Healthcare real estate investment trusts (REITs) have been hard hit by the coronavirus pandemic, particularly those with properties tied to senior housing. That makes sense, given that COVID-19 appears to be more dangerous for older individuals. However, long-term population trends haven’t changed — there are going to be more seniors in the very near future. And that means healthcare REITs are still worth looking at. But be careful; they aren’t all equal, as a comparison of Sabra Health Care (NASDAQ: SBRA) and Welltower (NYSE: WELL) shows.
Similar but different
Sabra and Welltower both provide housing for older people. However, they go about it in vastly different ways. Welltower’s portfolio is broken down between senior housing (59% of rents), outpatient medical assets (23%), long-term (nursing homes)/post-acute care (10%), and health systems (the rest). Its senior housing business is broken into two parts, assisted living and well living properties that it owns and operates, which are called SHOP assets (37% of overall rents), and properties it leases to others (22%).
Of note, Welltower actually hires others to run its SHOP properties, but the performance of these assets flows through to the real estate investment trust’s top and bottom lines. That’s a huge benefit when times are good, but when times are tough, like they are now, the SHOP portfolio is a net negative.
Sabra’s portfolio is very different. It generates about 15% of rents from SHOP assets, 10% from senior housing leased to others, 10% from specialty hospitals, which are all present in Welltower’s portfolio. However, nursing homes account for a huge 63% of its rent roll. That segment is a tiny part of the mix at Welltower, and that’s a very big difference.
While both companies are catering to seniors, they are doing so in very different ways. The vast majority of Welltower’s portfolio is private pay, meaning that the resident is paying rent out of his or her own pocket. Nursing homes are largely paid by third parties, notably government programs Medicare and Medicaid. Historically speaking that’s led to some troubles for nursing homes, as they try to balance their own profitability at the same time that the government is trying to keep costs in check. The two don’t always mix well, and it can result in nursing home operators struggling financially (more on this in a second).
The dividend story
That portfolio difference is a key reason why Sabra has historically had a higher yield than Welltower. Today, even after a 33% dividend cut in the second quarter of 2020, Sabra’s 7.2% yield is still well above Welltower’s 3.7%. Welltower didn’t increase its dividend in 2020, but it didn’t cut it, either. That said, there’s more to this story.
Right now, senior housing properties are facing hard times. There are increasing numbers of move-outs (often a euphemism for residents who pass away), fewer people moving in, and heightened cleaning costs. Welltower’s SHOP occupancy declined each month between March and September. Its senior housing lessees aren’t performing that much better, so there’s troubles to consider there, too. And, as you might expect, Welltower’s funds from operations (FFO) are getting pinched right now.
That will likely continue until the world learns to deal with COVID-19. Recent vaccine news suggests that good progress is being made, but there’s still a long way to go before an effective vaccine is widely available. Worryingly, Welltower’s normalized FFO of $0.84 per share in the third quarter was below its $0.87 per share dividend. However, a large and financially strong REIT like Welltower can lean on its balance sheet for a little bit until its business gets back on track. Notably, at the end of the third quarter, the REIT had $2.2 billion in cash and $3 billion available on an undrawn credit facility.
After Sabra’s dividend cut, it’s $0.30 per share payout is comfortably below its normalized FFO of $0.48 per share. But, in its third-quarter earnings release, Sabra noted that the auditors for two of its nursing home tenants, Genesis Healthcare and Signature Healthcare, provided going concern warnings during the third quarter. So there’s more risk to the dividend here than may meet the eye, and a lot of that has to do with the core of the company’s business, which is nursing homes.
Although Sabra points out that no single tenant accounts for more than 10% of its top line, the fact that it’s dealing with two troubled tenants helps explain why Sabra’s yield is so much higher than Welltower’s yield. It’s reasonable to fear that these two tenants are a symptom of a bigger industry problem to which Sabra could end up heavily exposed. To be fair, Welltower has a relationship with Genesis, but it just doesn’t have the same level of exposure to the nursing home segment. That is, in the end, the fundamental difference between these two REITs.
It’s highly unlikely that Sabra Health Care is going to go out of business anytime soon, even in the face of COVID-19. However, its higher yield is a reflection of the higher risk investors face today. A lot of that has to do with Sabra’s focus on nursing homes. The solvency issues facing Genesis and Signature clearly show that there are very real pressures facing the nursing home niche of the senior housing space. The REIT has taken steps to ensure it can handle some adversity, including cutting its dividend, but investors should go in expecting more turbulence.
Welltower, meanwhile, is facing difficulties of its own but so far has been able to navigate the headwinds a little bit better. Although it is leaning on its balance sheet to cover its dividend right now, the fact that it doesn’t own many nursing homes gives it a leg up in this comparison. For income investors looking for dividend consistency, Welltower, despite a lower yield, is probably the safer choice in this head-to-head comparison.