To deal with the Covid-19 pandemic, Tim Wallace, CEO of Community Healthcare Trust, had to make a few changes.
Community, which owns medical offices and other health-care facilities, has now equipped buildings with “needlepoint bipolar ionization” air-filtration systems to kill the virus. Clinics and doctors’ offices are getting higher-speed internet to handle more telemedicine. And its chief building inspector travels in a recreational vehicle, rather than flying, to check out properties before an acquisition.
“As long as there’s demand for health care, there will be a need for office space,” says Wallace, 62, who has run medical real estate properties since the 1990s. “That isn’t going to change until we get one of those devices that Bones used in Star Trek to fix any medical issue.”
Hospitals, clinics, and doctors’ offices aren’t filling up to prepandemic levels. But with health services getting back to normal, demand for medical real estate is holding steady. Landlords say rents are being collected at nearly 100% of pre-Covid-19 levels. Acquisitions are ramping up, and interest rates remain low—conditions that should fuel dividend and asset growth.
Those trends could help lift returns for real estate investment trusts, or REITs, that specialize in health-care facilities. Three to consider are Community Healthcare Trust (CHCT), Physicians Realty Trust (DOC), and Healthcare Realty Trust (HR). The stocks should hold up better than nursing facility and senior housing REITs.
“These companies have strong tenants, and the risk of a blowup is low,” says Berenberg Capital Markets analyst Connor Siversky, whose firm has Buy ratings on all three stocks. One measure of their health: Tenants of medical REITs, such as large health-care systems, typically have cash flows that are more than six times their rental expenses, versus coverage of 1.2 times for skilled-nursing facilities and senior housing. Medical REITs haven’t had to renegotiate leases and write down rental losses like some senior-housing and nursing REITs, he adds.
“We like the defensive nature of medical REITs relative to other areas of health care,” says BMO Capital Markets analyst John Kim, who has Outperform ratings on Healthcare Realty and Physicians.
Medical REITs aren’t cheap. They trade at a premium to health-care REITs overall, partly because of low multiples in senior housing and nursing. But medical REITs are well off peak multiples before the pandemic; Healthcare Realty, for instance, trades at 22 times estimated 2021 adjusted funds from operations, or AFFO, a REIT measure of operating income. That is down from 26 times AFFO at the end of 2019.
One reason multiples have compressed: a slower growth outlook. Medical REITs won’t be able to raise rents as much if demand for space weakens because of the pandemic.
Community owns 131 properties in 33 states, including clinics, surgical centers, rehabilitation facilities, and oncology and dialysis centers. No tenant amounts to more than 10% of total annualized rent, and properties are 90% leased with an average remaining lease length of 7.7 years. The company raised its dividend during the pandemic, and has increased it every year since going public in 2015.
Community’s returns on acquisitions top 9%, one of the highest rates among health-care REITs, Siversky says. It is on track to buy $120 million to $150 million of properties this year, adding to its $612 million asset base.
Telehealth isn’t a threat, says CEO Wallace, because doctors and nurses still need office space to see patients, partly to comply with privacy laws and insurance-reimbursement rules.
Physicians Realty owns 268 properties worth $4.8 billion. Its properties are spread across the Midwest, West Coast, and South, including assets such as the Baylor Charles A. Sammons Cancer Center in Dallas. About 47% of its properties are located off hospital campuses, one the highest percentages among medical-office REITs. That poses more risk than locations on campus, which are considered more stable, but acquisition and development yields tend to be higher off campus, and that is where health services are heading, says Physicians’ CEO John Thomas. “It’s an evolution of health care moving to more-convenient locations,” he says.
At 17 times estimated 2021 AFFO, Physicians trades at a premium to the health-care REIT average of 16. But its 5.3% yield looks well-covered: Its payout ratio was 91% of AFFO in the second quarter, which may have been the high point of the pandemic.
Healthcare Realty is a play on the stability of major hospitals in cities like Dallas, Seattle, Los Angeles, and Charlotte, N.C. About 89% of its 210 properties are located on or within a quarter mile of hospital campuses. Tenant retention and occupancy rates tend to be more stable on campus—both averaging more than 84% a year. And its tenant roster is well diversified. The company expects to add properties worth as much as $375 million to its asset base of $4.3 billion this year.
The trade-off with the stock is that it doesn’t offer the growth or yield that off-campus REITs generate. The company hasn’t raised its dividend in at least a decade, keeping it at $1.20 a share. Carla Baca, head of investor relations, says income growth stagnated because most properties were rented to single tenants for 10-year terms. But more than 90% of the portfolio is now in multitenant leases with shorter terms and 3% to 4% rent increases when leases are renewed. The dividend is well covered, she says, and “we’re in a better place to discuss increasing it.”
BMO’s Kim likes the stock for its income and asset-base stability. “There’s a fine line between off-campus properties and suburban office space,” he says. “If a physician group leaves off campus, it can be more challenging to release the space, whereas on campus is more defensive.” He expects the stock to hit $38 over the next year, implying a 27% gain from a recent $30.
Even if the stock doesn’t budge, it yields 4%, a healthy payout in today’s low-rate climate.
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