After a shaky start to the year, investors are not cutting senior housing real estate investment trusts (REITs) any slack. But with significant ups and downs across the stock market in 2016 so far, REITs are starting to see some gains once more amid a mixed economic environment.
The big three health care REITs in particular are focused on their positions coming out of 2015, with each of them seeking to reassure investors regarding their approach to specific challenges and larger market forces.
Mixed Signals
Health care REITs saw their stock prices battered in 2015, but most had long-prepared for the cost of capital to increase at the end of the year as a result of a rising interest rate market. In December, the Federal Reserve reversed its nearly decade-long policy of keeping interest rates at zero by aiming to increase its benchmark rate 25 basis points. While most REITs were already bracing for continued hikes in 2016, recent economic data leaves room for speculation on the Central Bank’s next steps.
Despite strong job gains, near-static wage growth and inflation rates may give the Fed reason to rethink its strategy for the time being, which could give a boost to REITs.
“The [jobs] report will give the Fed pause when it meets later this month at its FOMC March 15-16 meeting,” writes Beth Mace, chief economist and director of capital markets research at the National Investment Center for the Seniors Housing & Care Industry (NIC). “The Fed has indicated that it is closely tracking current economic conditions as it makes a decision on raising interest rates further this year from its target range of 0.25% to 0.5%.”
Even if the Fed’s reverses its recent decision to start increasing interest rates, the current economic environment still presents major challenges to public companies. In a market where many senior housing businesses and REITs have seen their stock prices hammered, companies are going to get less of a break from investors, says Dan Bernstein, vice president at Capital One.
“When an operator reports lease coverages or weak growth or an operator puts out a more tepid outlook for 2016, those items are going to get heavily scrutinized and heavily penalized in this market,” Bernstein tells Senior Housing News. “Depending on what it was, it may have been given a pass three months ago or four months ago. They’re not going to get a pass on that today.”
With a higher cost of capital, REITs are also likely to slow acquisitions over the next few years.
“They’re all getting creamed on the equity side,” Brad Thomas, editor of the monthly subscription-based newsletter Forbes Real Estate Investor, tells SHN. “That’s making it difficult for any REIT to grow. They’re having to focus more on their positions.”
Big Three on the Defense
One example of this is HCP Inc. (NYSE: HCP), which saw its end-of-year earnings report dampened by the performance of its SNF portfolio—specifically, its tenant HCR ManorCare.
The REIT is underway with the process of selling 50 HCR ManorCare assets, but the results were unpleasant to the ears of investors, and its stock price fell to a 52-week low a few days after the earnings report late last month.
“All of those concerns and risks get simply heightened when the market is volatile,” Bernstein says. “When things are good, investors sometimes look past those weaknesses and risk. In this market, they won’t.”
While HCP’s less-than-stellar results were specific to its SNF portfolio, the rest of the company’s portfolio had overall positive reports. Despite investors’ initial reactions, the REIT is a Dividend Aristocrat, as part of a group of businesses that have raised dividends for 25 consecutive years, and its stock price has started to recover.
Investors may have overreacted amid greater market turmoil, but HCP’s portfolio concerns with HCR ManorCare are having a real impact, says Thomas.
“I think the company [HCP] is not going to recover overnight, and it’s going to take a while and the skilled nursing issues to turn around,” Thomas says.
Bernstein sees little concern over the skilled nursing sector at large, and again points out the importance of distinguishing the “noise” of the economic conditions and the impact of broader industry issues versus what is specific to one company.
“It comes back to [the fact] that each individual operator is going to react differently to the broader industry pressures,” Bernstein underscores.
By comparison, Welltower Inc. (NYSE: HCN) has positioned itself to be defensive against economic headwinds and higher interest rates, Thomas says.
“It appears that Welltower has been the most defensive of the bigger players out there,” he says. “They’ve really reduced their debt while HCP and Ventas Inc. (NYSE: VTR) have increased their debt. When you dig deeper into these companies, Welltower has been more defensive and is one of the few REITs that has the lowest cost of capital today on the equity and debt side.”
Welltower, by contrast to HCP, saw its end-of-year earnings jump following its earnings report, which beat estimates.
Another thorn in the side of investors this earnings season was oversupply. Ventas recently revealed roughly 30% of its senior housing operating portfolio (SHOP) is exposed to markets with oversupply pressures. However, the REIT’s strategy of only working with best-in-class operators, along with its spin-off of its SNF assets into a pure-play REIT, has set Ventas apart from its peers.
Following its earnings release for the end of the year, Ventas’ stock price dipped slightly on the oversupply news, but was more in line with the greater market. Its share price has since recovered—and then some—from the lows of 2015.
“There are some challenges and some markets with oversupply, but the argument is that these are really strong operators,” Thomas says.
Despite these heightened risks for investors and market reactions, Thomas is still bullish on the health care sector.
“I think most of these REITs are reporting strong earnings and balance sheets are in good shape,” adds Thomas. “Health care today is just an attractive opportunity.”
Written by Amy Baxter
Companies featured in this article:
Forbes Real Estate Investor, HCP Inc., NIC, Ventas Inc., Welltower Inc.
