increase of $3.1 million from our investment in shares of CPA:18 – Global.
(Provision for) Benefit from Income Taxes
For the year ended December 31, 2022 we recorded a provision for income taxes of $6.3 million, compared to a benefit from income taxes of $0.2 million recognized during the year ended December 31, 2021, within our Investment Management segment. During 2022, in connection with the CPA:18 Merger, we incurred one-time current taxes upon the recognition of taxable income associated with the accelerated vesting of shares previously issued by CPA:18 – Global to us for asset management services performed.
Liquidity and Capital Resources
Sources and Uses of Cash During the Year
We use the cash flow generated from our investments primarily to meet our operating expenses, service debt, and fund dividends to stockholders. Our cash flows fluctuate periodically due to a number of factors, which may include, among other things: the timing of our equity and debt offerings; the timing of purchases and sales of real estate; the timing of the repayment of mortgage loans and receipt of lease revenues; the timing and amount of other lease-related payments; the timing of settlement of foreign currency transactions; changes in foreign currency exchange rates; and the timing of distributions from equity method investments. We no longer receive certain fees and distributions from CPA:18 – Global following the completion of the CPA:18 Merger on August 1, 2022 (Note 3). Despite these fluctuations, we believe that we will generate sufficient cash from operations to meet our normal recurring short-term and long-term liquidity needs. We may also use existing cash resources, available capacity under our Senior Unsecured Credit Facility, proceeds from dispositions of properties, and the issuance of additional debt or equity securities, such as issuances of common stock through our ATM Forwards (Note 13), in order to meet these needs. We assess our ability to access capital on an ongoing basis. Our sources and uses of cash during the period are described below.
Operating Activities — Net cash provided by operating activities increased by $77.1 million during 2022 as compared to 2021, primarily due to an increase in cash flow generated from net investment activity (including properties acquired in the CPA:18 Merger (Note 3)) and scheduled rent increases at existing properties. These increases were partially offset by higher interest expense and merger expenses recognized during the current year related to the CPA:18 Merger (Note 3).
Investing Activities — Our investing activities are generally comprised of real estate-related transactions (purchases and sales) and funding for build-to-suit activities and other capital expenditures on real estate. In connection with the CPA:18 Merger, we paid $423.4 million in cash consideration, and acquired $331.1 million of cash and restricted cash. We received $147.6 million of proceeds from the redemption of WLT preferred stock and cash exchanged for WLT common stock (Note 9). In addition, during the year ended December 31, 2022, we used $26.0 million to fund short-term loans to the Managed Programs, all of which were repaid during that period (Note 4). We also received $7.1 million in distributions from equity method investments.
Financing Activities — Our financing activities are generally comprised of borrowings and repayments under our Unsecured Revolving Credit Facility and Unsecured Term Loans, issuances of the Senior Unsecured Notes, payments and prepayments of non-recourse mortgage loans, and payments of dividends to stockholders. In addition to these types of transactions, during the year ended December 31, 2022, we received (i) $284.3 million in net proceeds from the issuance of common stock under our Equity Forwards (Note 14) and (ii) $218.1 million in net proceeds from the issuance of shares under our prior ATM Program (Note 14).
Summary of Financing
The table below summarizes our Senior Unsecured Notes, our non-recourse mortgages, and our Senior Unsecured Credit Facility (dollars in thousands):
December 31,
Carrying Value
Fixed rate:
Variable rate:
Non-recourse mortgages (a):
Amount subject to interest rate swaps and caps 94,189 79,055
Percent of Total Debt
Variable rate 14 % 13 %
Weighted-Average Interest Rate at End of Year
Fixed rate 2.9 % 2.7 %
Variable rate (b) 3.6 % 1.1 %
Total debt 3.0 % 2.5 %
____________
(a)Aggregate debt balance includes unamortized discount, net, totaling $35.9 million and $30.9 million as of December 31, 2022 and 2021, respectively, and unamortized deferred financing costs totaling $26.0 million and $28.8 million as of December 31, 2022 and 2021, respectively.
(b)The impact of our interest rate swaps and caps is reflected in the weighted-average interest rates.
Cash Resources
At December 31, 2022, our cash resources consisted of the following:
•cash and cash equivalents totaling $168.0 million. Of this amount, $96.6 million, at then-current exchange rates, was held in foreign subsidiaries, and we could be subject to restrictions or significant costs should we decide to repatriate these amounts;
•our Unsecured Revolving Credit Facility, with available capacity of $1.5 billion (net of amounts reserved for standby letters of credit totaling $0.6 million);
•available proceeds under our ATM Forwards of approximately $530.0 million; and
•unleveraged properties that had an aggregate asset carrying value of approximately $13.1 billion at December 31, 2022, although there can be no assurance that we would be able to obtain financing for these properties.
We may also access the capital markets through additional debt (denominated in both U.S. dollars and euros) and equity offerings.
Our cash resources can be used for working capital needs and other commitments and may be used for future investments.
Cash Requirements and Liquidity
As of December 31, 2022, we had (i) $168.0 million of cash and cash equivalents, (ii) approximately $1.5 billion of available capacity under our Unsecured Revolving Credit Facility (net of amounts reserved for standby letters of credit totaling $0.6 million), and (iii) available proceeds under our ATM Forwards of approximately $530.0 million. Our Senior Unsecured Credit Facility includes a $1.8 billion Unsecured Revolving Credit Facility and Unsecured Term Loans outstanding totaling $552.5 million as of December 31, 2022 (Note 11), and is scheduled to mature on February 20, 2025. As of December 31, 2022, scheduled debt principal payments total $456.7 million through December 31, 2023 and $1.7 billion through December 31, 2024, and our Senior Unsecured Notes do not start to mature until April 2024 (Note 11).
During the next 12 months following December 31, 2022 and thereafter, we expect that our significant cash requirements will include:
•paying dividends to our stockholders; (which we expect to be higher, following the issuance of 13,786,302 shares of our common stock in the CPA:18 Merger (Note 3));
•funding acquisitions of new investments (Note 5);
•funding future capital commitments and tenant improvement allowances (Note 5);
•making scheduled principal and balloon payments on our debt obligations (Note 11);
•making scheduled interest payments on our debt obligations (future interest payments total $927.7 million, with $231.6 million due during the next 12 months; interest on unhedged variable-rate debt obligations was calculated using the applicable annual variable interest rates and balances outstanding at December 31, 2022); and
•other normal recurring operating expenses.
We expect to fund these cash requirements through cash generated from operations, cash received from dispositions of properties, the use of our cash reserves or unused amounts on our Unsecured Revolving Credit Facility (as described above), issuances of common stock through our ATM Program (Note 13), and potential issuances of additional debt or equity securities. We may also choose to prepay certain of our non-recourse mortgage loan obligations, depending on our capital needs and market conditions at that time.
