Healthcare REITs: Where Healthcare And Real Estate Intersect
- Can two profitable sectors, real estate and healthcare, be blended? Will the investment produce good profits?
- See how Healthcare REITs produce excellent total returns in the long run while giving investors excellent income streams.
- How do Healthcare REITs stack up against the stock market in performance?
- What are the risks in this exciting sector of the market?
(Photo credit: istockphoto.com)
By David Lerman & Jodie Warner
Aging is not lost youth but a new stage of opportunity and strength."
- Betty Friedan
On September 14th 1960, President Dwight D. Eisenhower signed legislation that created a new approach to income producing real estate investment - a manner in which the best attributes of real estate and stock-based investment are combined. REITs for the first time, brought the benefits of commercial real estate investment to all investors - benefits that previously had been available only to large financial institutions and to high net worth individuals.
Over time, investors responded to this new opportunity, and more than five decades after their creation, stock-exchange-listed U.S. REITs have grown to a trillion-dollar equity market capitalization. REITs around the world now regularly provide investors with the opportunity for meaningful dividends, portfolio diversification, valuable liquidity, transparency and market-beating performance.
If I told you that there is an investment class that matches or exceeds the performance of the stock market, pays a dividend double the S&P 500, reduces risk, is non-correlated to the stock market, is remarkably stable in the long run and is ground zero (excuse the pun) for the healthcare field, you’d likely respond with considerable skepticism. Before dismissing me, read on.
Real Estate Investment Trusts or REITs have been trading for quite some time now and have become more popular as time goes by. Most investors are cognizant of the three major asset classes in investing: stocks, bonds, and cash. There are actually several other asset classes but the 4th major asset class is generally agreed to be real estate. The vast majority of investors have been indoctrinated with the thinking that over the long run, stocks outperform bonds and cash and most other asset classes. While this may be true during some time frames, the long run returns of REITs may shock some people.
Figure 1. REITs vs. various stock indexes
| Compounded |
| FTSE NAREIT |
(all equity REITs)
| S&P 500 |
(Large cap stocks)
| Russell 2000 |
(Small cap stocks)
|3-years ending 3/31/2017||10.56||10.37||7.22|
|15-years ending 3/31/2017||10.39||7.09||8.38|
|30-years ending 3/31/2017||10.69||9.67||8.92|
Source: NAREIT (National Association of Real Estate Investment Trusts) REITWatch - April 2017
There are several ways to obtain real estate exposure. You can invest in actual real estate - office buildings, shopping centers, apartment rentals and of course medical office properties, senior living, nursing facilities and hospitals. Many pension funds and insurance companies own some of the most prime real estate in the country. Given that they have large amounts of investable capital, they can buy almost any property they desire.
You can also invest in these assets through private partnerships. But by far, the easiest way to invest in real estate is through REITs. A real estate investment trust (REIT) is a company that owns, and in most cases operates, income-producing real estate. REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, medical office buildings, hospitals, shopping centers, hotels and timberland.
By law, REITs must pass on at least 90% of their earnings to investors. Since many REITs are publicly traded, they are easily bought and sold and are quite liquid. The investor doesn’t have to worry about collecting rents, rehabbing office space, and paying property taxes as you do when you buy real estate directly. The REIT structure and management takes care of all those tasks and the investor pockets the income.
Besides making real estate investing much easier, there are many other advantages to owning REITs, particularly healthcare REITs:
- Expertise - REIT management usually has their fingers on the pulse of their particular industry. As such they know the local as well as national (and international) real estate market. Real Estate requires specific expertise that many investors lack.
- Diversification - REITs tend to have a low correlation with the broad stock market so when the market zigs, your REIT investment zags. The diversification can lead to increased returns and lower risks. REITs are also a way to complete your asset allocation among the four leading asset classes.
- Income - Healthcare REITs pay significant dividends which can grow quite persistently over time. Capital gains also are a prime benefit. The generous payouts also serve to reduce risk and cushion the blow should share prices decline.
- Inflation Protection - REITs have consistently outperformed inflation as measured by the CPI. Given that they invest in hard assets like real estate, they are a natural inflation hedge. As the value of the portfolio increases, the REIT holders benefit in two ways: 1) rising values of the real estate, and 2) rising rents which are passed on to the investor.
