5 Healthcare REITs For Your High-Yield Portfolio

Summary

• Real estate and healthcare are poised to deliver solid growth this quarter, this year, and next despite an uncertain outlook for the broader market.
• Healthcare REITs are a perfect blend of both worlds, healthcare and real estate, and deliver steady income for uncertain times.
• Within that umbrella, the healthcare services and facilities, and especially owners of senior living, skilled nursing and healthcare are especially well-positioned for long-term growth.
• This idea was discussed in more depth with members of my private investing community, The Technical Investor . Start your free trial today »

I've been targeting the healthcare and real estate sectors this quarter because of their earnings outlook. Both sectors are projected to produce positive earnings growth this quarter, positive growth this year, and positive growth next year at a time when the outlook for the broad market is uncertain at best. While researching REITs, it became clear very quickly there is an opportunity with healthcare REITs to capture strengths in both sectors.

Real estate, despite sluggishness in the housing market, is still a hot commodity. They aren't making any more land and the population of America is only getting bigger. Health care, especially senior living, skilled nursing facilities, rehab facilities, and patient care centers, are in high demand. Not only is our population growing but the spread of ages also continues to skew toward the elderly.

• High barriers to entry, regulation/regulatory
• Long-term contracts, steady dependable income
• Inflation protected income streams

Estimates from the Population Reference Bureau show the U.S. over-65 population will nearly double in the next 40 years. At the same time, the number of over-65 Americans will overtake their younger counterparts creating a crisis of care; there won't be enough traditional family-based caregivers.

Source: HCP investor presentation

What this means for investors is that while demand for real estate will continue to grow, the demand for health-related real estate infrastructure will grow the most. This is going to fuel rents and revenues for REITs and, in turn, dividends for investors. The July Beige Book says non-residential construction activity is strong and commercial rents are on the rise.

Nonresidential construction activity increased or remained strong in most reporting Districts, and commercial rents rose.

Source: own work

Welltower - Popular But Not Today's Best Choice

Welltower (WELL) is a popular and widely owned healthcare-oriented REIT but not the best choice for new money today. The company is highly valued relative to its competitors and rightly so. It is the largest (publicly-traded) operator of senior housing, skilled nursing, and rehabilitation centers in the country. Trading at nearly 19x next year's FFO, it is by far the richest valuation among the leading healthcare REITs. Others like LTC Properties (LTC), Ventas (VTR), and Omega Health (OHI) offer much fairer valuations for their yield.

Welltower is expected to report earnings at the end of July. In its favor, Welltower is one of few Healthcare REITs expected to post a net gain in FFO this quarter. Longer term, the company is expecting modest growth this year and next.

The dividend is a nice 4.10% at today's prices. 4.0% is attractive relative to the S&P 500 and 10-year Treasury, but it is not the highest in this group. It also comes with the weakest distribution coverage, so not worth the high valuation, in my opinion.

Source: own work - Treasury Yields

Omega Healthcare Investors - The Highest Yield, Lowest Valuation

Omega Healthcare Investors focuses on skilled nursing and assisted-living facilities in the U.S. and UK. Omega Healthcare Investors has the highest yield in the group at 7.07%. This payout is coupled with the second highest payout ratio in the group which makes it a less than ideal choice.

I usually target a payout ratio of sub-70% but not with REITs. REITs are designed to pay dividends, it would be amiss if the ratio was too low. For this article, I upped my threshold to 85% and even that may be too low. The important thing today is that at this level, the dividend is well-covered by cash and cash flow, so little fear of distribution decrease.

Omega Health has a history of dividend increases but that fact should not be relied upon for investment decisions. The company announced last year it would cease future increases while it worked to improve the balance sheet. The payout ratio is of particular concern at 87% and noted in the last earnings report. The good news is that no distribution cut is expected.

From the conference call:

Our adjusted FFO of $0.76 per share is $0.03 more than our fourth quarter 2018 adjusted FFO of $0.73 per share. This improvement was expected and reflects the beginning of our return to a more predictable environment post 2018's asset repositioning and restructuring activity. We again declared a $0.66 per share dividend. Payout ratio is 87% of adjusted FFO and 97% of FAD.

As we have indicated in the past, we expect that these payout ratios will continue to strengthen throughout 2019. Our adjusted FFO guidance remains unchanged with full-year guidance of $3 to $3.12 per share and fourth quarter 2019 guidance of $0.78 to $0.81 per share. We will revisit 2019 guidance after we close on the MRT acquisition and have our second quarter results.

In Omega's favor are the ongoing expansion plans that include the recent acquisition of MedEquities Realty Trust (MRT). Medequities is a small real estate trust invested in 34 properties and a handful of debt issues. The salient point is that Omega's growth outlook is positive although FFO is projected to be flat this quarter. The next earnings release is expected at the end of July.

