This article will provide data to make the following two arguments:
1. The REIT (Real Estate Investment Trust) Healthcare sector is not one sector. The key to understanding the valuations is to break up the sector into multiple pieces. My analysis will break them into three pieces. While most Healthcare REITs are combinations of those pieces, it is easier to see the valuations as based on their most important or dominant piece. Most of these companies truly lack a dominant piece.
The reason for this tri-furcation is that properties strongly vary in the percentages of income they generate from Medicare, Medicaid and private pay. The stock market likes it when earnings react to market forces, not government limited mandates. The market logically likes properties with higher private pay percentages. While I lack stats for the full sector, the break down by source of payment is provided for two REITs owning a variety of properties.
2. The best valuation picture is provided by metrics that are based on FAD (Funds Available for Distribution), not FFO (Funds from Operations). The main difference between the two is the separate metric pictures one gets on their dividend coverage. REITs lacking in good coverage also tend to be those lagging in dividend growth.
If you have been using FFO projections as the key metric for investing in REITs, then you have been using the suboptimal earnings metric. This article presents data that gives evidence to that point. This article focuses on REIT FAD data. It includes several performance and valuation spreadsheets.
Healthcare REITs vary substantially on the types of properties they own. Some are heavy in Skilled Nursing facilities. Even within this group, there are variances in the percentage of revenues they get from Medicaid, Medicare and private pay. REITs like Aviv REIT (AVIV) and Omega Healthcare Investors (OHI) have leases to operators where Medicaid and Medicare are a heavy source of funding - and their valuations are lower due to the added risk of cuts in that funding hurting the holders of those leases, and thus eventually hurting the REITs themselves. Hospitals are another property type with a low percentage of earnings from private pay. If there were more REITs with high hospital components, I would break them off into another sub-sector. At this time, there is only one - Medical Properties Trust (MPW). And the second group is relatively heavy in senior housing facilities. These are moderately valued due to a heavier percentage of income generated by private pay. And third group is heavy in MOBs or medical office buildings - and they are more highly valued due to their significantly lower dependence on Medicare and Medicaid.
There are several other factors of smaller or more nebulous importance:
3. Changes in job growth one can find from the Bureau of Labor Statistics are an indicator of the demand for specific types of space. That data indicates a major increase in employment of home Healthcare works. That trend towards home Healthcare will negatively impact the need for Skilled Nursing facilities one day. On the other hand, there is such a large increase in the U.S. over 80 population, that the existing facilities will have little problem finding new tenants in the here and now.
4. The percentage of revenues these REITs get from investment grade rated clients varies significantly. This is a difficult attribute to track in this sector due to the lack of reporting of this attribute. Most of the major brokerages fail to track these numbers.
5. Most Healthcare REITs are heavy in triple-net leases - but some are morphing due to regulation changes. The REIT Investment Diversification and Empowerment Act or RIDEA has allowed Healthcare REITs to be "operators" - or more like direct landlords. In other words, they can be less like triple-nets with their Senior Housing Facilities. This is a second factor (besides the strong "private pay" components) aiding the valuations of REITs owning Senior Housing Facilities.
6. Some Healthcare REITs own relatively high yielding loans, which make a varying component of their earnings more like mREITs - or mortgage REITS - than triple-nets. Medical Properties Trust has the highest loan allocation. Healthcare Realty Trust (HR), Nationwide Health Investors (NHI) and OHI also have these kinds of loans. Those investments assist both in generating a good and growing FAD/share, but hurt their valuations.
One needs to know all of these seven factors to generate a good risk and valuation assessment. This article will only focus on the first two.
I lack information for the full sector when it comes to payment source breakdowns by property type. Most of the REITs fail to report these stats. There are two REITs that do provide a parsing of their earnings or investments by property type. Below is my collection of that data:
Q2-13 Portfolio Performance for Healthcare REIT (HCN)
|Occupancy||EBITDAR Coverage||EBITDARM Coverage||Private Pay||Medicaid||Medicare|
|Seniors housing triple-net||88.4%||1.14x||1.32x||88.7%||6.2%||5.1%|
|Seniors housing operating||90.1%||n/a||n/a||99.0%||0.6%||0.4%|
Q2-13 Portfolio Performance for Aviv REIT
|EBITDARM||EBITDAR||Facility Revenue Mix||EBITDAR|
While lacking a break-out by property type, other REITs do provide total payments by source. For HCP in Q2-13, private-pay as a percentage of total revenues was 32.4% and Medicare was 36.1%. For LTC Properties (LTC) in Q2-13, their same property portfolio, which includes skilled nursing, assisted living, memory care, independent living and properties in combination was 59% private pay, 15% Medicare, and 26% Medicaid. In the data provided by one of the brokerage analysts, Senior Housing Properties (SNH) and Ventas (VTR) have high private pay percentages that are similar to HCN's.
