EPR Properties (EPR -0.32%) has done a good job of navigating a very difficult period. But this real estate investment trust (REIT) still has some lingering issues to deal with. The biggest by far is its exposure to the struggling movie theater sector.
In the second quarter, EPR Properties was forced to take back 16 theater properties from a large tenant and instantly wrote down the value of those assets by $42.4 million. Such write-downs could become the norm for this property segment.
EPR was in the wrong place at the wrong time
The fact that EPR Properties focuses on experiential assets isn't actually a bad thing. It is an interesting approach, and it's one that, from a big-picture perspective, appears to align with consumer trends. In some ways, it is no different than the tactic being used by casino REITs.
But when the coronavirus pandemic hit in 2020, that focus turned into a huge liability. People started to socially distance, work from home, and generally hide from the world around them. The REIT suspended its dividend as a precautionary measure.
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The good news is that the world is learning to live with the coronavirus. People are going back to leading normal lives and seeking out experiences again. EPR's business is rebounding, and the dividend has come back again, though it remains below pre-cut levels. To put a number on the business rebound, the rent coverage ratio for roughly 60% of EPR's portfolio was 2 times in 2019, and is now 2.7 times. Rent coverage basically assesses how well a tenant can pay its rents, with higher numbers being better (a figure of 1 would mean just covering rent). So most of the business is in better shape than it was prior to the pandemic.
The problem is that the other 40% of the portfolio has seen its rent coverage drop from 1.7 times in 2019 to just 1.3 times today. The 60% of the portfolio that's doing well covers a variety of different property types, while the 40% that's still struggling are all movie theaters. That's a lot of concentration in a single property type that has clearly not yet recovered in a meaningful way from the pandemic hit.
EPR is working with its tenants
There's no question that EPR has been doing the right things to get through the troubles in the theater segment. For example, it has worked with struggling tenants by offering rent deferrals and rent reductions. Most recently it negotiated with bankrupt theater operator Regal around the 57 properties it leased. Regal retained 41 locations and "gave back" 16.
As part of the accounting for this event, EPR wrote down the value of those 16 properties by $42.4 million. Using back-of-the-envelope math, that amounts to $2.65 million per theater. It was able to release five properties, likely under less attractive terms, and plans to sell the other 11. Once again, there is nothing wrong with EPR's approach here. It is making the best of a bad situation.
However, the write-down suggests that the theater properties the company still owns might not be worth what they once were. Applying the roughly $2.65 million per theater haircut to the rest of the theater portfolio puts an estimate on the potential pain that could still be coming for EPR and its shareholders. Here's the math on that: EPR owns 171 theaters, but 16 have already been written down, so the number left after that is 155. Thus the remaining theaters could result in a write-down of around $400 million or so. That's not chump change for a company with a $3.2 billion market cap, though it may come in dribs and drabs over time.
Movie theater problems aren't going away quickly
To be fair, some properties are likely to be more valuable than others, but then some will be worth much less too. And while these are back-of-the-envelope calculations, they are likely to be directionally correct. EPR's large theater portfolio isn't as well positioned today as it was before the pandemic. If you own EPR or are looking at it, likely because of its hefty 7.7% dividend yield, the broader improvement in the business still has to be couched in the sizable problems that continue to face the REIT's large theater exposure.