Ventas, Inc. - A Great REIT But Not A Pure-Play On Senior Care

Ventas, Inc. owns and leases skilled nursing and senior healthcare facilities but not exclusively. The company's diversified portfolio of real estate projects includes medical office space, research and development facilities, and acute care centers among others.

The dividend is the highest in this group after Omega and one of the more attractive. The company is unencumbered by debt and has ample cash on hand, so little fear of a distribution cut. The payout ratio is at the lower end of the scale, and there is a history of increase which ups the odds for future distribution increase. The income statement, balance sheet, and cash flow all support this idea as well.

Ventas is expected to report before the end of July, and the outlook for this quarter is not awesome. The company is projected to post a -5% decline in FFO, but no indication yet if that will impact future distributions. The company reaffirmed guidance at the last report and cited expansion efforts that have begun to take root.

At the recent Investor Presentation, Ventas highlighted the long-term growth strategy. The company has spent the last several years actively investing in strategic/growth efforts and those investments are about to pay off. The company expects YOY FFO growth as soon as next year and for that growth to accelerate over the 3-5 years. Yet, another reason to expect future dividend increases.

Source: Ventas Investor Presentation

HCP, Inc. - Another Great Diversified Healthcare REIT

HCP, Inc. (HCP) is another great healthcare REIT but not a pure-play on senior care. It is a fully integrated and diversified REIT with holdings in senior living, medical office facility, and life sciences.

The dividend is one of the more attractive in terms of yield, about 4.5%, and it is coupled with a relatively low payout ratio. The drawback is the company has recently decreased the distribution which is not what I like to see. That said, distribution decreases were preemptive moves on management's part to help shore up the balance sheet. Since then, HCP has been working to expand its footprint in all three operational areas which set it up for future increases if not soon. HCP was a dividend aristocrat up until two years ago, just FYI.

Source: HCP Investor Presentation

Earnings are due out in the first week of August. The company is expecting a slight decline in FFO, but this should be the last quarter of negative FFO growth for a while. The company is expected to produce 4% FFO growth next year, by then, the HCP's development projects will begin adding to NAV and income.

Source: HCP Investor Presentation

LTC Properties, Inc. - Small Company Big Value

LTC Properties is the smallest company on my list by market cap. It is trading about $1.9 billion which is less than 25% the value of the next largest REIT, Omega Health. LTC Properties is also one of the best values. At 15x next year's FFO consensus estimate, it is the lowest valued healthcare REIT not counting Omega.

Source: LTC Investor Presentation

To be fair, that valuation may be deserved because LTC also pays the lowest dividend. Even so, the 4.00% it pays today is more than double the S&P 500 average and double the ten-year Treasury.

The company is known to be a dividend-grower but failed to do so last year. The company held the payment flat and is likely to do so again although there is some expectation for future increases. The payout ratio is below my 70% threshold, the lowest in this group, and revenue is growing despite headwinds. Once those headwinds abate, the company should return to dividend growth.

One headwind is bankruptcies and that is a risk faced by all the REITs. They (the REITs) have contracts with their clients but little control of how the business is run. There are protections for the REITs but that doesn't mean they can't or won't experience revenue hiccups due to non-payments.

LTC Properties struggled with bankruptcies and non-payment with some of its key tenants last year. That situation may be why it did not increase the dividend. While the risk of future bankruptcies remains, LTC is emerging from those storms and looking to be benefiting from recently completed projects.

From the last earnings conference call:

...decreases were partially offset completed developments in capital improvement projects, $777,000 in increased rent from Anthem, Preferred Care, and Senior Care, and $1.4 million in deferred rent received from Thrive.

During the first quarter, Thrive paid $1.4 million of deferred rent and $740,000 of past due rent that was accrued in outstanding as December 31, 2018. Additionally, they paid property tax impounds for the first quarter that paid rent to date in 2019.

The Bottom Line

I think the healthcare REITs are a great investment. The only thing these REITs don't have is a really good outlook for future dividend increases. Even so, they are poised to begin growing FFO later this year and next, dividend increases may be more likely than they appear today.

Healthcare REITs combine two of the most well-supported sectors in the market, healthcare and real estate. These sectors are supported by demographic trends, a growing need for space, and a lack of new land. These REITs are yielding 4-7%, much better than the broad market or bonds, and come with non-cyclical, real asset appeal.

The outlook for the broad market is cloudy at best and downright dismal at worst. This is no time to be invested in growth stocks, not if you are a safety-seeking income investor like me. If you are looking for a relatively safe way to make 4% on your money, get some inflation protection and diversification within your portfolio a healthcare REIT may be for you.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.