One of the largest U.S. healthcare real estate investment trusts (REITs), Ventas (NYSE:VTR) has a long history of success behind it. In today's market, though, investors appear to have taken a "what have you done for me lately?" view of things. So the stock sold off sharply when Ventas highlighted a change in fortunes in a key business segment during its third-quarter conference call. What's going on, and is the news really so bad?
Teeing things up
To be fair, Ventas set itself up for this one. During recent company presentations, it has made a grand show of how it was "pivoting to growth" in 2020. That was based on a couple of big trends. First, Ventas has been rebalancing its portfolio in recent years. It spun off its nursing home business, which was heavily exposed to Medicare and Medicaid spending changes. Luckily for Ventas shareholders, it got out of the sector before nursing homes started to struggle. The same can't be said of peer Healthpeak Properties (NYSE:PEAK), formerly known as just HCP, which only spun off its nursing homes after the segment's results started to hit the skids.
Ventas has also been pruning weaker assets in other healthcare niches while expanding its portfolio into areas with growing demand, specifically the medical office and research niches. Notably, it didn't just buy medical office and research facilities, it partnered with companies that build these assets. It created platforms for long-term growth, putting up the money so its partners can build new facilities. It has material spending plans in these spaces over the next few years.
But the biggest driver of the company's "pivot to growth" was going to be its senior housing operating portfolio, known as "SHOP" within the industry. These are assets that Ventas owns and operates, allowing it to get a piece of the revenue upside at these properties when things are going well. (Note that Ventas technically hires third parties to actually run the properties on its behalf.) About a third of the company's portfolio is SHOP. The big story was that the dynamics in senior housing were going to shift positively, and this business was on the verge of material demand, and thus pricing strength. The company even brought out a collection of data analysts to prove the point with proprietary data.
One small problem
When Ventas released its third-quarter earnings, however, it reported that results in its SHOP portfolio weren't living up to expectations. That's perhaps an understatement since net operating income from the segment fell a material 5% year over year in the quarter. Meanwhile, occupancy in the SHOP portfolio fell 70 basis points from the same time period in the previous year. The downside of the SHOP portfolio is that Ventas takes a hit when properties don't perform as well.
It was a shock to Wall Street, particularly since Ventas had been telling everyone who would listen that the senior housing sector was set for improvement. But the worst sin was that Ventas' highly respected CEO, Debra Cafaro, had to tell listeners on the REIT's Q3 conference call:
Because we will end 2019 and enter 2020 off a lower base, we have also concluded that our enterprise growth will be deferred until after 2020.
There's no way to put a good spin on that -- Cafaro had promised something and it didn't happen. Investors were justifiably disappointed, and the shares sold off sharply. But how bad was this transgression?
The senior housing space is set to see a material increase in demand backed by an aging population. That's a virtual lock because of the demographics of our society. The problem is that this information isn't a secret. A lot of companies have been building senior housing assets to meet that demand, whenever it finally starts to arrive in force.
That's probably at least a few years off, so right now the senior housing market is oversupplied. With newly opened facilities starting to pile up, competition has become increasingly intense. That was the problem in the third quarter for Ventas and peer Healthpeak, which saw results dip 4.1% in its SHOP portfolio. That said, Welltower (NYSE:WELL), the last of the large diversified healthcare REITs, managed to increase its SHOP results by 2.8%. So Ventas wasn't alone in its misery, but it still fell short of a key competitor. Moreover, by pushing the "pivot to growth" out a year, Ventas has notably diminished its near-term outlook.
But there's a silver lining here. First off, the demand for senior housing is based on a very large and highly likely population trend. Whether it happens in 2020 or 2021 (or 2025, for that matter), the demand side of the equation looks rock solid. In fact, Cafaro noted that demand for senior housing is at record levels. It's the supply of senior housing that is the big issue right now.
The news is actually not so bad on that front, either. New construction of senior housing has been declining, reaching the lowest point in nine years in the quarter. So the glut of newly opened properties is hurting today, but once the increasing demand fills those beds, there's likely to be a much better supply/demand balance. And that, in turn, should lead to better results for Ventas' SHOP portfolio. This is an embarrassing delay for sure, but it still looks like Ventas' senior housing business has a bright future.
Too much hype
At this point, investors who own Ventas probably shouldn't run for the hills. Yes, Cafaro oversold the "pivot to growth in 2020" story, and it came back to bite her. But the story itself isn't dead, the time frame has simply shifted out a bit. This appears more likely to be a blip in an otherwise long string of success. It's not the end of the world as Ventas knows it. Dividend investors should give the REIT the benefit of the doubt (but keep an eye on the SHOP portfolio just the same).