Stocks for healthcare real estate investment trusts (REITs) that serve seniors have been hit hard by investors concerned about fallout from the COVID-19 pandemic. That makes some sense, given that the coronavirus has had a greater and deadlier impact on the older population. Concern that these healthcare-related REITs will be weakened isn't unreasonable. However, it's important to dig a bit deeper ... and then deeper still to see if this assumption is actually correct.
Here's why REIT Omega Healthcare Investors (NYSE:OHI) is still in a tough spot, even though the funding providers for its biggest customers are rock solid.
Dealing with real medical issues
COVID-19 is a new disease for which humans have yet to build up defenses (like a vaccine, for example). That's one of the reasons why it has had such a marked effect on the world. It is also highly contagious, compounding the problem. Then add in the fact that mortality rates for the disease skew much higher in older adults. This means that the very people who would be most likely to occupy senior housing facilities are the most at risk of contracting the disease and dying from it. It's no wonder investors are avoiding real estate investment trusts like Omega which own such assets.
To complicate matters, types of senior housing vary with need and level of care. The lowest level is well-living, which is pretty much what it sounds like. Largely healthy older adults choosing to live in a group setting with other people like themselves. Often these properties offer amenities and programs to help keep people active. They are also geared to reduce some of the limitations that might result from aging, like installing specially designed bathrooms and using lever door handles.
The next broad step is assisted living, where a resident needs assistance with some activities of daily living (like washing and eating, among many others). A primary purpose of these facilities is to enable an individual to live as independently as possible for as long as possible. Within this assisted-living category, there are specific facilities for addressing a range of medical issues. For example, memory care units are designed for residents with Alzheimer's disease.
In general, however, the most common type of facility in this REIT sector is the nursing home, where medical professionals oversee nearly all aspects of a person's basic needs.
Getting paid is only one piece of the problem
Well-living and assisted-living facilities are often paid for out-of-pocket by residents. Nursing homes are generally paid for via third parties, very often government programs like Medicare and Medicaid. Government payment has historically been seen as a negative because the payment rates can be changed at the whim of the government. In the past, that's led to serious problems for some nursing home operators (the companies that lease Omega's properties). Investors felt (not wrongly) that having more self-pay residents was a good thing and encouraged efforts to attract those types of residents. The COVID-19 pandemic has severely complicated those efforts, but it has also turned the logic of what type of residents to go after on its head.
Let me explain: Living in a well-living facility or even an assisted-living facility is generally a choice, not a necessity. Because of the coronavirus (a highly communicable disease), fewer people are considering living in a group setting where the risk of mortality has potentially increased -- at least until the disease can be better controlled or prevented. Then you have the issue of social distancing rules making it difficult to give tours to those who might still be interested despite the increased threat. So, at least for now, the pool of potential new well-living and assisted-living residents is likely to dry up.
Nursing homes, by comparison, aren't really optional (or a decision that can be delayed) for the residents considering them. Add in the government backstop on the payments providing relatively consistent income and suddenly nursing homes look like a pretty desirable segment as it relates to senior housing investments. This is all good news for Omega, which pegs such higher-care facilities at about 85% of its business.
Insulated somewhat, but not unaffected
But there are still concerns potential investors in Omega needs to factor in. Omega's tenants still expect to feel a significant impact from COVID-19. For instance, at the end of March, the REIT noted that there were 42 residents and 15 employees in 28 facilities who had been diagnosed with the coronavirus. Omega has been taking steps, such as drawing down on a revolving credit facility, to deal with any repercussions this might create.
Also, the elevated death rates among older adults who get COVID-19 will likely result in more residents dying (often called "move outs" in the industry) throughout the senior housing space. That means more current residents in nursing homes are likely to die, putting pressure on occupancy rates. Moving into a nursing home isn't an option; you only do so if you need the care. But as more older adults die (often because of complications from other medical issues), nursing homes are likely to see a drop in the number of potential residents as well. That will put further pressure on occupancy. Lower occupancy levels will make it harder for Omega's tenants to cover their costs and pay the REIT its rents.
At the same time, Omega's operators are going to face the cost increases hitting other senior care facilities due to more stringent cleaning regimens, increased spending on medical supplies, higher payroll costs to deal with social distancing requirements (no more sharing nurses across facilities), and employee COVID-19 infections. So at the very same time that Omega's lessees are dealing with top-line pressure, they will also be trying to navigate bottom-line pressure. And that could make it much harder for them to cover rent costs. This is a fast-evolving situation, but it's clear that Omega isn't going to sidestep the impact of COVID-19, even if Medicare and Medicaid cover the costs for many of the residents in its properties.
Think about the big picture
So while Medicare and Medicaid are likely to keep paying through thick and thin, nursing homes are not really that much better protected than any other senior housing property type. Omega's business is facing headwinds every bit as material as REITs that focus more on assisted-living and well-living facilities.
If you are a dividend investor looking at Omega and its hefty 8.2% dividend yield, don't go in thinking that government pay is a material differentiator. Sure, it may look like a net benefit, but the other factors facing senior housing because of COVID-19 are still going to cause Omega's tenants -- and in turn Omega -- material financial strain.