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Why HCP Shareholders Have Nothing to Worry About

By Matthew Frankel, CFP® - Jul 19, 2017 at 8:02AM

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Here's why HCP should be an excellent long-term investment for shareholders.

Healthcare real estate investment trust HCP (PEAK 2.68%) has had an interesting couple of years, with several strategic asset sales, a spinoff of a large portion of its portfolio, and the necessary dividend reduction that came with it. However, at this point, there's good reason to believe that HCP's future is bright. Here are five reasons why HCP shareholders shouldn't worry about their investment.

One of the best portfolios in healthcare real estate

HCP maintains a portfolio of about 800 properties concentrated in senior housing, medical office, and life science buildings. Since the 2016 spinoff of Quality Care Properties, or QCP, there are no skilled nursing assets in the portfolio, and 95% of the portfolio's revenue is derived from private-pay sources, which generally implies stability.

Nurse examining senior patient.

Image source: Getty Images.

About 25% of the portfolio is triple-net senior housing, which means that the properties are leased to tenants, who not only sign long-term leases but pay other costs such as property taxes, building insurance, and certain maintenance expenses. Another 20% is made of senior housing operating partnerships, under which HCP and some of the best operators in the business share in the property's revenue.

Life science facilities, most of which are leased to public or well-known private companies, comprise 21% of the portfolio. In fact, HCP is the largest owner and developer of life science properties on the West Coast. Medical office properties, most of which are located in top metropolitan areas and virtually all of which are affiliated with hospitals or major healthcare systems, consist of 22% of the portfolio.

Improved balance sheet and tenant concentration

Since splitting off QCP and completing some de-leveraging activities, HCP's balance sheet has improved dramatically. By the end of 2017, the company is targeting leverage in the 43%-44% range, and for its top three tenant concentration to drop to 35%-40%. For comparison, at the end of 2016, HCP had 48.6% leverage and 44% of its portfolio was concentrated in just three tenants.

The company currently has Baa2/BBB investment-grade credit ratings, and is hoping to improve this in the not-too-distant future. In addition, HCP has very little secured debt, and a $2 billion revolver that allows it the financial flexibility to pursue attractive opportunities as they arise.

Development and redevelopment opportunities can add value

I personally love REITs that grow through development as well as acquisitions. When done correctly, development can be an excellent way to create value and boost returns.

Think of it this way: If you can buy a particular property for $10 million and generate $600,000 in annual rental income, this translates to a 6% yield on your initial investment. On the other hand, if you can build a similar property for just $8 million, you've not only instantly created $2 million in equity, but the $600,000 in income now translates to a 7.5% yield on your investment. Of course, this is a simplified example, but it's the basic principle.

HCP currently has $834 million of committed ground-up developments, about 80% of which are life science properties. And to my last point, HCP's development program aims to achieve a spread of 150-200 basis points between its development yield and market cap rates. What's more, the company expects its current pipeline to do even better.

In addition, HCP seems like a massive opportunity in redeveloping/renovating its current medical office properties. The company plans to spend $75 million to $100 million per year on redevelopment, and expects 9%-12% cash-on-cost returns.

A growing market

Perhaps the most compelling reason to invest in a healthcare REIT like HCP is for the long-tailed growth opportunity brought on by the aging U.S. population.

Specifically, as baby boomers continue to retire, the population of older Americans is expected to skyrocket. In fact, the 75+ population is expected to grow by 50% in just the 10-year period from 2020 through 2030. This translates to 11 million more people who have a disproportionately high need for healthcare services, particularly senior housing and medical offices.

Projected growth in 75+ population.

Image source: HCP investor presentation using U.S. Census Bureau projections.

Abundant opportunities in the existing healthcare real estate market

In addition to the development and redevelopment opportunities, and the growing healthcare real estate market, HCP also has tons of opportunity in the existing inventory of healthcare properties. Specifically, healthcare real estate is a $1.1 trillion market, and is in the very early stages of REIT consolidation. In other words, the majority of healthcare real estate isn't owned by REITs but by physicians, hospital systems, private investors, and the companies that occupy the buildings.

HCP's portfolio and overall healthcare RE market.

Image source: HCP investor presentation.

In fact, HCP estimates an "investable universe" of $660 billion between its three core property types. The company is prioritizing SHOP senior housing acquisitions, on-campus medical office buildings, and top-tier life science research clusters.

To be clear, I'm not saying that HCP is actually going to acquire $660 billion of properties or anything close. The point is that this is a massive list, from which HCP can select the most appealing opportunities.

The Foolish bottom line

As I've outlined, there are several reasons to like HCP going forward. The company has a rock-solid asset portfolio, several avenues for future growth, and the financial flexibility to grow as it sees fit.

Having said all of this, it's important to point out that HCP is not without risk. In fact, REITs like HCP can be quite volatile over short periods of time, particularly while interest rates are rising. In addition, there are company- and industry-specific risks, such as possible oversupply in the senior housing market.

My point is that HCP is not a short-term investment by any means. However, if approached from a long-term perspective, there's little reason to worry about the company's future.

Matthew Frankel owns shares of HCP and Quality Care Properties, Inc. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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