EPR Properties (NYSE:EPR) specializes in real estate holdings that are experiential in nature, a unique approach among real estate investment trusts (REITs). In the face of the fast-spreading coronavirus, such assets quickly became pariahs. While the situation was terrible at the start of the pandemic, it is now getting better. But does that really mean the worst is over for EPR Properties?
A painful hit
EPR Properties' portfolio is broken down across movie theaters (46% of first-quarter revenue), what it calls "eat and play" assets (22%), ski facilities (8%), attractions (6%), experiential lodging (3%), gaming (2%), cultural (1%), fitness (1%), and education (11%, mixed between private schools and early childhood education). Although the education component has different dynamics, the rest of the portfolio (89% of first-quarter rents) is all about bringing large numbers of people together in one place for shared experiences.
Such experiential assets were once viewed as resistant to the growing impact of the internet on the retail sector (the so-called "retail apocalypse"). COVID-19 has turned that on its head, as the government closed non-essential businesses to slow the spread of the pandemic. Being in close proximity to strangers is now a high-risk decision. It got particularly bad in the second quarter, when the economic shutdowns and peoples' social distancing efforts led EPR to a rent collection rate of just 21%, and July wasn't much better at 28%. It's not surprising that the REIT suspended its monthly dividend when it announced first-quarter earnings in May.
There's no way to sugarcoat this situation: EPR has been dealing with a terrible business environment. However, things are starting to get better, even if that improvement is small and slow-moving. The increase in July rent collections over the first quarter's number is a perfect example.
But the bigger picture is that experiential properties are, indeed, starting to reopen for business. There are restrictions in place on both the cleaning and occupancy sides of things, but going from basically no customers to at least some customers is a massive improvement.
Will it be enough?
The ongoing problem here is that EPR's properties are leased out to companies that are facing their own financial strains. For example, AMC Entertainment Holdings is one of EPR's largest tenants. It is a highly leveraged company that's working hard to muddle through the pandemic without having to take a trip through bankruptcy court. EPR is doing its best to help, offering AMC a 21% rent reduction and the ability to pay deferred rent over a 14-year time period -- both very generous moves. That said, AMC accounted for nearly 18% of EPR's revenue in 2019, so it is a very important tenant. Fellow movie theater operator Regal Entertainment is nearly as important to EPR's top line, however, accounting for about 10% of revenue, and is basically suffering the same headwinds as AMC.
The point here isn't to go through the portfolio tenant by tenant. The big takeaway is what's important: A large portion of EPR's rent could quickly be put into question if a sizable tenant were to be forced into bankruptcy by the impact of COVID-19. Although the movie chains above are starting to reopen, there's material uncertainty about how long it will take their businesses to return to some semblance of normal -- and whether or not they can remain solvent until that point. And these aren't the only tenants that are facing such uncertainty.
To be fair, EPR is currently projecting that rent adjustments will only amount to a reduction of between 5% and 7% across its entire portfolio. That looks pretty impressive given the headwinds, and it suggests that the REIT is in pretty good shape, all things considered. So from one perspective, the worst is likely over.
But that doesn't mean that there's no risk here. A big tenant bankruptcy could lead to vacant properties that would be hard to fill, and further extend EPR's recovery process. That would not be a good outcome for shareholders.
Not out of the woods just yet
When you step back from this situation, it's clear that EPR's business is slowly starting to work back from a devastating hit as its experiential lessees begin to reopen for business. Things are definitely getting better today, and there's turnaround potential here for more aggressive types. However, there's still material risk at EPR, since some of its largest customers are financially troubled and at a very real risk of tumbling into bankruptcy if their businesses don't pick up quickly enough. At the end of the day, there are still troubling risks here, and EPR is not an appropriate option for risk-averse dividend investors hoping that the REIT's monthly payment will quickly return.