There are two phenomena in the stock market that should influence your investment decisions from now till the end of the year: retail investor tax loss selling and institutional investor "window dressing." And one or both of those factors will have a negative influence on the Healthcare REITs (Real Estate Investment Trusts) that I perceive to be the best values. Right now is the wrong time to be buying - but it is a great time to start your due diligence.
This article should be viewed as an offering of a minority opinion to the recently published "3 Healthcare REITs To Buy When Others Are Despondently Selling" by Brad Thomas - where he suggested that the three buy candidates are Healthcare Trust of America (HTA), Health Care REIT (HCN) and Universal Health Realty (UHT). I believe that there are problems with the timing of a purchase of HTA and HCN. I believe that there are problems with the selection of UHT. I believe that Ventas (VTR) is the most undervalued Healthcare REIT.
Retail investor tax loss selling and institutional investor "window dressing" are topics that have been addressed by the academics in their papers. Zoraqn Ivkovic, James Poterba, and Scott Weisbenner reported in a 2005 paper, "Tax-motivated trading by individual investor" that they found "tax-loss selling throughout the calendar year, though it is most pronounced in December. Tax loss trading is more pronounced among investors who have realized capital gains elsewhere in the portfolio during the year." 2013 has been a good year - and most REIT investors should have gains elsewhere. Iwan Meier and Ernst Schaumburg, in the 2004 paper "Do funds window dress?" analyzed "the semi-annual holdings and daily net asset values of 4,025 U.S. domestic equity mutual funds over the period from 1997 to 2002 and find strong evidence of window dressing. In particular, we show that growth funds and funds with poor recent performance are more likely to report misleading holding." The year to date returns for most Healthcare REITs make them candidates for sales during the window dressing season. There are many papers on these two topics. I am saving both of us time by briefly providing the findings of only two.
Let's dive right into the year to date numbers to provide evidence that specific REITs are potential victims of tax loss selling and window dressing.
Healthcare Update for Q4-13
Yields are calculated on Q4-13 dividends. HCN has pre-announced a February increase in the dividend to $0.795/share - a 4% increase. MPW has announced an increase to $0.21/share for the dividend to be paid in January 2014. The Dividend/FFO ratio uses the 2014 FFO projection. AVIV started trading on 3-21-13 and DOC on 7-19-13. The change in the FFO projection for those two are for the last 90 days. The change in price is from their second day of trading. The sector average LTM (last twelve month) dividend change omits AVIV and DOC from that calculation.
|Share Price||2013 FFO Estimate||Div/||Percent Change||LTM|
|Health Care REIT||61.29||55.75||3.91||3.79||5.49||76.12||-9.04||-4.05||-3.07||6.99||3.38|
|Health Care Prop||(HCP)||45.16||36.34||2.97||2.99||5.78||68.63||-19.53||-14.88||0.67||-3.85||5.00|
|Health Care Realty||(HR)||24.01||21.78||1.39||1.30||5.51||84.51||-9.29||-4.29||-6.47||-0.56||0.00|
|Health Care Trust||9.90||10.15||0.66||0.64||5.67||83.33||2.53||8.33||-3.03||2.93||0.00|
|Med Prop Trust||(MPW)||11.96||12.97||1.07||1.00||6.48||75.00||8.44||15.13||-6.54||1.69||5.00|
|Nat'l Health Inv||(NHI)||56.53||57.22||3.39||3.54||5.14||72.24||1.22||6.42||4.42||15.48||9.70|
|Sabra Health Care||(SBRA)||21.72||26.26||1.72||1.87||5.18||63.26||20.90||27.16||8.72||30.51||3.03|
There are two Healthcare REITs that could be helped by window dressing and not be hurt by tax loss selling - Omega Healthcare Investors and Sabra Health Care REIT. There are three Healthcare REITs that are in real danger of being hurt by year end tax loss selling.
A look at dividend growth
Mr. Thomas noted that "UHT is considered a prestigious dividend champion and the only two other (non-Healthcare) REITs with a better track record for paying (and increasing) dividends." A stock becomes a champion due to the length in years of dividend growth, not by the strength of the dividend growth. And UHT is really lacking in the strength of that growth. Let's look at the data for the sector:
Dividend History [based on Q4 Dividends]
The dividends are displayed rounded to a tenth of a penny. For the last to columns, "Av Grw Last 2Yrs" is the average dividend growth over the last two years and "Av Grw Last 6 Yrs" is the average growth over six years. The average is derived by calculating the dividend growth for each year, and dividing by the number of years. This is not a compounded growth rate.
|Dividends/Share/Quarter||Percentage Dividend Growth||Av Growth Last|
Over the last six years, the dividend growth "All-Stars" have been LTC, NHI, OHI and VTR. Three of the four have last twelve-month growth that is higher than the six-year trend. All have dividend/FFO ratio that show good dividend coverage and the potential for the growth to continue. LTC and NHI both have 2014 forecasts for very strong FFO growth. OHI and VTR have acceptable projected growth - and given their very low dividend/FFO ratios, their dividend trends could easily continue. And those two also have trends of current year FFO projections growing after the start of the year.
