Medical Properties Trust (MPW 4.61%) had an adjusted funds from operations (FFO) payout ratio of 81% in 2022. That's a reasonable coverage number for a real estate investment trust (REIT).
So why are investors so negative on the stock that the dividend yield now hovers around an eye-catching 11%? To find out, you just need to look at the tenant roster.
Medical Properties Trust operates in an altered landscape
Providing healthcare services has generally been a fairly consistent and reliable business over time. Generally speaking, a person doesn't go into one of the over 440 hospital properties that REIT Medical Properties Trust owns for the fun of it. Demand for the services these properties provide is largely necessity-based.
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While that remains true, the coronavirus pandemic of 2020 upended the medical profession in some important ways. Very specifically, costs are on the rise. That includes things as mundane as enhanced cleaning regiments to higher staffing costs, most recently thanks to elevated levels of inflation pushing salaries higher. Staffing shortages, however, are another key factor empowering employees to demand higher pay. Basically, the operators that lease Medical Properties Trust's assets are experiencing a profit squeeze.
On the one hand, this doesn't directly impact Medical Properties Trust. Its leases have to be paid even if its tenants' profits are under pressure. However, if a tenant gets to the point where it is having trouble covering the rent, then the REIT does have a problem. And a potentially big one, given that 60% of its revenue came from just five tenants in the fourth quarter of 2022.
The big problems for Medical Properties Trust
The two tenants of note here are Steward Health Care (26.1% of fourth-quarter 2022 revenue) and Prospect Medical (11.5%). Together these two lessees account for a whopping 37.6% of revenue, or more than a third of Healthcare Properties Trust's total. The financial troubles these two tenants are experiencing is not a small problem. And yet, even as the REIT faced these headwinds, its adjusted FFO payout ratio was still a very comfortable 81% in 2022. In fact, there's a fair amount of leeway there for adversity.
But what about the future? Medical Properties Trust's outlook for 2023 is for normalized FFO to fall between $1.50 and $1.65 per share. Only that's not adjusted FFO, which came in about $0.40 per share lower than normalized FFO in 2022. If you assume, using back-of-the-envelope math, a similar difference between these two figures in 2023, that suggests the adjusted FFO range in 2023 could fall between $1.10 per share and $1.25. That would push the adjusted FFO payout ratio above 100% at the low end. Unless, of course, Medical Properties Trust can solve the problems it has with Steward Health Care and Prospect Medical.
As you might expect, management is working on this. For example, it has been selling assets managed by these troubled companies and is working to bring in replacement operators. The company is also looking to take advantage of a lease provision that entitles it to a portion of "the significant value embedded in Prospect's managed care platform." In other words, Medical Properties Trust is making what appear to be the right moves.
However, it takes time to sell assets and replace operators (which may then require time to improve property-level operations), and getting any "value" out of Prospect's managed care platform could be "12 to 18 months" away since it would require Prospect to sell or recapitalize the business. REITs can pay out more than their adjusted FFO for short periods of time, but it is not something that can go on over the long term.
So there's a clock ticking, and that assumes that no other tenants end up in trouble. As it is, the high end of management's outlook appears to be back-end loaded, so the first six months of 2023 could be fairly ugly, financially speaking.
What's your wager on Medical Properties Trust?
Medical Properties Trust is not an appropriate investment for risk-averse investors. The only reason to buy is if you believe the REIT can solve the current issues it faces with two of its largest tenants and return its adjusted FFO payout ratio back to stronger, historical levels before the board decides that the cash needs of the business necessitate a dividend cut.
All in, it looks like 2023 is going to be a pretty active year for the company and, perhaps, a tense one for investors. Everything could turn out just fine, of course, but the risk of a dividend cut is very real. Only those with strong stomachs should be looking at Medical Properties Trust today.