Our liquidity could be adversely affected by unanticipated costs, greater-than-anticipated operating expenses, and the ongoing impact of the COVID-19 pandemic. To the extent that our working capital reserve is insufficient to satisfy our cash requirements, additional funds may be provided from cash from operations to meet our normal recurring short-term and long-term liquidity needs. We may also use existing cash resources, available capacity under our Unsecured Revolving Credit Facility, mortgage loan proceeds, and the issuance of additional debt or equity securities to meet these needs.
Certain amounts disclosed above are based on the applicable foreign currency exchange rate at December 31, 2022.
Environmental Obligations
In connection with the purchase of many of our properties, we required the sellers to perform environmental reviews. We believe, based on the results of these reviews, that our properties were in substantial compliance with federal, state, and foreign environmental statutes at the time the properties were acquired. However, portions of certain properties have been subject to some degree of contamination, principally in connection with leakage from underground storage tanks, surface spills, or other on-site activities. In most instances where contamination has been identified, tenants are actively engaged in the remediation process and addressing identified conditions. We believe that the ultimate resolution of any environmental matters should not have a material adverse effect on our financial condition, liquidity, or results of operations. We record environmental obligations within Accounts payable, accrued expenses and other liabilities in the consolidated financial statements. See Item 1A. Risk Factors for further discussion of potential environmental risks.
Critical Accounting Estimates
Our significant accounting policies are described in Note 2. Many of these accounting policies require judgment and the use of estimates and assumptions when applying these policies in the preparation of our consolidated financial statements. On a quarterly basis, we evaluate these estimates and judgments based on historical experience as well as other factors that we believe to be reasonable under the circumstances. These estimates are subject to change in the future if underlying assumptions or factors change. Certain accounting policies, while significant, may not require the use of estimates. Those accounting policies that require significant estimation and/or judgment are described under Critical Accounting Policies and Estimates in Note 2.
Supplemental Financial Measures
In the real estate industry, analysts and investors employ certain non-GAAP supplemental financial measures in order to facilitate meaningful comparisons between periods and among peer companies. Additionally, in the formulation of our goals and in the evaluation of the effectiveness of our strategies, we use Funds from Operations (“FFO”) and AFFO, which are non-GAAP measures defined by our management. We believe that these measures are useful to investors to consider because they may assist them to better understand and measure the performance of our business over time and against similar companies. A description of FFO and AFFO and reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are provided below.
Funds from Operations and Adjusted Funds from Operations
Due to certain unique operating characteristics of real estate companies, as discussed below, the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”), an industry trade group, has promulgated a non-GAAP measure known as FFO, which we believe to be an appropriate supplemental measure, when used in addition to and in conjunction with results presented in accordance with GAAP, to reflect the operating performance of a REIT. The use of FFO is recommended by the REIT industry as a supplemental non-GAAP measure. FFO is not equivalent to, nor a substitute for, net income or loss as determined under GAAP.
We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as restated in December 2018. The White Paper defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property, impairment charges on real estate or other assets incidental to the company’s main business, gains or losses on changes in control of interests in real estate, and depreciation and amortization from real estate assets; and after adjustments for unconsolidated partnerships and jointly owned investments. Adjustments for unconsolidated partnerships and jointly owned investments are calculated to reflect FFO.
We also modify the NAREIT computation of FFO to adjust GAAP net income for certain non-cash charges, such as amortization of real estate-related intangibles, deferred income tax benefits and expenses, straight-line rent and related reserves, other non-cash rent adjustments, non-cash allowance for credit losses on loans receivable and direct financing leases, stock-based compensation, non-cash environmental accretion expense, amortization of discounts and premiums on debt, and amortization of deferred financing costs. Our assessment of our operations is focused on long-term sustainability and not on such non-cash items, which may cause short-term fluctuations in net income but have no impact on cash flows. Additionally, we exclude non-core income and expenses, such as gains or losses from extinguishment of debt, and merger and acquisition expenses. We also exclude realized and unrealized gains/losses on foreign currency exchange rate movements (other than those realized on the settlement of foreign currency derivatives), which are not considered fundamental attributes of our business plan
and do not affect our overall long-term operating performance. We refer to our modified definition of FFO as AFFO. We exclude these items from GAAP net income to arrive at AFFO as they are not the primary drivers in our decision-making process and excluding these items provides investors a view of our portfolio performance over time and makes it more comparable to other REITs that are currently not engaged in acquisitions, mergers, and restructuring, which are not part of our normal business operations. AFFO also reflects adjustments for unconsolidated partnerships and jointly owned investments. We use AFFO as one measure of our operating performance when we formulate corporate goals, evaluate the effectiveness of our strategies, and determine executive compensation.
We believe that AFFO is a useful supplemental measure for investors to consider as we believe it will help them to better assess the sustainability of our operating performance without the potentially distorting impact of these short-term fluctuations. However, there are limits on the usefulness of AFFO to investors. For example, impairment charges and unrealized foreign currency losses that we exclude may become actual realized losses upon the ultimate disposition of the properties in the form of lower cash proceeds or other considerations. We use our FFO and AFFO measures as supplemental financial measures of operating performance. We do not use our FFO and AFFO measures as, nor should they be considered to be, alternatives to net income computed under GAAP, or as alternatives to net cash provided by operating activities computed under GAAP, or as indicators of our ability to fund our cash needs.
