Health Care REIT: Slow and Steady Wins the Race


Health Care REIT (HCN) released its second-quarter earnings this week, and the results were broadly good. Funds from operations (FFO) came in at $1.09 per share, beating consensus estimates by a penny. HCN also reaffirmed its guidance for the full year, estimating that FFO will come in between $4.25-$4.35. That amounts to growth of 3%-5% over last year. Not amazing, but well above the inflation rate and certainly not shabby for a conservative health care REIT.


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At the property level, the results were also broadly good. Same store net operating income (NOI) rose 3.2% year over year, and for the full year HCN’s management expects same-store NOI growth of 3.0%-3.5%.

All told, a very solid quarter. So, is HCN stock a buy at current prices? Let’s take a look.

Large, Diversified Portfolio

Health Care REIT is big, with 1,411 properties spread across three countries and a market cap of $23.6 billion. It’s also one of the few REITs in the S&P 500. Its size is a source of financial strength, but it by no means dooms HCN to slow growth. The health and senior living sector are highly fragmented, and HCN’s portfolio accounts for just 2.4% of the existing inventory. And, this is also a segment of the real estate market that still has plenty of growth left in it with the aging of the Baby Boomers. Over the next 35 years, the American population aged 85+ is expected to rise by more than 200%.

Unlike most of its REIT peers, which tend to invest exclusively in the United States, Health Care REIT is also modestly diversified. It gets 84.8% of its net operating income from the U.S., but 8.4% and 6.8% from the UK and Canada, respectively.

Health Care REIT Does More Than Health Care

From its name, you might assume that HCN was primarily a play on hospitals and doctors’ offices, but it’s not. Only about 37% of the property portfolio by value is invested in health-related properties.

About 63% of the portfolio is in senior housing, split between properties that HCN operates (35%) and those that are leased on a triple-net basis (27%). Looking at the health-related properties, 21% is invested in long-term care / post-acute care facilities, 15% is invested in outpatient medical properties, and just 1% is invested in hospitals.

This is major positive for a REIT in the health sector: HCN’s tenants have very little dependence on the government. Across its portfolio, 87% of its revenues are from private-pay clients. That’s a major positive in an era of slashed reimbursements and Obamacare restrictions.

Steady Dividend Growth

HCN is not the highest yielding REIT, but it sports a respectable dividend yield of 4.9% and has been a steady dividend grower for years. Over the past five years, HCN has grown its dividend at a 3.4% clip. Had you bought HCN five years ago, you’d be enjoying a yield on cost of 5.5% today.

Within the health and senior care space, HCN stock is a fair option. But, I would recommend buying rival Ventas (VTR) first. Despite being about the same size as HCN (market cap of $22.2 billion), Ventas has managed to grow its dividend at a much faster clip: 7.9% per year over the past five years vs. 3.4% for HCN. And, Ventas’ current yield is competitive at 4.7%. Ventas is one of the true star performers among REITs, and shares today are priced at a very competitive yield.

Fed Risks Overstated

Of course, I would be remiss if I didn’t at least mention the Fed’s looming rate hike. If I were a betting man, I would wager that a rate hike is coming in December. But, it would be just like the Fed to surprise us with a hike in September…just to show us all who wears the pants.

The received wisdom here is that rising rates will be bad for REIT prices. Ordinarily, I would agree, but there are two reasons I believe that Fed fears are overdone. The first is that this is the most telegraphed rate hike in history. Janet Yellen has been warning us for months that this day would be coming, and REIT prices duly suffered a steep selloff earlier this year. The damage from a rate hike is likely already priced in. But, secondly, long-term bond yields are far more important to REIT prices than the Fed funds rate, and longer-term yields have already backed off of their recent highs.

Bottom line: Come what may from the Fed, REITs are attractively priced in today’s yield environment.

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

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