Even before the recent market drop, Ventas' (NYSE:VTR) stock price was falling. Wall Street has a good reason for taking a dim view of this real estate investment trust (REIT), noting that management badly misread the prospects for a key business in 2019. In fact, the lingering issues for that division, which the COVID-19 pandemic could actually make worse, appear to be all that investors are thinking about.
The thing is, the news isn't all bad for the REIT. Here's a closer look at what's going wrong -- and what's going right -- at Ventas today.
Getting the bad out of the way
There's no way to sugarcoat the problem Ventas faces. Senior housing makes up roughly half of this healthcare REIT's net operating income. This segment is broken further into two different groupings, properties operated with net leases (rented to a third party) and a senior housing operating portfolio, called SHOP in the industry, where properties are "operated" by Ventas. The SHOP portfolio makes up roughly a third of Ventas' net operating income.
The net lease side of senior housing has been fairly steady. That makes sense, given that the properties are generally rented out under long-term leases. It's the SHOP side that's the big concern. Ventas really hires outside operators to run these assets, but the nature of the business is that the REIT participates financially in the performance of the facilities -- for better and, recently, for worse. For example, in 2019 net operating income in Ventas' SHOP portfolio fell 4.4%. Some of its peers are seeing declines, too, but not all. Specifically, Welltower's SHOP portfolio saw growth in every quarter of 2019.
Worse, Ventas had been calling for its SHOP portfolio to be a key driving force behind a period of growth. That didn't work out as planned, and investors were deeply disappointed. The truth is that a construction boom has led to a supply overhang that is likely to only be worked off over time. So the upturn that Ventas was expecting is most likely still going to happen, just a year or two later. Backing the positive view here is the fact that demand for senior housing has remained strong and construction of these facilities has declined, which Ventas tried to highlight during its fourth-quarter 2019 conference call. But Wall Street is more focused on the near term than the long term.
COVID-19, meanwhile, could make things even worse for senior housing assets over the next year. Seniors appear to be at greater risk of death from the new coronavirus, which tends to spread easily in group settings. Wall Street is right to be worried about REITs like Ventas that own senior housing, though it's hard to tell how big an impact COVID-19 might have just yet. Yes, Ventas' SHOP troubles could linger for longer than currently expected, and the pain could bleed into its net lease senior housing assets as well. However, COVID-19 isn't going to change the long-term need for senior housing -- the aging of the baby boomer generation is simply too big of a demand driver.
So what about the good news?
Here's the thing: Senior housing is roughly half of Ventas' portfolio. The other half is actually doing reasonably well. In fact, the company's full-year 2019 net operating income was flat, so the positives were able to offset the negatives last year. There is ample bad news at Ventas, but all the fuss about it is hiding some good things.
The most notable positive is Ventas' efforts over the last few years to build up its position in the medical research and medical office niches. Combined, these two account for about 27% of rents and are both classified under "office" in the REIT's results. In 2019, the office segment grew net operating income 2.6%, slightly higher than guidance.
The larger segment here is medical office at roughly 20%. This is a stable business that is set to benefit as more and more medical care is performed outside of a hospital setting. Medical research facilities make up about 7% of net operating income but are seeing much faster growth. In 2020, Ventas is expecting this segment's rents to expand at a 9% clip. COVID-19, by the way, helps to prove the need for more medical research. Ventas has partnerships in place in the broader office segment that are focused on ground-up construction, which should help support long-term growth on the office and research side of things.
Ventas also just announced the creation of a perpetual life vehicle that it will manage (with a 20% ownership stake) in the office space. Basically, it will get paid a fee for running this entity on behalf of institutional-level investors, giving it access to a new, long-term capital source as it seeks to grow revenue. Right now the contribution from this entity is likely to be small, but Ventas is basically being paid to do things it already does. The incremental income isn't exactly free, but it should be pretty close to it. And, assuming the venture works out as hoped, that income will grow over time as more institutional investors seek out the stability that healthcare properties can provide.
On top of that, Ventas is a fairly strong company financially speaking. Its financial debt-to-equity ratio is roughly 0.6 times, which is higher than that of its closest peers but not a particularly disturbing number for a landlord. It covered its trailing interest expenses by 1.9 times in 2019, again not an incredible number but not overly concerning given the nature of its assets and the size of its portfolio (Ventas owns roughly 1,100 healthcare properties). It should easily muddle through to better days on the SHOP side, while still continuing to invest in its growing office segment.
Thinking long term
It's easy to dislike Ventas right now given that near-term performance in the SHOP portfolio is likely to remain weak. However, that is overshadowing the good growth the REIT is achieving in its office segment. When you consider the company's reasonably strong financial foundation and the fact that the senior housing issues are likely to be temporary, Ventas' 6% dividend yield starts to look a lot more enticing. You just have to look past what Wall Street is focusing on today to see that long-term opportunity.