Consolidated FFO and AFFO were as follows (in thousands):
Years Ended December 31,
Adjustments:
Depreciation and amortization of real property 500,764 470,554
Gain on change in control of interests (a) (b) (33,931) —
Impairment charges — Investment Management goodwill (c) 29,334 —
Proportionate share of adjustments for noncontrolling interests (f) (491) (16)
FFO (as defined by NAREIT) attributable to W. P. Carey 1,105,613 896,560
Adjustments:
Straight-line and other leasing and financing adjustments (h) (54,431) (83,267)
Above- and below-market rent intangible lease amortization, net 41,390 53,585
Amortization of deferred financing costs 17,203 13,523
Tax benefit — deferred and other (3,759) (5,967)
Other amortization and non-cash items 1,931 1,709
Proportionate share of adjustments for noncontrolling interests (f) (769) (24)
Summary
FFO (as defined by NAREIT) attributable to W. P. Carey $ 1,105,613 $ 896,560
FFO and AFFO from Real Estate were as follows (in thousands):
Years Ended December 31,
Net income from Real Estate attributable to W. P. Carey $ 591,603 $ 384,766
Adjustments:
Depreciation and amortization of real property 500,764 470,554
Gain on change in control of interests (a) (b) (11,405) —
Proportionate share of adjustments for noncontrolling interests (f) (491) (16)
Adjustments:
Straight-line and other leasing and financing adjustments (h) (54,431) (83,267)
Above- and below-market rent intangible lease amortization, net 41,390 53,585
Amortization of deferred financing costs 17,203 13,523
Tax benefit — deferred and other (8,164) (4,938)
Other amortization and non-cash items 1,931 1,709
Proportionate share of adjustments for noncontrolling interests (f) (769) (24)
AFFO attributable to W. P. Carey — Real Estate $ 1,042,782 $ 896,139
Summary
AFFO attributable to W. P. Carey — Real Estate $ 1,042,782 $ 896,139
FFO and AFFO from Investment Management were as follows (in thousands):
Years Ended December 31,
Adjustments:
Impairment charges — Investment Management goodwill (c) 29,334 —
Gain on change in control of interests (a) (b) (22,526) —
Total adjustments 6,808 —
Adjustments:
Tax expense (benefit) — deferred and other 4,405 (1,029)
Other (gains) and losses (g) 1,111 (791)
Merger and other expenses 3 51
AFFO attributable to W. P. Carey — Investment Management $ 17,816 $ 25,352
Summary
AFFO attributable to W. P. Carey — Investment Management $ 17,816 $ 25,352
__________
(a)Amount for the year ended December 31, 2022 represents a gain recognized on the remaining interests in four investments acquired in the CPA:18 Merger, which we had previously accounted for under the equity method (Note 3).
(b)Amount for the year ended December 31, 2022 represents a gain recognized on our previously held interest in shares of CPA:18 – Global common stock in connection with the CPA:18 Merger (Note 3).
(c)Amount for the year ended December 31, 2022 represents an impairment charge recognized on goodwill within our Investment Management segment, since future Investment Management cash flows are expected to be minimal (Note 7, Note 9).
(d)Amount for the year ended December 31, 2022 includes our $4.6 million proportionate share of an impairment charge recognized on an equity method investment in real estate (Note 8). Amount for the year ended December 31, 2021 includes a non-cash other-than-temporary impairment charge of $6.8 million recognized on an equity method investment in real estate (Note 9)
(e)Equity income, including amounts that are not typically recognized for FFO and AFFO, is recognized within Earnings (losses) from equity method investments on the consolidated statements of income. This represents adjustments to equity income to reflect FFO and AFFO on a pro rata basis.
(f)Adjustments disclosed elsewhere in this reconciliation are on a consolidated basis. This adjustment reflects our FFO or AFFO on a pro rata basis.
(g)Primarily comprised of gains and losses on extinguishment of debt, the mark-to-market fair value of equity securities, and foreign currency exchange rate movements, as well as non-cash allowance for credit losses on loans receivable and direct financing leases.
(h)Amount for the year ended December 31, 2021 includes an adjustment to exclude $37.8 million of lease termination fees received from a tenant, as such amount was determined to be non-core income (Note 5).
(i)Amounts for the years ended December 31, 2022 and 2021 are primarily comprised of costs incurred in connection with the CPA:18 Merger (Note 3) and/or reversals of estimated liabilities for German real estate transfer taxes that were previously recorded in connection with mergers in prior years.
While we believe that FFO and AFFO are important supplemental measures, they should not be considered as alternatives to net income as an indication of a company’s operating performance. These non-GAAP measures should be used in conjunction with net income as defined by GAAP. FFO and AFFO, or similarly titled measures disclosed by other REITs, may not be comparable to our FFO and AFFO measures.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market Risk
Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, and equity prices. The primary market risks that we are exposed to are interest rate risk and foreign currency exchange risk; however, we do not use derivative instruments to hedge credit/market risks or for speculative purposes. From time to time, we may enter into foreign currency collars to hedge our foreign currency cash flow exposures.
We are also exposed to further market risk as a result of tenant concentrations in certain industries and/or geographic regions, since adverse market factors (such as the COVID-19 pandemic) can affect the ability of tenants in a particular industry/region to meet their respective lease obligations. In order to manage this risk, we view our collective tenant roster as a portfolio and we attempt to diversify such portfolio so that we are not overexposed to a particular industry or geographic region.
Interest Rate Risk
The values of our real estate and related fixed-rate debt obligations, as well as the values of our unsecured debt obligations, are subject to fluctuations based on changes in interest rates. The value of our real estate is also subject to fluctuations based on local and regional economic conditions (including the ongoing impact of the COVID-19 pandemic) and changes in the creditworthiness of lessees, which may affect our ability to refinance property-level mortgage debt when balloon payments are scheduled, if we do not choose to repay the debt when due. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political conditions, and other factors beyond our control. An increase in interest rates would likely cause the fair value of our assets to decrease. Increases in interest rates may also have an impact on the credit profile of certain tenants.
We are exposed to the impact of interest rate changes primarily through our borrowing activities. To limit this exposure, we generally seek long-term debt financing on a fixed-rate basis. However, we are subject to variable-rate interest on our Unsecured Term Loans, Unsecured Revolving Credit Facility, and certain of our non-recourse mortgage debt. We have entered into, and may continue to enter into, interest rate swap agreements or interest rate cap agreements with counterparties related to certain of our variable-rate non-recourse mortgage loans. See Note 10 for additional information on our interest rate swaps and caps.
At December 31, 2022, a significant portion (approximately 86.8%) of our long-term debt either bore interest at fixed rates or was swapped or capped to a fixed rate. Our debt obligations are more fully described in Note 11 and Liquidity and Capital Resources — Summary of Financing in Item 7 above. The following table presents principal cash flows based upon expected maturity dates of our debt obligations outstanding at December 31, 2022 (in thousands):
__________
(a)Amounts are based on the exchange rate at December 31, 2022, as applicable.
(b)Amounts after 2023 are primarily comprised of principal payments for our Senior Unsecured Notes (Note 11).
The estimated fair value of our fixed-rate debt and our variable-rate debt that currently bears interest at fixed rates or has effectively been converted to a fixed rate through the use of interest rate swaps, or that has been subject to interest rate caps, is affected by changes in interest rates. Annual interest expense on our unhedged variable-rate debt that does not bear interest at fixed rates at December 31, 2022 would increase or decrease by $5.9 million for our euro-denominated debt, by $3.7 million for our British pound sterling-denominated debt, by $0.3 million for U.S. dollar-denominated debt, and by $0.2 million for our Japanese yen-denominated debt for each respective 1% change in annual interest rates.
