The COVID-19 pandemic is leaving no stone unturned. The whole world has been affected by the spread of the disease, but some industries have been negatively affected more so than others. One such industry -- perhaps somewhat surprisingly -- has been healthcare.
Enter Welltower (NYSE:WELL), a leading medical property real estate investment trust (REIT), with about two-thirds of its portfolio tied up in senior housing and the balance in post-acute care and outpatient surgery facilities. Social distancing has even extended to the medical community, creating new challenges for facilities as they try to keep patients and staff safe.
The near-term reality for Welltower isn't pretty but much of the pain was looking priced in, so I made a small purchase in anticipation of an eventual rebound.
Falling income and rising costs
First, let's address the elephant in the room. Welltower is best known for its senior housing operations (SHO), a segment of healthcare that has drawn criticism during the coronavirus crisis. Seniors have been especially vulnerable to COVID-19, and although 72% of Welltower's 586 SHO properties had no reported cases as of May 1, group housing for a high-risk segment of the population has been a bad recipe as of late.
SHO occupancy rates had fallen to 82.7% on May 1, down from 85.1% on March 31, 2020. Welltower said it expects occupancy to be lower still -- somewhere in the range of 79% to 80% -- by the end of the second quarter of 2020. The cause is largely due to decreases in new move-ins. Shelter-in-place means few to no tours for prospective new residents are allowed, and many facilities aren't even accepting new tenants during the lockdown.
Elsewhere in the portfolio, elective surgeries and outpatient visits were down well over 50% year over year starting in mid-March and through April. As the economy begins to open back up, some of the traffic is returning, but it's going to take time for Welltower's tenants to get going at full steam. Chances are full steam will look much different once the dust settles. New social distancing requirements could stick for some time and reduce the number of surgeries and patients that can be taken on any given day. Compounding the problem are elevated operating expenses due to higher staff pay, purchase of new protective equipment, and new cleaning procedures. Falling revenue and rising expenses at the same time are a terrible scenario.
Financial guidance has been withdrawn due to lack of visibility during these fast-moving times, but second-quarter numbers are not going to look good.
Sandbagging against further disruption
Nevertheless, I do expect business to rebound. Elective surgery isn't optional surgery, so there's likely to be pent-up demand for that portion of the portfolio. And though senior housing has gotten a shiner from COVID-19, the average age in America is on the rise and expected to keep rising for the foreseeable future. Senior housing demand may be damaged for a while, but it certainly isn't going to disappear -- pandemic or not.
Plus, Welltower may be in better shape than many realize. Roughly 97% of its triple net-lease rents (most of which are SHO) were collected for April, and 95% of its outpatient rents for April were collected or received approved deferred payment. Approximately 8% of outpatient rents received a 60-day deferral of payment and are expected to be repaid by year-end.
There are some higher expenses that will need to be dealt with too, but Welltower has taken steps to shore up its liquidity and balance sheet in order to prepare. At the end of March, the company had $303 million in cash and equivalents and $2.2 billion available via its revolving credit facility. Subsequent to the end of Q1, it also completed a $1 billion term loan and offloaded a few assets, giving Welltower access to $4.02 billion in available funds as of May 1. If it needs to tap into the balance sheet while it navigates the crisis, the company has plenty of room to do so. Capital spending has also been cut this year and acquisition activity has been suspended for the time being. Development costs beyond 2020 total just $178 million.
Perhaps the biggest move, though, pertains to the dividend payment. Dividend payments are the real reason to own a REIT, so Welltower reducing its quarterly payment to 70% of its pre-coronavirus level isn't great news. Nevertheless, the reduction frees up $110 million in cash every quarter. Besides, after reducing payout and Welltower shares tumbling 45% from all-time highs as of this writing, the REIT still yields 5.1% a year -- not bad at all.
Of course, with that high yield comes risk, specifically that surrounding this healthcare REIT's rebound that will no doubt take at least a few years or more to recover back to where it was before COVID-19 exacted its heavy toll. My initial position of 1% of my portfolio value is accordingly small. Nevertheless, Welltower's debt-to-equity ratio is below average at 0.7, has ample access to cash, and has tenants providing services likely to rally once the economic lockdown eases up. With the physical world out of favor at the moment and the digital world picking up the slack, real estate may not be popular. But that's just the opportunity I've been waiting for.