Assessing Health Care REIT Valuations - Part 1

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 |  Includes: HCN, HCP, VTR
by: Factoids

Summary

This article starts with a description of FAD (Funds Available for Distribution) - and why it is the superior REIT earnings metric.

This article contains a brief intro to the significance of FAD retention.

This is why FAD is important: The dividend/FAD ratio and FAD growth both predict dividend growth. You need FAD numbers to refine your dividend CAGRs (Compound Annual Growth Rate).

Here is what I perceive to be the logical sequence in telling the story in this article on valuation assessment for Health Care REITs (Real Estate Investment Trusts):

1. What is FAD (Funds Available for Distribution)?

2. A brief intro to the significance of FAD retention

3. Why FAD is important. The dividend/FAD ratio predicts dividend growth and FAD growth predicts dividend growth. You need FAD numbers to refine your dividend CAGRs (Compound Annual Growth Rate) projections.

4. Setting CAGRs - historical numbers and ratios

5. Setting CAGRs - briefly looking at all the inputs

6. What are RRRs (Required Rates of Return) - and why "cap rates" are REIT RRRs.

7. Putting it all together with "yield + CAGR - RRR".

8. Confirming valuations assessments with analyst ratings.

9. Confirming valuation assessments with the trends in share price appreciation.

This two-part article will address some complicated topics. This article is very long (14 pages in MS Word - before the addition of spreadsheets). Part one will address the first five points. Part two will address the final four. This article is heavy on "ways to analyze" - while being light on "what to buy".

This is my 47th Seeking Alpha article. In most of those articles, I have supported the theory that "all income stocks sell at a reasonable yield + dividend CAGR with significant adjustments for risk". Higher yielding stocks have lower growth rate projections and/or higher risk. Lower yielding stocks have lower risk and/or lower projected growth. I have supported that theory with an abundance of metrics in those prior articles. I am writing this article with the view that this theory has already been proven true.

If the reader can forgive the above shortcomings, then this writer will try to deliver more data than you can easily handle. I will present that data with explanatory text. Many of you will see data sets that you have never seen before. I hope that your perceptions on valuations will be clearer - but reaching that objective may take more than one reading. You will be presented with data that strongly points to what to buy and what to avoid

One last warning: If I was certain that I knew what I'm talking about - then I might keep this information to myself. I only suspect that I know the secrets that the data is whispering. I may learn more than you from the comments on this article that will appear at the end.

It is tradition that I start my articles with the year to date numbers so readers can see my coverage universe. Here is that data:

Health Care Update for Q2-14
Yields are calculated on Q2-14 dividends. The dividend/FFO ratio uses the 2014 FFO projection. AVIV started trading on 3-21-13 and DOC on 7-19-13. The percent change columns measures the changes since the beginning of the year. LTM (last twelve month) dividend growth uses Q2-14 minus Q2-13 normalized dividend/share divided by Q2-13 dividend. LTM FFO growth uses Q1-14 minus Q1-13 normalized FFO/share divided by Q1-13 normalized FFO. LTM FAD growth does not use quarterly numbers - but the 2014 midpoint of the yearly guidance. The sector average LTM dividend change omits AVIV and DOC from that calculation. NHI, OHI and SBRA announced dividend increases in Q2-14. UHT has yet to announce its Q2-14 dividend - and this is the quarter when its small yearly increases happen.


  Share Price 2014 FFO Estimate   Div/ Div/ Percent Change LTM Growth
Company_name_and_ticker 1-01 05-23 1-01 05-23 Yield FFO FAD Price Pr+Div 14 FFO Target Div FFO FAD

Aviv REIT, Inc. (NYSE:AVIV) 23.70 27.65 1.85 1.89 5.21 76.19 75.39 16.67 19.70 2.16 4.23 0.00% 0.0% 11.0%
Physicians Realty Trust (NYSE:DOC) 12.24 12.99 0.98 0.88 6.93 102.27 90.91 6.13 9.80 -10.20 3.21 0.00% 300.0% 7.6%
Health Care REIT, Inc. (NYSE:HCN) 53.57 64.51 4.00 4.07 4.93 78.13 88.33 20.42 23.39 1.75 1.16 3.92% 9.9% 7.1%
Health Care Properties (NYSE:HCP) 36.32 42.11 3.06 3.03 5.18 71.95 87.20 15.94 17.44 -0.98 -2.82 3.81% 1.4% -0.8%
Healthcare Realty Trust Incorporated (NYSE:HR) 21.31 24.77 1.41 1.46 4.84 82.19 81.63 16.24 17.64 3.55 -0.41 0.00% 9.4% 10.5%
Healthcare Trust of America, Inc. (NYSE:HTA) 9.84 12.03 0.69 0.73 4.78 78.77 92.74 22.26 25.18 5.80 5.35 0.00% 12.5% 6.9%
LTC Properties Inc. (NYSE:LTC) 35.39 39.57 2.65 2.60 5.16 78.46 81.60 11.81 13.73 -1.89 6.31 9.68% 3.3% 6.8%
Medical Properties Trust Inc. (NYSE:MPW) 12.22 13.42 1.12 1.10 6.26 76.36 79.25 9.82 13.26 -1.79 0.23 5.00% 4.0% 14.0%
National Health Investors (NYSE:NHI) 56.10 61.99 4.13 4.20 4.97 73.33 82.80 10.50 13.12 1.69 2.45 4.76% 23.5% 6.3%
Omega Healthcare Investors Inc. (NYSE:OHI) 29.80 36.65 2.73 2.77 5.46 72.20 80.00 22.99 26.28 1.47 -1.54 8.70% 7.9% 11.1%
Sabra Health Care REIT, Inc. (NASDAQ:SBRA) 26.14 28.75 2.20 2.27 5.29 66.96 71.03 9.98 11.36 3.18 0.56 11.76% 19.6% 21.6%
Senior Housing Properties Trust (NYSE:SNH) 22.23 23.68 1.74 1.76 6.59 88.64 97.50 6.52 10.03 1.15 -2.95 0.00% 0.0% 1.9%
Universal Health Realty Income Trust (NYSE:UHT) 40.06 43.24 2.80 2.83 5.78 88.34 89.93 7.94 9.50 1.07 0.00 0.00% -1.4% 1.1%
Ventas, Inc. (NYSE:VTR) 57.28 67.03 4.36 4.38 4.33 66.21 68.40 17.02 18.29 0.46 -0.23 8.21% 5.8% 7.1%