The three suggestions by Mr. Thomas - HCN, HTA and UHT - do not look like such strong candidates in comparison to what I would call the Healthcare REIT dividend growth All-Stars. Only HCN has a quarterly trend of rising FFO per share. None are ending 2013 with strong dividend to FAD ratios.
Next, I will examine the data on FAD ratios. I lack good data on FAD numbers from AVIV and DOC, so they are left out of this data.
There are two important attributes that are derived from looking at FAD (Funds Available for Distribution); dividend to FAD and price to FAD stats. The dividend to FAD ratio provides an accurate omen for future dividend growth. REITs with the best dividend coverage are those with the best dividend growth prospects. The price to FAD ratio tells us which REITs have high valuations, average valuations, and cheap valuations.
Historically, property type has had a strong influence on FAD ratios. MOBs (medical office buildings) have tended to have the highest valuations, followed by senior housing, with skilled nursing facilities being the cheapest. During the second half 2014, the position of skilled nursing and senior housing has flipped. The data:
The relationship between property type and FAD ratios: While valuations are also strongly influenced by distribution growth and credit ratings, the influence of property types can also be seen.
- The following had over 40% in skilled nursing facilities: LTC, NHI, OHI and SBRA. Their current average price/FAD ratio is 15.44.
- The following had over 45% in senior housing: HCN, SNH and VTR. Their current average price/FAD ratio is 15.08
- The following had over 79% in medical office buildings: HR and HTA. Their current average price/FAD ratio is 16.94
A dollar's worth of earnings in all sectors is not created equal. Growing earnings have more value than stagnant earnings. This is also true when it come to REITs and FAD ratios. I will first show the influence of dividend/FAD ratios on yields. Then I will show the influence of dividend/FAD ratios on price/FAD ratios.
The relationship between the Dividend/FAD ratio and yields: The Q4-13 dividend to 2013 FAD projection ratio is used for this test.
- The following had dividend/FAD ratios of less than 80%: LTC, SBRA and VTR. Their current average yield is 5.13%.
- The following had dividend/FAD ratios between 80% and 90%: HCP, NHI and OHI. Their current average yield is 5.63%.
- The following had dividend/FAD ratios of more than 90%: HCN, HR, HTA, MPW, SNH and UHT. Their current average yield is 6.03%.
The relationship between FAD payout ratios and price to FAD ratios:
- The following had FAD payout ratios over 95%: HTA and SNH. Their current average price/FAD ratio is 15.86.
- The following had FAD payout ratios between 95% and 84%: HCN, HR, MPW, OHI and UHT. Their current average price/FAD ratio is 15.29.
- The following had FAD payout ratios under 84%: HCP, LTC, NHI, SBRA and VTR. Their current average price/FAD ratio is 15.22.
This number cruncher is surprised by the lack of influence of the dividend/FAD ratio on the price/FAD ratio. While it is never dramatic, there is a correlation in other sectors. This lack of a correlation in Healthcare REITs is evidence that the valuations in this sector are in error. On the other hand, one can see the influence of the dividend/FAD ratio on yields.
It has historically been the case the REITs have failed to be priced like their stock fundamentals would imply. REITs have been priced more in line with the real world pricing of the assets they own. For example, the MOB or medical offices building REITs have higher valuations because those individual properties sell at high cap rates than other types of healthcare properties. At the same time, the MOB REITs have recent records of well below average dividend growth. My analysis is based on how the stocks should behave and how they should be valued. REITs frequently behave as if they are exceptions to those rules. As shown in my last spreadsheet, I have attempted to set required rates of return on the individual REITs to be in line with cap rates - in order to adjust to this reality.
The next spreadsheet is on FAD growth, dividend/FAD ratios and price/FAD ratios. That data:
Healthcare Price/FAD Ratios 12-02-13
For REITs not providing FAD data, AFFO numbers are used. 2013 numbers are from guidance or from run rate performance. The 2011 Div/FAD ratio used the Q4-11 dividend and the 2012 Div/FAD ratio uses the Q4-12 dividend. There are several REITs for which I am unable to find and harvest 2010 FAD data.
|FAD/Share||% Growth||Price/FAD||Div/FAD||Div Growth||Current|
This is a simple spreadsheet with a strong message. With one exception - that being LTC - the REITs with the strongest dividend growth in 2013 all had dividend/FAD ratios under 83%. The REITs with dividend/FAD ratios in the high 90s failed to have distribution growth. The same kind of relationship happened in 2012. The same kind of relationship should happen in 2014.
