DOC - Physicians Realty Trust: A 7% REIT Gem With Merger-Related Growth Potential

2024-01-08 02:04:03 ET

Summary

• Physicians Realty Trust offers passive income investors a high-quality dividend and portfolio growth in the medical office industry.
• The merger with Healthpeak Properties presents upside potential for the trust.
• The long-term growth drivers in the healthcare market support the investment thesis for DOC.

Physicians Realty Trust ( DOC ) is a leading MOB-focused healthcare REIT that offers passive income investors a high quality dividend and portfolio growth in the lucrative medical office industry.

Healthcare spending is a long-term uptrend in the U.S. and with the aging of the U.S. population driving healthcare expenditures, I think that Physicians Realty Trust is a solid income choice for retirees or other investors that need to produce recurring income from their stock portfolios.

Taking into account that the REIT announced a merger with Healthpeak Properties, Inc. in the fourth quarter, the trust also has merger-related upside potential.

My Rating History

The potential for dividend growth was a primary conviction point for me in my last article on Physicians Realty Trust in which I pointed to the trust's well-covered dividend and income potential.

The merger between Healthpeak Properties and Physicians Realty Trust, which was announced in the fourth quarter, is set to yield an even larger, MOB-focused trust with considerable growth potential in the medical office market.

Merger Between Healthpeak Properties And Physicians Realty Trust

The merger between Healthpeak Properties and Physicians Realty Trust, two large MOB and lab-focused healthcare trusts is leading to the creation of a new REIT with more than 750 properties in its real estate portfolio and a considerable percentage of its square footage assigned to the medical office category.

Healthpeak Properties is the larger of the two trusts that are merging and the new company is on track to achieve $1.7 billion in run-rate base rent, annually.

The merger will be concluded in an all-stock deal and values both companies at $21 billion, including the assumption of debt. The core asset of the merged company will be the medical office portfolio which I already mentioned will make up the majority of the REIT's real estate.

With 40 million square feet and an occupancy of 92%, outpatient medical offices are going to be the key source of strength or growth for the new REIT moving forward.

Long-Term Growth Drivers

U.S. healthcare spending is in a long-term uptrend which in turn is driven by an aging of the U.S. population that is spending more money on healthcare as well as innovation that has made a lot of medical procedures easier, cheaper and less painful.

Moving forward, healthcare providers are more likely than not to see further growth in national healthcare expenditures as well as growth in per-capita healthcare spending.

Outpatient medical offices are the new winners in the healthcare market as more procedures can be done by physicians without admission to a hospital. Thus, medical office buildings may profit from increasing outpatient-driven revenue growth while hospitals may see growing sales pressure moving forward.

Outpatient visits have soared in the last decade which of course benefits those companies that lease medical office buildings to specialized physicians.

Given these fundamentally positive drivers in the healthcare market, MOB-focused healthcare REITs like Physicians Realty Trust and Healthpeak Properties have, not surprisingly, also seen the strongest rates of growth in their funds available for distribution.

Other healthcare trusts like Ventas, Inc. ( VTR ) and Welltower Inc. ( WELL ) , which operate in other healthcare segments, have seen declines in their funds available for distribution.

Why You Should Consider Physicians Realty Trust

Physicians Realty Trust is a well-managed healthcare trust that I appreciated previously for its moderate pay-out ratio (around 90%) and high dividend safety. In the short term, I think, the focus could be shifting away a bit from the mere payment of a nice 7% dividend and towards the realization of the merger's benefits.

These benefits are estimated to include $40-60 million in synergies and the merger is anticipated to be accretive to funds from operations for both healthcare trusts also.

Furthermore, I think the merger makes a lot of sense and will result in one of the largest MOB-focused trusts in the market. Physicians Realty Trust earned $0.25 per share in normalized funds from operations in 3Q-23 which equates to about a $1.00 annual run-rate FFO potential. With a stock price of $13.00 this implies a 13x normalized FFO multiple which is cheaper than DOC was a year ago.

Besides the difference in valuation multiple, Physicians Realty Trust now also offers passive income investors the realization of merger benefits.

Balance Sheet

The combined company will carry about $9 billion in debt on its balance sheet, but only a small portion of it (less than 1%) will be floating-rate, thereby limiting the potential fall-out from a drastic rise in interest expenses which, for example, weighed heavily on Medical Properties Trust, Inc. ( MPW ) .

Merger-Related Risks

Large REITs often can only grow through the pursuit of acquisitions which exposes investors invested in such REITs to certain merger-related risks. The most obvious one is that merger benefits could be overly optimistically assessed and may not be fully realized in the end.

Furthermore, doing acquisitions also exposes REIT investors to the very real risk of companies overpaying for their acquisition targets because they want to show shareholders that they are capable of growing funds from operations.

My Conclusion

Physicians Realty Trust was a bargain during October and November, but despite a substantial re-rating since, I think that the MOB-focused healthcare REIT has considerable long-term potential to grow its real estate portfolio and increase its dividend.

The merger between Physicians Realty Trust and Healthpeak Properties is creating a leading medical office healthcare trust that stands to profit from a shift towards outpatient treatments as well.

Long-term growth in national healthcare expenditures, particularly in the medical office market, further supports the investment thesis, in my view. Buy for income.

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