Average           5.41 77.98 82.69 13.87 16.36 0.53 1.11 4.65% 33.0% 9.4%

Click to enlarge

What is FAD

What is the simple difference between FFO (Funds from Operations) and FAD? That is almost a trick question. There is not a simple difference - it is mostly the sum of a lot of trivial accounting differences. But there will be two big components - straight line rents and maintenance capital expenditures - that are the bulk of the cause for the difference. These items are not subtracted from FFO. Non-cash or stock based compensation is a small third component - one which is subtracted from NOI and FFO, but added back for FAD. (If I understood direct finance loan accretion well enough to simplify an explanation, that topic would merit inclusion.) I am inviting trouble when this non-accountant starts to explain accounting stuff to other non-accountants. But you need to have some idea of what's going on. So - "hello trouble".

I will start with an example of a person owning one rent house - and include the example to a person owning 20. Roughly every 20 years, you need to buy new appliances - and replace the roof. You may need to replace the carpet and drapes every five years. You will need to paint every five years. If you only own one rent house, the replacement of the appliances is a big event. And you would expect to generate increase rental income when you replace and re-lease.

But if you own 20 homes, you will replace appliances (on average) in one of the houses every year. In 19 homes, the appliances became one year older. In one home, the appliances became 20 year newer. In total, it is a wash. These replacements become needed expenses to maintain the houses and maintain your income. But if you added a new bath room, or a covered garage, or a covered patio with gas BBQ and mini-bar - then you have done capital improvements in which you would need an expectation of increased income to justify the expenditure. Those would be "capital improvements" and not "maintenance capital" expenses. FFO lumps all both types of "capital" together. FAD subtracts maintenance capital. Health Care REIT shows the subtraction of "Cap-ex, tenant improvements, lease commissions" in their FAD calculation. Health Care Properties shows the subtraction of "Leasing costs and tenant and capital improvements" in their FAD calculation. Ventas shows the subtraction of "Amortization of deferred revenue and lease intangibles, net" in their FAD calculation. All of these three are still mainly triple-net leasing REITs. Triple-net leases typically do not have maintenance capital expenses. I am speculating that these accounting lines include maintenance capital - but I could easily be in error.

If you lease the house for one year - you would strongly tend to have a single rental rate for the term of the contract. REITs lease to commercial operators with longer contract terms. There are usually annual increases in the rents during the term of the multi-year contract. This is where G.A.A.P. accounting somewhat messes with reality. Reality can be tricky too - like when a "first and last month rent is half off" offer is done. The rules of accounting cause you to recognize and equal amount of income over the term of the contract - and not more income in the full priced months. The same principal applies to multi-year contracts. You are not allowed to recognize the rental income from year one - then a separate rental income rate for year two, etc. You recognize as income the "average rent of the full contract" in each year. On the other hand, this income does not generate "cash available for distribution" - because you did not receive any of this income in cash. Health Care REIT shows the subtraction of "Gross straight-line rental income" in their FAD calculation. Health Care Properties shows the subtraction of "Straight-line rents" in their FAD calculation. Ventas, Inc. shows the subtraction of "Straight-lining of rental income, net" in their FAD calculation.

HCN fails to mention deferred compensation in their FAD calculation. HCP shows the addition of "Amortization of deferred compensation" to FFO in their FAD calculation. VTR shows the addition of "Stock-based compensation" in their FAD calculation. (HCP is the only one of these three to include Direct Finance Loan accretion in its subtractions from FFO to arrive at FAD.)

The example below for a triple-net leasing REIT could be so overly simplistic that it is wrong. The purpose is to show the effect of incremental earnings from FAD retention.

