Ventas (VTR 0.48%) is one of the largest, most diversified healthcare real estate investment trusts (REITs) you can buy. However, it has material exposure to senior housing, which was a huge problem during the coronavirus pandemic. Management thinks the worst is behind the company and that the future is looking increasingly positive.
The key fact
There are two broad ways to own senior housing assets when it comes to REITs like Ventas. The first, and simpler, approach is to lease the properties out to operators using net leases. That means the operators have to pay most of the costs of the property and owe Ventas rent, regardless of how well or poorly the properties are performing. This tends to be a very stable business and makes up about 14% of the REIT's net operating income (NOI) today.
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The other approach is to both own and operate the senior housing assets, which is often referred to as a senior housing operating portfolio (SHOP). In practice, Ventas hires a third party to handle the day-to-day operations of the properties, but the performance of the asset flows through to the REIT. Thus, Ventas directly benefits when performance is good and is directly hurt when performance is bad. SHOP assets account for the largest portion of NOI, at about 36%.
Those numbers are a bit different today than they were before the coronavirus pandemic for several reasons. First, Ventas bought a company with material SHOP operations. Second, while net lease assets tend to be stable, when a tenant gets into trouble, a quick fix is to switch the property to a SHOP structure.
Ventas was forced to do that during the pandemic as it looked to keep its properties up and running. Still, SHOP has always been a major focus for the REIT because of the financial flow-through when things are going well.
The worst is in the past
Of course, the coronavirus pandemic wasn't something Ventas was expecting. And since the SHOP business was hit hard, which flowed through to the REIT's top and bottom lines, it was forced to cut its dividend in 2020. But things have improved dramatically since then.
For example, occupancy, which fell sharply during the early days of the pandemic, rose 2.6 percentage points year over year in the third quarter of 2022 to 84.7%. Leads remain above pre-pandemic levels in the U.S., as do move-ins. Move-outs, meanwhile, are below pre-pandemic levels. Performance in the company's Canadian business is the real standout, with occupancy of 94% and strong overall performance even during the pandemic.
SHOP revenue increased by 9% in the third quarter, driven by both occupancy gains and the company's ability to increase rents. Inflation has been a benefit on the pricing front, even though it has also led to increased costs. Given the trends it is seeing, management expects the good news to continue.
That said, Chief Executive Officer Debra Cafaro was very clear during the company's earnings call that Ventas is set to benefit from a multiyear upturn in the senior housing market. The bounceback from the pandemic is just one factor, though admittedly an important one.
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Key Data Points
The other reason for optimism is the fact that the aging demographic trends that existed before the pandemic are still in place. Older people simply need more assistance, and that's exactly what they can get at a senior housing property.
This is buttressed by the fact that construction starts in the senior housing market have been pretty low, which isn't shocking, given the impact of the pandemic on the property sector. So there's more demand and limited supply, which Ventas expects to lead to higher occupancy and continued strong pricing dynamics.
This all suggests that 2022 could be an important inflection point for Ventas, with 2023 turning into the first year of a long-term uptrend.
The big sign
Such a positive underlying outlook in this very important business segment suggests that Ventas's performance will start to improve notably in the quarters and perhaps years ahead. That's the good news, but dividend investors are still smarting from the 2020 dividend cut.
Although Ventas' dividend yield is a generous 4% today, it would be a much more enticing investment if the recovering SHOP portfolio led to a return to dividend growth. At that point, long-term investors will likely take a different view of the REIT and its long-term investment appeal, which might result in a pleasing share price recovery. Although it is still a bit early for that (given the continued lack of dividend growth), now might be the right time to dig into the Ventas story if you are interested in senior housing REITs.
