One way to own real estate without being a landlord is to invest in a REIT. Senior Housing Properties Trust (SNH) operates as a REIT, which requires it to give at least 90% of its taxable income to shareholders. Currently, the trust pays a distribution of $1.56 per share with a yield of 6.5%. The next quarterly dividend of $0.39 per share will be paid on or about November 21, 2013 to shareholders on record as of October 17, 2013. SNH is a play on the aging baby boomers as it owns 395 healthcare related properties in 40 states and Washington D.C. This includes the following facilities: assisted living, independent living, nursing homes, and medical office buildings. Ultimately, SNH looks attractive as it continues to increase its funds from operations (FFO).
SNH recently agreed to sell two hospitals for $90 million. The hospitals being sold include: New England Rehabilitation Hospital with 198 licensed beds and Braintree Rehabilitation Hospital with 166 licensed beds. The trust is expected to realize a gain of $30 million from the sale. This sale will reduce the trust's exposure to Medicare and Medicaid revenues to only 2%. By reducing exposure to Medicare, SNH will be better protected against the uncertainty of government funding. Although the trust will lose $9.5 million in annual rent as a result of the sale, SNH plans on offsetting this by investing in other healthcare related real estate.
Financial Performance & Valuation
SNH has achieved increased year-over-year FFO for the first half of 2013. The trust increased its FFO by 10% from $137 million in the first half of 2012 to $151 million for the first half of 2013. When looking at full-year increases in FFO, the results are even better. SNH increased its FFO 15% from 2010 to 2011 from $213 million to $245 million. FFO increased 15% again from 2011 to 2012 from $245 million to $280.5 million. The FFO is a more accurate measure for a REIT than earnings because it also adds depreciation & amortization and subtracts gains from property sales. This provides a more accurate account of how well a REIT's properties are producing for the trust.
The market cap of $4.42 billion divided by the $280.5 million FFO provides a price to FFO (market cap to FFO) of $15.8. This can be considered as a more relevant valuation measure for a REIT than the standard PE ratio. Here's a valuation comparison of SNH and its competitors:
Health Care REIT (HCN)
HCP Inc. (HCP)
Price to FFO ratio
We can see that SNH is valued attractively as compared to most of its competitors. HCP is right about in-line with SNH regarding price to FFO. However, HCP has grown its FFO by 33% from 2011 to 2012. On the other hand, HCP is going through a transition with recent termination of CEO, James F. Flaherty III. HCP's stock was down over 4% on the termination news as investors felt uneasy about the situation. Is there an underlying issue with company? With the uncertainty regarding HCP and SNH's higher yield, I see Senior Housing Properties Trust as the standout for valuation in the health-REIT arena.
To look further into SNH's valuation, it's useful to look at the adjusted funds from operations (AFFO). This REIT valuation metric is a more precise measure of the residual cash flow available to shareholders as it subtracts capital expenditures. The FFO of $280.5 million minus the CapEx of $174 million gives SNH an AFFO of $106.5 million. This gives the trust a price-to-AFFO ratio of 41. Let's see how this compares to its competitors:
Price to AFFO
The thing that stands out with the Price to AFFO among the competitors is the negative figures. HCN, HCP, and VTR all have negative AFFOs because their CapEx exceeds their FFO. This makes SNH the most attractive REIT among this group as its CapEx is less than its FFO. This gives the trust a better chance of maintaining its dividend and its real estate portfolio. This reinforces the idea that SNH is the best value out of this group of health-care REITs. The negative AFFO figures associated with the competition show that they are in a less desirable position to maintain their dividends or their real estate. It also puts the competitors at risk of diluting their shares if the need to do an equity offering arises.
What matters for SNH is its ability to grow FFO for the future. This depends on the ability of its properties to continue to generate reliable income. We know it has a good track record of increasing its FFO by 15% annually for the past two years. The trust's income is generated primarily from its 62 independent living facilities, 151 assisted living facilities, and its 115 medical office buildings. Together, these properties generate 90% of SNH's net operating income (NOI). One long-term catalyst for SNH is the large amount of aging baby boomers that will be in need of the services that the trust's properties provide. The medical office buildings will be in increased need by baby boomers for various procedures and check-ups. As they age further, independent living facilities will become attractive for many who wish to make their lives easier and more convenient, but are still able to live on their own. As their age progresses and their health declines, more baby boomers will need assisted living facilities for those who need help with activities of daily living. This aging demographic should have a significant positive effect on SNH's ability to maintain and increase occupancy and rental coverage from its current properties. Income from the increase in occupancy and rental coverage will also allow for new properties to be added, thus contributing to continued annual FFO growth.
SNH sold off recently from its 52-week high of nearly $30 the past few months as a result of fears of the Fed curbing their bond buying program. However, I think that those fears have been put aside and that SNH's business remains intact. With $37.3 million in cash & cash equivalents and $720 million available in its revolving credit facility, SNH has sufficient liquidity to fund future acquisitions without accessing the capital markets. The trust's strong liquidity can be viewed as a catalyst for FFO growth because more properties can be acquired and existing ones can be maintained. Furthermore, the trust's current properties have plenty of long-term growth potential due to the aging baby boomers.
SNH derives 44% of its total rental income from Five Star (managed care communities), thus giving the trust significant risk exposure if this business were to decline. Increasing labor costs could be an issue for Five Star. The market for nurses and therapists is highly competitive and therefore Five Star may need to increase pay for these professionals, which could reduce profitability for SNH. However, the rise in pay can be offset by increases in lease revenue, provided that the supply/demand conditions in the market allows it.
Rising interest rates could negatively affect the price of the underlying REIT price. If interest rates rise, the trust's interest costs could also rise, thus causing a decline in cash flow. However, SNH can hedge this risk and it has performed well in the last cycle of rising interest rates. I think that if the trust continues to manage interest rate risk prudently, it will perform well in the next cycle of rising interest rates.
Senior Housing Properties Trust consistently pays a high dividend among the healthcare REITs. The dividend yield has primarily ranged between 6% and 7% for the past few years. This attractive dividend yield is driven by the trust's strong financial performance as evident in its FFO growth. SNH is attractively valued as compared to the other healthcare REITs. Therefore, investors have the opportunity to own a healthcare REIT that has an attractive valuation along with an above average yield. The large amount of aging baby boomers, should allow for continued long-term growth in FFO. The trust's prudent use of CapEx, allows for a positive AFFO, which is missing from its competitors. Given these conditions, Investors can expect continued high yields along with a steadily rising underlying price over the long-term.