Despite a 20% rise in the S&P 500 so far in 2017, real estate hasn't performed well at all. Leading healthcare REIT Welltower (HCN +0.20%) is an excellent example of this, down by nearly 4% for the year. Even when including dividends, investors have received a total return of just over 1%.
Here's a rundown of why Welltower performed poorly this year, and what could be in store for 2018.
How did Welltower do in 2017?
Welltower's stock has performed poorly. However, this was due mainly to factors such as rising interest rates and oversupply fears in the senior housing industry, as opposed to company-specific performance. In addition, Welltower and REITs in general largely missed out on the tax reform rally, as a lower corporate tax rate has no direct effect on REIT profits.
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On the other hand, Welltower's business is doing quite well. Same-store net operating income in the company's senior housing portfolio (70% of Welltower's holdings) grew by more than 4%, the balance sheet is significantly improved, and the company recently raised its full-year guidance. In other words, Welltower's stock isn't doing poorly because its business is struggling.
In fact, the company continues to pursue attractive growth opportunities. For example, Welltower is currently developing a senior housing facility in Manhattan, a surprisingly underserved market with only 70 fully licensed memory care beds and high projected elderly population growth.
2018 could be a strong year for REITs, and healthcare REITs in particular
While I think that the favorable demographic trends, opportunities for growth through acquisition and development, and other factors will result in solid performance over the long run, the factors that tend to move the stock most over shorter time periods have little to do with the company itself.
Having said that, some of these external factors could become catalysts for REIT performance in 2018.
As I mentioned, interest rate hikes and the projections for further rate hikes were a major drag on REITs in 2017. Conversely, the Fed's forecast, which calls for another three rate hikes in 2018 and two more in 2019, is mostly priced in at this point. In other words, it's unlikely that REITs will face the same amount of interest rate pressure in 2018. In fact, if rates end up rising slower than expected, it could be a major boost to REIT prices.
Tax reform could be another boost. Since REITs don't pay corporate taxes, they won't benefit from the corporate rate cut. However, since REIT distributions are considered pass-through income, which gets a new 20% deduction, that makes REITs a more attractive investment to hold in taxable accounts and could be a positive catalyst in 2018.
In addition to these external factors, oversupply fears in the senior housing industry were also a negative factor in 2017, which disproportionately affected Welltower since senior housing makes up the bulk of its portfolio. So, if these fears begin to subside because of positive data like strong occupancy rates, that could help boost the stock.
But, its best year ever?
I'm hesitant to project that 2018, or any other year for that matter, has the potential to be Welltower's best year yet simply because the company has a phenomenal track record of performance. Since 1971, the company has averaged a 15.6% total return. Since 2000, there have been seven years with total returns exceeding 20%, including performances of 65.9% and 48.5% in 2001 and 2014, respectively.
Having said that, I think that 2018 could be a very strong year for REITs, as a relatively aggressive Fed rate hike projection is largely priced into the stock at this point and tax reform could help shift some investor money into the sector. And as one of the biggest and strongest REITs in its industry, Welltower could recover nicely from 2017's dismal performance.