Foreign Currency Exchange Rate Risk
We own international investments, primarily in Europe, Canada, and Japan, and as a result are subject to risk from the effects of exchange rate movements in various foreign currencies, primarily the euro, the British pound sterling, the Canadian dollar, the Japanese yen, and certain other currencies which may affect future costs and cash flows. We have obtained, and may in the future obtain, non-recourse mortgage financing in the local currency. We have also completed several offerings of euro-denominated senior notes, and have borrowed under our Senior Unsecured Credit Facility in foreign currencies, including the euro, British pound sterling, and Japanese yen (Note 11). Volatile market conditions arising from the ongoing effects of the COVID-19 global pandemic, as well as other macroeconomic factors, may result in significant fluctuations in foreign currency exchange rates. To the extent that currency fluctuations increase or decrease rental revenues, as translated to U.S. dollars, the change in debt service (comprised of principal and interest, excluding balloon payments), as translated to U.S. dollars, will partially offset the effect of fluctuations in revenue and, to some extent, mitigate the risk from changes in foreign currency exchange rates. We estimate that, for a 1% increase or decrease in the exchange rate between the euro, British pound sterling, or Japanese yen and the U.S. dollar, there would be a corresponding change in the projected estimated cash flow (scheduled future rental revenues, net of scheduled future debt service payments for the next 12 months) for our consolidated foreign operations at December 31, 2022 of $2.7 million, $0.3 million, and less than $0.1 million, respectively, excluding the impact of our derivative instruments.
In addition, we may use currency hedging to further reduce the exposure to our equity cash flow. We are generally a net receiver of these currencies (we receive more cash than we pay out), and therefore our foreign operations benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar, relative to the foreign currency.
We enter into foreign currency collars to hedge certain of our foreign currency cash flow exposures. See Note 10 for additional information on our foreign currency collars.
Concentration of Credit Risk
Concentrations of credit risk arise when a number of tenants are engaged in similar business activities or have similar economic risks or conditions that could cause them to default on their lease obligations to us. We regularly monitor our portfolio to assess potential concentrations of credit risk. While we believe our portfolio is well-diversified, it does contain concentrations in certain areas.
For the year ended December 31, 2022, our consolidated portfolio had the following significant characteristics in excess of 10%, based on the percentage of our consolidated total revenues:
•67% related to domestic operations; and
•33% related to international operations.
At December 31, 2022, our net-lease portfolio, which excludes our operating properties, had the following significant property and lease characteristics in excess of 10% in certain areas, based on the percentage of our ABR as of that date:
•63% related to domestic properties;
•37% related to international properties;
•27% related to industrial facilities, 24% related to warehouse facilities, 17% related to office facilities, and 17% related to retail facilities; and
•21% related to the retail stores industry (including automotive dealerships).
Item 8. Financial Statements and Supplementary Data.
TABLE OF CONTENTS Page No.
Report of Independent Registered Public Accounting Firm (PCAOB ID 238) 49
Consolidated Balance Sheets as of December 31, 2022 and 2021 52
Notes to Consolidated Financial Statements 60
Schedule IV — Mortgage Loans on Real Estate as of December 31, 2022 135
Financial statement schedules other than those listed above are omitted because the required information is given in the financial statements, including the notes thereto, or because the conditions requiring their filing do not exist.
Report of Independent Registered Public Accounting Firm
To theBoard of Directors and Stockholders of W. P. Carey Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets ofW. P. Carey Inc.and its subsidiaries(the “Company”) as of December 31, 2022 and 2021,and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2022, including the related notes and financial statement schedules listed in the accompanying index (collectively referred to as the “consolidatedfinancial statements”).We also have audited the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework(2013)issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidatedfinancial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of itsoperations and itscash flows for each of the three years in the period ended December 31, 2022in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework(2013)issued by the COSO.
Basis for Opinions
The Company’s management is responsible for these consolidatedfinancial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidatedfinancial statements and on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidatedfinancial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidatedfinancial statements included performing procedures to assess the risks of material misstatement of the consolidatedfinancial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidatedfinancial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidatedfinancial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Purchase Price Allocation for Asset Acquisitions and Business Combinations
As described in Note 2 to the consolidated financial statements, management determines whether a transaction or other event is a business combination, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired and liabilities assumed are not a business, management accounts for the transaction or other event as an asset acquisition. As described in Note 5, the Company completed real estate asset acquisitions with total capitalized costs of $1.2 billion during the year ended December 31, 2022. As described in Note 3, the Company accounted for the CPA:18 Merger as a business combination under the acquisition method of accounting for total merger consideration of approximately $1.6 billion during the year ended December 31, 2022. Land is typically valued utilizing the sales comparison (or market) approach. Buildings are valued, as if vacant, using the cost and/or income approach. Under the income approach, management uses either the discounted cash flow method or the direct capitalization method. For the discounted cash flow method, the fair value of real estate is determined (i) by applying a discounted cash flow analysis to the estimated net operating income for each property in the portfolio during the remaining anticipated lease term and (ii) by the estimated residual value, which is based on a hypothetical sale of the property upon expiration of a lease factoring in the re-tenanting of such property at estimated market rental rates and applying a selected capitalization rate. For the direct capitalization method, the fair value of real estate is determined (i) by the stabilized estimated net operating income for each property in the portfolio and (ii) a selected capitalization rate. For acquired properties with leases classified as operating leases, management allocated the purchase price to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. For acquired properties that do not qualify as sale-leaseback transactions, management records above- and below-market lease intangible assets and liabilities for acquired properties based on the present value, using a discount rate reflecting the risks associated with the leases acquired. For acquired properties with tenants in place, management records in-place lease intangible assets based on the estimated value ascribed to the avoidance of costs of leasing the properties for the remaining primary in-place lease terms.
The principal considerations for our determination that performing procedures relating to the purchase price allocation for asset acquisitions and business combinations is a critical audit matter are (i) the significant judgment by management to develop the fair value estimates of tangible and intangible assets and liabilities using the discounted cash flow and direct capitalization methods; (ii) a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating management’s significant assumptions related to the market rental rates, capitalization rates, and discount rates used in the discounted cash flow method, and capitalization rates used in the direct capitalization method; and (iii) the audit effort involved the use of professionals with specialized skill and knowledge.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to purchase price allocations for asset acquisitions and business combinations, including controls over management’s valuation of the tangible and intangible assets and liabilities and controls over management’s review of the assumptions related to market rental rates, capitalization rates, and discount rates. These procedures also included, among others, (i) reading the executed purchase agreements and leasing documents; (ii) testing management’s process for developing the fair value estimates of tangible and intangible assets and liabilities, (iii) evaluating the appropriateness of the discounted cash flow and direct capitalization valuation methods, (iv) evaluating the reasonableness of the significant assumptions related to market rental rates, capitalization rates, and discount rates used in the discounted cash flow method, and capitalization rates used in the direct capitalization method, and (v) testing the completeness and accuracy of data used in the valuation methods. Evaluating management’s significant assumptions related to market rental rates, capitalization rates, and discount rates involved evaluating whether the assumptions used by management were reasonable considering (i) comparable market data and other industry
factors and (ii) whether these assumptions were consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in evaluating (i) the appropriateness of the Company’s valuation methods and (ii) the reasonableness of the significant assumptions related to market rental rates, capitalization rates, and discount rates.
