Investment Thesis

Healthpeak Properties (PEAK) owns a high-quality portfolio of healthcare properties leased overwhelmingly to private-pay tenants. The REIT should be minimally impacted by COVID-19 and is well-positioned to benefit from the long-term secular tailwind of an aging population. Debt is moderately low, liquidity is more than adequate, and shares yield 5.5%.

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Pitch For PEAK

PEAK is a healthcare-focused real estate investment trust. Unlike most other healthcare REITs that focus primarily on one sub-sector within the healthcare space (such as medical office, hospitals, life science, senior housing, or nursing homes), PEAK owns and operates a diversified portfolio of properties predominantly in the life science, medical office, and senior housing spaces.

In mid-2016, after suffering from some tenant concentration and sub-sector over-diversification issues, PEAK (then called Healthcare Properties) decided to spin-off its tenant-concentrated, non-private pay properties into its own REIT called Quality Care Properties. This was no small spinoff. It included 243 skilled nursing facilities, 61 memory care or assisted living facilities, a surgical hospital and a medical office building. QCP was eventually sold to Welltower (WELL) in 2018.

A tragic casualty of the spinoff and repositioning was a ~30% dividend cut, thus ending the 27-year dividend growth streak in place before that. However, on the plus side, the company was able to clean up its balance sheet and lower debt. Net debt to EBITDA fell from the high 7x range in 2016 to 4.8x at the end of the first quarter. Fixed charge coverage is a very comfortable 4.4x. PEAK’s credit rating from Moody’s is BBB+ with a stable outlook.

Quality medical office and life science buildings trade in the mid 4 to low 6 cap rate range (e.g. The Post, an SF life science building bought at a 5.1 cap rate in Q1), which makes equity issuance for acquisitions dilutive when the stock yields 5.51% as it does now. In contrast, the company traded at a sub-5% yield through almost all of 2019.

ChartData by YCharts

For a REIT with assets of such high quality, PEAK’s price should finish 2020 higher, rendering a suitable cost of equity for acquisitions in 2021.

The Case For PEAK

The most obvious secular tailwind for PEAK is the demographic environment. Advanced economies are graying faster than any time in history. In the United States, the sizable Baby Boomer generation is reaching old age as the birth rate is declining among younger generations and net immigration is falling. This large and growing older population provides and will continue to provide a steady, reliable source of demand for PEAK’s tenants.

Source: U.S. Census Bureau

By 2030, all Baby Boomers will be over the age of 65. By 2034, seniors (over 65 years old) are expected to outnumber children (under 18) for the first time in U.S. history. From 2016 to 2060, the over 65 population is projected to rise 92%, while the over 85 population is set to explode higher by 198%.

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PEAK’s real estate assets are well-located in the highest demand urban centers around the country. The giant, orange-shaded bubble below represents PEAK’s highly valuable San Francisco-based biopharma research and development properties.

Source: Q1 2020 Presentation

The largest segment of the portfolio is senior housing at 34%, followed by life science (biopharma R&D) at 32% and medical office at 29%.

Source: Q1 2020 Presentation

Occupancy in its senior housing segment was just shy of 80% at the end of May. Unsurprisingly, rent collection in its triple-net leased properties came in very strong: 97% of rent was received in May, while the remaining 3% was deferred. Occupancy was 95.6% in life science and 91.4% in medical office at the end of May.

As for rent collection, 97% of May rent was received for life science and 96% for medical office. Both collection levels were roughly the same in April. At the few hospitals owned by PEAK, rent collection came in strong at 96% for May.

In Q1, same-store net operating income rose 2.0% YoY.

Even after the spinoff of Quality Care Properties, the portfolio continued to be downsized and improved. In Q3 2019, the company owned 740 properties and had an enterprise value of $25 billion. In Q1 2020, PEAK owned only 636 properties and had an EV of $22 billion. Between then and now, PEAK sold around 2,000 units of senior housing while adding a million square feet each to medical office and life science.

Meanwhile, debt has come under control in the last three years, and the bond maturity schedule is well-laddered. The average remaining debt maturity is 6.7 years, with no bond maturities until August 2022.

