The aging baby boomer generation is set to materially increase demand for senior housing. The question isn't if but when because the demographic shifts this giant generation will engender are largely unavoidable. Investors looking at the senior housing sector have a number of options to pick from, with two of the biggest names in the space being HCP, Inc. (NYSE:HCP) and Brookdale Senior Living, Inc. (NYSE:BKD). But what's the better choice here: the property owner or the facility manager?
Very different models
The first thing to note about Brookdale and HCP is that they are vastly different companies. Broadly speaking, Brookdale runs senior housing properties while HCP owns healthcare properties, including senior housing. It's also noteworthy that HCP is structured as a real estate investment trust, or REIT. So income is going to be a big piece of the return profile for this stock, which currently has a robust 6.3% yield (more than three times what you'd get from an S&P 500 index fund). Brookdale, structured as a regular corporation, doesn't pay a dividend.
That said, this pair operates in the same industry, just in different ways. So what impacts one will affect the other. In fact, Brookdale and HCP have a business relationship, with Brookdale operating a number of HCP facilities (more on this below), which isn't a great thing right now.
A troubled industry?
Senior housing operators like Brookdale have been facing increasing competition from new construction. The baby boom wave that's set to sweep over the country is well documented. Between 2020 and 2030, the number of people age 75 and older will grow by 50% in the United States. You can see why a lot of companies have been building in the senior housing space, since the 75-and-older age group is a key customer.
That's made it difficult to keep facilities at high occupancy levels, with industrywide occupancy falling 2 percentage points over the last four years (that may sound small, but it's a material change). Add in a bad flu season last year and the euphemistically titled "moveouts" only made things worse. Brookdale has been struggling in this environment, with earnings falling from a loss of around $1 a share in 2014 to a loss of just over $3 a share last year.
HCP, in fact, has been selling assets run by Brookdale, including to Brookdale itself. Healthcare REIT peer Ventas, Inc., meanwhile, just reworked Brookdale's lease agreement to give the company additional financial support so it can work through this rough patch. This isn't to suggest that Brookdale is bad at what it does, which is not true -- only that the near-term pressures in the senior housing industry are taking a notable toll on the company's financial results.
A different way to go
This is why HCP comes out on top here, in my opinion. For starters, senior housing only makes up around 35% of the REIT's net operating income. In fact, it has recently started to focus more attention on the medical office and medical research spaces, which combined make up more than 50% of the top line. These sectors should benefit materially from the fact that those over 65 spend four times as much on healthcare as those under that age -- no matter where they choose to live. The big takeaway here, however, is that HCP has a more diversified business.
Moreover, HCP owns assets but doesn't actually operate properties. It either leases senior housing assets out to third parties or hires companies to manage them (known as SHOP assets in industry lingo). If it has a property that isn't performing as well as expected, it can change operators or simply sell the asset. That's the basic approach it's taking with many of its Brookdale assets today, which is not exactly a ringing endorsement for Brookdale. But the upshot is that HCP has a relatively easy way to deal with the headwinds that are hitting the senior housing space.
It's also noteworthy that HCP receives rent for properties it leases to others (about 22% of net operating income). Rent has to be paid regardless of how the property is performing. And while it participates in the performance of the properties it owns and hires others to run them (13% of net operating income), this is a smaller part of the business. Ultimately, Brookdale's financial results are more directly impacted by the headwinds facing senior housing.
Diversification wins here
HCP's financial results aren't exactly squeaky-clean. The company recently jettisoned most of its nursing home assets because the outlook for that area of senior housing, which is heavily reliant on government payments, looks weak, at best. That move has trimmed revenues, resulted in significant one-time costs, and led to a dividend cut. However, HCP is successfully repositioning itself and looks far better positioned to benefit from the aging wave of baby boomers than Brookdale today.
I'm confident that Brookdale will adjust and adapt. In fact, new building starts in the senior housing space are down around 30% from their 2015 peak. This suggests that competition will be less of an issue over the next few of years. Moreover, industry watchers estimate that a mere 1% increase in the number of people choosing senior housing would fill up most of the vacant beds today. But I'd still rather collect a 6% yield from a better-positioned company than invest in what is currently a turnaround situation at Brookdale.