Before we begin parsing the data by attribute, let's look at the three basic spreadsheets most investors compile (or their brokerage reports gather for them) to look at the data: a spreadsheet of yields and year to date returns; a spreadsheet on FFO growth the price/FFO valuations; a spreadsheet on FAD growth the price/FAD valuations; and a spreadsheet on property type weightings.
Healthcare Update for Q3-13
Yields are calculated on Q3-13 dividends. The Dividend/FFO ratio uses the 2013 FFO projection.
|Share Price||13 FFO Estimate||Div/||Percent Change||LTM|
|Med Prop Trust||MPW||11.96||11.55||1.07||1.00||6.93||80.00||-3.43||1.59||-6.54||5.77||0.00|
|Nat'l Health Inv||NHI||56.53||54.90||3.39||3.42||5.36||85.96||-2.88||1.02||0.88||15.18||9.70|
Healthcare Price/FFO Ratios 08-30-13
The analyst projected FFO stats for UTH look wrong to me. The 2013 FFO projection is four times the Q1-13 FFO. HTA IPOed in June of 2012. 'Normalized FFO' stats for the pre-IPO years came from its 2011 10-K.
|FFO / Share||% FFO Growth||Price/FFO||13 FFO Range|
Healthcare Price/FAD Ratios 08-30-13
For REITs not providing FAD data, AFFO numbers are used. 2013 numbers are from guidance or from run rate performance.
There are several REITs for which I am unable to harvest 2010 FAD data.
|FAD/Share||% Growth||Price/FAD||Div/FAD||Div Growth||Current|
Property Type Weightings
|Company||Hospitals||Skilled Nursing||Senior Housing||MOBs||Life Science||Debt|
|Med Prop Trust||MPW||81%||0%||0%||1%||0%||18%|
|Nat'l Health Inv||NHI||5%||42%||45%||1%||0%||7%|
Viewing the data in this un-parsed fashion leaves us with too many questions. For example; why does HR, with zero dividend growth over the last several years, sell at the highest current of 2013 price/FFO valuation and a below sector average yield? Why does OHI, which has out-performed the sector for several years when it comes to dividend growth, sell at the lowest 2013 price/FFO valuation and a well above sector average yield?
The relationship between credit ratings and yields: While yields are also strongly influenced by distribution growth, the influence of credit ratings can also be seen. The ratings from S&P are used here:
- The following REITs had corporate credit ratings of BBB or BBB+: HCN, HCP and VTR. Their current average yield is 4.81%.
- The following REITs had corporate credit ratings of BBB-: HR, HTA, OHI and SNH. Their current average yield is 6.10%.
- The following REITs had corporate credit ratings of BB+, BB or BB-: MPW and SBRA. Their current average yield is 6.54%.
If we pause here, we can see a strong relationship between risk attributes that determine bond ratings and yield. But we have one more grouping to go. This will be the first instance where property types will work to hide the correlation.
- The following had ratings of B, B- or not rated (all were not rated): LTC, NHI and UHT. Their current average yield is 5.61%.
All three REITs in the last grouping had high components in the higher valued property groups. LTC and NHI are not rated. Both have good allocations to Senior Housing. UHT has a good allocation to MOBs.
The relationship between the Dividend/FFO ratio and yields: This is the same kind of test done above. The Q3-13 dividend to 2013 consensus FFO projection ratio is used for this test.
- The following had dividend/FFO ratios of less than 73%: HCP, LTC and VTR. Their current average yield is 4.90%.
- The following had dividend/FFO ratios between 73% and 84%: MPW, OHI and SBRA. Their current average yield is 6.57%.
- The following had dividend/FFO ratios of more than 84%: HCN, HR, HTA, NHI, SNH and UHT. Their current average yield is 5.72%.
There really is a good correlation between the dividend/FFO ratios and yields. The three REITs that fell into the middle group had high components of property groups that are lightly valued. That resulted in the middle group having the highest yield.
