The coronavirus pandemic has had a huge and negative impact on senior living properties. For a time in 2021, it looked like things were improving for nursing home-focused Omega Healthcare (OHI). But its fourth-quarter earnings release suggests that the upturn stalled out. Is this real estate investment trust (REIT) a buy, or would income investors be better off waiting for more recovery before jumping aboard?
Not a great quarter
In Omega Healthcare's second-quarter 2021 earnings conference call, management noted that it needs occupancy to be north of 80% "in order to meaningfully mitigate the cash flow reductions from a pandemic." The healthcare REIT's occupancy started 2021 at 72.3% and ended the year at 75.8%. So throughout 2021 the trend was moving, albeit slowly, in the right direction.
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The problem is that in mid-January of 2022, the rate slipped back to 75.4%. Nothing goes up or down in a straight line, so it's not shocking that occupancy would ebb and flow a little. However, the number had basically been steadily increasing until that point. Complicating the problem is that, according to Omega's fourth-quarter 2021 earnings call, some of the current occupancy headwind stems from the fact that the REIT's tenants can't find enough staff and are thus unable to admit more residents. The company explained that, "...even though there is an opportunity to increase census based on demand in the market, these facilities have elected to limit new admissions due to staffing limitations." That's not particularly good news, especially considering occupancy is still notably below that 80% target.
Adding to the negatives, Omega now has four tenants that have stopped paying rent. These tenants account for about 16% of the REIT's total rent roll. Although management has been able to use security deposits and other cash balances from the companies to cover some of the expected rent payments that have been missed, these remedies are starting to run out. That suggests that cash to pay the dividend could get tighter before it gets better.
Some dividend math
Omega has held its $0.67 per-share quarterly dividend steady throughout the pandemic. The yield is about 9.3%. That's a fair amount of compensation for the risk here, but as noted above, the risks are fairly high and not fading quickly. In fact, the situation could get worse if occupancy doesn't start rising again and if tenants continue to miss rent payments.
Notably, the company's funds from operations (FFO) -- a key metric of REIT performance -- was just $0.50 per share in the fourth quarter of 2021. That's well below the dividend it paid. However, that number includes one-time items that Omega believes should be backed out. Its adjusted FFO was reported as $0.77 per share, leading to an adjusted FFO payout ratio of 87%. That's on the high side but still leaves some room for adversity. That said, the REIT noted that its funds available for distribution coverage was a little tighter, at 93%. And neither of those numbers takes into account the full impact of tenants that have stopped paying rent, since Omega has been drawing on backstops in some cases.
Given the needs-based nature of senior housing, particularly on the nursing home side, it seems highly likely that Omega's business eventually gets to the 80% occupancy figure. And FFO, in its various forms, should recover as well. However, at this point, it appears like there's a bit of a race going on. If business doesn't improve quickly enough for its tenants, the dividend could run out of time. Although the hefty 9.3% yield is the compensation for taking on the risk of a dividend cut, this is clearly not a stock for low-risk investors.
Is the stock a buy?
The quick answer here is that, for most investors, the risk-reward balance doesn't seem particularly attractive at Omega given the recent pullback in occupancy. This is something of a special-situation stock that's working to balance how it rewards investors with how its underlying business is recovering from a major outside shock.
It is not clear at this point that Omega has proven it can pull the recovery off without having to trim the payout. This is the kind of name that you want to love because of the long-term story and fat yield, but the near-term story just keeps you from pulling the trigger. It's probably best to keep waiting, even if it means giving up some price recovery and yield.