An intro to FAD retention and growth

There are REITs that are basically paying out all of their FAD in dividends. (There are even REITs with 2% rent growth and lower SSNOI and FAD growth - but I ignore that for a few minutes.) I will use a hypothetical billion dollar portfolio at a 10% cap rate - thus it generates $100 million in income. To keep it unrealistically simple, we will start with no debt and no GnA (General aNd Administrative expenses) - so income is the same as FAD. The growth in FAD dollars might look like this:

No FAD Retention 0 1 2 3 4 5 6
Increase caused by rent bump 100.00 102.00 104.04 106.08 108.20 110.26 112.47
Click to enlarge

The standard triple-net lease contains bump-ups of rental income of 2% per year. To simplify the math, I will be using big round numbers. Let's use the average cap rate of 10% for properties purchased with the funds from FAD retention. I will use the average payout ratio of 90% of FAD for the next example. And then we will play around with the numbers. The first year generates rent growth. In the second year you also generate income from FAD retention.

In the first year, you have $100 in come.

After 1 year (or for year 2), rent increases to $102. From FAD retention, I have 10 more invested, generating $1 more dollar.

After 2 years (or for year 3), I have $6 more in income from rent growth. From FAD retention, I have $20 more invested, generating $2 more dollars.

After 3 years (or for year 4), I have $8 more in income from rent growth. From FAD retention, I have $30 more invested, generating $3 more dollars.

After 4 years (or for year 5), I have $10 more in income from rent growth. From FAD retention, I have $40 more invested, generating $4 more dollars.

After 5 years (or for year 6), I have $12 more in income from rent growth. From FAD retention, I have $50 more invested, generating $5 more dollars.

Below is the same data in spreadsheet form:

10% FAD Retention 0 1 2 3 4 5 6
Increase caused by rent bump 100.00 102.00 104.04 106.08 108.20 110.26 112.47
Increase caused by FAD retention 0.00 1.00 2.02 3.06 4.12 5.13 6.23
New Total 100.00 103.00 106.06 109.14 112.36 115.39 118.71
Click to enlarge

Let's now use the average payout ratio of 80% of FAD. The first year generates rent growth. In the second year you generate income from FAD retention.

Using 20% FAD retention:
In the first year, you have $100 in come.
After 1 year, I have $2 more in income from rent growth. From FAD retention, I have $20 more invested, generating $2 more dollars.
After 2 years, I have $4 more in income from rent growth. From FAD retention, I have $40 more invested, generating $4 more dollars.
After 3 years, I have $6 more in income from rent growth. From FAD retention, I have $60 more invested, generating $6 more dollars.
After 4 years, I have $8 more in income from rent growth. From FAD retention, I have $80 more invested, generating $8 more dollars.
After 5 years, I have $10 more in income from rent growth. From FAD retention, I have $100 more invested, generating $10 more dollars.
After 6 years, I have $12 more in income from rent growth. From FAD retention, I have $120 more invested, generating $12 more dollars.

20% FAD Retention 0 1 2 3 4 5 6
Increased caused by rent bump 100.00 102.00 104.04 106.08 108.20 110.26 112.47
Increase caused by FAD retention 0.00 2.00 4.04 6.12 8.24 10.40 12.61
New Total 100.00 104.00 108.16 112.20 116.44 120.66 125.08
Click to enlarge

There was one thing that was unrealistic in the last two examples. I failed to add leverage on those new purchases. I will now add leverage in one more example using 20% FAD retention. To keep things relatively simple - let's say I pay 5% interest, and half of my growth is financed by debt and half by FAD retention. The increase in income from rent bumps looks the same. The dollar amount from FAD retention stays the same. The dollar amount from leverage is roughly half the amount from FAD retention due to the payment of interest. (Most REITs do not have this large a spread in cap rates on properties and interest payments on debt.) For the text version of this data, I will show the subtraction of the interest payment from total new investment. For the spreadsheet version, I will separate the increase cause by retention and by leverage.

Using 20% FAD retention + leverage:
After 1 year I have $2 more in rent growth. From FAD retention and added debt, I have $40 more invested, generating (4.00 - 1.00) $3.00 more dollars.
After 2 years I have $4 more in rent growth. From FAD retention and added debt, I have $80 more invested, generating (8.00 - 2.00) $6.00 more dollars.
After 3 years I have $6 more in rent growth. From FAD retention and added debt, I have $120 more invested, generating (12.00 - 3.00) $9.00 more dollars.
After 4 years I have $8 more in rent growth. From FAD retention and added debt, I have $160 more invested, generating (16.00 - 4.00) $12.00 more dollars.
After 5 years I have $10 more in rent growth. From FAD retention and added debt, I have $200 more invested, generating (20.00 - 5.00) $15.00 more dollars.
After 6 years I have $12 more in rent growth. From FAD retention and added debt, I have $240 more invested, generating (24.00 - 6.00) $18.00 more dollars.
In the spreadsheet below where I show the pennies - the increase caused by "retention and leverage" jumps $3 per year plus 1.02 times the prior year retention bump.

  0 1 2 3 4 5 6
Increase caused by rent bump 100.00 102.00 104.04 106.08 108.20 110.26 112.47
Increase caused by FAD retention 0.00 2.00 4.04 6.12 8.24 10.40 12.61
Increase caused by leverage 0.00 1.00 2.02 3.06 4.12 5.20 6.30
New Total 100.00 105.00 110.10 115.26 120.56 125.86 131.38
Click to enlarge

The point I have tried to make with the stats above is that FAD retention matters. You can see that in the examples above.