The dividend/FAD ratio suggests that HCP should have better dividend growth than HCN in 2014. But HCN sells at a higher price/FAD ratio. The key to understanding HCN's superior pricing is in its property mix - which is superior to HCP's. Today - even with the management changes - I would gamble on HCP over HCN. VTR, the dividend growth all star, sells at a below sector average price/FAD ratio. That is not logical. It makes me question my FAD calculation for VTR. This is an opportune time to remind you that you should take the time to verify my data with reports from your brokerage. You should do that with all SA authors.
Moving on to the final "yield plus CAGR" spreadsheet
When I do my due diligence on a sector, I try to assess the forward dividend growth - also known as the forward Compound Annual Growth Rate projection or CAGR. I also judge the risk that goes into a required rate of return or RRR assessment. In a prior article, I made the case that Healthcare REITs required rates of return are based on the attributes of the property types they hold.
I believe that all income equities sell at something close to a reasonable "yield plus dividend CAGR, with significant adjustments for risk." But some are "less close" than others. The valuation is judged by a "yield plus CAGR minus RRR" calculation. When that valuation is positive - the stock is relatively a buy. This is a system for the relative valuation within a sector - and not whether the sector is a buy - or not. What follows is my spreadsheet for that calculation on this sector:
Yield + CAGR Total Return Expectations
|Company||Q4-13||My||Total||Bonds||My||Total Rtn||Consensus||Pr Impl||Div|
|Yield||CAGR||Return||Ratings||RRRs||- RRR||Ratings||CAGR||/ FAD|
|Health Care REIT||HCN||5.49%||4.10%||9.59%||BBB||9.00||0.59||2.7||3.51||92.17|
|Health Care Prop||HCP||5.78%||4.10%||9.88%||BBB+||9.20||0.68||2.8||3.42||83.67|
|Health Care Realty||HR||5.51%||1.50%||7.01%||BBB-||8.20||-1.19||3.0||2.69||90.23|
|Health Care Trust||HTA||5.67%||3.00%||8.67%||BBB-||8.00||0.67||2.4||2.33||99.14|
|Med Prop Trust||MPW||6.48%||4.50%||10.98%||BB||10.60||0.38||3.0||4.12||90.32|
|Nat'l Health Inv||NHI||5.14%||5.00%||10.14%||NR||9.80||0.34||3.1||4.66||82.82|
|Sabra Health Care||SBRA||5.18%||5.00%||10.18%||BB-||10.00||0.18||1.9||4.82||77.27|
I have intentionally raised my required rate of return for VTR given its shift towards operating many of its senior living facilities. This is an area where its record is still unproven. VTR has been great at triple-netting. It is a rookie at operating. I have made that upwards adjustment to mirror what the market must be doing. There is no other explanation why a REIT that is heavy is safer and better assets types would need to have such a high "yield plus CAGR." I believe that all my CAGR projections are conservative - and thus lower than one will find from most sources.
This spreadsheet is showing VTR to be the most under-valued Healthcare REIT - followed by DOC, HCP, HTA and HCN. DOC is new. DOC is also in a period of acquiring new properties. My RRR assessment partially reflects that reality. If DOC is headed more towards a portfolio of Medical Office Buildings, then my RRR assessment is high. If DOC is headed more towards a portfolio of hospitals, then my RRR assessment is low. DOC did not cover its dividend with FFO last quarter. Due to DOC having so little history, it is hard to put much confidence in any FAD or FFO projection. The large spread in DOC's 2014 FFO projections echo with this kind of concern.
In a spoken part of the recording of "You Never Even Call Me by My Name" done by David Allen Coe are the following words:
"... a friend of mine named Steve Goodman wrote that song. And he told me it was the perfect country and western song. I wrote him back a letter and I told him it was not the perfect country and western song - because he hadn't said anything at all about momma, or trains, or trucks, or prison, or gettin' drunk. Well, he sat down and wrote another verse to this song ..." That verse began with the words "I was drunk the day my mamma got out of prison."
(1) This article has been my attempt to play the role of singer David Allen Coe to Mr. Thomas's songwriter role of Steve Goodman. Any article about undervalued Healthcare REITs that lacks a mention of VTR is as lacking as a country song without a mention of momma, trucks and drinking.
(2) UHT is too dang small. It lacks coverage by many of the major brokerages. It lacks a competent FFO projection at Yahoo Finance. I like my investment options to have existing projections from competent sources. UHT had falling FFO in 2013. It is heavily invested in hospitals - the lowest of the Healthcare REIT property classes. There are reasons for it to have cheap valuations. This investor is not comfortable with its characterization as being undervalued.
(3) This is the wrong time of year to be buying this year's under-performing stocks.
I will continue to follow Brad Thomas on Seeking Alpha - and I strongly suggest that other investors in REITs do the same. This is the only time I have had a major difference of opinion with Mr. Thomas. I hope that the data I have provided justified that difference of opinion. I have forewarned you that the kind of analysis I am doing has shortcomings when applied to REITs. If you did not find the data supported my opinion - or if you are in doubt, then use the fail safe method I use. I count the "followers" of an author. And Mr. Thomas wins that contest in a landslide.