/s/ PricewaterhouseCoopers LLP
New York, New York
February 10, 2023
We have served as the Company’s auditor since 1973, which includes periods before the Company became subject to SEC reporting requirements.
W. P. CAREY INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
December 31,
Assets
Investments in real estate:
Land, buildings and improvements — operating properties 1,095,892 83,673
Net investments in direct financing leases and loans receivable 771,761 813,577
Liabilities and Equity
Debt:
Accounts payable, accrued expenses and other liabilities 623,843 572,846
Below-market rent and other intangible liabilities, net 184,584 183,286
Commitments and contingencies (Note 12)
Preferred stock, $0.001 par value, 50,000,000 shares authorized; none issued — —
Distributions in excess of accumulated earnings (2,486,633) (2,224,231)
__________
(a)See Note 2 for details related to variable interest entities (“VIEs”).
See Notes to Consolidated Financial Statements.
W. P. CAREY INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share and per share amounts)
Years Ended December 31,
Revenues
Real Estate:
Income from direct financing leases and loans receivable 74,266 67,555 74,893
Investment Management:
Operating Expenses
Impairment charges — Investment Management goodwill 29,334 — —
Subadvisor fees — — 1,469
Other Income and Expenses
Gain on change in control of interests 33,931 — —
Net loss (income) attributable to noncontrolling interests 657 (134) (10,596)
Diluted Earnings Per Share $ 2.99 $ 2.24 $ 2.60
Weighted-Average Shares Outstanding
See Notes to Consolidated Financial Statements.
W. P. CAREY INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
Years Ended December 31,
Other Comprehensive (Loss) Income
Amounts Attributable to Noncontrolling Interests
Foreign currency translation adjustments (5) — —
Unrealized gain on derivative instruments — (21) (7)
See Notes to Consolidated Financial Statements.
W. P. CAREY INC.
CONSOLIDATED STATEMENTS OF EQUITY
(in thousands, except share and per share amounts)
W. P. Carey Stockholders
Distributions Accumulated
Common Stock Additional in Excess of Deferred Other Total
Shares Amount Capital Earnings Obligation Loss Stockholders Interests Total
Deferral of vested shares, net (6,696) 6,696 — —
Distributions to noncontrolling interests — (413) (413)
Contributions from noncontrolling interests — 30 30
Other comprehensive loss:
(Continued)
W. P. CAREY INC.
CONSOLIDATED STATEMENTS OF EQUITY
(Continued)
(in thousands, except share and per share amounts)
W. P. Carey Stockholders
Distributions Accumulated
Common Stock Additional in Excess of Deferred Other Total
Shares Amount Capital Earnings Obligation Loss Stockholders Interests Total
Deferral of vested shares, net (7,044) 7,044 — —
Distributions to noncontrolling interests — (145) (145)
Other comprehensive loss:
(Continued)
W. P. CAREY INC.
CONSOLIDATED STATEMENTS OF EQUITY
(Continued)
(in thousands, except share and per share amounts)
W. P. Carey Stockholders
Distributions Accumulated
Common Stock Additional in Excess of Deferred Other Total
Shares Amount Capital Earnings Obligation Loss Stockholders Interests Total
Shares issued under ATM Program, net 2,500 — 60 60 60
Deferral of vested shares, net (3,854) 3,854 — —
Distributions to noncontrolling interests — (5,326) (5,326)
Redemption of noncontrolling interest (Note 4) — (9,865) (9,865)
Other comprehensive income:
See Notes to Consolidated Financial Statements.
W. P. CAREY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended December 31,
Cash Flows — Operating Activities
Adjustments to net income:
Gain on change in control of interests (33,931) — —
Distributions of earnings from equity method investments 30,236 15,471 9,419
Impairment charges — Investment Management goodwill 29,334 — —
(Decrease) increase in allowance for credit losses (24,976) 266 22,259
Net changes in other operating assets and liabilities (14,269) (14,252) 5,831
Cash Flows — Investing Activities
Cash paid to stockholders of CPA:18 – Global in the CPA:18 Merger (423,435) — —
Capital contributions to equity method investments (93,416) (107,552) (4,253)
Proceeds from repayment of loans receivable 34,000 — 11,000
Proceeds from repayment of short-term loans to affiliates 26,000 62,048 51,702
Purchases of securities — — (95,511)
Cash Flows — Financing Activities
Distributions to noncontrolling interests (413) (145) (5,326)
Contributions from noncontrolling interests 30 — —
Redemption of Senior Unsecured Notes — (617,442) —
Change in Cash and Cash Equivalents and Restricted Cash During the Year
See Notes to Consolidated Financial Statements.
W. P. CAREY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Supplemental Non-Cash Investing and Financing Activities:
2022 — On August 1, 2022, CPA:18 – Global (as defined herein) merged with and into one of our indirect subsidiaries in the CPA:18 Merger (as defined herein) (Note 3). The following table summarizes estimated fair values of the assets acquired and liabilities assumed in the CPA:18 Merger (in thousands):
Total Consideration
Fair value of W. P. Carey shares of common stock issued $ 1,205,750
Cash consideration paid 423,297
Cash paid for fractional shares 138
Assets Acquired at Fair Value
Land, buildings and improvements — net lease and other 881,613
Land, buildings and improvements — operating properties 1,000,447
Net investments in direct financing leases and loans receivable 38,517
In-place lease and other intangible assets 224,458
Above-market rent intangible assets 61,090
Assets held for sale 85,026
Other assets, net (excluding restricted cash) 25,229
Liabilities Assumed at Fair Value
Non-recourse mortgages, net 900,173
Accounts payable, accrued expenses and other liabilities 90,035
Below-market rent and other intangible liabilities 16,836
Deferred income taxes 52,320
Amounts attributable to noncontrolling interests 14,367
Net assets acquired excluding cash and restricted cash 1,414,995
Cash and cash equivalents and restricted cash acquired $ 331,063
See Notes to Consolidated Financial Statements.