There are a lot of investors that will tell you that Omega and VTR have had superior dividend growth for what I believe are vague reasons like the management teams are better; or because dividend growth ebbs and flows, and it was just "their time"; or because they were just plain lucky. I look at the dividend/FAD ratios and I can see a numeric reason for their superior dividend growth. I hope that you can too. I also hope that by observing the numbers above - you can imagine the power of the spreads between cap rates and the average rates on debt and its influence on growth. There will be variances in the spreads when comparing REITs. I hope you can imagine the power of superior growth in SSNOI (the rent bumps would be larger). There will be variances there. As REITs recycle their portfolios, some will book gains on those sales while others will book losses. FAD retention is only one reason one REIT can be superior to another. Now it is time to move from the hypothetical to the real world.

Why FAD is important

The dividend/FAD ratio predicts dividend growth and FAD growth predicts dividend growth. You need FAD numbers to refine your dividend CAGRs. To start this process, I will provide two spreadsheets. In the first spreadsheet, let's look at FAD growth.

Health Care Price/FAD Ratios 05-23-14

For REITs not providing FAD data, AFFO numbers are used. 2014 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.


  FAD/Share % Growth Price/FAD Div/FAD Div Growth Current
Co. 2011 2012 2013 2014 11-12 12-13 13-14 2012 2013 2014 2012 2013 2014 2013 2014 Yield

AVIV 0.00 0.00 1.72 1.91 na na 11.05 na 16.08 14.48 na 83.72 75.39 na na 5.21
DOC 0.00 0.00 0.92 0.99 na na 7.61 na 14.12 13.12 na 97.83 90.91 na na 6.93
HCN 2.84 3.11 3.36 3.60 9.51 8.04 7.14 20.74 19.20 17.92 95.18 91.07 88.33 3.38 3.92 4.93
HCP 2.14 2.22 2.52 2.50 3.74 13.51 -0.79 18.97 16.71 16.84 90.09 83.33 87.20 5.00 3.81 5.18
HR 1.36 1.38 1.33 1.47 1.47 -3.62 10.53 17.95 18.62 16.85 86.96 90.23 81.63 0.00 0.00 4.84
HTA 0.44 0.53 0.58 0.62 20.45 9.43 6.90 22.70 20.74 19.40 108.49 99.14 92.74 0.00 0.00 4.78
LTC 2.05 2.18 2.34 2.50 6.34 7.34 6.84 18.15 16.91 15.83 85.32 87.18 81.60 6.90 9.68 5.16
MPW 0.81 0.81 0.93 1.06 0.00 14.81 13.98 16.57 14.43 12.66 98.77 86.02 79.25 0.00 5.00 6.26
NHI 2.90 3.15 3.50 3.72 8.62 11.11 6.29 19.68 17.71 16.66 85.08 84.00 82.80 3.08 9.70 4.74
OHI 1.89 2.19 2.25 2.50 15.87 2.74 11.11 16.74 16.29 14.66 80.37 85.33 80.00 9.76 8.89 5.35
SBRA 1.51 1.59 1.76 2.14 5.30 10.69 21.59 18.08 16.34 13.43 83.02 77.27 71.03 3.03 5.88 5.01
SNH 1.51 1.56 1.57 1.60 3.31 0.64 1.91 15.18 15.08 14.80 100.00 99.36 97.50 2.63 0.00 6.59
UHT 2.76 2.61 2.75 2.78 -5.43 5.36 1.09 16.57 15.72 15.55 95.02 90.91 89.93 1.64 0.81 5.78
VTR 3.28 3.60 3.96 4.24 9.76 10.00 7.07 18.62 16.93 15.81 68.89 73.23 68.40 8.06 8.21 4.33

Average         7.51 8.02 18.33 16.78 15.57 89.76 87.76 83.34
Click to enlarge

The low FAD growth REITs are SNH and UHT. Both had low dividend growth - and both had low dividend/FAD ratios.

It is a tougher call to isolate a few high FAD growth REITs. VTR would qualify - and it has higher dividend growth and lower payout ratios. I will go one by one through the rest of the sector for the REITs where I have 2011 FAD data.

HCN has had high mid-single digit FAD growth, but it has always had a high FAD payout ratio - and that ratio might have resulted in the average dividend growth. It is good news that the payout ratio is improving. The bad news is that the ratio is improving from a very bad starting point.

HCP has had oscillating growth and oscillating ratios - and that might have resulted in average dividend growth.

Going by 2014 FAD growth and the 2014 FAD payout ratio, HR appears on the cusp of dividend growth. But if FAD projection accuracy turns out to be anything like FFO projection accuracy, then HR is not a safe bet to deliver on those expectations.

HTA has good FAD growth, but the payout ratio appears to have prevented any dividend increase. HTA could be at least 2 years away from dividend growth due to its already high FAD payout.

LTC has had average FAD growth and an average payout ratio - but very strong dividend growth. This data suggests that the next dividend increase will be closer to 5% than 10%.