In short, PEAK’s portfolio of assets is extraordinarily well-positioned to benefit from the wave of aging boomers, and the company’s finances have been conservatively managed in the last several years. This should give PEAK the ability to make accretive acquisitions when its stock price has recovered to median 2019 levels.

The Dividend

Healthcare Properties (ticker: HCN), the former iteration of PEAK, had an impressive dividend growth streak from 1989 to 2016 – until the tenant issues and asset repositioning. Since then, the dividend has been held flat as the company remains a net seller and deleverages.

Source: Seeking Alpha

In the first quarter, PEAK paid out 82.2% of FFO as dividends, and the expected full-year payout ratio for 2020 is 90.8%, based on analysts’ FFO estimates. Considering that the debt level is low (4.8x net debt to EBITDA in Q1 and low- to mid-5x range expected by year-end 2020), I would expect PEAK to become a net buyer in 2021.

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Consider this: debt represents 33.2% of capitalization and equity makes up 66.8%. The average interest rate on the debt is 3.66%, and this could even fall with the recent drop in interest rates. If PEAK waits until it can issue equity at a 4.5% average dividend yield (which would have been easy to do in 2019) while keeping the same mixture of equity and debt, its weighted cost of capital would be 4.2%.

Most life science properties and MOBs trade for cap rates in the 5 to 6 range, and senior housing properties are in the 7.5 to 9 range. Let’s say the average cap rate for acquisitions is 6.2 (which is the weighted average of the three property types). That would give PEAK an average spread between cost of capital and acquisitions of 2 points, which is very strong considering the quality of the assets.

A Strength And A Challenge

Interestingly, one of PEAK’s primary strengths as a REIT is also a potential weakness, and that is its portfolio diversification.

The portfolio is roughly 30% senior housing, 30% life science, and 30% MOB, with the remainder made up of hospitals and skilled nursing facilities. This gives the company a rare amount of diversification among REITs. As mentioned previously, most healthcare REITs tend to focus on one sub-sector of real estate.

But there is a reason for that. REITs tend to trade at lower FFO multiples and higher yields when their primary assets are higher cap rate properties, and the opposite holds true for REITs that primarily own low cap rate properties. Alexandria Real Estate (ARE), which exclusively owns life science properties, trades at 22.1x FFO and a 2.6% yield. LTC Properties (LTC), which owns a portfolio of half senior housing and half skilled nursing, trades at 12.8x FFO and a 6.1% yield. This effectively means that REITs tend to have costs of equity that correspond with their asset cap rates.

With a diversified portfolio, it becomes more difficult for investors to price PEAK’s shares. Often, its shares split the difference between higher valuation MOB/life science REITs and lower valuation senior housing/skilled nursing REITs. PEAK’s FFO multiple is 16.5x, and its dividend yield is 5.5%. Effectively, significant exposure to higher cap rate properties can cause shares to trade at valuations that make it difficult to accretively acquire lower cap rate properties.

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If PEAK’s shares consistently trade at a 5%+ yield, it would be very difficult to profitably acquire life science centers and MOBs. That, in short, is the biggest risk facing PEAK, in my estimation.

However, if 2019 is any indication of how PEAK’s shares perform in a normal market environment, there is little reason to be concerned about cost of capital issues over the long term. With interest rates set to remain low for an extended period, I would fully expect PEAK to return to 2019’s valuation and dividend yield within the next 12 months. If this happens, then PEAK should be able to become a net buyer of properties and finally resume dividend growth again.

Conclusion

Investing is a game of calculated bets. One can never know the future or all potential outcomes, so one has to make bets based on the most probable outcomes. There are, however, ways to put the odds in your favor when making these bets.

One way is to deeply understand what you’re investing in. “Invest in what you know,” as the saying goes. Another is to find companies with quality assets and strong management teams. A third way to put the odds in your favor, as Warren Buffett has famously espoused and exhibited over his investing career, is to invest for the long term. That is, buy companies with quality assets, strong management teams, and business models that you understand – and hold those for decades and decades. Pay less attention to the price than to the fundamental performance and income generation.

In other words: invest as if you personally own a business or a piece of real estate. In fact, when you buy shares of PEAK, that’s exactly what you are doing!

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Disclosure: I am/we are long PEAK, WELL, LTC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



Via SeekingAlpha.com