The story behind healthcare real estate investment trusts (REITs) has long been that they will benefit from the giant baby boomer generation as it crests into retirement. After all, healthcare needs materially increase for people age 65 and older and real estate that accommodates those needs will be in higher demand.
So far, however, the math hasn't worked out so well for senior housing, because construction has outstripped demand. But REIT industry giant Ventas (NYSE:VTR) thinks the trend is going to turn in a positive direction very soon.
A little background
At Ventas' investor day, the company spent some time discussing its market research approach. This was important because Ventas is making a bold call. After several years of performance decline due to portfolio repositioning, It believes that 2020 will be the year in which its funds from operations (FFO) start to "pivot" back to growth, with 2021 being the key year. That's when Ventas says demand for senior housing will outstrip supply following years of over-construction in anticipation of the baby boom retirement wave. That, in turn, will push the company's FFO higher.
This is a big deal for Ventas, which generates around 55% of its net operating income (NOI) from senior housing. Around 23% of its total NOI comes from net-lease senior housing properties. These assets are leased under long-term contracts to operators and generally include pre-set rent increases. This business has been doing OK, with a projected NOI growth rate of around 1% for 2019.
That growth rate isn't great, but it looks wonderful when you consider the REIT's senior housing operating portfolio (SHOP), which accounts for around 32% of NOI. These are assets that Ventas effectively owns and operates (though technically it hires others to run the facilities), allowing it to benefit from the upside of operating performance -- and weather the downside. Ventas' 2019 projections call for an NOI decline of as much as 3% in the SHOP group, largely because of weak pricing and demand driven by oversupply.
The SHOP portfolio has been a major headwind for Ventas, and a major concern for investors. It's one of the reasons why Ventas' shares have lagged the broader REIT group over the last three years. An upturn in this division would be a huge benefit to the REIT, but it isn't alone in the space. Peers Welltower (NYSE:WELL) and HCP (NYSE:PEAK) also have notable SHOP portfolios, at roughly 40% and 36%, respectively.
The 2021 story
So how exactly did Ventas come to the conclusion that 2021 would be the transition year for supply and demand?
First, it hired a data specialist to help it build out a proprietary database. That was necessary because the senior housing industry is fairly fragmented. While there are some major players, like Ventas, Welltower, and HCP, there are still a lot of smaller operators out there.
Second, it gathered data from around the country on population metrics, senior housing construction, senior housing permits, occupancy levels, and penetration levels (the percentage of seniors that currently make use of senior housing), among other things. Using this data to look at the industry from a ground-up perspective, the researchers concluded that the overall market will see falling supply and increasing demand sometime between 2020 and 2021. This is a much deeper look at the space than just examining the number of senior housing properties that are under construction.
This accumulated data has provided Ventas even more detailed analysis, offering new insights on the submarkets it currently serves. In those markets, which are generally in high-barrier-to-entry wealthy regions, Ventas believes there's even more upside potential. Although HCP is projected to be better positioned overall to take advantage of this particular trend, Ventas' projections suggest it will see more demand growth than Welltower, and better growth than the industry average. It leads the space, meanwhile, in the percentage point increase in the penetration rate it is projecting for the regions its serves. In simple terms, the data shows more people will start to use senior housing in the areas where it operates.
Ventas should do very well if its projections play out. That said, Welltower and HCP will do quite well in this scenario, too. So these projections aren't a reason to necessarily select Ventas over its closest peers. However, they are a reason to be optimistic about the senior housing space in general.
Still a little time to go
Ventas has been struggling with oversupply in the senior housing market for a few years, as have its peers. That's been a particular pain point within each REIT's SHOP portfolio. But based on proprietary research, Ventas believes there is a light at the end of the tunnel that will start to shine in 2021.
If you have been waiting for the healthcare REIT story to play out, it looks like the day is fast approaching. If you have been on the sidelines, waiting for positive news before jumping aboard Ventas, Welltower, or HCP, you might want to start looking more closely right now.