Shares of healthcare real estate investment trusts (REITs) with senior housing exposure have been volatile as COVID-19 has spread through the United States. Healthpeak Properties (NYSE:PEAK) is no different. The shares are down massively one day, up massively another. With a yield that's well above the market, is it worth stepping into this crazy trading? If you are looking for a diversified healthcare REIT today, Healthpeak may be one of the better options. Here's why.
A miss and a change
Healthpeak used to be known as just HCP, with that name itself an abbreviation of Health Care Properties. It's one of the largest and most diversified healthcare real estate investment trusts around. But it is a very different company than it was a decade ago. At one point the REIT had notable exposure to nursing homes. That niche, however, took a turn for the worse, and led to a restructuring of the portfolio that included a spin-off of nursing home assets and a dividend cut. Competitors weathered this period much better.
This was an important moment for Healthpeak, which basically took the opportunity to shift its portfolio around and refocus around better-performing assets (it also changed its name). The big shift was to increase the portfolio's exposure to healthcare offices and healthcare research facilities. That, in turn, reduced the company's exposure to senior housing assets, with roughly 30% of the portfolio in each of these three categories at this point in time ("other" assets make up the remainder). Healthpeak's closest peers, Welltower and Ventas, both have materially larger exposure to senior housing.
Less is more today
One of the big reasons that diversified healthcare REITs like Healthpeak are getting hit hard by COVID-19 is that senior housing is suddenly a less desirable property type. First, residents of these facilities are at higher risk of death from the new coronavirus. Second, the disease tends to spread easily in group settings. That's a double whammy here, since a senior housing facility is basically a place where one of the most at-risk populations congregates in groups.
A bad flu season can lead to occupancy issues in the senior housing sector, so COVID-19 could be much worse. That would exacerbate the situation in what is already an oversupplied market. In fact, before the coronavirus started to escalate, Healthpeak was already having troubles in this segment, which was its weakest performer in 2019. That said, there are two sides to this business. It leases assets out to others on a net lease basis (meaning its tenants are responsible for most of the costs of the properties they occupy), and it owns and "operates" assets on its own, in what is known as a senior housing operated portfolio (or SHOP in industry lingo). That said, the REIT actually hires others to run SHOP properties, though the performance of the properties, both good and bad, flows through to Healthpeak. Roughly 13% of the total portfolio is net lease, and 15% is SHOP.
The company's net lease assets are doing reasonably well, which isn't a surprise because these properties have long-term leases with regular rent escalations built in. The SHOP portfolio, on the other hand, has been suffering, with net operating income down around 1.5% in 2019 and a notably worse 3.4% in the fourth quarter of that year. The big problem is that everyone knows that there is a large demographic shift taking place that will result in more demand for senior housing. And, thus, a lot of properties were built in anticipation of that upcoming demand. At this point, there's too much housing, and it's putting downward pressure on rents and occupancy. COVID-19 could make things worse, which is why investors are punishing senior housing related names right now.
That said, the number of people choosing to move into senior housing (known as the penetration rate) has been increasing, the demographics remain in place for an increase in the number of seniors, and construction of senior housing has begun to slow. So Healthpeak is expecting to see its SHOP portfolio performance improve over the next few years. COVID-19 might delay the upturn, but it is highly unlikely to derail it permanently. And, with the least exposure to SHOP assets among its closest peers, the REIT is really the least exposed to the coronavirus impact.
Meanwhile, the company's medical office and medical research assets are performing quite well. The office segment saw same-store net operating income rise 3% in 2019, with medical research up 6.2%. These two segments make up roughly 60% of the overall portfolio, and are expected to continue performing well. So, right now, Healthpeak appears to be the best positioned of the large, diversified healthcare REITs. In tough times like we are facing today because of COVID-19, diversification clearly has some benefits.
Trying to find bargains when everyone is fearful is a tried and true value approach, but it is not an easy task since it requires going against the investing grain. Right now, healthcare REITs with senior housing assets are trading in an incredibly volatile fashion, including Healthpeak. But investors willing to dig in can see that it has the least exposure to COVID-19 risks relative to its closest peers. Add in a hefty dividend (which at the time of writing was around 6%), and this could be a good option for investors that can think long-term to take advantage of short-term market fears to increase the income they generate from their portfolios.