2023-06-14 09:30:00 ET
Summary
- National Health REIT delivered one dividend cut on schedule but we thought there would be more.
- We look at what we got right and what we got wrong in our previous piece.
- We update the outlook for this and give you our best play.
On our last coverage of National Health Investors Inc. ( NHI ), we had a degree of skepticism towards the REIT's operating areas and felt staying out would be the best bet. Our general takeaway, which could be applied to almost any REIT in the senior housing sector, was as follows.
Our take has been that this is that the operators in the skilled nursing and senior housing space have the worst business models. Making money is hard and supply of new senior homes is relentless. This supply has for the most part outpaced any gains in the senior population. Down the line there may be improvements in home care alongside breakthroughs in Alzheimer treatments. Don't begin and end your research based on demographics.
Source: National Health Management Believes The 6.4% Yield Is Sustainable
The call was a mixed bag. NHI did indeed underperform even holding cash over this timeframe.
But our "hold" call aside, we expected far worse. So let's start off by saying we got this wrong. We go over what we expected, what actually happened and how that influences our outlook today.
Our Forecast Vs. What Happened
In the most recent update NHI's property breakdown was predominantly focused on triple net leases in senior housing and skilled nursing. A small number of SHOP (Senior Housing Operating Portfolio) were also present.
For those unaware, the SHOP assets are the ones where NHI is fully exposed to the ups and downs of the property, whereas on the triple net ones, it just collects rent. While it has had major issues on both sides of this diagram, the SHOP is where it has been dealing with strongly contracting net operating income (NOI) margins. As seen below, those have declined from 32.4% in Q1-2022 all the way to less than half that in Q1-2023.
So in our earlier work we saw this as a problem that would come to bite, and it really has as far as the company's cash flow is concerned.
We further predicted that its extremely troubled tenants would have difficulty in meeting in rent roll. After all, the rent coverage levels were extremely precarious at the time of our last coverage. The vast majority of senior housing assets were producing cash flow just near 1.0X the monthly rent. There were also multiple tenants well below that. As we see in the most recent update, NHI has had to give $36 million in rent deferrals and $8 million in rent abatements cumulatively to the problem children.
While all of those events played out exactly as we foresaw we definitely missed one major factor. That factor was the ability of NHI to keep selling properties at rather incredible prices. The picture below shows just how many dispositions they have had since our last coverage.
More importantly, these properties had extremely poor EBITDARM coverage and NHI was still able to dispose them at very low cap rates.
Now some of that low cap rates might be an artifact of rent reductions given to tenants, but those cap rates are just insane. They have allowed deleveraging even though NHI faced multiples challenges. So missing this piece was why we missed how NHI could still continue its hefty dividend.
Outlook
NHI has navigated some tough times and through it all they have maintained a solid debt to EBITDA ratio. The interest coverage has fallen but that has to be blamed solely on rising interest rates as the ZIRP era ended.
The current debt maturity schedule is a bit on the short side and we expect refinancing costs to be significantly higher.
NHI's 2031 bonds are trading with a 7.5% yield to maturity and that shows that there where be pressure on the funds from operations (FFO) when the near term bonds are replaced.
Normally, we can expect tenant rents to reset in case of a REIT and offset this pressure, but it will be tough in the case of these tenants collectively. Sure, the last few years have had the pandemic and the REIT faced abnormal challenges, but the trend in NOI and EBITDA tells you what is likely going to happen ahead.
What NHI does have going for it are two things. The first being that senior housing property demand remains extremely high. If they need some extra cash to deleverage, they can find it. Most properties are unencumbered as well and secured mortgages form a small percentage of the debt structure. The other important thing is that NHI is legitimately cheap relative where the companies are trading in this space. Both Welltower Inc. ( WELL ) and Ventas Inc. ( VTR ) trade several multiples higher based on price to cash flow per share (closest proxy to FFO). They both also have far lower dividend yields.
Yes, the two have exposure to medical office buildings but for WELL this about one quarter of the total.
Both VTR and WELL have similarly struggling tenants and both have struggled to give their FFO traction in recent years. So all said and done, if you want exposure to senior housing assets, NHI is a good bet at this multiple.
Verdict
Getting the conclusion wrong to this story was instructive. NHI delivered here with timely asset sales and navigated the last 24 months with aplomb. The REIT is not exactly out of the woods. Tenants are still struggling and its own SHOP side looks awful. The dividend payout ratio is in the high 80's and could get worse if any large tenant throws in the towel. On the plus side, the supply of new senior homes has dried up with higher interest rates and that should help SHOP and NHI's tenants in the next 12 months. We rate this a hold/neutral at present and think that the bonds would be the most solid play for this investment grade rated REIT .
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
National Health: What We Got Wrong With This Healthcare REIT