Countries around the world have essentially shut down economically because of COVID-19, and a global recession is likely already underway. Companies across most sectors will feel the pinch. However, for real estate investment trusts (REITs) that own senior housing properties, like Ventas (NYSE:VTR), the coronavirus pandemic is having a larger than average impact.
At this point, investors in this niche need to be anticipating dividend cuts. Here's a look at where things stand at Ventas.
Already facing headwinds
Ventas ended 2019 on a very weak note. The real estate investment trust's portfolio is divided into three main segments: medical office, medical research, and senior housing. The first two combined made up around 27% of its net operating income (NOI) in 2019. Senior housing accounted for almost 70% of NOI, so it's clearly the most important part of the business. That segment is broken down into two parts, with properties leased to others accounting for 36% of NOI, and properties that Ventas owns and manages (it actually hires others to do the day-to-day work), accounting for the other 32%. That second part is known in the industry as a senior housing operated portfolio (SHOP), and it allows property-level performance to flow through to the REIT. In good years, that means a boost to earnings. In bad years, it means exactly the opposite.
The office segment has grown rapidly recently, and it performed fairly well in 2019. The senior housing portfolio leased to others also did OK, which was to be expected based on the nature of the long-term leases that generally back these properties. However, Ventas' SHOP portfolio had an ugly year and an even worse fourth quarter. For the year, NOI in this segment fell 4.4%. In the fourth quarter, it declined an even more troubling 7.5%. The big problem was that the industry, anticipating the growth of its target demographic, has built new senior housing properties, but supply has gotten ahead of demand. That has put pressure on rents, stretched lease-up times for new construction, and cut into occupancy levels. The financial impact of those issues has taken a toll on Ventas.
The hit was so bad that Ventas management had to walk back its early 2019 statement that it would grow funds from operations (FFO) -- the key performance metric for a REIT -- in 2020. Investors were not pleased. In fact, based on the company's guidance for 2020 FFO, it looked like the REIT's dividend coverage would be very tight. To put a number on that, Ventas' dividend is $3.17 per share per year. It was projecting that FFO could be as low as $3.56 per share for 2020. That would give it a payout ratio of roughly 90%, which is worryingly high. And it explains why Ventas didn't increase its dividend in the first quarter as it has for the last few years.
Then things got worse
So 2019 ended on a sour note and 2020 looked like it would be a tough, but manageable year. The wave of baby boomers steadily hitting retirement age suggested that the headwinds would just take some time to work through. Overall, Ventas' long-term plans for its senior housing business still looked sound. And then COVID-19 started to spread aggressively around the world, hitting the United States particularly hard.
Although there is still a lot that isn't known about COVID-19, some things have become disturbingly clear. It is highly contagious in group settings, and older people appear to be at greater risk of mortality. Senior housing is directly in the path of this disease. Ventas and its operators have taken aggressive steps to address the issue, focusing on resident health and safety. While the financial impact is still unclear, whatever it is won't be positive. At this point, Ventas has withdrawn its guidance for 2020.
The problems Ventas faces are material and widespread. For example, the company's senior housing lessees will face higher costs as they attempt to deal with the impact of COVID-19. In addition, they will likely see an increase in move-outs and a decline in the number of new people moving in. Social distancing makes it difficult, if not impossible, for potential residents to tour senior living facilities, and in any case, many who were considering moving into one are likely rethinking the idea in light of recent events. That means the REIT can anticipate a drop in occupancy, and lessees will probably have a harder time paying Ventas the rents it's due. Ventas is already offering rent deferrals to help its lessees manage during these difficult times. Meanwhile, these same problems are also hitting the REIT's SHOP assets, where all of the impact flows directly through to Ventas. And that segment was already facing headwinds. It's no wonder the company withdrew its guidance for the year.
The upshot is that the 90% payout ratio calculated above is likely to prove overly optimistic. The REIT is at real risk having to cut its dividend. Ventas has drawn down $2.75 billion from a revolving credit facility to help it stay liquid through this difficult period, but if the COVID-19 pandemic has a lingering impact on the senior housing sector, that won't be enough to stave off a dividend cut.
Things have changed
Ventas' dividend looked stretched but secure at the start of 2020, but COVID-19 has altered its outlook for the worse. The REIT's current run-rate dividend in 2020 isn't likely to be covered by FFO. That can happen at REITs over short periods of time, and they can use debt to make up the shortfall, but those conditions can't last for too long. Right now, investors are justifiably concerned that Ventas will have to cut its dividend. Management will probably try to hold off on that move for as long as possible, but if you own shares of the REIT or are considering buying them, you should be expecting the worst right now (a dividend cut) even if you are hoping for the best (no cut).