A swarm of baby boomers reaching old age is going to keep assisted living centers and skilled nursing facilities extremely busy in the years ahead. Omega Healthcare Investors (OHI 0.34%) is a laser-focused real estate investment trust (REIT) with hundreds of these facilities spread across the U.S. and the United Kingdom.
Shares of Omega Healthcare Investors offer a juicy 6.6% dividend yield at the moment, but can the company continue raising the payout into the long run? Let's weigh arguments for and against buying this high-yield healthcare stock.
Reasons to buy Omega Healthcare Investors
According to Medicare, one-fifth of all hospital discharges sent patients to a skilled nursing facility (SNF) in 2016. Although Omega has some senior housing properties, SNFs make up 83% of the REIT's real estate portfolio.
America's over-75 population is expected to rise from 22.7 million in 2020 to 40.2 million in 2040. That's a strong tailwind that could help Omega shares deliver market-beating gains to your retirement portfolio.
In early 2018, Omega Healthcare Investors made the 22nd consecutive increase to its quarterly dividend. Unfortunately, the company had to temporarily freeze the payout in place while shuffling facilities from one insolvent operator to others that are able to pay their rent.
In October, Omega increased its payout for the first time in a year and a half and there's a good chance this REIT will continue bumping the payout quarter after quarter in the years ahead. In October, Omega Healthcare acquired 58 SNFs and two assisted living facilities that are leased to two operators that will pay the REIT $64 million to rent next year.
In the third quarter, adjusted funds from operations (FFO) rose 6.1% year over year to $172.5 million. The latest dividend increase raised the payout to 88% of adjusted FFO, which gives the company all the room it needs to continue raising its dividend at a rate that falls in line with profit growth.
Reasons to remain cautious
While demand for SNFs will climb faster than ever over the next two decades, the level of reimbursement Omega's operators receive for each occupied bed might not grow in lockstep with the over-75 population. Over the past 15 years, the level of reimbursement per occupied bed received from Medicare has grown at 2.7% annually and Medicaid payments grew by 3.7% annually over the same period.
It's especially difficult to forecast how much Omega's operators will receive from the government due to fee-for-service reforms that went into effect in October. The new rules reduce payments for some services while incentivizing shorter lengths of stay.
In theory, fee-for-service reforms should increase the demand for SNFs because they provide the sort of care meant to get patients back on their feet as quickly as possible. In practice, though, it's hard to tell which part of America's convoluted healthcare sweater will unravel once the government begins tugging at this thread.
It's important to remember that Omega Healthcare Investors receives nearly all its revenue from triple-net leases that pass on all of the variable costs that come with building ownership to facility operators. This means its operators don't necessarily need to thrive for the REIT to outperform, they just need to pay the rent.
A comforting 85.1% of leases and mortgages in Omega Healthcare's portfolio don't expire until after 2026. That should provide fairly predictable cash flows for the long term.
The portfolio's so diverse that just 1 out of 73 different operators that Omega works with is responsible for more than 10% of contractual rent. The operator, Ciena, runs 69 properties responsible for 11.1% of Omega's contractual rent expectations.
Geographically, Omega's portfolio is diverse enough that one or two states making drastic cuts to their Medicaid programs won't stop the company from growing. As you may have guessed, more of Omega's revenue originates in Florida than any other state. At just 10.4% of expected rent payments, though, trouble needs to spread to several other states before Omega's shareholders begin to sweat.
A buy now?
The SNF industry isn't one that investors should directly invest in, but the country's largest landlord for SNF operators looks like a buy at recent prices. There isn't a lot Omega can do about potential reimbursement issues from Medicaid and Medicare, but a 6.6% dividend yield that will most likely rise steadily is well worth the risk.