Ventas (VTR) and Welltower (HCN) are both healthcare REITs focused mainly on senior housing. They face similar risks and similar opportunities. This article describes ten similarities between the two and then provides 10 reasons why we believe one is more attractive than the other. We’ve also ranked the winner on our broader list of Top 5 Big-Dividend Healthcare REITS Worth Considering.
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They Are Similar Because…
1. Senior Housing Focus: As we mentioned above, both Ventas and Welltower are focused mainly on senior housing. For example, as the following graphics show, Ventas is 54% senior housing and Welltower is 70% (as a percent of net operating income).
2. Demographic Tailwinds: The fact that both companies invest largely in senior housing is important because they face some of the same long-term demographic opportunities. Specifically, as the following graphic shows, the number of people aged 85 and above is expected to grow dramatically in the coming years, and this also is expected to increase the demand for senior housing.
3. Potential oversupply of Senior Housing: In addition to the demographic-driven opportunities, there is a near-term risk of oversupply in senior housing. For example, during a conference call earlier this year, Welltower CEO, Thomas DeRosa, summed up the situation by saying:
“Yes, headlines of senior housing oversupply and the continuing saga of senior housing operators with poorly managed real estate make bad headlines.” Hower DeRosa went on to say “This is not our story.”
(Source: Welltower CEO: Occupancy Down, but Oversupply 'Not Our Story' - Senior Housing News)
Welltower has been focusing on urban senior housing locations, an area that has experienced less supply growth challenges.
Ventas CFO, Bob Probst, also commented on the potential oversupply issues in that company’s second quarter conference call by saying:
“Despite the strength in certain high barrier markets (such as California and Canada), elevated levels of new building openings in select markets constrained our portfolio growth,” Probst said. “The second quarter saw the highest number of new units coming online in recent experience, with overall deliveries of new units in our trade areas up 50% sequentially from Q1 of 2017.”
However, Ventas CEO, Debra Cafaro, went on to optimistically explain:
“We should in all events remain financially strong and liquid, maintain diversification and balance in our portfolio, continue to drive cash flow and efficiency in our enterprise, allocate capital wisely, stay nimble and opportunistic, and continue to elevate the mix and quality of our portfolio.”
Source: Ventas Optimistic Despite Oversupply Challenges - Senior Housing News
4. Regulatory Risks: Both companies operate in the same industry and face similar regulatory risks. For example, according to Ventas’ annual report:
“Regulation notably affects the operations of Ventas and its tenants. If the company does not anticipate and adapt to changes, performance could meaningfully decline.”
In particular, changes to the Affordable Care Act could impact the success of both company’s operations. Welltower describes this risk in its annual report as follows:
“The requirements of, or changes to, governmental reimbursement programs, such as Medicare or Medicaid, could have a material adverse effect on our obligors’ liquidity, financial condition and results of operations, which could adversely affect our obligors’ ability to meet their obligations to us.”
5. Private Pay: Interestingly, both companies receive 93% of their revenues from private payors. This is important because it reduces some of the direct risks of changes to government reimbursement programs. However, both companies continue to face challenges from some of their operators (more on this later).
6. Credit Ratings: Both companies have received the same credit rating from all three of the major credit rating agencies.
It’s important to note these are investment grade credit ratings, a classification many other healthcare-related organizations (for example, some of these company’s operators) are NOT able to achieve. An investment grade credit rating is an indication of higher financial safety and stability.
7. Low Betas: The common stock of both of these companies have similarly low betas. Specifically, Welltower’s beta is 0.57 and Ventas’ is 0.55. The point of sharing this information is to highlight the fact that these stocks have been less impacted by broader stock market moves than other companies (the average market beta is one). This is good for portfolio diversification reasons, and good for investors that like less risk as measured by volatility.
8. Similar Market Capitalizations: Both Ventas and Welltower are large-cap companies with market caps of $24.5 and $27.3 billion, respectively. They are among the largest of publicly traded US REITs by enterprise value (enterprise value is basically the combined value of a company’s debt and equity).
9: Similar Dividend Yields: Welltower and Ventas also offer similar dividend yields or 4.7% and 4.5%, respectively. Further still, both companies have a history of steadily increasing their dividend payments (a good thing for income-investors). We’ll have more to say about the sustainability and safety of these dividend payments later.
10: Similar Price Performance: Finally, both companies have experienced similar price performance in recent years as shown in the following chart.
Worth noting, the REIT sector, in general, has underperformed the rest of the market (as measured by the S&P 500) in recent years as fears of rising interest rate expectations have driven investors to favor other market sectors that are perceived to be more “pro-growth” and less sensitive to interest rates. In our view, this has created an attractive contrarian opportunity to invest in REITs (i.e. buy low, not high), especially since we believe interest rates will remain low for longer and because both Ventas and Welltower have the financial wherewithal to easily support their debts as evidenced by their strong investment grade credit ratings and powerful long-term growth potential.
Ventas is Better Because…
In our view, Ventas in the more attractive of these two REITs for the following reasons.
