Financial Review Of The Debt Structure Of The 4 Biggest Healthcare REITs

| About: Welltower Inc. (HCN)

Summary

This article provides an overview of the debt structure of the 4 biggest healthcare REITs.

Which company is best equipped to handle a possible interest rate hike?

No company outperforms the others on all of the researched metrics.

Gun to my head? HCP. Reality? Monitor regularly and diversify!

In the last few years there have been various occasions where speculation about possible interest rate hikes have impacted share prices in the short term, especially for REITs. Two years ago I wrote an article about the sensitivity of Omega Healthcare Investors (NYSE:OHI) and three other healthcare REITs to a possible interest rate hike. You can read the article here.

I concluded that OHI seemed less sensitive to interest rate changes because they only have to refinance a much smaller portion of their debt load before 2019. So this begs the question: at this moment, how do different healthcare REITs compare on the sensitivity to interest rate hikes? Which REIT is best equipped, from an operational perspective, to withstand rising rates in the future?

This article is not meant to forecast what will happen to REIT share prices when rates are hiked. A comment from richjoy403 on my earlier article summarized it clearly: " When rates rise, the market shoots first and aims later". It's pure speculation to assess the impact of rising rates on share prices in the short term. Given the recent history with share price volatility due to possible rate hikes, I tend to agree with richjoy403. However this article is meant to discuss the capital structure, debt ladder and composition of fixed and variable debt for four of the biggest healthcare REITs, OHI, HCN (NYSE:HCN), HCP (NYSE:HCP) and Ventas (NYSE:VTR).

Capital structure

As a starting point in our analysis, let's take a look at the capital structure. The idea is that a REIT with high amount of debt financing (more leverage) usually is more sensitive to interest rate hikes. The table below provides a breakdown of the capital structure of the different REITs.

Source: table created by author, data from latest Q2 2016 earnings reports

The amount of (net) debt hovers somewhere between 43% and 53% . The differences between the various companies are relatively small. The question however is how much debt is variable rate debt and how much debt is fixed rate debt. The underlying rationale is that a higher amount of variable rate debt is riskier than fixed rated debt.

Source: table created by author, data from latest Q2 2016 earnings reports

The big three healthcare REITs each have around 85% to 90% fixed rate debt. OHI however has only 58% fixed rate debt. OHI has a credit revolver and several term loans with floating rates. These floating rates are based on an underlying benchmark rate (LIBOR). This means that a possible interest rate hike would directly lead to a higher interest expense for a big part of OHI's debt portion.

Debt maturities

The amount of variable rate debt however is not the only indicator. Fixed rated debt which matures in the short term is just as sensitive to rising interest rates than variable rate debt. The table below provides an overview of the amount of debt maturities between now and 2019 relative to the outstanding long-term total debt.

Source: table created by author, data from latest Q2 2016 earnings reports

An analysis of the debt maturity schedule shows that HCN and OHI each have lower debt maturities than their peers HCP and VTR. So a larger part of their debt load needs to be refinanced in the coming years. A rising interest rate will impact VTR and HCP sooner based on this indicator.

However, it's also important to check what the average rate of the maturing debt is. Debt with a relatively high interest rate that matures in the short term actually offers a chance to improve the financial operations. If a company is able to refinance expensive debt with cheap debt, it is a good thing. The table below provides an overview of the average weighted debt rate of the debt that matures between 2016-2019.

Source: table created by author, data from latest Q2 2016 earnings reports

This data actually paints a different picture. HCP has the highest amount of debt that needs to be refinanced but this debt is also the most expensive compared to other REITs. So HCP seems to be positioned well if they are able to refinance their debt in the current low rate environment. On the other hand, the maturing debt from OHI is already relatively cheap so the upside is not as big as in HCP's case.

Other indicators

In the section above I've discussed the capital structure and the debt maturity schedule of the four healthcare REITs. I will finalize my analysis of the rate sensitivity with two more general indicators of the health of the companies as it relates to debt and interest payments.

Source: table created by author, data from latest Q2 2016 earnings reports

The net debt/ebitda multiple shows how many years it would take for a company to pay back its debt. The big three healthcare REITs (HCP, HCN and VTR) each have a multiple of around 5.8x to 6.1x. OHI has the smallest multiple with just 4.7x ebitda.

The table below provides the interest rate coverage ratio.

Source: table created by author, data from latest Q2 2016 earnings reports

The interest coverage ratio measures a company's ability to pay the interest on its outstanding debt. HCP has the smallest ratio whereas OHI has the best ratio.

Summary

The table below provides a summary of the various indicators I have mentioned in this article. The number (1 to 4) represents the rank where 1 is the best and 4 is the worst company based solely on that indicator. Obviously this table and the ordinal ranking system do not take into account the degree of differences between them.

From the data we can see that Ventas is never the best or the worst company and that each of the other companies have their different strengths and weaknesses regarding the sensitivity to rising rates.

HCP:

  • Upside: high amount of fixed debt and shorter term debt maturities have a relatively high interest rate.
  • Downside: lower interest coverage ratio and high amount of debt maturities in the short term.

HCN:

  • Upside: lowest amount of debt that needs to be refinanced soo
  • Downside: highest net debt/ebitda multiple.

OHI:

  • Upside: low net debt/ebitda multiple and consequently high interest coverage ratio.
  • Downside: high amount of variable rate debt and shorter term debt maturities have a relatively low interest rate.

Given these facts I find it hard to offer a clear-cut conclusion as to which company is best equipped to handle possible rate hikes in the future. No company outperforms the others on most metrics. In my opinion HCP's weaknesses are not as big as the ordinal scale in the summary table suggests. The higher amount of debt maturities in the short term combined with the fact that exactly that debt is relatively expensive, offers a chance to actually improve the financial performance. As a result of this improvement, the last weak spot of HCP in this analysis, the interest coverage ratio, will be better off as well.

Gun to my head? HCP. Reality? Monitor regularly and diversify!

Disclosure: I am/we are long OHI.

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.