Healthcare real estate investment trust (REIT) Welltower (NYSE:WELL) is one of the largest players in a sector expected to have a bright future. The positive outlook here is backed by demographics, as an aging baby boomer population is destined to increase demand for healthcare services. That, in turn, will be good news for the landlords that house these businesses. Is that enough to make Welltower a buy?
A good company
Few REIT investors would argue that Welltower is a bad company. Most, in fact, would tell you it is a well run property owner with a large and diverse portfolio of enviable healthcare assets. The company generates roughly 45% of its net operating income from senior housing that it operates (technically it hires others to run the assets). This allows it to enjoy the upside of the properties. Another 18% comes from senior housing that is leased to others on a net lease basis, which means the lessees are responsible for most of the properties' costs. These assets are the clear core of Welltower's portfolio, and provide generally healthy seniors a place to live with a little bit of support.
Roughly 21% of rents come from medical office buildings, and 7% from health systems. These are the places where seniors go to receive ongoing care of varying types, including basic doctor visits, specialized tests, and emergency care. The rest of the portfolio, around 9% of net operating income, is long-term care -- effectively, nursing homes. These are the facilities seniors go to when they need material help with daily activities. But you see the trend. Welltower is placed all along the continuum of senior housing and care needs.
This isn't the only thing to like about Welltower's portfolio. It also has broad geographic exposure, with a focus on top markets. For example, it has properties in the U.S., Canada, and the U.K. In Canada, 78% of its senior housing rent roll comes from the top 10 markets. In the U.S. 79% of rents come from the top 25 markets. In England, 88% of net operating income is derived from London and other southern parts of the country. Put simply, Welltower is ready for the wave of baby boomers that is going to increasingly use healthcare facilities.
Don't get too excited
The problem here is that investors are well aware of Welltower's strong industry position. Take the company's dividend yield, which sits at roughly 3.9%. That may sound attractive to dividend investors compared to the S&P 500 Index's lowly 2% or so, but when you step back and look at the REIT's own history, that yield is a rock-bottom number. Investors have bid the stock price up to the point where the dividend yield is near its lowest levels ever. Suddenly Welltower's yield no longer looks like a great buy -- and that yield is also lower than those of its two closest peers, Ventas and HCP.
Taking a more traditional look at valuation, Welltower is projecting funds from operations (FFO) of between $4.10 and $4.20 a share in 2019. FFO is the REIT equivalent of earnings per share for an industrial company. With a recent price of around $91 per share, that puts the REIT's price to FFO ratio at nearly 22 times. That's a hefty figure for an income-focused stock (REITs must pay out 90% of earnings in order to avoid corporate-level taxation) known for slow and steady growth. That remains true despite the fact that Welltower expects to see increasing demand for its properties in the years ahead. Investors today are pricing in a lot of good news.
Value and price
To paraphrase Benjamin Graham, the famed value investor who helped train Warren Buffett, a great company can be a bad investment if you pay too much for it. It is broadly accepted that Welltower is a good company. However, investors have pushed the price of this healthcare REIT up to the point where it looks expensive. Now is not the best time to buy Welltower, though you should probably consider keeping it in on your watchlist just in case a correction brings the shares down to an attractive level again.