In the long term, demographics are destiny, or so the saying goes. This is the big reason to like senior housing real estate investment trusts (REITs), given the aging of the massive baby boomer generation. However, not all senior housing sectors are the same, and one always stood out as riskier than the rest. But is it? Here's why high-yield Omega Healthcare Investors (NYSE: OHI) changed my mind about nursing homes.
It's about who pays
Although there are multiple different forms of senior housing, spanning from well care to nursing homes, there are two basic categories properties fall into: self-pay and third-party pay. It's a huge difference. Self-pay basically means that the person living in the facility, or their family, is footing the bill. Third-party pay means someone else is covering the cost.
The "someone else" can be an insurance company, but it normally means one of two government programs, Medicaid or Medicare. This is where the risk lies, because it leaves the property owner subject to the whims of politicians who can change payment policies.
This very issue was why healthcare REIT giant Ventas jettisoned its nursing home assets in the previous decade. Healthpeak did the same thing in 2016, but not before financial troubles in the sector forced a de facto dividend cut as the spinoff it created floundered.
Here's the thing: Omega Healthcare Investors, which is focused on nursing homes, got through that same period without a dividend cut. And then there was 2020 and the coronavirus pandemic.
Another strong showing
As the novel illness spread across the globe, the private-pay areas of the senior housing sector saw falling occupancy and rising costs. That left REITs focused on self-pay struggling, including Ventas, Healthpeak, and Welltower. All three eventually cut their dividends this time around, though the cut at Healthpark was related to its decision to get out of the senior housing sector altogether. Omega, meanwhile, didn't cut its dividend.
The key difference was that Omega's tenants got material financial assistance from the government to ensure nursing home residents remained safe. It now seems to me that relying on Uncle Sam for nearly 90% of your rents isn't such a bad thing after all. However, that's not the whole story either, since political whims can still change payment methodologies.
The next big issue is scale, with Omega owning around 950 properties spanning over 95,000 beds, managed by roughly 70 different operators across 41 states and the United Kingdom. Essentially, no single property, state, or operator is likely to cause a major financial hit should something change politically.
Now add in an investment-grade balance sheet, and Omega has the financial strength to deal with some headwinds when they do arise. But there's one more essential piece to this story: Entering a nursing home generally isn't a choice.
Most patients in a nursing home are there because the care they need is elevated. And while the public might be reading about the cost savings of providing in-home care, that's only true for those with less critical needs. Omega reports that more people are released from hospitals to nursing homes than any other type of care, including home care. Further, nursing homes are one of the lowest-cost options available. All in, the government is getting a bargain for care that would be difficult to provide in any other way.
Now, to be fair, Omega's ability to weather the pandemic hit without a dividend cut doesn't mean it's risk-free. Without the government assistance its lessees received, there would have been materially more financial strain here. And if this assistance gets cut, there will be financial strain, likely in the second half of 2021.
However, the REIT's management team expressed confidence during Omega's first-quarter 2021 earnings conference call that financial support for nursing home care will continue, given the critical nature of the services provided.
Time to reconsider my stance
I haven't made my mind up about buying Omega Healthcare just yet, given that I already own a senior housing-focused REIT. However, after years of simply crossing this REIT off of my list because of its nursing home focus, I've started to do some additional research. Simply put, I was wrong -- Omega is a better business than I thought.
As baby boomers continue to age, the high levels of care provided by Omega's properties will see even more demand. And unlike many other senior housing options, there are really few alternate choices for providing the care Omega's residents need in a cost-effective manner.