- Performance - as mentioned, REITs including healthcare REITs, have beaten the market over the long run and the VERY long run. They also beat the bond market and small cap stocks too. They deliver consistent growth in share price and dividend growth. A distinct few are members of the dividend aristocrat club (25 years of increasing dividend payouts) and others are members of the dividend achievers club (10 years of rising dividends).
- Liquidity - You can easily liquidate shares as REITs are bought and sold like common stock. You can add to positions, change asset allocations easily and rebalance a portfolio.
- Transparency - REITs have strong governing structures, and as required by law, tax transparency as well. As publicly traded investments they have market transparency too.
Despite all the aforementioned positives, we expect our readers to continue to ask questions and retain a dose of skepticism. REITs as a whole have done well versus the market. But there are at least a dozen types of REIT property types. Where do healthcare REITs stand in the rankings in terms of returns to shareholders? Excellent question.
And the honest answer: while they are not the number one ranked of all the subtypes of REITs, taking into account 10 and 15-year returns, they rank in the top 2 to 4, behind only self-storage REITs (yes, America’s affliction with affluence has resulted in our homes being too small to store all our junk, and whatever isn’t sold in a garage sale gathers dust in our basements, attics, or... self-storage facilities!). In a 20-year ranking, REITs are ranked very highly out of about a dozen categories:
Figure 2: Return rankings for various REIT subtypes
(Compounded annual returns ending 2015)
Self-Storage REITs 16.6%
|Self-Storage REITs 19.2%||Self-Storage REITs 16.6%|
|2||Healthcare REITs 12.9%||Healthcare REITs 17.6%||Regional Malls 14.0%|
|3||Residential apartments 11.6%||Regional Malls 15.2%||Free standing retail 13.9%|
|4||Manufactured housing 11.6%||Free standing Retail 14.8%||Healthcare REITs 13.3%|
|5||Free standing retail 10.9%||Apartments 12.9%||Apartments 13.2%|
|6||Regional malls 7.6%||Diversified REITs 11.4%||Office 12.0%|
|7||Industrial 6.9%||Shopping Centers 11.5%||Manufactured Housing 11.8%|
|8||Diversified REITs 6.8%||Manufactured homes 11.1%||Shopping Centers 10.8%|
|9||Office REITs 6.5%||Office REITs 9.3%||Diversified REITs 9.7%|
Still skeptical? Two terrific investments in one!
Healthcare REITs literally blend together two extraordinary investments in the economy of the United States: Real Estate and Healthcare. REITs are a $1-Trillion business. Healthcare is a $3.5 trillion business. Combine the two and you have a multitude of opportunities for investment returns. Consider the following - Healthcare REITs invest in any or all of the following:
- Medical office Buildings (MOBs). There is an excellent chance that the office your physician uses for his practice is leased. Doctors have to make very costly investments in their practice (and pay off their medical school loans too). Hence, to construct a medical office from the ground up would be costly; therefore they tend to rent and not buy.
- Seniors Housing. When the kids grow up and leave home, Mom and Pop may decide that the upkeep and maintenance on their 2500 square-foot home is too much, and perhaps eventually move to a seniors housing facility. The number of seniors who will switch to seniors housing is projected to double in the next 10 to 15 years. Many Healthcare REITS have substantial stakes in seniors housing. Some of them own the buildings outright and have tenants pay the leases, as well as the taxes and upkeep (so called triple-net-lease arrangements, or NNN). Some healthcare REITs have SHOP portfolios - Seniors Housing Operating Portfolios - where the REIT owns the property but has an operating company run the day-to-day operations. SHOP and NNN arrangements are common in the Healthcare REIT world.
- Hospitals. Some Healthcare REITs own/manage/lease hospitals. Given that you pay $3,000 for a bottle of Tylenol and some gauze during your hospital stay, you might want to consider these investments. The dividend growth is intriguing. There is one REIT that focuses primarily on hospitals - Medical Properties Trust (MPW). Hospitals typically are stable and rarely shut down or fail; and the ACA provided many more people the opportunity to seek hospital care. With legislative decisions, these could both change, but the need to procure and efficiently manage buildings and facilities will remain a priority (and perhaps escalate) for hospital systems to deliver healthcare services.
