With the stock market near its all time high, many stocks look too expensive as 2018 gets going. However, healthcare REIT Welltower (NYSE: HCN) still looks attractive. Here's why we like the stock for 2018 and beyond.
A full transcript follows the video.
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This video was recorded on Jan. 8, 2018.
Michael Douglass: I wanted to talk about another stock, Welltower, that's ticker symbol HCN. Now, I'm hearkening back to my healthcare roots here a little bit, because Welltower is kind of, in a lot of ways, a crossover stock. It's a financial stock, a financial company, because it's a real estate investment trust, or REIT. What that means is, real estate investment trusts, you can tell from the name, invest in real estate. Their real focus is in owning property, usually. There are also mortgage REITs, but I tend to only look at equity REITs, which own actual property. Then they lease that out to, if it's an apartment REIT, they lease it out to renters. If it's a hospital REIT, then they're leasing it out to hospitals. And they have to pay out 90% of their otherwise taxable income to shareholders in the form of dividends. So they can be really powerful dividend stocks .
Welltower specifically invests in healthcare and senior-focused properties, particularly senior housing. Now, thinking really broad brush here, every day from now through 2029, 10,000 baby boomers are turning 65. So there's a lot of reason to like healthcare and senior-focused properties. And let's also face it -- healthcare in general is moving toward cheaper outpatient settings, typically in an attempt to, as all these more people continue accessing the healthcare system, trying to find ways to cut costs so we don't get totally swamped as a society. And as a result, Welltower has really shifted its portfolio toward these lower-cost outpatient settings.
Anyway, that's all the macro stuff, and that's all well and good, but frankly, when you think about macro healthcare, or macro aging of America, there are a lot of companies that could theoretically benefit. So the question then is, why Welltower specifically? And I think there are two key reasons to like it. One of them is, 93% of Welltower's in-place net operating income comes from private payers. That means not a government insurer. Many senior operators are heavily exposed to government payers, so when Medicare or Medicaid decide to cut rates, they get slammed. That's a big problem for them, because sometimes it's a little bit difficult to predict exactly what the government is going to do, particularly when Congress changes parties.
So Welltower has 93% of its revenue not dependent, directly, at least, on the government. And that's a good thing, because that means a lot of that is commercial insurance, or people renting senior housing themselves. That leaves it operating in a stronger position on the whole.
The second thing is, they have what I would consider both geographic density and dispersion. It's very geographically diverse. It operates across the United States, Canada, and the U.K., but also a lot of density in urban markets. About 15% of operating net income is in Los Angeles. About 9.7% in Boston. You get the idea. These tend to be urban areas with high barriers to entry. Permitting isn't easy; building expenses are high. That gives them a really nice spot in the market, where it's going to be hard for a lot more stuff to come on the market, which basically means they and their operators will have some pricing power. And that's a really good thing for shareholders long-term.
Matt Frankel: Yeah, definitely. Welltower considers one of their big competitive advantages to be that their properties are newer than those offered by the competition, and they're in areas where people can afford to utilize their services. As you said, most senior housing is private-pay. That's the right kind, in my mind, of senior property to invest in. The other side is skilled-nursing facilities, which tend to be more Medicare and Medicaid dependent, which have been absolutely getting crushed lately, if you own any of those types of stocks. They tend to like to find properties located in affluent areas. They're actually developing one in Midtown Manhattan right now, which is a very underserved market.
Douglass: And also pretty wealthy.
Frankel: Yeah, definitely. The idea is, the people who live there can actually afford to privately pay for their services, which gives them a competitive advantage over other companies who might own senior housing in less affluent markets.
Douglass: Yeah. It's interesting, because looking at all of that, my initial thought is, fantastic stock. On the flip side, there are a couple of things that I think any investor thinking about Welltower should be aware of. It's one of the largest REITs in the country, so Welltower isn't in the same ballpark as Synchrony Financial in terms of volatility and risk. But when you look at it, there are still a couple of things to consider, one of which is, Welltower is, about 70% of their property is senior housing. Of that 70%, 36% is represented by a single operator, Sunrise Senior Living. And the top five partners add up to 76% of that 70%. So a significant portion of their money is concentrated in just a few businesses. So if you invest in Welltower, you're also investing in a bet that Welltower has picked good businesses to work with, and that those businesses aren't going to have something happened to them.
