Shares of Ventas (VTR -0.79%) and Welltower (WELL -0.64%) lost more than half their value during the pandemic-driven bear market in 2020. Even now, the stocks are still down by 8% and 13%, respectively, from where they started that year. By comparison, the S&P 500 index is up more than 20% over the same span. A big part of the problem for these two real estate investment trusts (REITs) is their focus on senior housing properties. But that's starting to change.

What you own and how you own it

Covid-19 has proven particularly deadly to older adults and spreads more easily in group settings. So it shouldn't come as any surprise that senior housing properties have had a tough time dealing with the illness. Investors reacted by selling stocks that had exposure to senior housing, including REITs.

A medical professional working with an older adult.

Image source: Getty Images.

That said, there are two ways to own senior housing properties. The first is fairly simple. A REIT buys the property and leases it out to another company, which operates the asset. The REIT collects rent, which must be paid like any other operating expense, and the lessee operator takes on the risks and benefits of running the actual senior housing business. In good years the operator will make more money, in bad years less. During the pandemic, most lessees continued to pay rent as scheduled or worked out a deal with their landlord if they were having trouble. Overall, these traditional landlord/lessee relationships have held up relatively well.

The other way for a REIT to own senior housing is to both own it and run it, in what's known as a senior housing operating property (SHOP). Functionally, the REIT hires an operator to handle the day-to-day running of the asset, but the property-level performance flows through to the REIT's top and bottom lines. 

During the early days of the pandemic occupancy fell and move-ins dropped, leading to poor operating performance. Enhanced cleaning regimes increased costs. Then staffing problems and inflation led to additional costs. The SHOP portfolios of Ventas (34% of net operating income) and Welltower (44%) struggled and both REITs ended up cutting their dividends. Neither has fully recovered or started to increase their dividends again.

Things are changing

While it won't be time to call a turnaround until Ventas and Welltower increase their dividends, the underlying performance of their SHOP portfolios is starting to look impressive. Ventas, for example, saw net operating income (NOI) growth of 13.4% in its SHOP portfolio in 2022. By comparison, its medical office and medical research properties grew NOI 3.8% while senior housing properties leased to others grew NOI 2.4%.

The fourth quarter was particularly strong for Welltower, which saw SHOP NOI growth of 28% in the final stanza of the year. Ventas' SHOP NOI grew by 19.1% in the same quarter. Even Welltower's senior housing leased to others did better than Ventas' similar portfolio, with NOI gaining 4.3% compared to Ventas' 1.8%.

More important to the future, both Ventas and Welltower expect strong SHOP results to continue. Ventas is calling for 2023 NOI growth in its SHOP portfolio of between 15% and 21%. Welltower's guidance is for SHOP NOI growth to fall between 15% and 24%. Simply put, what was once a negative is swinging back to become a positive, and in a very big way.

Digging out

Of course, both Welltower and Ventas have been muddling through a shockingly difficult period of time. So far it has mostly been a matter of digging out of the pandemic hole. However, if this pair can hit their SHOP guidance, investors may start to take a much brighter view of the future and place a higher valuation on them.

The key turning point for Wall Street will probably be a return to dividend growth. Now, however, is the time to start digging in, as the underlying SHOP performance improves and the likelihood of a dividend increase starts to pick up.