- Science/Medical Labs. In Sickness and Wealth (ISAW) previously owned the Healthcare REIT, Biomed Realty Trust (BMR). However, it was bought out by Blackstone group. We took our profits and are now looking to reinvest that money in a similar type of investment. BMR leased lab space to pharmaceutical companies and universities around the country. Laboratories often require specialized buildings with specific needs in terms of ventilation, plumbing, electricity and architecture. If you want to study the Ebola Virus…you can’t do it in an ordinary medial building or laboratory unless you want a worldwide outbreak. If you want to install an MRI machine, you need special walls and precision builds. If you want to find the next cancer treatment, you need state of the art facilities. Healthcare REITs lease out these critical areas of real estate to the life science field.
- Skilled Nursing Facilities. In the next 20 years, the population of people 85 years or older is projected to double. The amount spent on healthcare per capital for this demographic far exceeds other age brackets and for obvious reasons. The demographic and longevity issue in the United States and other developed countries is a ticking time bomb… especially in Japan, Germany and other parts of Europe.
- Post-Acute Care Facilities. When you're released from the hospital and you need physical therapy, rehabilitation, palliative care or some kind of outpatient treatment as follow up, you will likely visit a post-acute care facility. These facilities occupy the portfolios of many healthcare REITs.
Simply put, healthcare REITs are landlords to the medical world. There are dozens of healthcare REITs in existence today. Like most industries, a handful of companies dominate the space. While we will try and give you a view from 35,000 ft., we will focus on the stalwarts - Welltower (HCN), Ventas (NYSE:VTR), and HCP, Inc. (HCP).
Welltower and Ventas are the 4th and 7th largest REITs respectively (#1 and #2 in the Healthcare REIT rankings). They have thousands of properties and thousands of tenants that provide a steady stream of dependable and steadily growing dividends. As we go through the pros and cons of these healthcare REITs, you get a good sense of how good the opportunity is going forward. And as always, we will balance the argument with a discussion of the risks in Healthcare Real Estate Investment Trusts.
Welltower has 1,414 healthcare properties in their portfolio with 210,000 residents. According to their investor relations folks they also generate 16 million outpatient medical visits each year. Interestingly, they boast a BBB-plus rating from Standard and Poor’s. Hence their debt is generally investment grade which is a nice positive for a company involved in real estate that might want to borrow money to finance expansion. The higher the credit rating, the lower their borrowing costs. Thus, it makes good sense to keep their credit rating as high as possible. Access to cheaper capital is crucial to those in the real estate business.
Since 2010, Welltower has made some strategic moves that will capitalize on the massive shift in healthcare. HCN management and others in the space believe that healthcare is steadily moving to lower-cost settings. Care will migrate from high-cost centers (hospitals, long-term and post-acute care facilities and skilled nursing facilities) to lower-cost centers like seniors housing, assisted-living and independent-living, outpatient medical office buildings and even into the home.
Welltower’s portfolio has shifted accordingly. In other words, in 2010, seniors housing was 40 percent of their net operating income (NOI). At the end of 2016, it was nearly 70 percent of NOI. Outpatient medical facilities remained largely constant while hospitals and life sciences (lab space rental) were virtually abandoned. Post-acute care has declined precipitously in terms of NOI from 31 to 13 percent. Fans of Welltower think these moves make great sense.
A few detractors though, are not as enthusiastic, as the supply of senior facilities will likely explode in coming years. The competition will drive down rents and force up costs, and this could impact HCN negatively. Welltower also has an eye on the Alzheimer’s problem and believes specialized residential memory care might be part of the answer to a problem that threatens to bankrupt the system (see ISAW Alzheimer’s issue). HCN sees residential memory care becoming as important as assisted-living and independent-living facilities.
Welltower is also trying to drive a percentage of its NOI from private payers and has been very successful in this endeavor with NOI from private payers which has risen from 69 percent to 93 percent in the last six years.