And this is one of the problems with REITs. Their money is largely dependent on other people. It's not just, do they do a good job of negating risk on their side? It's also, do the people they're serving, do the folks who are tenants and operators, also do a good job at that? And that's an incredibly difficult thing to figure out. So that's definitely for me something that you should always keep an eye on and be aware of.
Frankel: In Welltower's case, it's also interesting to point out that senior housing makes up about 70% of their portfolio. About half of that is structured as operating partnerships with their tenants, like Sunrise. Brookdale is another big one. I'm not sure of the exact percentage. It's less than 35%, but it's still a significant portion. So if the tenant does well, the properties are generating profit, Welltower benefits from that as well. They're not just a landlord collecting a check. Which is an interesting distinction between them and, say, an apartment REIT, which generally just collects a check from their tenants.
Douglass: Yeah. And that does mean, in some ways, that Welltower does get to participate extra in upside, but it's also going to participate extra in downside. So in some ways, that makes them a little bit riskier. Of course, I think, whenever you buy a company, I think it's core that you're betting on management, and you're betting that they're good people who know what they're doing. So I would say both trustworthy and competent. And if you're concerned about that, don't buy. Straight up, don't do it. So, for me, I'm comfortable with Welltower's management team and what they're doing.
Another thing to point out here is, we just talked about, Synchrony Financial will probably benefit, will probably have a catalyst as a result of these interest rate increases that are signaled by the Fed. REITs as a whole tend to suffer when interest rates increase. So Welltower is on the other side of that, because they're taking out debt to fund new properties, buy other properties, and things like that. So, what that means is that new debt is going to cost them more money, which means that their profit margin on what they're able to make on other properties will decrease, all other things being equal.
So that's kind of a problem for REITs as a whole. It's one of the reasons that Welltower's stock hasn't really done that well in the last year. Of course, the flip side of that is, I tend to think when the tide goes out, you tend to see who's quality and who's not. And that could be really helpful, actually, for investing in, for example, REITs. You look at Welltower's balance sheet, which I think is appropriately levered, and you look at their debt profiles from the rating agencies, the Moody's of the world, and generally, things look pretty good.
So my hope is, while all REITs will suffer, some will suffer a lot more than others. So folks like Welltower, if they have a competitive advantage, that will express itself more fully in the coming years.
Frankel: Yeah, definitely. I already mentioned that the Fed is expected to hike rates several more times over the next few years. The thing to really pay attention to is, if that happens quicker or a little more slowly than expected. If the Fed ends up hiking rates quicker than you think they're going to, that's when you're going to see the REIT sector really take a beating, which is what happened in 2017. REITs were barely up for the year, while the rest of the market was up by 20%-25%.
So this is a thing to keep an eye on. I think a lot of the interest rate hikes are mainly priced in at this point, which is why Welltower is, I believe, and I think Michael does, too, on sale right now.
Douglass: Yes. [laughs]
Frankel: It's one of the few areas of the market that actually looks really attractively valued, and that's why, it's because they're expecting so many interest rate hikes ahead. In 2017, the economy improved a lot quicker than people thought it would, and that was a very negative thing for most of the REIT sector. Like you said, quality REITs should be fine no matter what, should do better than most. And Welltower is definitely a quality REIT. I like Welltower here. Full disclosure: I own the other big healthcare REIT, HCP , which I say is 90% the same business idea. So this is one area of the market that's still a bargain right now.
Douglass: Yeah, and I'm certainly thinking about my REIT exposure this year in 2018. That's actually one of my New Year's resolutions, to think about rebalancing my portfolio, and thinking through which sectors I think are most attractive in the coming years.
Matthew Frankel owns shares of HCP. Michael Douglass has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Moody's. The Motley Fool recommends Synchrony Financial and Welltower. The Motley Fool has a disclosure policy .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.