W. P. CAREY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Business and Organization
W. P. Carey Inc. (“W. P. Carey”) is a real estate investment trust (“REIT”) that, together with our consolidated subsidiaries, invests primarily in operationally-critical, single-tenant commercial real estate properties located in the United States and Northern and Western Europe on a long-term basis. We earn revenue principally by leasing the properties we own to companies on a triple-net lease basis, which generally requires each tenant to pay the costs associated with operating and maintaining the property.
Founded in 1973, our shares of common stock are listed on the New York Stock Exchange under the symbol “WPC.”
We elected to be taxed as a REIT under Section 856 through 860 of the Internal Revenue Code effective as of February 15, 2012. As a REIT, we are not subject to federal income taxes on income and gains that we distribute to our stockholders as long as we satisfy certain requirements, principally relating to the nature of our income and the level of our distributions, as well as other factors. We also own real property in jurisdictions outside the United States through foreign subsidiaries and are subject to income taxes on our pre-tax income earned from properties in such countries. Through our taxable REIT subsidiaries (“TRSs”), we also earn revenue as the advisor to certain non-traded investment programs. We hold all of our real estate assets attributable to our Real Estate segment under the REIT structure, while the activities conducted by our Investment Management segment subsidiaries have been organized under TRSs.
On August 1, 2022, a non-traded REIT that we advised, Corporate Property Associates 18 – Global Incorporated (“CPA:18 – Global”) merged with and into one of our indirect subsidiaries (the “CPA:18 Merger”) (Note 3). At December 31, 2022, we were the advisor to Carey European Student Housing Fund I, L.P. (“CESH”), a limited partnership formed for the purpose of developing, owning, and operating student housing properties in Europe (Note 4).
We refer to CPA:18 – Global (prior to the CPA:18 Merger) and CESH collectively as the “Managed Programs.” We no longer raise capital for new or existing funds, but currently expect to continue managing CESH through the end of its life cycle (Note 4).
Reportable Segments
Real Estate — Lease revenues from our real estate investments generate the vast majority of our earnings. We invest primarily in commercial properties located in the United States and Northern and Western Europe, which are leased to companies on a triple-net lease basis. At December 31, 2022, our owned portfolio was comprised of our full or partial ownership interests in 1,449 properties, totaling approximately 176 million square feet (unaudited), substantially all of which were net leased to 392 tenants, with a weighted-average lease term of 10.8 years and an occupancy rate of 98.8% (unaudited). In addition, at December 31, 2022, our portfolio was comprised of full or partial ownership interests in 87 operating properties, including 84 self-storage properties, two student housing properties, and one hotel, totaling approximately 6.6 million square feet (unaudited).
Investment Management — Through our TRSs, we manage the real estate investment portfolio for CESH, for which we earn asset management revenue. We may also be entitled to receive certain distributions pursuant to our advisory arrangements with CESH. At December 31, 2022, CESH owned (i) all or a portion of three net-leased properties, totaling approximately 0.4 million square feet (unaudited), all of which were leased to one tenant, with an occupancy rate of 100.0% (unaudited), and (ii) one active build-to-suit project.
Note 2. Summary of Significant Accounting Policies
Critical Accounting Policies and Estimates
Accounting for Acquisitions
In accordance with the guidance for business combinations, we determine whether a transaction or other event is a business combination, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, we account for the transaction or other event as an asset acquisition. Under both methods, we recognize the
Notes to Consolidated Financial Statements
identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired entity. In addition, for transactions that are business combinations, we evaluate the existence of goodwill or a gain from a bargain purchase. We capitalize acquisition-related costs and fees associated with asset acquisitions. We immediately expense acquisition-related costs and fees associated with business combinations. All transaction costs incurred during the reporting period were capitalized since our acquisitions were classified as asset acquisitions (excluding the CPA:18 Merger).
Purchase Price Allocation of Tangible Assets — When we acquire properties with leases classified as operating leases, we allocate the purchase price to the tangible and intangible assets and liabilities acquired based on their estimated fair values. The tangible assets consist of land, buildings, and site improvements. The intangible assets include the above- and below-market value of leases and the in-place leases, which includes the value of tenant relationships. Land is typically valued utilizing the sales comparison (or market) approach. Buildings are valued, as if vacant, using the cost and/or income approach. Under the cost approach, the fair value of real estate is based on estimated costs to construct a vacant building with similar characteristics. Under the income approach, we use either the discounted cash flow method or the direct capitalization method. For the discounted cash flow method, the fair value of real estate is determined (i) by applying a discounted cash flow analysis to the estimated net operating income for each property in the portfolio during the remaining anticipated lease term and (ii) by the estimated residual value, which is based on a hypothetical sale of the property upon expiration of a lease factoring in the re-tenanting of such property at estimated market rental rates, and applying a selected capitalization rate. For the direct capitalization method, the fair value of real estate is determined (i) by the stabilized estimated net operating income for each property in the portfolio and (ii) a selected capitalization rate.
Assumptions used in the model are property-specific where this information is available; however, when certain necessary information is not available, we use available regional and property-type information. Assumptions and estimates include the following:
•a discount rate or internal rate of return;
•market rents, growth factors of rents, and market lease term;
•capitalization rates to be applied to an estimate of market rent at the beginning and/or the end of the market lease term;
•the marketing period necessary to put a lease in place;
•carrying costs during the marketing period; and
•leasing commissions and tenant improvement allowances.
The discount rates and residual capitalization rates used to value the properties are selected based on several factors, including:
•the creditworthiness of the lessees;
•industry surveys;
•property type;
•property location and age;
•current lease rates relative to market lease rates; and
•anticipated lease duration.
In the case where a tenant has a purchase option deemed to be favorable to the tenant, or the tenant has long-term renewal options at rental rates below estimated market rental rates, we generally include the value of the exercise of such purchase option or long-term renewal options in the determination of residual value.
The remaining economic life of leased assets is estimated by relying in part upon third-party appraisals of the leased assets and industry standards. Different estimates of remaining economic life will affect the depreciation expense that is recorded.
Purchase Price Allocation of Intangible Assets and Liabilities — For acquired properties that do not qualify as sale-leaseback transactions, we record above- and below-market lease intangible assets and liabilities for acquired properties based on the present value (using a discount rate reflecting the risks associated with the leases acquired including consideration of the credit of the lessee) of the difference between (i) the contractual rents to be paid pursuant to the leases negotiated or in place at the time of acquisition of the properties and (ii) our estimate of fair market lease rates for the property or equivalent property, both of which are measured over the estimated lease term, which includes renewal options that have rental rates below estimated market rental rates. We discount the difference between the estimated market rent and contractual rent to a present value using an interest rate reflecting our current assessment of the risk associated with the lease acquired, which includes a consideration of the credit of the lessee. When we enter into sale-leaseback transactions with above- or below-market leases, the intangibles will be accounted for as loan receivables or prepaid rent liabilities, respectively. We measure the fair value of below-market
Notes to Consolidated Financial Statements
purchase option liabilities we acquire as the excess of the present value of the fair value of the real estate over the present value of the tenant’s exercise price at the option date. We determine these values using our estimates or by relying in part upon third-party valuations conducted by independent appraisal firms.
