This article is republished with permission from REITCafe.
Health care has been one of the worst-performing sectors for real estate investment trusts (REITs) this year, with a total year-to-date return of –17.60 percent. This performance has been surprising, since the sector has been a model for growth in prior years. Between 2009 and 2014, total returns averaged more than 17 percent per year, and returns were negative only in 2013, according to data from the National Association of Real Estate Investment Trusts. Many health care REITs surpassed earnings expectations in the third quarter, and long-term growth trends looked positive. So what has pulled the sector down during 2015?
The expected interest rate increase has been at the forefront of investors’ minds this year. Higher interest rates will make portfolio expansion and earnings growth more difficult to achieve. Some health care REITs rely on contractually specified revenues that will not increase as the cost of capital rises, which could put pressure on earnings. In addition, property values could drop, because if financing is more expensive, buyers will not be able to afford to pay as much for properties. Still, interest rates have affected all REIT sectors and do not fully explain the especially weak performance for health care REITs.
| TREPP-i Survey Loan Spreads (50–59% LTV)* |
| This Week | Previous Week | Previous Month | End 2014 | End 2013 | |
| Industrial | 166 | 168 | 166 | 138.5 | 170 |
| Multifamily | 164 | 165 | 162 | 139.8 | 166.7 |
| Office | 173 | 172 | 174 | 148 | 175 |
| Retail | 166 | 168 | 165 | 139.8 | 175 |
| Average Spread | 167.25 | 168.25 | 166.75 | 141.5 | 171.7 |
| 10-year Treasury Yield** | 2.27 | 2.33 | 2.03 | 2.17 | 3.04 |
Some investors may believe that the sector’s story about long-term growth supported by demographic trends and the implementation of the Affordable Care Act is already priced into stock values. The sector may also be correcting after becoming overvalued during years of strong growth.
Where are the sector’s growth opportunities? High property valuations have made property acquisitions more difficult. For the biggest health care REITs, large transactions are needed to move the needle on earnings. With asset prices high and REIT valuations low, it often makes more sense for REITs to acquire other REITs or to buy back stock than to invest in individual assets.
New supply, particularly for senior housing, also is weighing on the health care sector. The supply issue appears to be market- and submarket-specific. Ventas noted that supply pressures in specific markets and submarkets are affecting about 30 percent of its portfolio. On the other hand, Welltower reported limited supply pressures in its markets and provided a detailed description of competing new supply in its U.S. senior housing operating portfolio in its third-quarter supplemental report.
Health care REITs have repositioned portfolios to increase private-pay tenants and have expanded internationally to decrease their reliance on sometimes-uncertain U.S. government payments. Illustrating this trend, Welltower and Revera recently completed the acquisition of Regal Lifestyle Communities, which includes 23 private-pay senior housing communities in Canada.
The number of health care REITs that beat consensus estimates for third-quarter earnings outweighs those that missed. Welltower, HCP, and Sabra Health Care are among those that exceeded earnings estimates. On the other hand, issues related to mergers and acquisitions affected earnings for both Ventas and Omega Healthcare Investors, whose earnings missed estimates.
A number of factors make the health care REIT sector attractive. The current dividend yield of 6.17 percent is among the highest of the equity REIT sectors, and implementation of the Affordable Care Act has led to significant growth in health care sector employment. Health care REITs face challenges, but for those with a long-term investing horizon, demand trends support long-term growth, which could indicate a buying opportunity in a sector that has been beaten down this year.
* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.
** - 10 yr. Treasury Yield as of 11/13/2015.
