The first 12 months of the coronavirus pandemic have proved to be a real test for dividend-paying companies, with many real estate investment trusts (REITs) trimming or even suspending their dividends. Omega Healthcare Investors (OHI +0.17%) passed that test by adding another annual increase to its record. Here's what investors need to know about Omega as it marches toward Dividend Aristocrat status.
1. What it does
Omega Healthcare is a real estate investment trust (REIT), a corporate structure specifically designed to return cash to shareholders via dividends. So it isn't shocking that it pays dividends. However, the company's portfolio is built around nursing homes, which make up around 85% of its portfolio (the rest is senior housing). That's a material focus on a very specific property type.
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The big issue is that the company's "average" facility gets 37% of its rental income from Medicare and 52% from Medicaid; only 11% comes from private pay. This breakdown is important because it means that the average Omega property has one main customer: the U.S. government. Payment trends within these programs can and do get political, which some investors don't like since a government action can upend the sector's profitability. Many other healthcare REITs focus far more on healthcare niches with private payers (like assisted living), which are considered more stable.
2. A not so terrible year
But 2020 was a test for healthcare landlords beyond any in recent history, given that the elderly are most at risk of negative outcomes from the coronavirus and it spreads easily in group settings. Nursing homes, assisted living facilities, and other senior housing properties are purpose-built to bring older people into a group setting. A number of prominent healthcare REITs, including Ventas and Welltower, cut their dividends. The main problem was that their private-pay properties witnessed a decline in occupancy and demand, and an increase in operating costs.
Omega Healthcare's properties held up relatively well. In fact, the REIT's adjusted funds from operations (FFO) actually increased from $3.07 per share in 2019 to $3.23 in 2020. That isn't to suggest that it was an easy year, but rent collections did remain strong throughout the 12-month span. It ended 2020 with a collection rate of 99%. A big piece of that is the fact that nursing homes are need-based and, in a twist on the normal view, Medicaid and Medicare are backed by the U.S. government. That may increase the risk of political issues, but when the chips were down, Uncle Sam proved to be a highly reliable payer.
3. The dividend
Omega didn't increase its dividend in 2020; it held it constant at a quarterly $0.67 per share the entire year. But the last increase occurred in the fourth quarter of 2019, so the full-year dividend in 2020 was, indeed, higher than the full-year 2019 payment. That extended the streak of annual increases to 17 years. To add year 18, the REIT needs another hike by the fourth quarter of 2021. If history is any guide, there's a pretty high likelihood that this will happen.
OHI dividend data by YCharts.
Meanwhile, Omega's yield is a very generous 7.3%. The yield has historically been toward the high end of the healthcare space because of its nursing home focus, so this isn't an unusual figure. But that doesn't change the desirability of such a large yield when the S&P 500 Index is offering up a scant 1.5% or so. The average REIT, using the Vanguard Real Estate Index ETF as a proxy, has a 3.8% yield.
4. Getting stronger
Meanwhile, Omega is actually taking advantage of the difficult industry conditions today to strengthen its business. In January, the REIT acquired 24 senior living facilities from Healthpeak Properties, which is looking to exit the senior housing space to focus on medical office and research properties.
And throughout the year, Omega culled some of its weaker assets. It tends to actively manage its portfolio, so none of this is particularly shocking. However, the fact that it continued to improve its portfolio in an operationally difficult time speaks to a dedicated and consistent management team. Many REITs simply hunkered down and hoped for the best as the pandemic storm blew over them.
The longer-term implications here are that Omega took the opportunity presented by the pandemic to strengthen its industry position. That, in turn, should improve the REIT's outlook and increase the chances of it becoming a Dividend Aristocrat. While Omega isn't currently in the S&P 500 -- a requirement for full-blown Dividend Aristocrat status -- it seems to have a good chance to achieve the mark of 25 straight years of dividend increases.
It's not for everyone
When you step back, Omega Healthcare does come with a payment concentration that some investors may not like. Uncle Sam came through when the chips were down, but that doesn't change the fact that politics can lead to payment uncertainty for nursing home operators.
Still, Omega has done a good job of navigating this risk over time and showed its resilience during a year that left other healthcare REITs reeling. For dividend investors looking to maximize their income stream, and who are willing to stomach a little extra risk, Omega could be a very good fit.