MPW may be putting together two strong years of FAD growth. And 2013 growth along with a falling FAD ratio indicates that last year's dividend growth - the first dividend growth in years - will not be a one-time event.

NHI has slightly better than average FAD growth and slightly lower FAD payout ratio. These "near average" numbers suggest that the very high LTM dividend growth of 9.7% is more of a one-time event - and that longer term forward dividend growth of 7% to 8% is a realistic expectation.

OHI has had oscillating FAD growth - but two of the three years contained high growth. The FAD ratio has mostly been low - which may be the cause of the superior dividend growth.

SBRA has had fantastic FAD growth - and the FAD ratio is low. This strongly suggests that forward dividend growth will be relatively high.

SNH has anemic FAD growth; a high payout ratio; and anemic dividend growth. The good news is that big acquisitions in 2014 may change that trend. The bad news is that those big acquisitions came with low cap rates. Even if there is going to be a turnaround for SNH, that turn around will take time. It is hard for this investor to have patience with a REIT that has such a sub-par history. With a yield over 6%, some investors will believe they are being paid to wait for that potential good news. In my opinion, 110 basis points over sector average is too low of a wage for that task of waiting.

The same "anemic" description fits UHT. And for an ultra-small, off the radar stock that is so lacking in growth, the valuations are way too high.

VTR has well above average FAD growth, the lowest payout ratio in the sector; and one of the best dividend growth records in the sector. And you can buy those three great attributes for a price to FAD ratio that is just barely above sector average. This data is screaming that VTR is a bargain. Is there bad news out there that is hiding from me? I will end this article with a guess as to what that bad news might be.

I will now show the spreadsheet for historical dividend growth along with some correlation data.

Dividend History [based on Q4 Dividends]

The dividends are displayed rounded to a tenth of a the penny. For the last to columns, 'Average Growth Last 2Yrs' is the average dividend growth over the last two years and 'Average Growth Last 6 Years' 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
Co. 2007 2008 2009 2010 2011 2012 2013 07-08 08-09 09-10 10-11 11-12 12-13 2Yrs 6Yrs

HCN 66.0 68.0 68.0 69.0 71.5 74.0 76.5 3.03 0.00 1.47 3.62 3.50 3.38 3.44 2.50
HCP 44.5 45.5 46.0 46.5 48.0 50.0 52.5 2.25 1.10 1.09 3.23 4.17 5.00 4.58 2.80
HR 38.5 38.5 38.5 30.0 30.0 30.0 30.0 0.00 0.00 -22.08 0.00 0.00 0.00 0.00 -3.68
HTA 0.0 0.0 0.0 0.0 0.0 14.4 14.4 na na na na na 0.00 na na
LTC 12.5 13.0 13.0 14.0 14.0 15.5 17.0 4.00 0.00 7.69 0.00 10.71 9.68 10.20 5.35
MPW 27.0 20.0 20.0 20.0 20.0 20.0 20.0 -25.93 0.00 0.00 0.00 0.00 0.00 0.00 -4.32
NHI 50.0 55.0 55.0 60.5 65.0 67.0 73.5 10.00 0.00 10.00 7.44 3.08 9.70 6.39 6.70
OHI 27.0 30.0 30.0 37.0 40.0 44.0 48.0 11.11 0.00 23.33 8.11 10.00 9.09 9.55 10.27
SBRA 0.0 0.0 0.0 0.0 32.0 33.0 34.0 na na na na 3.13 3.03 3.08 na
SNH 35.0 35.0 36.0 37.0 38.0 39.0 39.0 0.00 2.86 2.78 2.70 2.63 0.00 1.32 1.83
UHT 58.0 59.0 59.5 60.5 61.0 62.0 62.5 1.72 0.85 1.68 0.83 1.64 0.81 1.22 1.25
VTR 47.5 51.2 51.2 53.5 57.5 62.0 72.5 7.89 0.00 4.39 7.48 7.83 16.94 12.38 7.42

Average             0.00 0.69 5.06 5.57 7.78 9.60    
Click to enlarge

The relationship between the Dividend/FAD ratio and dividend growth: This test done on 2012 data.
The following had Q4-11 dividend/ 2012 FAD ratios of less than 80%: LTC, OHI and VTR. Their average dividend growth - comparing Q4-12 to Q4-11 - was 9.51%.
The following had dividend/FAD ratios between 80% and 90%: HCP, HR, NHI and SBRA. Their average dividend growth was 2.59%.
The following had dividend/FAD ratios of more than 90%: HCN, MPW, SNH and UHT. Their average dividend growth was 1.94%.

The relationship between the Dividend/FAD ratio and dividend growth: This test done on 2013 data.
The following had Q4-12 dividend/ 2013 FAD ratios of less than 80%: HCP, LTC, NHI, OHI, SBRA and VTR. Their average dividend growth - comparing Q4-13 to Q4-12 - was 8.91%.
The following had dividend/FAD ratios between 80% and 90%: HCN and MPW. Their average dividend growth was 1.69%.
The following had dividend/FAD ratios of more than 90%: HR, HTA, SNH and UHT. Their average dividend growth was 0.20%.

