Seeking Alpha

The Outlook For These 3 REITs Is Promising

Includes: HCP, VTR, WELL
by: Mark Roussin

Healthcare REITs have outpaced the market by 8% year-to-date and have historically been a defensive investment.

WELL, VTR, and HCP are three of the top players in the industry with reliance in Senior Housing and Medical Office Buildings.

All three of these REITs lack large exposure to Skilled Nursing Facilities, which is an area I particularly do not prefer do to reliance on the government.

As many of you are well aware, cracks in this historic bull run are beginning to show. A trade war with China looms over what has been the strongest economic recovery in history. Based on increased tensions between the two largest economies in the world, US consumer sentiment fell to 89.8 in August, from 98.4 in July, good for the largest monthly drop since 2012.

As I have been discussing, the amount of uncertainty in the back half of the year continues to grow. Aside from the ongoing trade war, the European Union economy has been struggling, the UK cannot seem to come to a conclusion when it comes to Brexit, and then there is the nuclear threat from North Korea and Iran.

Mounting uncertainty tends to lead to volatility, which is where we find ourselves now. In the month of August alone, we saw 15 days of 100+ point sways in the Dow Jones Industrial. Unfortunately, the volatility is here to stay for the time being and to add onto that, September is historically the worst trading month of the year. Since 1937, the average September performance for the S&P 500 and Dow Jones Industrial Average is a 1% decline. This is not welcomed news to investors considering we are coming off the worst August performance since 2015.

Looking at the glass half full, the past 15 times the S&P 500 declined in August, the remainder of the year saw positive returns every single time. With that being said, September could be rough, but as history indicates, we could find ourselves in better shape to close the year.

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Based on the economic uncertainty I touched on above combined with the bond markets flashing recession indicators, it is important for investors to properly align their investments with high-quality dividend paying stocks, preferably REITs.

Today I will touch on three Healthcare REITs, which have promising futures, regardless of the economic backdrop. These three REITs would fit the bill in terms of high-quality dividend stocks.

Healthcare has long been a defensive sector for many investors over the years, as it is an industry that is always in need. Healthcare REITs comprise of roughly 15% of the broad-based Real Estate ETFs (VNQ and IYR), which are both up 23% year-to-date. The Long-Term Care ETF (OLD) is a pure play Healthcare REIT ETF that has outpaced the market by 6% this year, up 22% year-to-date.

Here is a look at the three Healthcare REITs I will discuss today.

As I mentioned above, the Healthcare REIT sector has been on a solid run in 2019, and these three REITs have led the charge. Here is a quick snapshot of their performance over the past few years compared with the S&P 500 SPDR ETF (SPY) and the Long-Term Care ETF (OLD).

There is a lot to like within the healthcare sector, especially as the aging US population continues to grow. Healthcare tenants tend to sign long-term leases and have low turnover providing stable and predictable income streams over time. In a recent Ventas (VTR) earnings call, CEO Debra Cafaro mentioned the silver wave of the over 75 population experiencing a net gain of 70 million individuals between 2020 and 2035. According to Forbes, about 10,000 baby boomers are turning 65 per day.

In addition to an increasing older population, supply has begun to level out as senior housing starts have slowed to a 5-year low, which is a great sign for the future. With a boom in senior housing over the course of the last few years, it has really had an adverse impact on many healthcare companies within the sector, thus the mere 5.6% return from Ventas over the course of the last 48 months.

3 Healthcare REITs With A Promising Outlook

Healthcare REIT #1 – Welltower Inc. (WELL)

To begin, let’s start with the largest healthcare REIT in the industry, Welltower Inc. The company was actually founded in 1970 as the two founders, Bruce Thompson and Fritz Wolfe owned two skilled nursing facilities worth $800,000. The company incorporated as a REIT in 1985 and later changed its name to Welltower in 2015. Fast forward to Q2 2019, and the company now owns 1,711 properties. The properties reside in the United States, Canada, and the United Kingdom.

Like Ventas, which we will discuss next, Welltower took a similar approach after the last recession in which they shed their exposure to skilled nursing. Personally, I am not a huge fan of the skilled nursing sector, as it puts more of a reliance on the government, which is never something I prefer.

