Healthcare real estate investment trusts (REITs) were once viewed as having a solid future because of demographic trends. The outlook for the sector drastically changed, however, when COVID-19 started to spread. Owning medical facilities -- specifically those that house the elderly -- is now a massive liability. Industry bellwether Ventas (VTR -0.15%) is getting through this rough patch by focusing on the important stuff.
The problem, compounded
Ventas generates around 55% of its net operating income from senior housing assets. Ventas leases some of these assets to others using a net lease structure that requires the tenant to pay for most of the operating expenses of the property. The rest Ventas considers a senior housing operating portfolio (called SHOP in the industry) that it owns and runs. In reality, it hires companies to operate the facilities. The important fact is that property level performance flows through to the real estate investment trust, for better or for worse. Ventas' SHOP portfolio thus makes up the lion's share of its senior housing business.
As 2019 started, Ventas was expecting demand for senior housing to pick up in 2020. However, toward the end of that year, it found that overbuilding had swamped demand, leading to price competition in some markets and longer timelines for filling new facilities. It ended up walking back its growth projections, which investors were not pleased to see. However, it was keen to point out that customer demand was still increasing and that supply was the problem. Notably, the supply of new properties started to wane following a construction boom. Put simply, management believed that the future was still bright, but the good times were just being pushed out a little.
And then COVID-19 hit the industry. It's been particularly bad for senior housing, because the coronavirus appears to spread easily in group settings and older adults (along with those who have preexisting conditions) appear most at risk. Costs are heading higher throughout the sector for staffing and enhanced cleaning regimes. Facilities have been shut to outsiders, limiting the ability to show properties to potential customers. And move outs, an industry euphemism for residents that pass away, have increased. That's hurting both Ventas' SHOP assets and its lessees.
Doing the right thing
This is a terrible turn of events for all involved, but Ventas is working hard to make sure it gets through this period in one piece. That has included shoring up its balance sheet by drawing down $2.75 billion on a revolving credit facility in March and issuing $500 million in debt shortly after the end of the first quarter. It is basically using the extra liquidity to do whatever needs to be done to help the company and its residents get through this period.
For example, it stepped in quickly to provide a rent deferral option for lessees, to help them deal with the initial spike in costs from COVID-19. Although it expects to be paid the back rent in the future, this move enhanced the liquidity of its direct customers. That's a goodwill gesture that tenants are unlikely to forget.
In one case, meanwhile, Ventas went even further, stepping in to restructure a relationship with partner Holiday. The REIT basically took over that senior housing company's properties and hired it as an operator, effectively shifting the assets into the SHOP portfolio. If that helps Holiday avoid bigger financial problems it's a net win for everyone involved.
In addition, Ventas has used its scale to coordinate the purchase of safety equipment, is sharing best practices, and it is providing COVID-19 testing free of charge to some of its operators. Effectively, it is making sure the facilities it owns (and often operates via its SHOP portfolio) are safe places for residents.
None of these things is likely to be good for investors over the near term. The REIT chose to hold its dividend flat as the year began, before COVID-19. But with peers like Welltower cutting their payments because of the coronavirus and Ventas' business under at least a similar level of stress, it wouldn't be a surprise to see the REIT cut its dividend, too. It has yet to make that announcement, but a decision should be announced shortly.
However, Ventas is doing the right things to ensure it will survive this period, along with its tenants and key operating partners. And that will set it up to benefit over the long term from the still growing population of older adults. In fact, while occupancy rates are down in the company's SHOP portfolio, it recently noted that it is seeing customer leads pick up again and move-ins have started to trend, modestly, higher. Things aren't back to normal, but there is demand for the senior housing assets Ventas owns despite the COVID-19 pandemic.
Ventas is not a REIT for the faint of heart right now, as it continues to deal with the fallout from COVID-19. However, it appears to have the financial strength to get through this difficult period while doing its best to help its operators, lessees, and residents. There's very likely to be a dividend cut, but once that's out of the way, long-term investors with strong stomachs might want to take a second look at this diversified healthcare REIT. It is making the types of decisions that you would expect from an industry leader -- which is exactly what Ventas is.