Real estate investment trusts, or REITs, tend to have higher dividend yields than the average S&P 500 dividend stock. However, healthcare REIT Senior Housing Properties Trust (NASDAQ:DHC) has a sky-high 10% dividend yield, which is enormous even by REIT standards.
Obviously, a stock with a double-digit yield and long-term growth potential would be any dividend investor's dream, but many stocks that fit this description are highly risky or have something else wrong with them. With that in mind, let's take a closer look at Senior Housing Properties Trust to see if it's too good to be true, or if it could be an excellent addition to your portfolio.
What Senior Housing Properties Trust does
Senior Housing Properties Trust is a real estate investment trust, or REIT, that owns healthcare properties. Despite the name, the company doesn't exclusively invest in senior housing. In addition to senior housing properties, the company also owns a substantial amount of medical office buildings and also has several other types of healthcare-related investment.
As of the latest data, Senior Housing Properties Trust owns 443 properties. During the third quarter, about 44% of the rental income came from medical office properties, 40% came from senior housing properties that are leased to tenants on a triple-net basis, and about 14% came from managed senior housing properties.
Why healthcare real estate?
There are a few reasons to invest in healthcare real estate. For starters, it's a very defensive type of asset. When a recession hits, people can cut back on things such as shopping at malls, staying at hotels, and renting storage spaces. On the other hand, healthcare is essential no matter what the economy is doing.
In addition, there are a lot of healthcare properties that aren't owned by public or private REITs yet. Medical offices in particular have a high rate of ownership by health systems and the physicians who occupy them. The existing healthcare real estate market is estimated to be $1.1 trillion in size, so it's fair to say there's a huge opportunity for consolidation.
Finally, the demographic trends indicate that there are several decades of steady growth ahead for healthcare real estate -- particularly property types that focus on the older age groups, like senior housing. The aging of the baby boomer generation is expected to cause a surge in the senior citizen population, especially in the oldest age groups. In fact, the 85-and-older segment of the population is the most likely group to utilize senior housing and is expected to double in size over the next 20 years.
Know the risks
As far as risks go, no stock with a 10% dividend and growth potential is low-risk, and Senior Housing Properties Trust is no exception.
On the positive side, in addition to having healthcare as a defensive property type, most of the company's property income comes from private-pay sources, which is generally more stable than revenue dependent on government reimbursements like Medicare and Medicaid. And the portfolio is geographically diverse without too much reliance on any single tenant.
However, there are some key risk factors. For starters, the company's debt-to-total capitalization ratio is about 50% -- definitely on the high end for a REIT. Senior Housing Property Trust does have an investment-grade credit rating, but with a Baa3/BBB-, it isn't by much. In fact, these are the lowest credit ratings that are still considered to be investment grade. And the company's leverage is one of the main reasons.
Interest-rate risk is another one, as rising rates increase the company's borrowing costs. Senior Housing Properties Trust has a $1 billion unsecured credit facility with a variable rate, so as rates rise, this becomes more expensive to use, and new loans become more expensive to obtain. Plus, rising rates tend to put downward pressure on REIT stocks regardless of borrowing impact.
In addition, there are several other potential risk factors. For example, if one of Senior Housing Property Trust's major tenants ran into financial trouble and couldn't pay rent, it could have a big impact on profitability.
Dividends and valuation
Senior Housing Properties Trust pays an annual dividend rate of $1.56, which translates to a massive 10.1% dividend yield based on the current share price. To be fair, this is an astronomically high dividend and should set off red flags, so let's look at its sustainability.
The company's normalized FFO (funds from operations, the REIT version of earnings) was $1.31 through the first nine months of 2018. Extrapolating this figure translates to full-year FFO of $1.75, which would imply a payout ratio of 89%.
Two things to note. First, while Senior Housing Properties Trust is earning enough money to cover its dividend, this is a high payout ratio -- even for a REIT. In other words, this doesn't leave lots of wiggle room if revenue drops unexpectedly. Second, it's worth noting that normalized FFO actually declined by $0.02 compared with the first nine months of 2017, so if this trend continues, the dividend's sustainability may be in trouble.
On a valuation basis, Senior Housing Properties Trust is extremely cheap. Based on the current stock price, shares trade for just 8.8 times projected 2018 FFO. To be clear, this stock is cheap for a reason (or several) -- not only does the dividend sustainability look questionable, but the company has relatively high debt.
Is it a buy?
To be perfectly clear, even though it invests in a somewhat recession-resistant type of real estate, Senior Housing Properties Trust isn't a low-risk REIT in any sense of the term. The question is whether the massive dividend yield and cheap valuation are enough to make up for the risks involved.
For long-term investors with the stomach to ride out some ups and downs, the risk/reward of Senior Housing Properties Trust could certainly make sense. Having said that, it wouldn't be my first choice for risk-averse investors or those who depend on their investments for current income. There are other healthcare REITs that could better suit investors who fit those descriptions.