Contributed by: Matt Mattox – EVP/Partner
Ups and downs are becoming the norm for healthcare REIT stocks lately. The “Big 3” publicly traded healthcare REITs – Ventas (VTR), Welltower fka Healthcare REIT (HCN), and HCP – have a combined market cap of roughly $60 billion. Obviously, they have historically been a big driver of transaction volume in the world of healthcare real estate assets, primarily hospitals, MOB’s, senior living communities, skilled nursing facilities, ambulatory surgery centers, and other post-acute facilities.
As healthcare real estate remained largely unscathed through the last recession and as interest rates have remained at historically low levels, the healthcare REITs had a fantastic run from 2009 through 2014 with some normal peaks and valleys along the way. Healthcare REIT dividends in the face of a global pursuit for risk-adjusted yield were very attractive, and this led to higher stock prices which led to more capital raising which led to more buying and so on.
Enter 2015 and the “promise” of rate hikes by the Fed and then the realization of a quarter point hike in November of 2015. The graph below depicts the Big 3 as compared to the S&P 500 (in red). Higher rates not only lead to higher borrowing costs but can also interrupt/reverse the cascade of events noted in the previous paragraph causing investors to head for the exits in anticipation of a “correction” in these stock prices. Note, however, the rebound after the realization that long-term rates did not materially increase after the Fed hike. While we don’t turn a blind-eye to the short-term rates in real estate, it’s long-term rates that really drive asset values.
Then, in February, HCP announces a significant downward revision in future FFO (Funds From Operations) largely stemming from its exposure to HCR ManorCare, a skilled nursing operator embroiled in a federal investigation for Medicare fraud, and to the government-pay-dependent skilled nursing sector in general. In 2015, HCP generated 23% of its revenue from HCR ManorCare alone. The market was further spooked that month when Brookdale (NYSE: BKD), the nation’s largest owner/operator of senior living communities, missed on 4th quarter earnings and lowered guidance for 2016 (BKD also operates 7.3% of HCN’s senior living portfolio). Fair or not, these events cast a pall over several healthcare REITs as many have a significant exposure to senior living assets, and investor sentiment was that the entire senior living industry was going the way of BKD. We feel the reaction was knee-jerk in nature, and while HCP has continued to struggle, VTR and HCN have rebounded nicely. All told, we expect the healthcare REITs to continue the rebound, especially as the (world) economy remains uncertain and long-term rates remain low. We do, however, expect greater discernment in their buying habits, favoring newer assets and better credit going forward.