Sources: Welltower Corporate Presentation–May 2017 & Morningstar
While Welltower has the largest market cap among the healthcare REITs, Ventas is a close second. Both are considered the dominant franchises in the healthcare real estate space. Ventas has rewarded shareholders significantly over the long run and boasts a very diversified portfolio of real estate. About 29 percent of Ventas’ operating income comes from its Senior Housing Operation Portfolio (aka SHOP). About 25 percent comes from seniors housing triple net leasing (again triple net is where the tenant pays the typical rent but also taxes, maintenance and other expenses associated with the property).
Ventas gets another 20 percent of its net operating income from medical office properties. The remaining NOI is from specialty hospitals, life science, acute-care hospitals and a very small amount from their loan portfolio and skilled nursing facilities.
As economics shift in the healthcare real estate, one would expect savvy management to adjust accordingly. Welltower, as mentioned, has adjusted its portfolio. Ventas’ smart management has also made similar moves. They spun off their skilled nursing portfolio into a separate company - Care Capital Properties, and have concentrated on seniors housing and medical office properties. VTR also spent $1.75 billion on the purchase of Ardent Health Services, an acute care hospital owner.
Most of VTR’s SHOP portfolio is located in prime areas that would have very large barriers to entry. Markets like the Pacific Northwest, Central and Southern California and many demographically-blessed areas along the Eastern seaboard, are inhabited with individuals with substantial net worth and large houses, priced well above the median in the U.S. Hence as this population ages, they are more able to afford Seniors Housing. For any competitor wishing to enter the space, the costs to build similar facilities would be large. Thus, Ventas has a very attractive portfolio with 66 percent of its seniors housing portfolio located on the coasts.
It is not only the aging population that is driving seniors housing, but the value proposition that goes with it. Seniors enjoy independence, social life, housekeeping, exercise and physical activity programs, dining and emergency assistance. If you have never visited a seniors housing facility, you would be amazed at the lifestyle they provide their residents. Trying to recreate that environment in your own home would be very costly on a relative basis. While nothing beats being in a home you have come to love over the years, seniors housing of the type that Ventas provides is a terrific alternative.
In addition, Ventas’ medical office buildings are located primarily near hospitals and other medical campuses. In fact, over 90 percent of their MOB portfolio is located in close proximity to larger medical campuses with hospitals and acute care facilities. With the affordable care act encouraging medical providers to offer coordinated, value-based treatment (with reimbursement based on patient outcome goals versus traditional fee-for-service reimbursement), Ventas’ MOB portfolio stands to gain due to this advantage.
Because companies like Welltower and Ventas have a large national presence, they also enjoy economies of scale. For example, with Ventas’ ATRIA subsidiary they save 22 percent on insurance because they can aggregate policies. They save 13 percent of food costs with a national culinary program and about 11 percent on property management using national contracts. They also save another 9 percent on in-house printing of collateral and marketing materials.
Sources: Ventas Investment Presentation – March 2017 And Morningstar
Figure 3. Financial Comparisons
|Market Capitalization||$25.6 bn||$22.9 bn||$14.5 bn|
|Number of properties||1400||1300||770|
|Price to FFO||17.02||15.53||16.76|
|5-year Dividend growth||3.64||11.20||-.52|
|2017 Div’ds % of FFO||82%||76%||78%|
|Return on Equity||7.0%||7.0%||6.5%|
|Total Debt to Equity||.89:1||1.06:1||1.66:1|
|3-year annualized return||10.28||9.45||1.49|
|5-year annualized return||10.81||9.52||3.48|
|10-year annualized return||8.75||9.02||4.33|
|15-year annualized return||8.93||14.79||7.40|
|% Decline from high price||15%||16%||37%|
|Standard & Poors credit rating||BBB+ |
*FFO = Funds From Operations (a measurement for REITs, is a distant “cousin” to Earnings Per Share)
Sources: Morningstar, Value Line, Bloomberg
In our financial comparison chart above (Figure 3), we listed HCP Inc. for comparison purposes. More on that later. But it’s generally thought that Ventas and Welltower are the best of breed in the Healthcare REIT space. Both are well-diversified REIT companies that match up well in a financial comparison. It’s tough to pick looking at most of the attribute comparisons. However, where I think Ventas gets the edge is in annual return to shareholders over the long and intermediate time frame, and in dividend growth (a significant part of the total return to its shareholders comes from their large and growing dividend).
