(Published Feb. 14 by Bob Ciura)
Real Estate Investment Trusts, or REITs, are a favored asset class for income investors. There is good reason for this since REITs are required to distribute 90% of their taxable income to shareholders.
This typically results in high dividend yields across the REIT space.
Welltower (HCN, Financial) is a REIT specializing in health care properties such as seniors housing and post-acute communities and outpatient medical properties.
On Jan. 26, the company raised its dividend by 1%. The upcoming payment will mark Welltower’s 183rd consecutive dividend.
Welltower is a Dividend Achiever, a group of 272 stocks with 10-plus years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
After the dividend increase, Welltower’s forward yield rose to 5.3%.
Business overview
Welltower owns more than 1,400 properties in the U.S., Canada and the U.K.
Source: Third Quarter Earnings Presentation, page 17
Among geographic regions, Welltower has placed the following investments:
- U.S. (76% of Gross Real Estate Investments).
- Canada (13% of Gross Real Estate Investments).
- U.K. (11% of Gross Real Estate Investments).
The company’s focus is on high barrier-to-entry markets such as urban areas and large cities. These markets tend to offer larger populations and pricing power, thanks to favorable supply-and-demand characteristics.
The company holds this emphasis across its Canada and U.K. operations as well.
Source: Third Quarter Earnings Presentation, page 20
Source:Ă‚ Third Quarter Earnings Presentation, page 19
These types of properties are the focus of the company’s investment. For example, Welltower placed gross investment of $1.2 billion in the third quarter alone.
One of the company’s properties currently under development that epitomizes this focus is Welltower’s Midtown Manhattan development, set to open in 2019.
Manhattan is an attractive location for Welltower because it has high population density and an underserved market. The company states Manhattan has five times less availability of assisted living facilities compared with the national average.
Welltower is highly profitable. The company generated $3.45 per share in funds from operation, or FFO, over the first nine months of 2016.
REITs typically report financial results in terms of FFO rather than traditional earnings per share. The reason is because earnings per share are usually low for REITs, sometimes even in negative territory.
That is because REITs incur significant noncash expenses like depreciation, which depress GAAP metrics like earnings per share.
As a result, FFO is commonly viewed as a better gauge of the cash generation of a REIT.
Welltower increased FFO by 6.2% over the first three quarters of the year.
For 2016, Welltower expects FFO in a range of $4.50 to $4.56 per diluted share, which would represent a 3% to 4% increase from 2015.
Growth prospects
Welltower operates in an industry expected to enjoy robust economic tailwinds going forward. Health care is an attractive area of real estate right now. This is driven by demographics.
The U.S. is an aging population. The baby boomers are among the largest generational groups in the U.S., with thousands of people entering retirement every day.
The 85-plus population is set to double over the next 20 years. This is likely to drive long-term increases in demand for health care properties.
It will also drive major increases in U.S. health care spending.
Source: Third Quarter Earnings Presentation, page 10
Secondly, Welltower’s future growth will benefit from the company’s major restructuring. Toward the end of 2016, the company launched a significant divestment of mostly long-term, post-acute care properties.
At the end of the third quarter, the company raised its disposition guidance for 2016, from $1.3 billion to $4.1 billion.
The strategy behind these moves is to reposition the company’s property portfolio toward private-pay facilities.
Going forward, approximately 92.4% of Welltower’s annual revenue will come from private-pay sources, up from 89.4% before the portfolio transformation.
Source: Third Quarter Earnings Presentation, page 13
It will also reduce Welltower’s concentration of long-term and post-acute care properties to 13.5% from 19.9%. The main goal of this is to increasingly focus on lower-cost settings.
The other purpose for the portfolio restructuring is to improve the company’s balance sheet. Since REITs rely heavily on debt, it is important to remain financially healthy, especially if interest rates are set to rise further in 2017.
Dividend analysis
After the first round of divestments, Welltower announced it had received a credit rating upgrade from Standard & Poor’s to BBB+.
Source: Third Quarter Earnings Presentation, page 29
Welltower has a balanced debt profile with an average weighted maturity of over seven years. Its total debt payments are between $839 million and $1 billion each year until 2021.
The company has made major efforts to improve its debt position over the last several years. This will help improve the sustainability of Welltower’s dividend over the long run.
Welltower has paid and steadily increased its dividend for more than four decades.
Source: Third Quarter Earnings Presentation, page 32
The dividend is sufficiently covered by cash flow. Over the first nine months of 2016, Welltower carried a 75% payout ratio.
Its manageable payout ratio gave the company enough flexibility to raise its dividend again for 2017.
Going forward, investors should reasonably expect dividend growth to mirror annual FFO growth. A good baseline of expectations would be for the company to increase FFO at a 3% to 6% annual rate, and the dividend increases will likely follow suit.
Final thoughts
Welltower, as a REIT, faces the challenge of higher interest rates going forward. Higher financing costs will raise the company’s cost of capital.
The company’s strong portfolio and future growth prospects should outweigh interest rate risk.
Investors likely own Welltower for its above-average dividend yield and annual dividend hikes. Even though the company’s 2017 dividend increase was just 1%, these qualities remain intact.
Future dividend increases could reaccelerate to Welltower’s historical average, once its portfolio transformation takes full effect.
With a 5.3% dividend yield, Welltower remains an attractive high-yield health care REIT.
Disclosure: I am not long any of the stocks mentioned in this article.
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