1. Less Senior Housing/More Diversification: One reason we like Ventas more than Welltower is because of its diversification. Specifically, Ventas is less exposed to the risk of near-term oversupply in senior housing. As shown in our earlier chart, Ventas has diversified more heavily into other types of real estate such as Medical Office Buildings and Life Science properties. In our view, this makes Ventas less risky.
2. Less Skilled Nursing: Another reason we like Ventas more than Welltower is because Ventas has wisely moved away from Skilled Nursing Facilities, perhaps the most sensitive healthcare real estate area relative to regulatory reform and public reimbursement. Specifically, the federal government has been putting significant pressure on skilled nursing facilities to reduce costs, and Welltower must face more of this challenging uphill battle because its exposure is 13% of its portfolio versus only 1% for Ventas. This is also an indication of Ventas' quality management team (more on this later).
3. Less Operator Concentration: As we’ll see in detail in the next section, Welltower has more operator concentration risk. Specifically, Welltower’s three largest operators make up 35% of the company’s net operating income, whereas that figure is only 22.8% for Ventas. We view higher concentration for Welltower as an indication of higher risk (particularly considering the financial condition of those operators, more on this in the next section). Worth noting, Ventas has a significant exposure “senior living operations,” which is managed by Altria and Sunrise (for a fee), however, that pool of operations is diversified across 266 seniors housing communities.
4. Less Risky Operator Risk: Both Ventas and Welltower face a variety of specific operator risks, however, we believe Welltower’s risk is greater. For example, for the year ended December 31, 2016, Welltower’s lease with Genesis accounted for approximately 8% of the company’s total revenues and 16% of net operating income.
This is a particularly large exposure not only because it represents 8% of total revenues (and 16% of NOI), but also because Genesis is basically in distress. For example, Genesis has seen its stock price decline 87% since the start of 2015, and its net income is consistently negative. Welltower notes this risk in its annual report as follows:
“We depend on Genesis Healthcare, LLC (“Genesis”) and Brookdale Senior Living for a significant portion of our revenues and any inability or unwillingness by Genesis and Brookdale Senior Living to satisfy their obligations under their agreements with us could adversely affect us.”
Similarly, Brookdale stock has fallen 68% since the start of 2015, and its net income is also consistently negative. Both Ventas and Welltower have exposure to Brookdale (Ventas’ exposure concentration table is below). However, in aggregate, we view Ventas’ operator exposure to be less risky because of the specific operators and because of its dividend coverage ratios (more on dividend safety later).
5. More Non-US diversification: We also like that Ventas has slightly more diversified non-US exposure. And while this exposure increases some risks (such as currency and regulatory risks) we appreciate the diversification benefits, and the fact that Ventas is a step ahead of Welltower for new non-US opportunities as they arise (more on Ventas’ management later). Specifically, Ventas NOI is 84% US, 8.2% UK, and 7.8% Canada, whereas the same exposures for Welltower are 88.5%, 0% and 11.5%, respectively.
6. More Triple Net Leases: A triple net lease basically means the tenant (not the owner) is responsible for paying rent, taxes and most maintenance/insurance expenses. We like that Ventas’ properties are 39% triple net leases and Welltower’s are only 27.7%. We view this as an advantage for Ventas.
7. Valuation (Price to 2017 Expected Normalized FFO): From a valuation standpoint, Ventas is more attractive, in our view, because of its lower price to 2017 expected normalized FFO ratio of 16.3x versus 17.1x for Welltower. FFO is funds from operations, and it is a common valuation metric for REITs.
8. Dividend Safety (Payout Ratio): We also like that Ventas has a lower normalized FFO payout ratio (73%) than Welltower (82%). We view this as a sign of dividend safety because it signals that Ventas is less likely to be required to cut its dividend, and more likely able to increase its dividend in the future. Both companies have a long track record of increasing the dividend (i.e. the dividend is fairly safe for both companies).
9. Financial Safety (Fixed Charge Coverage): We also like that Ventas has a higher fixed charge coverage ratio (4.6x) than Welltower (3.7x). This is another indication of financial strength and safety. We give Ventas the clear edge in this category.
10. More Forward Thinking Management: In the management category, we give Ventas the edge because of its track record of being forward thinking. For example, Ventas wisely dumped almost all of its skilled nursing facilities (1% exposure) while Welltower still has a significant exposure (roughly 13%) (remember, Skilled Nursing is facing intense spending pressure from the government regulators).
Also worth noting in the management category, we appreciate that Ventas has been able to maintain more conservative dividend coverage and fixed cost coverage ratios than Welltower.
Conclusion:
At the end of the day, we believe both Ventas and Welltower are attractive investments for conservative income-focused investors, but we give the slight edge to Ventas for the reasons described above. In fact, we have ranked Ventas No. 3 and Welltower No. 4 on our recent members-only report: Top 5 Big-Dividend Health Care REITs Worth Considering. Specifically, both Ventas and Welltower are attractive blue-chip healthcare REITs with relatively safe dividends and the potential for healthy long-term growth. They both may face some near-term challenges due to the potential oversupply of senior housing as well as the possibility of more financial troubles for their operators. However, over the long term, both are attractive, in our view, because they are well run and have powerful demographics on their side.
Article by Blue Harbinger