The correlation output uses historical numbers, but it is a forwarding looking growth using those historical numbers. Those REITs that entered the year with low payout ratios had significantly higher growth. If you are looking for reason that the dividend/FAD ratios matters - the answer is here. The answer is loud. The answer is clear. The ratio matters - and the ratio is worth knowing.

I need to take you through two complicated spreadsheets with lots of explanations to fully describe how I set my forward dividend CAGR projections. In this article which has a focus on FAD, I wanted to lead with a discussion of the FAD data that goes into the CAGR assessment. FAD related data is the dominant input, but not the only input.

Scrolling back and forth to the text the comment on the data on and spreadsheet that contains the data is going to be a little bit difficult for the reader. I believe the data speaks for itself. On the other hand, I know a reader has to acclimate to a spreadsheet. And this could be the first time a reader has seen a presentation like this. Most of you want and need the commentary. So get yourself prepped for a lot of scrolling. Here is the data on the REITs with a 10 year history:

Long term metric trends

The average calculation for growth is for ten years - for 2005 through 2014. The first average is the sum of changes for each individual year over ten year period - with that result divided by 10. The second average is the difference between the current and beginning number, divided by the beginning number - with that result divided by 10. Stats start in 2004. NHI had a dividend cut in 2001 and OHI had a cut in 2000. Stats are provided for the REITs that were paying dividends in Q1-04.


Co.   04 05 06 07 08 09 10 11 12 13 14 15 average average

HCN ffo 2.86 3.03 2.94 3.13 3.38 3.12 3.13 3.41 3.51 3.36 4.07 4.27
  growth   5.94 -2.97 6.46 7.99 -7.69 0.32 8.95 2.93 -4.27 21.13 4.91 4.37% 4.23%
  div 2.34 2.40 2.48 2.56 2.64 2.72 2.72 2.86 2.96 3.06 3.18  
  growth   2.56 3.33 3.23 3.13 3.03 0.00 5.15 3.50 3.38 3.92   3.12% 3.59%
  div/ffo 82% 79% 84% 82% 78% 87% 87% 84% 84% 91% 78%   83.49%
 
HCP ffo 1.66 1.89 1.82 2.14 2.25 2.14 2.19 2.69 2.76 3.01 3.03 3.13
  growth   13.86 -3.70 17.58 5.14 -4.89 2.34 22.83 2.60 9.06 0.66 3.30 6.87% 8.25%
  div 1.67 1.68 1.70 1.78 1.82 1.84 1.86 1.92 2.00 2.10 2.18  
  growth   0.60 1.19 4.71 2.25 1.10 1.09 3.23 4.17 5.00 3.81   2.71% 3.05%
  div/ffo 101% 89% 93% 83% 81% 86% 85% 71% 72% 70% 72%   80.28%
 
HR ffo 2.76 2.28 2.13 1.51 1.63 1.65 1.29 1.15 1.31 1.32 1.46 1.56
  growth   -17.39 -6.58 -29.11 7.95 1.23 -21.82 -10.85 13.91 0.76 10.61 6.85 -4.47% -4.71%
  div 2.52 2.60 2.64 2.64 1.54 1.54 1.20 1.20 1.20 1.20 1.20  
  growth   3.17 1.54 0.00 -41.67 0.00 -22.08 0.00 0.00 0.00 0.00   -5.90% -5.24%
  div/ffo 91% 114% 124% 175% 94% 93% 93% 104% 92% 91% 82%   106.27%
 
Co.   04 05 06 07 08 09 10 11 12 13 14 15 average average

LTC ffo 1.54 1.70 1.83 1.90 1.91 1.89 1.88 2.15 2.26 2.37 2.60 2.80
  growth   10.39 7.65 3.83 0.53 -1.05 -0.53 14.36 5.12 4.87 9.70 7.69 6.26% 6.88%
  div 1.20 1.32 1.44 1.50 1.56 1.56 1.56 1.68 1.74 1.86 2.04  
  growth   10.00 9.09 4.17 4.00 0.00 0.00 7.69 3.57 6.90 9.68   5.51% 7.00%
  div/ffo 78% 78% 79% 79% 82% 83% 83% 78% 77% 78% 78%   79.45%
 
NHI ffo 2.42 2.28 2.67 2.49 2.29 2.33 2.76 2.88 3.18 3.55 4.20 4.38
  growth   -5.79 17.11 -6.74 -8.03 1.75 18.45 4.35 10.42 11.64 18.31 4.29 6.61% 7.36%
  div 1.70 1.80 1.92 2.00 2.20 2.20 2.30 2.46 2.60 2.68 2.94  
  growth   5.88 6.67 4.17 10.00 0.00 4.55 6.96 5.69 3.08 9.70   5.67% 7.29%
  div/ffo 70% 79% 72% 80% 96% 94% 83% 85% 82% 75% 70%   81.77%
 
OHI ffo 0.89 0.79 1.32 1.42 1.30 1.47 1.61 1.89 2.19 2.53 2.77 2.83
  growth   -11.24 67.09 7.58 -8.45 13.08 9.52 17.39 15.87 15.53 9.49 2.17 13.93% 21.12%
  div 0.68 0.80 0.92 1.04 1.16 1.20 1.28 1.48 1.64 1.80 1.96  
  growth   17.65 15.00 13.04 11.54 3.45 6.67 15.62 10.81 9.76 8.89   11.24% 18.82%
  div/ffo 76% 101% 70% 73% 89% 82% 80% 78% 75% 71% 71%   78.97%
 
