Health Care REITs Crash: Is This a Buying Opportunity?

Real estate investment trusts, or REITs, are prized by their investors because they pay high dividend yields. REITs manage real estate properties and collect rents from tenants. REITs are generally regarded as steady dividend payers. But this does not mean that REITs are not susceptible to market volatility.
Since the beginning of the year, health care REITs – including Welltower (NYSE: HCN) and HCP Inc. (NYSE: HCP) – have sold off considerably. This may spook potential investors, but it could be that the sell-off has created a buying opportunity, as these stocks now sport high dividend yields not seen in several years.

Changing Demographics: A Long-Term Tailwind

Perhaps the biggest reason to favor the health care REITs like Welltower (formerly known as Health Care REIT) and HCP is because of the changing demographics. The United States is an aging population. In fact, the baby boomers – those born roughly between 1946 and 1964 – are the single largest generation in the United States. In fact, baby boomers alone constitute about one-third of the U.S. adult population.
The numbers involved are staggering. According to the U.S. Census Bureau, the 65-and-older population is set to more than double between 2012 and 2050, to more than 83 million. As these individuals age, and due to the fact that people are living longer than ever before, it is expected that health care will continue to be one of the fastest-growing sectors of the economy.

HCP and Welltower: Growth and Income

Both HCP and Welltower should grow alongside this trend because they have diversified, high-quality portfolios. Welltower has a high-quality tenant portfolio. It enjoys occupancy rates of 85% or higher across its portfolio. Welltower grew its funds from operation, a measure more commonly used to analyze REITs than GAAP earnings per share, by 8% last quarter. FFO reached $1.12 per share, which set a record for the company. For the full year, the company expects 5% to 6% FFO growth versus 2014. Similarly, HCP grew its adjusted FFO by 4% to $3.16 per share in 2015.
With their steadily rising profits, these stocks pay very attractive dividends to shareholders. This is one of the advantages of investing in REITs, as they are required to distribute 90% of their taxable income to shareholders in order to retain their tax-advantaged status.
HCP has increased its dividend for 31 years in a row, including its recent 2% raise. This makes it an S&P 500 Dividend Aristocrat, and the only REIT on the Dividend Aristocrat list. Meanwhile, Welltower just raised its dividend by 4%. It has now paid 179 consecutive quarterly dividends without interruption, an incredible streak spanning nearly 45 years.

Risks to Consider

For REITs, the biggest risk moving forward is rising interest rates. Higher rates would be a headwind for REITs, because they heavily utilize debt to finance purchases of new properties. Fortunately, even if rates do rise, the Fed is likely to take a very gradual approach. This will give the REITs more than enough time to prepare themselves. And, their debt looks manageable. Welltower’s interest coverage ratio is more than 4.7 times.
HCP has its own unique risk as its major tenant ManorCare is under investigation by the Department of Justice. Last year, ManorCare was charged with submitting false Medicare claims for services that, according to the DoJ, should not have been reimbursed because they were either not covered by the skilled nursing benefit or were not medically necessary.
Investors are panicking because ManorCare is HCP’s largest tenant and by itself represents approximately 23% of revenue. HCP took an impairment charge in excess of $800 million in the fourth quarter, which clearly spooked investors.
But HCP has taken steps to raise capital to withstand financial penalties. Last year, HCP sold 50 HCR ManorCare non-strategic assets with expected proceeds of $350 million. HCP also entered into an $847 million acquisition with Brookdale Senior Living (NYSE: BKD), of private-pay senior housing, to reduce its reliance on ManorCare.

Opportunity in Health Care REITs

The key takeaway for investors is that while the health care REITs have gotten caught up in the overall market sell-off, this seems to have opened up a nice buying opportunity. Welltower and HCP currently yield 6% and 8%, respectively, which are very attractive yields in this low interest rate environment.
HCP has its own unique risk from the Manorcare situation, and REITs in general are susceptible to higher interest rates, but income investors should feel at least somewhat reassured by their long track records of paying and raising dividends. Assuming they continue to pay their dividends, investors may look back at this and wish they had taken advantage.
DISCLOSURE: Bob Ciura personally owns shares of Welltower and HCP.