Dividend investors hate dividend cuts, and for good reason. Before you cut and run, however, you should step back and think about what a cut means for the specific company in question. In the case of real estate investment trust Welltower (NYSE:HCN), it's a sign of near-term obstacles. But it will also position the healthcare-focused landlord for faster growth once this rough patch is over. Here's what you need to know.

The global pandemic

There's no easy way to deal with COVID-19 -- at least, not yet. It tends to spread easily in group settings, and the elderly are more at risk than younger age cohorts. That's a terrible combination for real estate investment trusts (REITs) that own senior housing, like Welltower. The company generates roughly 70% of its net operating income from senior housing, spanning from well-living facilities to nursing homes. The still-spreading coronavirus is a very big deal for the REIT.  

A young woman in a medical coat comforting an older woman sitting down

Image source: Getty Images.

Moreover, roughly 20% of net operating income comes from senior facilities that it operates (it outsources the day-to-day work). In good times, that means the financial results of these assets flow through to the company's top and bottom lines and boost performance.

But the reverse takes place in the bad times, when weak performance detracts from results. So COVID-19 has increased operating costs, led to a slowdown in new residents, and increased move-outs for Welltower's tenants and for its portfolio of operated assets. With coronavirus cases picking up again, there's no clear end in sight for the pain.

That's why Welltower chose to cut its dividend by 30% when it announced first-quarter earnings in early May. That took the quarterly payment from $0.87 per share per quarter to $0.61. Income-focused investors would be right to be displeased, especially if they are trying to live off of the dividends their portfolios generate. But step back before selling. Welltower remains a very well-run company in what still appears to be an attractive niche of the healthcare real estate sector.  

For the best?

The near-term reason for Welltower's cut is that it needs access to cash, plain and simple. This is a difficult and uncertain time, and cash is king (the dividend cut frees up roughly $110 million each quarter). However difficult COVID-19 is today, though, it doesn't change the long-term demographic trends this country faces. A large generation (baby boomers) is flowing into retirement and will increasingly need extra help with day-to-day living. That's what Welltower's facilities provide. While the coronavirus is disrupting the senior housing business today, it isn't likely to alter the big picture.  

With that as a backdrop, think about what the longer term looks like. Assuming that the COVID-19 issue is eventually solved in some way (a vaccine, herd immunity, or accepting that it is here to stay and adjusting to it), Welltower could end up with an extra $400 million or so a year that it can put to work buying or building new senior housing assets. That will allow it to more easily expand its portfolio over time. But that's not the only potential benefit.

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As a REIT, Welltower has to pay out at least 90% of its taxable income to shareholders. That allows the company to avoid being taxed at the corporate level (shareholders, however, have to report the dividend as regular income). This leaves it with little extra cash for reinvesting in its business, which is true even considering the dividend cut. To raise money, REITs sell stock and debt.

Simplifying things, the cost of debt is the interest rate, and the cost of stock is the dividend. Having trimmed the dividend, raising cash via stock sales will likely be less onerous in the future once the COVID-19 issue has been dealt with. Once again, growth becomes easier to achieve. 

What to do?

COVID-19 is definitely not a best-case scenario for Welltower or any healthcare REIT focused on senior housing. However, this is an industry problem, not a Welltower problem. The REIT remains one of the best-run players in the sector. If you own it, the dividend cut is probably not a good enough reason to sell it.

In fact, the company is likely setting itself up for much stronger performance as it resets to a new normal. In other words, think twice before dumping Welltower because of its dividend cut. The decision stings today, but it could be good over the longer term.