We amortize the above-market lease intangible as a reduction of lease revenue over the remaining contractual lease term. We amortize the below-market lease intangible as an increase to lease revenue over the initial term and any renewal periods in the respective leases. We include the value of below-market leases in Below-market rent and other intangible liabilities in the consolidated financial statements.
For acquired properties with tenants in place, we record in-place lease intangible assets based on the estimated value ascribed to the avoidance of costs of leasing the properties for the remaining primary in-place lease terms. The cost avoidance is derived first by determining the in-place lease term on the subject lease. Then, based on our review of the market, the cost to be borne by a property owner to replicate a market lease to the remaining in-place term is estimated. These costs consist of: (i) rent lost during downtime (i.e., assumed periods of vacancy), (ii) estimated expenses that would be incurred by the property owner during periods of vacancy, (iii) rent concessions (i.e., free rent), (iv) leasing commissions, and (v) tenant improvements allowances given to tenants. We determine these values using our estimates or by relying in part upon third-party valuations. We amortize the value of in-place lease intangibles to depreciation and amortization expense over the remaining initial term of each lease. The amortization period for intangibles does not exceed the remaining depreciable life of the building.
If a lease is terminated, we charge the unamortized portion of above- and below-market lease values to rental income and in-place lease values to amortization expense. If a lease is amended, we will determine whether the economics of the amended lease continue to support the existence of the above- or below-market lease intangibles.
Purchase Price Allocation of Debt — When we acquire leveraged properties, the fair value of the related debt instruments is determined using a discounted cash flow model with rates that take into account the credit of the tenants, where applicable, and interest rate risk. Such resulting premium or discount is amortized over the remaining term of the obligation. We also consider the value of the underlying collateral, taking into account the quality of the collateral, the credit quality of the tenant, the time until maturity and the current interest rate.
Purchase Price Allocation of Goodwill — In the case of a business combination, after identifying all tangible and intangible assets and liabilities, the excess consideration paid over the fair value of the assets and liabilities acquired and assumed, respectively, represents goodwill. We allocate goodwill to the respective reporting units in which such goodwill arises. Goodwill acquired in certain business combinations was attributed to the Real Estate segment which comprises one reporting unit. In the event we dispose of a property or an investment that constitutes a business under U.S. generally accepted accounting principles (“GAAP”) from a reporting unit with goodwill, we allocate a portion of the reporting unit’s goodwill to that business in determining the gain or loss on the disposal of the business. The amount of goodwill allocated to the business is based on the relative fair value of the business to the fair value of the reporting unit. As part of purchase accounting for a business, we record any deferred tax assets and/or liabilities resulting from the difference between the tax basis and GAAP basis of the investment in the taxing jurisdiction. Such deferred tax amount will be included in purchase accounting and may impact the amount of goodwill recorded depending on the fair value of all of the other assets and liabilities and the amounts paid.
Financing Arrangements— In accordance with Accounting Standards Codification (“ASC”) 310, Receivables and ASC 842, Leases, real estate assets acquired through a sale-leaseback transaction are accounted for as a financing arrangement if the investment does not meet the criteria for sale-leaseback accounting. We record such investments within Net investments in direct financing leases and loans receivable on the consolidated balance sheets. Rent payments from these investments are included within Income from direct financing leases and loans receivable on the consolidated statements of income.
Impairments
Real Estate — We periodically assess whether there are any indicators that the value of our long-lived real estate and related intangible assets may be impaired or that their carrying value may not be recoverable. These impairment indicators include, but are not limited to, vacancies, an upcoming lease expiration, a tenant with credit difficulty, the termination of a lease by a tenant, or a likely disposition of the property.
Notes to Consolidated Financial Statements
For real estate assets held for investment and related intangible assets in which an impairment indicator is identified, we follow a two-step process to determine whether an asset is impaired and to determine the amount of the charge. First, we compare the carrying value of the property’s asset group to the estimated future net undiscounted cash flow that we expect the property’s asset group will generate, including any estimated proceeds from the eventual sale of the property’s asset group. The undiscounted cash flow analysis requires us to make our best estimate of market rents, residual values, and holding periods. We estimate market rents and residual values using market information from outside sources such as third-party market research, external appraisals, broker quotes, or recent comparable sales.
As our investment objective is to hold properties on a long-term basis, holding periods used in the undiscounted cash flow analysis are generally ten years, but may be less if our intent is to hold a property for less than ten years. Depending on the assumptions made and estimates used, the future cash flow projected in the evaluation of long-lived assets and associated intangible assets can vary within a range of outcomes. We consider the likelihood of possible outcomes in determining our estimate of future cash flows and, if warranted, we apply a probability-weighted method to the different possible scenarios. If the future net undiscounted cash flow of the property’s asset group is less than the carrying value, the carrying value of the property’s asset group is considered not recoverable. We then measure the impairment loss as the excess of the carrying value of the property’s asset group over its estimated fair value.
Assets Held for Sale — We generally classify real estate assets that are subject to operating leases as held for sale when we have entered into a contract to sell the property, all material due diligence requirements have been satisfied, we received a non-refundable deposit, and we believe it is probable that the disposition will occur within one year. When we classify an asset as held for sale, we compare the asset’s fair value less estimated cost to sell to its carrying value, and if the fair value less estimated cost to sell is less than the property’s carrying value, we reduce the carrying value to the fair value less estimated cost to sell. We will continue to review the property for subsequent changes in the fair value, and may recognize an additional impairment charge, if warranted.
Equity Method Investments — We evaluate our equity method investments on a periodic basis to determine if there are any indicators that the value of our equity investment may be impaired and whether or not that impairment is other-than-temporary. To the extent an impairment has occurred and is determined to be other-than-temporary, we measure the charge as the excess of the carrying value of our investment over its estimated fair value, which is determined by calculating our share of the estimated fair market value of the underlying net assets based on the terms of the applicable partnership or joint-venture agreement. For our equity investments in real estate, we calculate the estimated fair value of the underlying investment’s real estate as described in Real Estate above. The fair value of the underlying investment’s debt, if any, is calculated based on market interest rates and other market information. The fair value of the underlying investment’s other financial assets and liabilities (excluding net investment in direct financing leases) have fair values that generally approximate their carrying values.
