Thanks to the coronavirus pandemic, healthcare real estate investment trusts (REITs) have broadly broken into two camps, those with senior housing assets and those without. In fact, industry giant Healthpeak (NYSE: PEAK) has specifically decided to jettison its struggling senior housing business in favor of office and research properties. But investors shouldn't give up on REITs with senior housing assets. Here's why.
As people age, they need more healthcare of all forms. That's the basic logic behind the healthcare REIT thesis. However, there are all sorts of properties that tie into this story, including medical research facilities, medical office buildings, hospitals, and various forms of senior housing. There are slightly different dynamics to each, but during the 2020 coronavirus pandemic, senior housing was the one that got hit the worst.
That makes sense when you think about it. Senior housing is specifically designed to bring older people into a group setting where it will be easier to provide care. Unfortunately, the coronavirus is particularly dangerous for older adults and spreads easily in group settings. It ripped through the senior housing industry, increasing the number of move-outs (an industry term that includes deaths), limited move-ins, and reduced the ability to court potential new customers as properties went into lockdown mode to slow the spread of the novel illness. Meanwhile, operating costs were on the rise as enhanced cleaning regimens took hold.
There's no way to sugarcoat the issue, it was really bad last year. To put a number on it, Ventas' (NYSE: VTR) full-year 2020 normalized funds from operations (FFO) fell nearly 14%. The vast majority of the hit came from senior housing assets that fall into the company's SHOP assets (about 30% of its portfolio). That's industry lingo that stands for senior housing operating portfolio, which means Ventas both owns and operates the assets (it actually hires operators). In turn, the performance of the properties flows through to Ventas' top and bottom lines. Just how bad was it? In the fourth quarter, Ventas' SHOP portfolio witnessed a nearly 25% decline in net operating income. This wasn't unique, however; the entire senior housing industry was hit very hard.
As noted above, Healthpeak has decided to dump out of this healthcare niche in favor of more growth-oriented sectors like office and medical research (both of which held up well in 2020). Unfortunately, senior housing assets aren't properties that people want to go to -- they move into them out of necessity. In fact, the U.S. government, realizing the importance of the sector, has been providing specifically targeted help to senior housing during the pandemic. And despite the waning impact of the coronavirus in the United States, Omega Healthcare Investors (NYSE: OHI), which is focused on nursing homes, is confident that government assistance will continue until the industry starts to strengthen some more. Simply put, the U.S. can't afford to have the senior housing industry collapse.
This brings up the longer-term picture: If people don't move into senior housing because they want to, then what is demand driven by? The answer is demographics, and it's very favorable.
For example, the 65+ age cohort in the United States is projected to expand from 17% of the population in 2020 to 22% in 2040. That is an increase of around 24 million people. The 80+ population, where medical needs start to become more material, is expected to increase from 13 million in 2020 to 20 million in 2030. So the need is really pretty immediate, not off in some distant future.
On the opposite side of the equation is supply. Before the pandemic hit, there was a building boom that led to oversupply conditions. Construction had already been pulling back, and it got even worse during the pandemic when demand fell. But supply and demand are always moving. Construction starts for new senior housing assets have fallen 77% from their peak in 2017. In other words, while the pandemic upended the industry in the near term, the long-term picture is actually pretty bright, with limited new supply and the high likelihood of need-based demand starting to pick up in the next few years. And that demand is expected to last for decades.
With that backdrop, there's a reason to wonder if Healthpeak made the right call by getting out of senior housing. Ventas, Omega, and Welltower among others, have remained committed, with their eyes firmly fixed on the long-term prize. That's not to suggest things aren't bad in senior housing today, because they are. But this fact doesn't alter the demographics that are set to unfold in the years ahead.
Worth a second look
If you've been avoiding senior housing-focused REITs because of the pandemic, you might want to go back and have a second look. Yes, Welltower and Ventas (among others) cut their dividends last year, but the future for senior housing is likely to be brighter than many people think given the demand and supply fundamentals in the industry. And now that there are effective vaccines being deployed against the coronavirus, the long-term opportunity for senior housing is likely to start taking center stage again very soon.