Omega Healthcare Investors (OHI 0.72%) has a huge yield of more than 9%. That's generous by just about any standard. It is large on both an absolute level and relative to the broader market (the S&P 500 index has a roughly 1.6% yield) and the average real estate company (3.7%, using Vanguard Real Estate Index ETF as a proxy). Omega's yield is so disproportionately high for two important reasons.
A focus on high returns
Omega is a real estate investment trust (REIT) that focuses on the senior housing market using the net lease approach. That means the companies that lease out the REIT's properties are responsible for most of the operating costs. Although it's a vast simplification, Omega basically just collects rent, while the tenants pay for things like maintenance and taxes.
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Although some senior healthcare REITs like to spread their bets across various sub-sectors of the healthcare niche, Omega gets most of its rents from nursing homes. These are interesting assets in that the vast majority of the residents rely on third parties to pay their rent, including Medicare, Medicaid, and insurance companies. Note that two of those three are government agencies.
Although Omega believes the risks here are overstated, the government can choose to change what it pays to nursing home operators. If that were to happen, Omega would have little choice but to accept what it get. This has happened in the past, and there's no reason to believe it can't happen again.
This is a big reason Omega has long been looked at as risky, and so the dividend yield has generally been higher than that of other REITs. The flip side of this dynamic is that Omega can buy nursing homes at relatively cheap prices, which can lead to larger returns on its investments. And for many years, the REIT was able to generate strong returns and steadily increase its dividend.
Compounding the problem
Omega was long regarded as high-risk/high-reward investment. And then in 2020 there was the coronavirus pandemic. It was particularly dangerous for older people, and it spread easily in group settings. It was most deadly for people who had other medical issues, such as the type that might lead someone to live in a nursing home.
Omega stopped increasing its dividend because it was forced to give breaks to troubled tenants. Falling occupancy levels, driven by increased move-outs (a term that also includes resident deaths) and reduced move-ins, was too much for some of its tenants to handle.
Omega has had to sell assets or transfer assets to new operators, all of which put stress on the top and bottom lines. The REIT did not, however, cut its dividend, something which many healthcare REITs did to preserve cash in an uncertain time.
Omega has been dealing with the headwinds, and occupancy is slowly rising. That said, it remains well below where it was before the pandemic. This has investors worried that the dividend might ultimately need to be cut. That's not unreasonable, since the adjusted funds from operations (FFO) payout ratio was nearly 90% in the third quarter. That elevated level both helps to explain why the dividend yield remains extremely high today and why the dividend is seen as at risk.
For aggressive investors only
To be fair, Omega has managed to handle the worst headwinds while continuing to protect its dividend. And there are things to like about the business, including the fact that the pandemic hasn't altered the long-term trend of an aging population.
Still, given the lingering effects of the pandemic and the generally more-uncertain environment in the nursing home sector, Omega is probably only appropriate for aggressive investors looking to maximize the income their portfolios generate.
