Welltower (WELL 2.55%) and its healthcare real estate investment trust (REIT) peers have been suffering lately as COVID-19 has spread throughout the United States. The stock is down roughly 45% from its early-2020 highs. For those thinking long-term, however, this well-run REIT is worth a closer look. In fact, even as it deals with COVID-19, it is laying the foundation for future growth by expanding into a new market segment. Here's a quick primer on what you need to know.
The COVID-19 issue is real
Before getting to the long-term picture here, it is important to address the near term. COVID-19 is a very material threat to healthcare real estate investment trusts like Welltower. Although diversified, Welltower generates around 63% of its rents from senior housing facilities. The residents of these properties are at an elevated risk of dying from COVID-19, on top of the fact that the disease appears to spread easily in group settings.
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Worse, Welltower generates about 43% of its top line from its senior housing operated portfolio (SHOP). That's industry jargon to describe properties that the REIT owns and runs (it actually hires third parties to handle the day-to-day operations), allowing it to benefit from the actual performance of the assets in good times. The downside is that Welltower also has to feel the pain during tough times. Tough times are likely on the way because of COVID-19, as move outs (deaths) increase, potential residents reconsider the desirability of group settings, and the ability to give tours is curtailed by social distancing measures. But it is worth noting that the REIT's SHOP portfolio was doing quite well (with net operating income up 1.5% in the fourth quarter of 2019) before the coronavirus issue, which can't be said of some of its closest competitors.
Part of the reason for that outperformance is the company's historical focus on high-end markets. Notably, Welltower prefers areas where there are material barriers to entry for competitors. That's helped protect it from an oversupply issue that's been a notable headwind in the sector. There's no question that Welltower will be hit by the impact of COVID-19, but that's likely to be a near-term issue. And when times do get back to normal, Welltower has a new growth plan in the works.
Broadening its target market
Although historically focusing on the higher-end segment, Welltower recently unveiled a new business called WelltowerLIVING. At this point it consists of three properties located in Las Vegas. Renovated in 2017, the target market for these facilities is middle-income residents. That pits the company against a larger group of peers, but its diversified portfolio allows it to integrate these housing facilities into a bigger healthcare matrix. Essentially, its partners (tenants at nearby medical facilities like hospitals), will be able to offer services to WelltowerLIVING residents in a customer-friendly manner. That will be a net benefit to senior housing residents and the REIT's other tenants, with everyone seemingly ending up happy.
Moreover, from here on the REIT is looking to build from the ground up. That should provide higher returns from the start, as construction is generally more profitable than acquisition. It already has a partner here that will be building properties in the Southeastern United States. Welltower basically provides the capital, with its partner handling, and getting paid for, the construction work. In a business where returns are likely to be tighter than at its other properties, this will help boost the financial performance of this venture.
Stepping down the income scale is an interesting change for Welltower. However, being able to integrate the services from its other lessees is likely to help the properties stand out. Moreover, the age wave that's coming as baby boomers crest into retirement is still on the way -- even COVID-19 won't stop that trend. So more senior housing will be needed in the future, and the middle-income segment is likely to be a far larger market than the upper-income segment that Welltower is focused on today. Not only does it suggest that there will be plenty of room for WelltowerLIVING to compete, but in the end the REIT may not have much of a choice if it wants to keep growing its business.
Somewhat sadly, new buildings will also be a net benefit in another way. Existing senior housing facilities will have to deal with the immediate impact of COVID-19 on their residents. It is likely that this period of time, however, will lead to a bit of stigma across the industry -- no matter how hard companies work to protect their residents. A newly opened senior living facility won't have to deal with the same level of stigma, because it won't have existed when COVID-19 hit. Newly built assets can tout the updates that COVID-19 will likely lead to, but not have to field any questions about the historical impact of the coronavirus at the facility because there was none.
Worth a deep dive in a tough environment
Welltower is dealing as best it can with COVID-19, and investors need to dig into this issue if they are going to buy in here. However, with a hefty 6.9% yield and a strong history of operating performance, Welltower is worth that extra look.
But as you examine the near term, don't lose sight of the long term. WelltowerLIVING shows that this REIT is still prepared to grow once this rough patch is over.