According to Welltower management, who happens to be the most direct play on Senior Housing, they expect Senior Housing demand to soar by 92,000 units per year, by 2025.

As I alluded to above, the senior housing space has been contending with challenging operating conditions over the last four years due to excess new supply. However, the outlook for those in this space, particular the major players like Welltower, have seen construction starts decline of late.

As of Q2 2019, the company’s Senior Housing Operating Portfolio (SHOP) accounted for 50% of same-store NOI performance. This area of the business is key to the company’s success but is an area of the business that has been a major headwind, and a key concern for investors.

The tailwind, which has been well covered in the space for some time has been the growth in the senior age group. Here is an interest chart from Welltower’s investor day presentation giving you an idea on how the 85+ age group is growing, primarily due to the baby boomers coming of age.

Source: Welltower Investor Day Presentation

And when populations of seniors grow, that leads to higher health care spending.

Source: Welltower Investor Day Presentation

Here is a look at the company’s FAST Graphs chart:

Source: FAST Graphs

As you can see in the Fast Graphs chart above, the stock has been on quite the run of late and is well above their average trend line over the course of the last five years. Though the outlook appears promising, the stock seems a little rich and needs to remain on your watch list.

Over the course of the last five years, WELL has traded at an average P/FFO of 15.7x, and currently trades at a P/FFO multiple of 21.7x, suggesting the stock is overvalued.

In terms of dividends, the stock yields 3.88%, growing at average rate of roughly 3% during this stretch, and has paid uninterrupted dividends for an impressive 193 consecutive quarters.

The message has been clear in 2019 regarding the slowing in senior housing construction starts, which is what has fueled these stocks YTD performance. Welltower is a well-run company with a promising outlook, but that does not equate to a buy rating at this time. If you currently own the stock I think a hold here would be fine, unless it’s a rather large holding of yours, taking a little off the top I would not be opposed to either. The company continues to make strategic acquisitions to enhance their high-quality portfolio, all while providing a strong and stable dividend, making this defensive play a great stock to own….at the right price.

Healthcare REIT #2 – Ventas, Inc. (VTR)

Next, I will move to Ventas, which happens to be the second largest Healthcare REIT in the industry. Similar to Welltower, Ventas management lessoned their exposure to Skilled Nursing after the last recession and now own only 17 Skilled Nursing related properties. The company’s main focus is on Senior Housing Operating Properties, or SHOP. As of Q2 2019, Ventas owned 1,192 properties, of which they separate into three business models: Senior Housing – Operating, Triple-Net, and Office. Of the 1,192 properties, 60% are Senior Housing related properties.

However, though I prefer the Senior Housing properties this is what has been a headwind for the company over the past four years due to the heavy dose of new inventory entering the market, which has led to an oversupply. Management believes the economics are beginning to turn, in a recent quarterly earnings call, company management stated that senior living starts had reached a five-year low, which bodes well for the company going forward.

As you can see from the company’s latest quarterly report, Senior Housing is still lagging the rest of the portfolio.

Source: Q2 VTR Supplemental Information

In terms of the balance sheet, the company has no major debt due until 2022 with only 14% of total debt due by the end of 2021. Properly managing the balance sheet allows business to invest back into the company providing future growth opportunities in the years to come, which is exactly what VTR management has been able to do over the years.

The company’s net debt to EBITDA ratio through the first half of 2019 was 5.5x, which compares favorably with many of the top REITs that are publicly traded. Here is a look at how VTR’s financial strength compares with many of the top rate REITs on the market today.

Source: VTR 2019 Investor Day

I really like the prospects of Ventas moving forward in 2019, due to the fact they have a high-quality portfolio made up of properties in premiere locations with high-barrier of entry. In addition, CEO Debra Cafaro and her leadership team are highly competent and continue to focus on growing long-term shareholder wealth through timely investments, increased dividends, and responsible management of the balance sheet. As supply levels for senior living began to plateau, we expect a bright future for Ventas.