The relationship between the dividend/FAD ratio and yields: This is the same kind of test done above. The Q3-13 dividend to 2013 FAD projection ratio is used for this test.
- The following had dividend/FAD ratios of less than 80%: LTC and VTR. Their current average yield is 4.78%.
- The following had dividend/FAD ratios between 80% and 90%: HCP, HR, MPW, NHI, OHI and SBRA. Their current average yield is 5.92%.
- The following had dividend/FAD ratios of more than 90%: HCN, HTA, SNH and UHT. Their current average yield is 5.91%.
The relationship between Dividend Growth Inertia and yields: This is the same kind of test done above. The LTM (last twelve months) dividend growth is used for this test.
- The following had LTM dividend growth of more than 4.5%: HCP, NHI, OHI, and VTR. Their current average yield is 5.36%.
- The following had LTM dividend growth between 1% and 4.5%: HCN, SBRA, SNH and UHT. Their current average yield is 6.06%.
- The following had LTM dividend growth of less than 1%: HR, HTA, LTC and MPW. Their current average yield is 5.77%.
Both HR and HTA have high MOB allocations. Their inclusion in the low inertia group resulted in the low growth inertia group having the second lowest average yields.
The relationship between property type and valuations:
- The following REITs had over 40% in skilled nursing facilities: LTC, NHI, OHI and SBRA. Their current average yield is 4.97% and their average price/FFO ratio is 13.76.
- The following REITs had over 45% in senior housing facilities: HCN, SNH and VTR. Their current average yield is 5.38% and their average price/FFO ratio is 15.38
- The following REITs had over 79% in medical office buildings: HR and HTA. Their current average yield is 5.46% and their average price/FFO ratio is 18.05%
HCP was too diversified to fall into any of the above categories. MPW has a 90% weighting in hospitals, which also caused it to not fall into any of the above categories.
The relationship between property type and FAD ratios:
- The following had over 40% in skilled nursing facilities: LTC, NHI, OHI and SBRA. Their current average price/FAD ratio is 14.27.
- The following had over 45% in senior housing: HCN, SNH and VTR. Their current average price/FAD ratio is 16.28.
- The following had over 79% in medical office buildings: HR and HTA. Their current average price/FAD ratio is 17.59.
The skilled nursing group could even be broken in two pieces. There are two with over 77% weightings - and two under 77% weightings. The two with over 77% weightings - OHI at 12.62 and SBRA at 13.16 - had an average 12.89 price to FAD while the two with under 77% weightings - LTC at 15.14 and NHI at 16.15 - had an average 15.65 price to FAD. The two with over 77% weightings - OHI at 11.18 and SBRA at 12.93 - had an average 12.06 price to FFO while the two with under 77% weightings - LTC at 14.89 and NHI at 16.05 - had an average 15.47 price to FFO. Even within the "two pieces," higher skilled nursing owning OHI has the lower valuation metrics. And for the lighter weighting group, lower skilled nursing owning NHI had the higher valuation metrics.
While there is evidence that credit ratings, the dividend/FFO ratio and dividend growth inertia have an influence on yields -- it is only the Dividend/FAD ratio where each inferior grouping has a higher yield and the most inferior grouping has the highest yield. I am concluding that the importance of this ratio is verified by the strength of that correlation. Valuations by property type have the strongest correlations. This is information that is hidden in the yield data. But the valuation assessments show up in both the price/FFO and price/FAD ratios.
In order to make the argument that FAD stats are superior to FFO in making valuation assessments, I will do a series of valuation comparisons using those sets of numbers. In all of these sets, I will offer comparisons between REITs with similar property allocations. What follows is number intensive text that is slow and difficult to read. If FAD stats are better than FFO stats, then it needs to show up when the differences are small. The differences between HCN and HCP are relatively small. These are two of the older and larger Healthcare REITs. That is a good place to start.
Healthcare REIT vs. HCP
- HCP has better dividend growth (4.17% and 5.00%) over the past two years compared to HCN (3.50% and 3.38%).
- HCP has had better FFO projection accuracy. HCN has had two disappointments since 2010.
- FAD growth is nearly equal (4.23% and 11.49% for HCN and 3.74% and 11.71% for HCP) over the last two years.