Goodwill — We evaluate goodwill for possible impairment at least annually or upon the occurrence of a triggering event. Such a triggering event within our Investment Management segment depended on the timing and form of liquidity events for the Managed Programs (Note 3, Note 4). To identify any impairment, we first assess qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. This assessment is used as a basis to determine whether it is necessary to calculate reporting unit fair values. If necessary, we calculate the estimated fair value of the Investment Management reporting unit by utilizing a discounted cash flow analysis methodology and available net asset values. We calculate the estimated fair value of the Real Estate reporting unit by utilizing our market capitalization and the aforementioned fair value of the Investment Management segment. Impairments, if any, will be the difference between the reporting unit’s fair value and carrying amount, not to exceed the carrying amount of goodwill.
Credit Losses
We adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments — Credit Losses on January 1, 2020, which replaces the “incurred loss” model with an “expected loss” model, resulting in the earlier recognition of credit losses even if the risk of loss is remote. This standard applies to financial assets measured at amortized cost and certain other instruments, including net investments in direct financing leases and loans receivable. This standard does not apply to receivables arising from operating leases, which are within the scope of Topic 842. We adopted ASU 2016-13 using the modified retrospective method, under which we recorded a cumulative-effect adjustment as a charge to retained earnings of $14.8 million on January 1, 2020, which is reflected within our consolidated statements of equity.
Notes to Consolidated Financial Statements
The allowance for credit losses, which is recorded as a reduction to Net investments in direct financing leases and loans receivable on our consolidated balance sheets, is measured on a pool basis by credit ratings (Note 6), using a probability of default method based on the lessees’ respective credit ratings, the expected value of the underlying collateral upon its repossession, and our historical loss experience related to other direct financing leases. Included in our model are factors that incorporate forward-looking information. Allowance for credit losses is included in our consolidated statements of income within Other gains and (losses).
Other Accounting Policies
Basis of Consolidation — Our consolidated financial statements reflect all of our accounts, including those of our controlled subsidiaries. The portions of equity in consolidated subsidiaries that are not attributable, directly or indirectly, to us are presented as noncontrolling interests. All significant intercompany accounts and transactions have been eliminated.
When we obtain an economic interest in an entity, we evaluate the entity to determine if it should be deemed a VIE and, if so, whether we are the primary beneficiary and are therefore required to consolidate the entity. We apply accounting guidance for consolidation of VIEs to certain entities in which the equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Fixed price purchase and renewal options within a lease, as well as certain decision-making rights within a loan or joint-venture agreement, can cause us to consider an entity a VIE. Limited partnerships and other similar entities that operate as a partnership will be considered a VIE unless the limited partners hold substantive kick-out rights or participation rights. Significant judgment is required to determine whether a VIE should be consolidated. We review the contractual arrangements provided for in the partnership agreement or other related contracts to determine whether the entity is considered a VIE, and to establish whether we have any variable interests in the VIE. We then compare our variable interests, if any, to those of the other variable interest holders to determine which party is the primary beneficiary of the VIE based on whether the entity (i) has the power to direct the activities that most significantly impact the economic performance of the VIE and (ii) has the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. The liabilities of these VIEs are non-recourse to us and can only be satisfied from each VIE’s respective assets.
Upon the closing of the CPA:18 Merger, we acquired five consolidated VIEs and declassified three entities as VIEs.
At December 31, 2022 and 2021, we considered 16 and 14 entities to be VIEs, respectively, of which we consolidated 11 and six, respectively, as we are considered the primary beneficiary. The following table presents a summary of selected financial data of the consolidated VIEs included in our consolidated balance sheets (in thousands):
December 31,
Land, buildings and improvements — net lease and other $ 590,390 $ 426,831
Land, buildings and improvements — operating properties 143,390 —
Net investments in direct financing leases and loans receivable 144,103 144,103
In-place lease intangible assets and other 72,070 42,884
Accumulated depreciation and amortization (176,379) (154,413)
Below-market rent and other intangible liabilities, net 18,891 20,568
Notes to Consolidated Financial Statements
At December 31, 2022 and 2021, our five and eight unconsolidated VIEs included our interests in (i) three and six unconsolidated real estate investments, respectively, which we account for under the equity method of accounting (we do not consolidate these entities because we are not the primary beneficiary and the nature of our involvement in the activities of these entities allows us to exercise significant influence on, but does not give us power over, decisions that significantly affect the economic performance of these entities), and (ii) two unconsolidated investments in equity securities, which we accounted for as investments in shares of the entities at fair value. As of December 31, 2022 and 2021, the net carrying amount of our investments in these entities was $693.4 million and $581.3 million, respectively, and our maximum exposure to loss in these entities was limited to our investments.
Leases
As a Lessee: Right-of-use (“ROU”) assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments under the lease. We determine if an arrangement contains a lease at contract inception and determine the classification of the lease at commencement. Operating and financing lease ROU assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. We do not include renewal options in the lease term when calculating the lease liability unless we are reasonably certain we will exercise the option. Variable lease payments are excluded from the ROU assets and lease liabilities and are recognized in the period in which the obligation for those payments is incurred. Our variable lease payments consist of increases as a result of the Consumer Price Index (“CPI”) or other comparable indices, taxes, and maintenance costs. Lease expense for lease payments is recognized on a straight-line basis over the term of the lease. Below-market ground lease intangible assets and above-market ground lease intangible liabilities are included as a component of ROU assets. See Note 5 for additional disclosures on the presentation of these amounts in our consolidated balance sheets.
The implicit rate within our operating leases is generally not determinable and, as a result, we use our incremental borrowing rate at the lease commencement date to determine the present value of lease payments. The determination of our incremental borrowing rate requires judgment. We determine our incremental borrowing rate for each lease using estimated baseline mortgage rates. These baseline rates are determined based on a review of current mortgage debt market activity for benchmark securities across domestic and international markets, utilizing a yield curve. The rates are then adjusted for various factors, including level of collateralization and lease term.
As a Lessor: We combine non-lease components (lease arrangements that include common area maintenance services) with related lease components (lease revenues), since both the timing and pattern of transfer are the same for the non-lease component and related lease component, the lease component is the predominant component, and the lease component would otherwise be classified as an operating lease. For (i) operating lease arrangements involving real estate that include common area maintenance services and (ii) all real estate arrangements that include real estate taxes and insurance costs, we present these amounts within lease revenues in our consolidated statements of income. We record amounts reimbursed by the lessee in the period in which the applicable expenses are incurred, if the reimbursements are deemed collectible.
Reclassifications — Certain prior period amounts have been reclassified to conform to the current period presentation.