Here is a look at the company’s Fast Graph chart:

Source: FAST Graphs

As you can see in the chart above, the stock appears to be trading above its recent average P/FFO trend line. Over the course of the past last five years, VTR has traded at an average P/FFO of 14.3x, and currently trades at a P/FFO of 18.7x, suggesting the stock is currently overvalued.

In terms of the dividend, the stock currently sports a dividend yield of 4.3%. Looking over the course of the last five-years, the stock has averaged a dividend yield of 4.6%, again suggesting the stock may be overvalued.

The industry has been performing quite well as many see the senior housing play improving, but as the stock trades right now, I would recommend a hold and keeping VTR on your watch list for a better opportunity. There is no doubt the company has a promising outlook.

Healthcare REIT #3 – HCP, Inc. (HCP)

The final healthcare REIT we will discuss today is HCP, which sports a market cap of roughly $17 billion, making it one of the largest in its industry.

Similar to the other healthcare REITs I have discussed above, HCP invests in senior housing facilities, medical office, and life science buildings. Where HCP differs is the fact that their largest segment for a number of years has been medical office buildings, followed by senior housing facilities and life science buildings.

However, as of June 30, 2019, senior housing took the top spot in terms of portfolio income, as these properties accounted for 32% of the portfolio income followed by medical office buildings accounting for 31%.

Source: HCP Q2 Investor Presentation

At the end of Q2 2019, HCP's real estate portfolio consisted of 745 with a total invested value of $17.3 billion.

Here is a look at the portfolio summary.

Source: HCP Q2 Investor Presentation

The intriguing part of the HCP portfolio is their focus on medical office buildings, or MOB’s. This day in age, in order to properly control costs within the healthcare sector, many professionals have moved more from an inpatient option to an outpatient option. What this has done has driven the MOB market higher, and we have seen more and more healthcare REITs revamping their commitment to MOB’s.

The intriguing part of medical office buildings is the fact they tend to be more recession-proof in a way. When compared to the senior housing sector, MOB’s tend to be more predictable as we do not see volatile swings in occupancy, which can lead to changes in operating income as well. MOB operations are more fluid and stable due to long-term leases. JLL, who posted an article discussing the outlook of the healthcare industry, discussed the four leading factors for MOB’s: stable long-term occupancy rates and steady price performance with less volatility, consistent cap rate spreads of 2% or greater in the last five years, a higher quality and longer-staying tenant base, and a well-paced new construction pipeline alongside strong demand.

Taking a quick look at the company’s balance sheet, they do not have many debt concerns at the moment as only 14% of total debt is due within the next three years. The company’s net debt to EBITDA ratio at Q2 2019 was 5.7x, which compares favorably with many of the top REITs that are publicly traded.

Source: FAST Graphs

Similar to our other healthcare REITs above, HCP is also trading at a premium due to the buzz around the industry and REITs in general right now. Over the course of the past five years, HCP has traded at a P/FFO multiple of 12.5x, however, right now it trades at a multiple of 19.6x, suggesting the stock is overvalued. I suggest for my followers to wait on a better opportunity and for FFO growth to return consistently.

Investor Takeaway

Overall, healthcare REITs have always been a defensive play for investors as they offer high-yields in in a stable sector. The healthcare REITs we discussed today are three of the tops around, and they are all heavily involved in senior housing, which is a space I particularly like moving forward. This has been a headwind in years past due to the oversupply that hit the market, but the tide is turning, hence the run up in healthcare REITs of late.

Healthcare REITs, and REITs in general have seen their equity values rise of late due to concerns about the global economy and the economy here within the US. REITs, healthcare REITs in particular, have investors looming for yield.

However, as I mentioned above, the three names I discussed today all have promising outlooks, but their current trading levels are a bit rich. I think a pullback is warranted before we look to add or initiate a position in these names but keep them high on your watch list.

Note: I hope you all enjoyed the article and found it informative. As always, I look forward to reading and responding to your comments below and feel free to leave any feedback. Happy Investing!

Author’s Disclaimer: This article is intended to provide information to interested parties. I have no knowledge of your individual goals as an investor, and I ask that you complete your own due diligence before purchasing any stocks mentioned or recommended.

Disclosure: I am/we are long 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.