Co-produced with Beyond Saving
One of the sectors we have been focused on in 2020 is healthcare. The COVID-19 pandemic has underscored the need for essential medical infrastructure.
There are numerous ways for investors to buy into the medical sector. Certainly many in the market have been investing in developers of potential vaccines. Certain to be a big winner for the companies that come out with a working vaccine first, but also risking losses if the company you are invested in fails to develop a vaccine at all. Investors who are speculating in the sector are trying to strike gold. If it works, it’s very profitable. If you don’t strike gold, it isn’t.
At High Dividend Opportunities, we do not want to be speculating on which company is going to create a vaccine, or whether this or that new cancer treatment will be approved, or whether a particular operator in the medical sector is going to be successful.
You might have heard the saying “In a gold rush, sell shovels.” Suggesting that the way to strike it rich is not by getting lucky finding gold, it’s to sell the tools that are in high-demand. We say take it one step further: In a gold rush, be the landlord.
Or perhaps we today, we should say “silver-rush.” There’s no secret that the US has an aging population. One of the unfortunate but inevitable side effects of aging is that you need more medical care. Beyond COVID-19, long after we have dealt with the pandemic for better or worse, Americans are going to need healthcare to take care of a large variety of health needs. Unfortunately for all of us who are aging, diabetes, heart disease, high or low blood pressure, injuries, dental issues, eye issues, and hundreds of other health issues will plague us as we age. And the population in the United States is aging at a fast pace.
Don’t invest trying to predict which company will strike gold with a COVID-19 vaccine that will come and go, and many companies are going to spend more on R&D than they ever make from selling a COVID-19 vaccine. Buy the real estate which is necessary not only to serve COVID-related health issues but also the myriad of health issues that are never going to go away with vaccinations. These medical services are only going to become even higher in demand as Baby Boomers age.
Today, we take a look at a REIT that specializes in medical office buildings (or MOBs), which are buildings that are leased to physicians and healthcare systems primarily for outpatient services. Covering everything from cancer centers, to family doctors, to eye doctors, to dentists and everything in between. At approximately 25 million square feet of office space, this is the largest MOB owner in the U.S.
Healthcare Trust of America (HTA), like most REITs, has a very straight-forward business model. They buy real estate that’s dedicated to medical uses, lease it to various medical tenants for various uses and collect the rent. In exchange for providing the upfront capital, HTA collects long-term cash flow. For the tenants, instead of having a few million in capital tied to a building, they can invest that money into expanding their practice. It’s a win-win for everyone involved. Best of all, it means a dividend flowing into your account if you are an investor.
The MOB sector (Medical Office Buildings) is a very strong sector because it’s in very high demand, cash flow for tenants is generally strong, and the buildings themselves are specialized enough that designed medical space is materially superior to attempting to convert generic office space.
HTA has an impressive portfolio with significant geographical diversity:
Source: HTA Supplement Q3 2020
The types of tenants that HTA has span a wide variety of different medical specialties. Note that a very large number of these specialties simply cannot be done with online/telephone services.
Source: HTA Supplement Q3 2020
This diversity provides HTA with a lot of stability. When owning real estate, the No. 1 priority is ensuring that rent comes in predictable and stable/growing amounts.
Like most REITs, HTA was not completely immune to the impacts of COVID-19 shutdowns. “Non-essential” medical procedures were suspended during the shutdown, so the medical facilities that serve non-emergency needs were shut down or saw their business decline substantially. However, “non-essential” to the government does not mean that the problem plaguing the patient magically disappeared and no longer needed to be treated. As soon as restrictions were lifted, patients rushed to get their medical needs taken care of.
As a result, HTA deferred 2% of rent year-to-date. Much less than the majority of REITs. Additionally, one third of that deferred rent was repaid in September and management expects that rent collections will exceed 100% until all back rent is paid.
Yes, COVID-19 did have an impact. Yet HTA proved the recession resilience of their business as the amount of rent deferred was very small, and is already being paid back.
In Q3, investors were greeted with a dividend increase, as HTA posted their best FFO/share ever of $0.43/share. Q2 2020 unsurprisingly took a bit of a dip, but in Q3, revenue, NOI, Adjusted EBITDA, normalized FFO (Funds from Operations) and FAD (funds available for distribution) were all higher than their pre COVID-19 numbers.
Source: HTA Supplement Q3 2020
Note that the large difference between FFO and “normalized FFO” was a loss on extinguishment of debt when HTA refinanced $300 million on 3.7% 2023 Notes with 2.0% 2031 Notes.
HTA has been characterized by consistent NOI growth and slow and steady FFO/FAD growth. This has translated to steady dividend growth for shareholders.
Going forward, we can expect HTA to maintain steady growth. Their acquisition pace slowed for 2020, but going into 2021, management sees resuming the pace they had in 2019 at $400-$500 million.
Perhaps one of the most underrated stories of 2020 for REITs is that their cost of debt is falling significantly. The market has been obsessed with how much rent is being collected this quarter, but is ignoring that many REITs are taking out 10-year-plus debt at record low rates.
For a REIT, this is huge. We just outlined above how HTA replaced $300 million 3.7% Notes with 2% Notes. That’s over $5 million/year in interest savings that HTA has locked in for ten years. That $5 million/year goes directly to the bottom line. Their interest expense is going down, while at the same time the rent they collect is going up.
HTA has a well-laddered maturity schedule, with only their revolver and credit facility term loans maturing in the next five years.
Source: HTA Supplement Q3 2020
HTA’s $1 billion revolver is completely paid off, providing them ample liquidity for acquisitions. We expect that HTA will be able to acquire properties at similar prices as they were last year, but will have the advantage of having much cheaper debt. That means larger profits and faster growth, a scenario we expect not only with HTA, but many quality REITs.
Medical care is something that we generally consider a necessity in modern society. While there’s certainly a lot of political debate about how medical care should be paid for, there’s a broad assumption that access to medical care is a human right.
As the Baby Boomer generation continues to age, demand for medical care will continue to increase. This is a generation that does not want to slow down and sit around waiting to die. They will want medical care and they will want it to be fast and convenient. The “silver rush” is on, and medical companies are racing to expand to provide baby boomers the services they demand.
HTA is well positioned to profit from this increased demand. More demand for medical care means more demand for the buildings that medical care is performed in. Through COVID-19, HTA has proved our original thesis, with a truly minimal and short-term negative impact. HTA rebounded strongly in Q3, not just back to Q1 levels, but with their strongest earnings ever. HTA’s tenants are not shrinking their businesses, they are expanding and can be expected to keep expanding for the foreseeable future.
In addition to growth in the medical field, HTA benefits from the broader dynamics that will benefit all REITs. Real estate is a business that frequently relies on relatively high levels of leverage. Being able to borrow at very cheap rates fuels growth cycles in real estate, while also making the 4.5% yield that HTA currently pays more attractive as an investment. This creates a combination where we can expect HTA to have faster growth than in recent years, while the share price is likely to improve as investors search for yield.
The next few years are going to be exceptionally bright for HTA, and that is why we are buying it now. You should do too!
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Disclosure: I am/we are long HTA. 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.
Additional disclosure: Treading Softly, Beyond Saving, PendragonY, and Preferred Stock Trader all are supporting contributors for High Dividend Opportunities.