Co.   04 05 06 07 08 09 10 11 12 13 14 15 average average

SNH ffo 1.50 1.44 1.57 1.62 1.67 1.69 1.70 1.73 1.75 1.69 1.76 1.85
  growth   -4.00 9.03 3.18 3.09 1.20 0.59 1.76 1.16 -3.43 4.14 5.11 2.18% 1.73%
  div 1.24 1.28 1.28 1.36 1.40 1.40 1.44 1.48 1.52 1.56 1.56  
  growth   3.23 0.00 6.25 2.94 0.00 2.86 2.78 2.70 2.63 0.00   2.34% 2.58%
  div/ffo 83% 89% 82% 84% 84% 83% 85% 86% 87% 92% 89%   85.91%
 
UHT ffo 2.63 2.47 2.44 2.50 2.49 2.80 2.61 2.57 2.84 2.77 2.83 2.89
  growth   -6.08 -1.21 2.46 -0.40 12.45 -6.79 -1.53 10.51 -2.46 2.17 2.12 1.04% 0.76%
  div 1.98 2.02 2.24 2.28 2.32 2.36 2.40 2.42 2.44 2.48 2.50  
  growth   2.02 10.89 1.79 1.75 1.72 1.69 0.83 0.83 1.64 0.81   2.40% 2.63%
  div/ffo 75% 82% 92% 91% 93% 84% 92% 94% 86% 90% 88%   89.21%
 
VTR ffo 1.79 2.08 2.44 2.69 2.74 2.66 2.85 3.37 3.80 4.14 4.38 4.57
  growth   16.20 17.31 10.25 1.86 -2.92 7.14 18.25 12.76 8.95 5.80 4.34 9.97% 14.47%
  div 1.30 1.44 1.58 1.90 2.05 2.05 2.14 2.30 2.48 2.68 2.90  
  growth   10.77 9.72 20.25 7.89 0.00 4.39 7.48 7.83 8.06 8.21   8.46% 12.31%
  div/ffo 73% 69% 65% 71% 75% 77% 75% 68% 65% 65% 66%   69.60%
 
Click to enlarge

The first thing I notice - there is a strong correlation between FFO growth and dividend growth. It's like the song "Love and Marriage" which contains the line "you can't have one without the other". Let's take this one REIT at a time to get a brief commentary on each.

Over the last ten years, HCN has FFO growth higher than dividend growth. The dividend/FFO ratio has fallen some, indicating that forward dividend growth should be above trend. The 2014 and 2015 numbers are projections of things that are yet to come - and HCN has good projections. But four of the last five years (2009, 2010, 2012 and 2013) HCN had FFO growth that was noticeably below sector average and below its ten year trend in growth. That fact makes me a little uncomfortable. The dividend growth was already low when FFO growth averaged 4%. HCN needs the anticipated jump in FFO in 2014 to provide evidence that the slowing trend in FFO growth is behind them.

Over the last ten years, HCP has FFO growth a lot higher than dividend growth. In fact, HCP has had more FFO growth than HCN while having less dividend growth. But HCP started with a bad dividend/FFO ratio. The dividend/FFO has fallen a good bit, indicating that forward dividend growth should be above the long term trend. On the other hand, FFO growth in 2012 and projected for 2014 and 2015 is well below trend. HCP is low in RIDEA or operating properties - and that is where the growth is in this sector. So HCP's choice in asset allocation is already showing up in its FFO projections. At the same time, slowing dividend growth is not showing up yet in HCP's valuations.

HR's FFO has fallen big time compared to 2004 - and two dividend cuts have happened. Going back to the FAD numbers mentioned earlier, those numbers look very good. But HR has a history that stinks. I track history because it tells you something. And many years of disappointment results in a history that tells me to avoid HR. HR could easily have a different team management that leads to different results. But for me, HR is "a stock for other people". I will willingly let others be early to that party. The current valuations says HR is already priced as if it is a winner. I am not going to pay a winner's valuation for a stock with that history.

LTC has had FFO growth that is roughly in line with FFO growth, and both of those growth rates have been relatively good. The current forward FFO growth projections (or those for 2014 and 2015) are slightly ahead of average growth over the last ten years - while the dividend/FFO ratio is in line with the historical number. I wrote while commenting about the FAD numbers that FAD "data suggests that the next dividend increase will be closer to 5% than 10%." The FFO data suggest the same thing. But 5% growth with a 5% yield is a pretty good thing. Combine that with a great balance sheet - and you have a really good thing.

NHI has numbers that echo LTC's, and my valuation and CAGR assessment is close to the same. NHI has a better dividend/FFO ratio - which indicates that forward dividend growth should be higher for NHI.

