Omega Healthcare Investors (NYSE: OHI) largely owns nursing homes. That can be a tough sector even during normal times. During the coronavirus pandemic, well, it was basically at the center of the storm. But this real estate investment trust (REIT) managed to sail through 2020 without too much difficulty. How did it do that, and what should investors be watching today? Management has some important things to say on that front.
Cutting to the quick, nursing homes are purpose-built to bring older people into group settings where care is easier and more cost-effective to administer. The problem: The coronavirus spreads easily in group settings and is particularly dangerous for older adults. Pandemic-hit 2020 was a very tough year for the senior housing operators that REIT Omega Healthcare counts as tenants. Move-outs rose (this fairly neutral-sounding industry term includes deaths), move-ins fell, and costs rose as the world attempted to deal with the fallout of the health scare.
And yet Omega didn't see its business fall off to any great extent. In fact, unlike some of its peers, it was able to maintain its dividend despite the pandemic headwinds. That's largely a result of its triple net lease business model. Essentially, its lessees are responsible for most of the costs of the properties they occupy, leaving Omega to effectively just collect the rents due. That rent still had to be paid no matter what was going on at the property level.
To be fair, it was beneficial that the government stepped in to help senior housing operators. That made it easier for them to deal with the impact of the coronavirus and, thus, keep paying Omega rent. The REIT's management team is hopeful that this government largesse will continue, given that nursing home care is necessity-based and not really optional for most end customers. However, Omega has been pretty clear that it could see increased lessee problems if occupancy numbers don't pick up. At this point, there are three tenants that are having trouble making rent.
The number that counts
In Omega's second-quarter earnings conference call, management pegged occupancy in its portfolio at around 75.7%. That was an improvement from 72.3% in January. So, clearly things are getting better as 2021 progresses. That's good news.
The math here isn't complicated. The more patients in a facility, the more efficiently it can be run because costs are spread over more residents. That improves the ability of Omega's tenants to keep paying their rent and reduces the need for government handouts to keep an operator afloat. Only there's a fly in the ointment here, because Omega still isn't happy with the occupancy numbers it's seeing.
In fact, the REIT has stated that it is closely monitoring occupancy because, according to CEO Taylor Pickett, "We need occupancy to return over 80% in order to meaningfully mitigate the cash flow reductions from a pandemic." Although occupancy has picked up so far this year, with improvement in each month, there's still some issues that are slowing the progress.
Most notably, some of the company's lessees have been forced to stop taking new tenants because they can't find enough staff. That's complicated by fears around the pandemic keeping employees away from high-risk areas (like nursing homes) and the difficulty of convincing employees to get vaccinated. In other words, Omega's occupancy numbers are going in the right direction, but further improvement could be slower than hoped.
In other words, investors should be following management's lead here and paying extra attention to the occupancy levels in Omega's portfolio. Notably, when the REIT announced fourth-quarter 2019 earnings, occupancy was at 83.4%, up 1.1 percentage points over the same period of 2018. It still has a long way to go before it's anywhere near that figure, which would suggest that business had returned to normal.
Still muddling through
It is highly likely that Omega gets through the pandemic period without too much pain. The dividend doesn't yet appear to be at major risk, noting that the second-quarter payout ratio was roughly 79% of adjusted funds from operations. That's not an outlandish number and suggests there's some wiggle room if the occupancy recovery drags out a little bit. But if more tenants run into trouble, the payout ratio could get a lot more worrisome.
Still, since nursing homes are driven by necessity, demand should remain resilient. But if you own Omega or are watching it, you should follow management's lead and keep a close eye on occupancy. It is the number that will determine if the road gets bumpier or smoother in the quarters ahead.