- FFO growth is not as equal (-2.28% and 18.08% for HCN and 7.97% and 5.03% for HCP) over the last two years.
- HCN has had (343/313) 9.58% FFO growth since 2010 compared to HCP's (298/219) 36.07%.
- With a ratio of 18.62, HCN is (1862/1642) 13.40% more expensive compared to HCP's 16.42 price to FAD ratio.
- With a ratio of 17.91, HCN is (1791/1367) 31.02% more expensive compared to HCP's 13.67 price to FFO ratio.
- With a yield of 4.98%, HCN is (516/498) 3.61% more expensive compared to HCP's yield of 5.16%.
- With a dividend/FFO ratio of 89.21, HCN looks to have slower forward dividend growth compared to HCP's 70.17 ratio. Ratio spread is 1904 bps.
- With a dividend/FAD ratio of 92.73, HCN looks to have slower forward dividend growth compared to HCP's 84.68 ratio. Ratio spread is 805 bps.
HCN has a slightly better portfolio quality. HCP has a higher weighting in skilled nursing facilities and loans. It is the portfolio quality that accounts for the small differences in yield. It is my expectation that with superior dividend growth, if the portfolio qualities were equal, HCP would merit the lower yield.
The differences are relatively small while the differences in the price/FFO are relatively large. The differences in dividend growth are relatively small. I would argue that the picture one gets from the dividend/FFO ratios distorts the size of the differences.
The private pay differences between the two are huge. HCN operators get 82.4% of income from private pay. HCP operators get 32.4%. HCN wins on this attribute. If you are buying other Healthcare REITs for growth or yield where the private pay percentage is small, hedge your bets by choosing HCN in this decision.
LTC Properties vs. Nationwide Health Investors
- NHI has better dividend growth (8.94% and 9.70%) over the past two years compared to LTC (10.71% and 0.00%).
- LTC has had better FFO projection accuracy over a longer period - but both score well. LTD has smaller spreads in its 2014 FFO projections. Neither have corporate bond ratings.
- FAD growth is 6.34% and 7.34% for LTC and 8.62% and 7.94% for NHI over the last two years. NHI wins.
- FFO growth is 19.61% and 6.56% for LTC and 10.42% and 7.55% for NHI over the last two years. LTC wins.
- LTC has had (238/188) 26.60% FFO growth since 2010 compared to NHI's (342/276) 23.91%.
- With a ratio of 16.15, NHI is (1615/1514) 6.67% more expensive compared to LTC's 15.14 price to FAD ratio.
- With a ratio of 16.05, NHI is (1605/1489) 7.79% more expensive compared to LTC's 14.89 price to FFO ratio.
- With a yield of 5.25%, LTC is (536/525) 2.09% more expensive compared to NHI's yield of 5.36%.
- With a dividend/FFO ratio of 85.96, NHI looks to have slower forward dividend growth compared to LTC's 78.15 ratio. Ratio spread is 781 bps.
- With a dividend/FAD ratio of 86.47, NHI looks to have slower forward dividend growth compared to LTC's 79.49 ratio. Ratio spread is 698 bps.
The differences between the two are tiny. In this case, both the pictures generated by FAD and FFO are nearly equal. I would need information on why LTC is delaying current dividend growth before I could choose between the two. LTC did a secondary offering in May that added 4 million new shares. This was done to raise money for a transaction that will not close until Q4-13. At the current time, the CAGR projections are slightly higher for NHI, and NHI has better dividend growth inertia. But the dividend/FFO and dividend/FAD is saying that LTC should slightly outperform.
Omega Healthcare Investors vs. Sabra Healthcare
- OHI has better dividend growth (5.00% and 11.90%) over the past two years compared to SBRA (3.13% and 3.03%).
- OHI has a longer track record when it comes to FFO projection accuracy. OHI has had two small and one big disappointment - but that comes with four big projection increases. SBRA has a much larger 2013 FFO projection spread.
- FAD growth has been (15.87% and 2.74%) for OHI and (5.30% and 5.66%) for SBRA over the last two years.
- OHI has had (254/189) 34.39% FFO growth since 2011 compared to SBRA's (171/131) 30.53%.
- With a ratio of 13.16, SBRA is (1316/1262) 4.28% more expensive compared to OHI's 12.62 price to FAD ratio.
- With a ratio of 12.93, SBRA is (1293/1118) 15.65% more expensive compared to OHI's 11.18 price to FFO ratio.