OHI is one of the Rodney Dangerfields of REITdom - it can't get no respect when it comes to its price/FFO. But FFO growth has been great - and dividend growth has responded. The very low dividend/FFO ratio strongly indicates that - at least - short term dividend growth should continue to be strong. But remember that OHI owns triple-net assets with 2% rent bumps. The market always remembers that - and has kept OHI's price/FFO low. I expect that long term trend to continue. And it's almost certain that there will come a day when its low valuation will be warranted. I'm betting that day is still a few year off.

SNH has had low FFO growth, a high dividend/FFO ratio, and low dividend growth. There have been major changes in the SNH portfolio. Change can happen. And SNH is certainly undervalued given its assets. But its history stinks. Its metrics still stinks. That makes SNH another "stock for other people".

UHT's numbers are as bad as those from SNH. I can see why some will be tempted to buy a relatively high MOB component REIT with a higher than sector average yield. At least is has a better dividend history than HR's. But UHT is very small; lacks analyst coverage; fails to report too many metrics; and has had anemic dividend growth over a long period of time. Reluctantly, I find it to be another "stock for other people". I need to find one MOB stock that I hate the least. But as long as there is hope for DOC and HTA, I will not like UHT.

VTR has had great FFO growth, great dividend growth, and a very low dividend/FFO ratio. Given that I like those kind of numbers, my conclusion about VTR is obvious.

I believe that you could take a second to note the overall trend in the change in FFO in 2009. HCN, HCP, LTC and VTR had falling FFO. The force that hit those four may have hit NHI and OHI in 2008- when both had significant falls in FFO. This could be a reminder that all triple-net REITs are financial companies that need to do deals to maintain their FFOs.

The next spreadsheet is my dividend forward CAGR setting spreadsheet. I strongly believe that you should pay attention for the assessments of others - but they should not be your only guide. They should not be your dominant guide. I also believe that you should pay attention to the market - because the market is often right. I have a dividend discount model based formula that provides me with a price implied forward CAGR projection - and I intentionally set my personal CAGR projections to be aligned with it with 100 basis points. I am also influenced by the operating metrics - specifically the FAD related metrics. Here are my current 5 year forward CAGRs:

CAGR Explanation Spreadsheet


  Forward CAGRs 2012-2015 2012-2014 2014 2014 2014 Est. Pr Impl Site  
Co. Yahoo Others FFO/annum Div/annum FFO FAD FAD/Div CAGR CAGR Reason for Adjustment
  Q1-14 Q4-13 Fish Brk Growth Growth Growth Growth Ratio    

AVIV 8.5 7.9 0.0 0.0 na na 50.00 11.05 132.64 5.49 5.0 Too new to know
DOC 5.0 5.0 0.0 0.0 na na 238.46 7.61 110.00 2.07 3.2 Too new to know
HCN 5.6 6.2 0.0 4.5 7.22% 3.72% 21.13 7.14 113.21 4.27 4.4 Average metric growth
HCP 3.9 3.5 4.2 5.5 4.47% 4.50% 0.66 -0.79 114.68 4.02 4.0 Average growth
HR 4.0 4.0 0.0 3.3 6.36% 0.00% 10.61 10.53 122.50 2.76 2.5 Good FAD growth
HTA 4.0 4.0 0.0 4.0 9.84% 0.00% 14.06 6.90 107.83 2.62 2.7 Good trends - poor coverage
LTC 4.0 4.0 0.0 4.0 7.96% 8.62% 9.70 6.84 122.55 4.44 4.4 Good trend - average coverage
MPW 5.5 5.5 0.0 0.0 10.37% 2.50% 14.58 13.98 126.19 5.24 4.5 Growth trend beginning
NHI 5.6 3.3 4.5 7.0 12.58% 9.23% 18.31 6.29 126.53 4.63 5.4 Good growth & coverage
OHI 3.0 3.0 3.0 3.5 9.74% 9.52% 9.49 11.11 127.55 5.04 5.0 Good growth & coverage
SBRA 5.0 5.0 0.0 0.0 23.40% 7.58% 23.37 21.59 148.61 5.31 5.8 Great growth & coverage
SNH 4.2 3.8 0.0 2.5 1.90% 1.32% 4.14 1.91 102.56 2.11 1.8 Average metric growth
UHT 2.4 2.4 2.4 0.0 0.59% 0.81% 2.17 1.09 111.20 3.72 2.6 Low metric growth
VTR 5.7 5.9 0.0 5.5 6.75% 8.47% 5.80 7.07 146.21 5.17 5.8 Great growth & coverage
Click to enlarge

My CAGRs are five year forward CAGRs. HR and HTA are not likely to be growing their dividend this year - but they still have five year CAGR projections at or above 2.5%. The same goes for newbies AVIV and DOC. On the other hand, OHI and SBRA should have 2014 and 2015 dividend growth much higher than the 5 year CAGRs I have assessed for them. Projecting five years out is art. Projecting one year out is math. And this numbers guy is probably guilty in favoring math over art is his CAGR assessments. I believe that you need to use the upcoming "Yield + CAGR Total Return Expectations" spreadsheet to judge my CAGR projections. If those valuations are out of line, then my CAGRs are out of line. We have one more section to go through before that spreadsheet appears.

This gets us to the end of the first five points. Part two is already published and ready for your inspection.

Disclosure: I am long LTC, OHI, VTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.