Ventas (NYSE:VTR) is one of a handful of large, diversified healthcare real estate investment trusts (REITs) that have been hit hard by the impact of COVID-19. There are good reasons for that, and the problems are likely to linger for some time. It got so bad that Ventas was forced to cut its dividend. And now it has made a deal to help shore up a key tenant, including a significant rent reduction. Does this spell more trouble for the dividend?
The hit nobody expected
COVID-19 has proven to be a difficult illness that spreads easily in group settings. It also seems to impact older people more severely than younger ones. This is terrible news for companies that own and operate senior housing facilities, which are purpose-built to bring older people together in a group setting. Ventas generates around two-thirds of its net operating income from senior housing.
Looking at that, it's not very surprising to see that the healthcare REIT's stock was down 33% for the year earlier this week, compared to a decline of roughly 12% for Vanguard Real Estate ETF, a proxy for the REIT sector. However, there's more bad news once you dig in a little bit further.
Like many of its peers, Ventas not only leases out senior housing properties to others, but also operates many of the facilities it owns. These are known as a "senior housing operated portfolio," or SHOP in industry lingo. In reality, Ventas hires third parties to operate these assets, but the key is that the performance of these properties flows through to Ventas. When times are good, the portfolio boosts financial results, but when times are bad, it detracts from results. About half of Ventas' senior housing business is tied to its SHOP portfolio, which translates to around a third of its overall net operating income.
As the company worked through the early impact of COVID-19, it became clear that it would take a material financial hit. Essentially, costs were going up because of increased efforts to deal with COVID-19, occupancy was falling because of move-outs, and fewer new tenants were moving in. This was hitting Ventas directly because of its large SHOP exposure. The REIT cut its dividend by roughly 45%.
What about its tenants?
So far, however, the discussion has centered around Ventas' SHOP portfolio. But that's just part of its senior housing exposure -- the same problems that Ventas is dealing with are also affecting its tenants. On the surface, that's not a problem for Ventas, because it is the landlord and its rents don't change based on property-level performance. However, COVID-19 is a massive structural issue in the senior housing space, and Ventas can't collect its rent if its tenants don't make enough to pay it.
So Ventas recently stepped in to rework its lease with one of its biggest tenants, Brookdale Senior Living. There were a lot of moving parts to the deal, but the end result is that Ventas cut Brookdale's rent by 45%. Ventas' management team noted that this rent reduction was included in the company's thinking when it cut the dividend. This is a net positive for dividend-focused investors.
Basically, the dividend cut earlier in the year is likely to be the only one investors need to worry about -- at least for now, anyway, which brings up the long-term problem here. COVID-19 won't stop the demographics that support the need for senior housing. Baby Boomers continue to crest into their retirement years in large numbers, and eventually a material number will need the extra help that can be provided more cost-effectively in a group setting. In fact, Ventas has been highlighting that industry trends for leads and move-ins have been improving.
But improving isn't the same as a complete recovery. With COVID-19 cases picking up again in the United States, it's not at all clear when things will be back to some semblance of normal any time soon, or what that new normal will look like. In other words, Ventas' dividend looks safe for now, but you still need to keep a close eye on the REIT's senior housing business. If senior housing performance remains weak, particularly in the SHOP portfolio, Ventas may be forced to consider another dividend cut.
To be fair, Ventas is generally a well-run REIT. It's just struggling today because the COVID-19 situation is so extreme. But with no end in sight to this health crisis, investors can't simply sit back and think that the dividend reset is the end of the story. Long-term investors need to pay extra attention today. The risk of another dividend cut is not zero, even though management has already trimmed the payout by 45%.
The leading edge of further trouble, meanwhile, will likely show up first in Ventas' SHOP portfolio, so keep a keen eye on this segment of its portfolio in the quarters ahead -- anything that's happening there is likely to be impacting its lessees as well.