Both companies are off their all-time highs by approximately 15 percent. Hence, we are getting a more attractive price. For those with the financial means, a basket of all three would be an interesting total return play (healthy dividends and the long term stable growth from real estate).
HCP’s returns have been muted because of performance issues and they are spinning off most of their Manor Care Nursing homes as they have been a drag on the stock. They also carry relatively greater debt than Welltower and Ventas and that could also be a drag on the company if the economy should falter or interest rates rise appreciably. It’s no surprise then that HCP Inc has corrected, twice the amount of VTR and HCN.
There is another way for those with more limited budgets, to participate in this intriguing sector. There exists a Long Term Care ETF (you'll love the ticker symbol: OLD) and it’s offered by Janus Capital Management. It contains 38 issues, including all three healthcare REITs discussed in this issue, along with other companies that deliver goods and services to the elderly population. It carries a 3.7% dividend and trades at about $25.50 a share. It has an annual expense ratio of .50% which is quite low.
Since it’s an ETF, there is only a minimum 1 share amount so even those with under $1,000 to invest, could still participate. You get a nicely diversified portfolio of Healthcare REITs and other companies in the senior care business. One caveat... while the investments are in solid companies, the ETF itself only has 11 months of operating history. So you may wish to wait and see how it performs for a few months or quarters before committing.
As usual, we always balance the rewards and potential tailwinds with potential risks.
First, the Affordable Care Act has changed the landscape dramatically for all players in this sector, REITs and otherwise. But Congress and President Trump are promising changes in the law. The first set of modifications failed to attain adequate votes - even with a Republican-controlled House and Senate. However, they are reworking the changes, and whether repealed, replaced, or modified with bipartisanship, until these changes are public and can work through the system, it will be difficult to assess the impact. This uncertainty creates risk to healthcare sector shareholders.
Seniors Housing. While profitable and growing with great potential ahead, anytime a sector shows huge promise, everyone wants in. Before you know it, seniors communities are sprouting up like bank branches, and supply starts to gain on demand and the profitability dips. Both Ventas and Welltower have a significant share of their portfolios in seniors housing.
Overall real estate market. REITs have been fantastic investments over the long run and often outperform the stock market. However, the 2007 through 2009 financial crises laid waste to banks and mortgage companies. REITs of all kinds also suffered, but the recovery was quite powerful as well.
Interest rates. To a point, REITs do okay in a rising interest rate environment, but given that they rely on borrowing, a significant uptick in rates could adversely impact their access to cheap financing. Fortunately, the current debt portfolios of Ventas and Welltower are mostly fixed rate debt not subject to the whims of the interest rate markets.
Medicare and Payer reimbursement. Ventas does have exposure to medical office buildings and acute care. Should payer reimbursement pressures manifest themselves, it will also adversely affect the tenants, and thus the overall REIT outlook in the long term. Given that leases in some of these REITs are long term, and switching facility location is expensive for a medical building tenant, this is somewhat mitigated.
The following is adapted from a Ventas investors presentation given early in 2017:
- 10,000 - the number of baby boomers who turn 65 each and every day, and thus will enter Medicare eligibility.
- 34 million - the number of seniors reaching age 75 or greater by 2030; up from 20 million.
- 1 in 4 - the number of 65-year-olds who will live to age 90+.
- 1 in 10 - the number of 65-year-olds who will live past age 95.
- 1.2 million employees - the number of additional employees needed to work in the senior care industry by 2025.
- $640,000 - the average net worth of individuals age 74+ (the extraordinary net worth and spending power of the boomers is mind boggling).
- 73 percent - the percentage of all healthcare dollars spent from the over-50 population.
- $12 trillion - the estimate of the wealth that will be transferred to the boomers in the next several decades.
In addition, seniors spend 5 times more than the rest of the population; they have 2 to 3 more visits to their physicians. And 40 percent of seniors aged 85 and older need assistance with daily living activities. Combine the statistics above with the increasing need for care as we age, and you will see why these companies are positioned in the sweetest of sweet spots.
For a detailed research report on REITs, including healthcare REITs, see here.
This article was written by
Analyst’s Disclosure: I am/we are long HCN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
We are long Welltower and short call options for a covered write.
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