EPR Properties (EPR -0.32%) was basically in the wrong place at the wrong time when the coronavirus pandemic hit in 2020. That's because the properties it owns are experiential in nature and designed to bring people together in groups. The uncertainty was so great that the real estate investment trust (REIT) eliminated its dividend. The dividend is back, roughly 60% of the portfolio is performing better today than it was in 2019, and the outlook is bright. But there's still one big issue to deal with.
EPR's portfolio is only somewhat diversified
EPR Properties owns roughly 360 properties all centered around providing consumers with experiences. The list of property types includes things like amusement parks and ski resorts. It also has less unique assets like movie theaters. Movie theaters, with around 170 locations, account for about 40% of rent, while all of the other properties it owns make up the rest of the company's income stream.
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That's a lot of concentration in a single property type. To make matters worse, movie theaters aren't doing that well. The pandemic was an obvious problem, but theaters are also dealing with changing consumer habits. For example, streaming video on a phone or viewing media at home are both altering the demand for going to a movie theater to consume content.
The best example of the problem here comes from rent coverage. EPR highlights that 60% of its portfolio -- i.e., properties excluding theaters -- on average cover rent by 2.7 times. That's actually higher than the 2.0 times in 2019. So this side of the business has gotten stronger. But the 40% of rent that comes from movie theaters is only covered by 1.3 times on average. That's down from 1.7 times prior to the pandemic. Clearly, movie theaters are the big problem spot for the REIT.
The good news is building
At this point, EPR looks like it has gotten past the worst of the pandemic fallout. The company's dividend has been reinstated, though at a lower level than before. And the dividend has been increased once. It is also working with its movie theater tenants to muddle through the lingering problems in that industry. For example, it just inked a new lease deal with Regal. That deal comes with lower rent and requires EPR to take back a handful of properties.
Five of the 16 properties it is taking back have been re-leased to other tenants. The remaining 11 are slated to be sold. All told, the transactions here will reduce EPR's reliance on movie theaters, which is a long-term goal. As the exposure to this one segment declines, EPR's portfolio becomes stronger.
There are, of course, two ways to get there. The first is seen the example above: by selling movie theaters. The other is investing in non-movie theater properties to grow the rest of the business. Both strategies will be employed, but neither is simple or quick. Given the size of the movie theater portfolio, it will likely take some time for EPR to meaningfully reduce its exposure to this niche without risking a major upheaval in its business. Five years is probably a good starting point when thinking about the scope of change that is needed.
Moving in the right direction
Given EPR's still-meaningful exposure to the movie business, it is probably not an appropriate investment for risk-averse investors. Sure, the 7.7% dividend yield is enticing, but it is a sign of the elevated uncertainty here, and there is clearly a lot of work to be done on the portfolio front. More aggressive investors, however, might be willing to take on the risks knowing that EPR is working to rectify what is probably its biggest negative. Just go in knowing that the fix won't be a quick one.
