The big-picture story for healthcare real estate investment trusts (REITs) like Welltower ( WELL 1.21% ) hasn’t changed — society is getting older, and older people need more medical care. That said, the coronavirus pandemic upended the senior housing segment over the short term and caused Welltower to cut its dividend by 30%. Roughly two years into this headwind, here’s why Welltower thinks 2022 will be a turnaround year.
Although Welltower gets roughly a third of its rents from outside the senior housing sector (health systems and outpatient medical care), the rest comes from some form of senior housing. The smallest exposure is to nursing homes (5.5% of rents), which was probably the hardest hit subsector of senior housing. That’s a modest sum, which is positive. However, the REIT also has exposure to other senior housing properties.
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About 23.5% of its rents come from assets it leases to others on a net lease basis. Essentially, the operators of these properties are responsible for all of the property-level costs and have to pay their rent regardless of what is going on at the properties. This is a fairly stable business, though some tenants do struggle from time to time. However, the biggest piece of Welltower’s rents come from senior housing assets that it both owns and operates, known as a senior housing operating portfolio, or SHOP in industry lingo. At 39.3% of rents, this business is the real driving force at Welltower.
But it’s important to step back and consider the big picture here. Basically, Welltower hires operators to run the SHOP assets, paying them a management fee for their services. Still, the actual performance of the properties flows through to the REIT’s top and bottom lines. When the properties are doing well, this is a boon to cash flow. When the properties are struggling, like during the pandemic, it is a major headwind. It’s kind of a leveraged play on the senior housing space.
Times are changing
This helps explain the 2020 dividend cut, given that SHOP occupancy levels fell and move-ins declined. This wasn’t unique to Welltower, but because of its large SHOP exposure, the REIT was hit pretty hard by the pandemic.
Two years later, however, things are starting to look a lot better. Notably, occupancy has been trending generally higher since Feb. 2021 despite the new coronavirus variants that have come to the fore. Although occupancy is still well below where it was prior to the pandemic (87.2%), the trend is going in the right direction. And at 77.5%, SHOP occupancy still has more room to improve. Continued occupancy gains is the first reason why Welltower thinks 2022 will be a good year.
But there’s a bigger picture here, because demand is likely to start increasing materially as well. And that’s not just being driven by reduced COVID-19 fears. Notably, the growth of the 80+ population is expected to grow by 3% in 2022, with further increases in the future. Simply put, there is about to be a big upswing in the number of people who could potentially need senior housing that will add to the flow of customers.
That demand, meanwhile, is set to help Welltower push through large price increases, partly driven by inflationary pressures. However, some of the costs that Welltower is facing are likely to be temporary. That’s mostly from the use of contract labor, which is notably more expensive than employees. As these costs ebb, margins should begin to widen. So, management is looking for more occupancy and more revenue per customer.
The big turn
Basically, if Welltower is correct, its SHOP portfolio should hit an important inflection point in 2022. That could materially boost the REIT’s results, which investors appear to be anticipating given the stock’s strong recovery since the worst of the pandemic-driven bear market. That said, the real test here is likely to be the dividend. The turnaround won’t be complete until Welltower starts increasing the dividend payment again. Given management’s outlook, that might actually be in the cards for 2022.
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