It was a terrible year for senior housing in 2020, and the real estate investment trusts (REITs) that invest in the space are happy it's over. Only "terrible" is probably an understatement, and the problems of 2020 aren't in the rearview mirror just yet. But that could be opening up an opportunity for long-term investors looking at the sector. Are industry-leading landlords like Welltower (NYSE: WELL) and Ventas (NYSE: VTR) the way to go? Here's what you need to know.
A big focus
Senior housing made up roughly 65% of Welltower's net operating income (NOI) in the third quarter of 2020. That number was about 75% at Ventas. For comparison, similarly large and diversified peer Healthpeak (NYSE: PEAK) only generated around 25% of its NOI from senior housing in the third quarter last year. Although both Welltower and Ventas have other healthcare property types in their portfolios, senior housing is the driving factor right now.
That's not great news, given the pandemic. Indeed, older adults are more at risk from the coronavirus, and it spreads most easily in group settings. So REITs that own a lot of senior housing are basically right in the center of the storm. To put some numbers on that, Ventas' NOI fell just shy of 18% year over year in the third quarter of 2020. The drop was roughly 12% at Welltower.
But the story gets worse when you dig into the numbers a little more. Both of these REITs have net lease senior housing assets rented out to others, as well as facilities they own and operate (they actually hire third parties to handle the day-to-day business), known as senior housing operated portfolios, or SHOP in industry lingo.
Welltower's SHOP portfolio saw a 27% NOI drop in the third quarter last year. Ventas saw a 42% drop, but the numbers are kind of hard to read for this REIT because it's been switching properties from the net lease segment to the SHOP business in an attempt to help senior housing operators weather the pandemic.
But it's very safe to say that Ventas' SHOP portfolio isn't performing well. Roughly 38% of Welltower's portfolio falls into the SHOP category, with Ventas currently estimating that nearly 30% of its annualized NOI is in the segment. (Given the environment and the resultant changes in the REIT's portfolio, that's probably something of a moving target.)
Where to from here?
The key takeaway is that Welltower and Ventas are struggling. This helps explain why their stocks are still down 28% and 22% from their early 2020 highs, respectively.
And the troubles aren't over yet, given that the rollout of coronavirus vaccines hasn't been as smooth as hoped and it will likely be several more quarters before there's a material impact on the direction of the pandemic. The headwinds are so notable that Ventas cut its dividend by 43% in 2020, with Welltower enacting a roughly 30% cut.
After the dividend cut, Ventas' third quarter normalized funds from operations (FFO) payout ratio was roughly 60%. Welltower's normalized FFO payout ratio was about 73%. They both gave themselves some leeway to deal with further headwinds, but Ventas appears to have just a bit more room. That's important, since the pandemic is far from over, with coronavirus cases on the rise again.
Now add to this the fact that Ventas has been working to grow its medical office and medical research exposure, two of the hottest segments in the healthcare space. The REIT estimates nearly a third of its annualized NOI comes from these property types. Most of the rest of Welltower's business is hospitals, nursing homes, and outpatient facilities. It's not that these are bad assets, per se, but they haven't seen the same level of market demand as office and research assets in recent years.
In fact, it's these property types that have allowed peer Healthpeak to post positive NOI growth despite senior housing headwinds, given nearly 70% of its portfolio is in these segments. So Ventas' diversification into office and medical research is a notable second positive factor when comparing it to Welltower.
In the grand scheme of things, Ventas looks better-positioned to muddle through the current pandemic headwinds than Welltower. So investors looking to buy a senior housing-heavy healthcare REIT would probably be better off with Ventas, given it has at least some exposure to healthcare segments in demand right now and a lower payout ratio.
That said, peer Healthpeak is probably the best-positioned of the large diversified healthcare REITs, given its relatively light exposure to the troubled senior housing niche and material exposure to in-demand segments. So, in the end, neither Ventas nor Welltower may actually be the winners here.