- With a yield of 6.15%, SBRA is (662/615) 7.64% more expensive compared to OHI's yield of 6.62%.
- With a dividend/FFO ratio of 79.53, SBRA looks to have slower forward dividend growth compared to OHI's 74.02 ratio. Ratio spread is 548 bps.
- With a dividend/FAD ratio of 81.78, SBRA looks to have near equal forward dividend growth compared to OHI's 80.37 ratio. Ratio spread is 141 bps.
SBRA has a higher weighting in senior housing and a lower weighting in debt. SBRA is a tad safer. OHI has dividend growth inertia and lower dividend/earnings ratios. OHI has the higher yield. I would choose OHI. I could be biased - I already own shares in OHI. On the other hand, I am aware of the higher risk. I have a light weighting in OHI - and it will stay a light weighting.
The valuation picture provided by FAD stats show the valuations to be close to equal. The picture provided by the FFO stats show a tad more difference. I will repeat my finding from the HCN vs. HCP comparison and conclude that the FFO stats exaggerate the valuation differences between the two. In this case, the degree of exaggeration is small.
Healthcare Realty Trust vs. Healthcare Trust
- HTA has yet to declare an increased dividend and HR has not had changed its dividend since 2009.
- HTA has a short but good history of FFO projection accuracy. HR has a long history of projection disappointments.
- FAD growth has been 20.45% and 5.66% for HTA - and 1.47% and -2.90% for HR - over the last two years.
- FFO growth has been 19.61% and a projected 6.56% for HTA in 2013 and -15.27% and 32.43% for HR over the two years of historical 2012 and projected 2013.
- HTA has had (065/051) 27.45% FFO growth since 2011 compared to HR's (111/115) -3.48%.
- With a ratio of 18.39, HTA is (1839/1678) 9.59% more expensive compared to HR's 16.78 price to FAD ratio.
- With a ratio of 20.26, HR is (2026/1585) 27.82% more expensive compared to HTA's 15.85 price to FFO ratio.
- With a yield of 5.34%, HR is (558/534) 4.49% more expensive compared to HTA's yield of 5.58%.
- With a dividend/FFO ratio of 108.11, HR looks to have slower forward dividend growth compared to HTA's 88.46 ratio. Ratio spread is 1965 bps.
- With a dividend/FAD ratio of 102.68, HTA looks to have slower forward dividend growth compared to HR's 89.55 ratio. Ratio spread is 1313 bps.
With the market being in love with MOBs, both of the stocks are highly valued. The result is a combination of lower yields and - currently - no dividend growth. That is not an attractive combination. I want to see some dividend growth in the rear view mirror before I can generate any interest in these two. HTA has the better FAD growth trend. HTA has the higher yield. HTA has no debt investments. I would choose HTA over HR. I am abstaining from investing in both.
There are - once again - big differences in the valuation pictures provided by the FAD and FFO metrics. Which picture is right? I will let the future tell me. The one, which has the better dividend growth in 2014 and 2015, will determine the winner. I strongly suspect that the over valuation of HR that is provided by the price/FFO stats is a bad picture.
A quick summary
In order to make an argument that convinces me, I need to show that the dividend/FAD ratio is superior to the dividend/FFO ratio in projecting dividend growth. I currently lack a historical record for FAD data in order to make such a case. But for the short period of time that I have FAD data, the FAD data appears superior in projecting dividend growth - with the one exception of HCN. When the FAD data and the FFO data are in conflict, I put more weight in the FAD data as painting the more accurate picture of valuations. One can even use the dividend/FAD ratio to project that SBRA - a relatively new REIT which is yet to announce a dividend increase - has the prospects for dividend growth that is just around the corner.
It is my perception that the data that supports the perception that valuations are strongly correlated to property type is very strong. The Healthcare REIT sector is not one uniform sector. One needs to be highly aware of the property type differences in order to avoid comparing apples to oranges when it comes to valuations.
Given the apparent importance of the private pay percentage on Healthcare REIT valuations, I strongly believe that REITs which are failing to disclose details on this attribute are lacking in their transparency. All failures in transparency scare me. That concern also applies to the REITs that are lacking in their FAD/share or Adjusted Funds from Operations (AFFO) /share. There is only one Healthcare REIT lacking in this disclosure. On the other hand, there are lots of multi-family REITs that are lacking.