Real estate investment trust Ventas (VTR 3.01%) cut its dividend by nearly 45% in 2020. That's not a great sign, given that REITs are purpose-built to pay dividends. However, it appears likely that the cut last year will turn out to be the low-water mark for this diversified healthcare landlord -- so it's a safer investment than many people may realize.
To be fair, Ventas is most definitely not the only real estate investment trust that ended up cutting its dividend in the face of the global coronavirus pandemic. However, when you look at the business here, you'll see that the cut made a lot of sense.
That's because about half of Ventas' rent comes from senior housing assets. The impact of COVID-19 is particularly acute in the elderly, and it spreads quickly in group settings, so early on the news was pretty ugly for this niche of the healthcare property market. To make matters worse, Ventas has a sizable senior housing operating portfolio, or SHOP in industry lingo (technically, it hires others to handle the day-to-day operations). The performance of SHOP assets flows directly through to Ventas' top and bottom lines.
It was not a good year, with 2020 adjusted funds from operations (AFFO) dropping nearly 14% from 2019 levels. The biggest drag was Ventas' senior housing portfolio, where higher costs combined with increased move-outs (an industry term that includes deaths) resulted in net operating income in the segment falling by just shy of 25% year over year in the fourth quarter. The dividend cut looked like a good call -- after the cut, the AFFO payout ratio in the fourth quarter was a solid 55% or so. That provided ample room for more adversity.
That extra breathing room was needed, as AFFO dropped even further in the first quarter of 2021, resulting in a payout ratio of roughly 65%. But in the second quarter, AFFO held fairly steady with the first quarter, up a penny sequentially. Moreover, management noted that there were positive trends taking shape across the portfolio. Stepping back, it appears that the bottom for the senior housing sector may have been reached in the first quarter, with move ins trending higher, move outs falling, and strong new leads coming in the door.
Turning the corner
Income investors hate dividend cuts, and that's understandable, especially if you are trying to live off the income your portfolio generates. So really conservative types might want to take a pass on Ventas. However, assuming that the worst of the pandemic hit is over, the business is likely to pick up from here. And the dividend should begin to rise once again, as it has in the past. That would make this diversified healthcare REIT an increasingly attractive way to play the demographic story that will likely drive long-term performance.
Indeed, while COVID is more deadly for older adults, it didn't really change anything about the future. The baby boom generation is still cresting into retirement and on its way to increased medical spending. That will include visiting doctor's offices, going to hospitals, and moving into senior housing when the time comes. Ventas has exposure to all of these spaces and more. Its SHOP assets, meanwhile, are leveraged to an uptick because it both owns and operates those properties.
In fact, Ventas is so sure about the future that it doubled down on the SHOP business this year by acquiring a senior housing REIT with more than 100 properties. That move expanded Ventas' SHOP portfolio from 26% of its rents to 31%. Assuming the portfolio trends continue to improve, that deal, which closed in September, could prove to have been very well timed.
But the big story is that Ventas' dividend cut was tough, but it materially reduced the risk of further dividend cuts. And now that the business is starting to strengthen again, dividend growth could soon be in the cards, augmented by the acquisition of more SHOP assets.
Relax, there's plenty of time
The coronavirus pandemic remains a headwind, and Ventas' recovery will probably be lumpy. But the demographic trends it is positioned to ride will last for decades. Given the fairly solid payout ratio in the second quarter, another cut seems unlikely. And, with the SHOP business regaining its footing, a return to dividend growth looks increasingly likely. That makes Ventas a fairly low-risk way to invest in the long-term trends that are going to drive the healthcare REIT space higher. Adding to the allure, the stock is still below where it was before the pandemic hit, suggesting it could be a decent value, too.