Leading healthcare REIT Welltower (HCN +1.75%) delivered solid performance in 2015, but the demographic trends point toward accelerating growth in the years ahead. Could 2016 prove to be Welltower's best year?
2015 was a strong year
Welltower delivered another year of solid performance in 2015. Normalized FFO increased by 8% year over year as of the third quarter, and the portfolio has experienced year-to-date same-store NOI growth of 3.1%.
The company completed or announced $4.1 billion in new investments, 82% of which were completed in conjunction with Welltower's existing partners, who are among the best in the business. Included in this figure was more than $1.6 billion of investments in the U.K. and Canada, two rapidly growing markets for Welltower.
Welltower also completed the sale of its Life Sciences portfolio for $573.5 million, which was purchased in 2010 for $327 million, an annualized return on investment of 15%.
Finally, the company continued to improve its balance sheet in 2015. Since the end of 2013, Welltower's debt as a percentage of total capitalization has fallen from 42.6% to 37.4%, and interest coverage has improved from 3.4 times to 4.5 times.
As a result of the strong performance, Welltower was able to increase its dividend by 3.8% in 2015, and it recently announced that the payout will grow by another 4.2% in 2016, the company's highest dividend increase in four years.
What to expect in 2016 and beyond
Unlike many other REITs, Welltower has not yet issued guidance for 2016 yet for either FFO or investment activity.
What we do know is that the U.S. market for healthcare real estate is $1 trillion in size, and highly fragmented. In fact, Welltower is the largest healthcare REIT and has just 2.5% of the market.
Not only is the market already huge, but it is projected to grow rapidly over the coming years. The population of Welltower's markets is aging rapidly, and senior housing is the company's main focus. In the U.S., the 85+ population is expected to triple by the year 2050, and in the U.K. and Canada, the elderly population is expected to grow five and seven times faster than the overall population, respectively.
Source: Welltower.
Another positive catalyst going into 2016 is the recent decision to change the company's name from Health Care REIT to Welltower in order to create more of a brand name. I see this as a smart move, as a strong brand name can create numerous competitive advantages, such as pricing power over rivals (this is why people are willing to pay more for Pepsi than a generic brand). Welltower isn't a household name just yet, but that may change in the future.
Wait...aren't rising interest rates bad for REITs?
The Federal Reserve finally raised interest rates, and a few more increases are expected to take place during 2016. However, there are positive and negative aspects to this.
It's absolutely true that rising rates make borrowing money more expensive, which can cut into Welltower's initial profit margin when it acquires a property. Keep in mind, however, that Welltower isn't too reliant on debt -- in fact, debt makes up just 37% of the company's total capitalization. Still, higher rates could translate into lower profits.
Further, rising rates create selling pressure on high-yielding stocks like REITs. When rates rise, "safer" investments like bonds, CDs, and money market accounts pay more, and can become more attractive to income investors.
Having said that, I truly believe rising rates will do more good than harm to Welltower. The Federal Reserve has been extremely cautious when it comes to raising rates, and it wouldn't do so unless it saw clear evidence that the economy was on the right path. An improving economy means job and wage growth, as well as a healthy inflation rate, which means higher demand for properties and the ability to collect more rent on existing properties.
According to the National Association of Real Estate Investment Trusts, equity REITs have a strong history of performing well in rising-rate environments. Since 1995, there have been 16 periods of rising interest rates, and equity REITs produced positive returns during 12 of them. My point here is that it would be a mistake to let the possibility of rising interest rates scare you away from investing in a great company like Welltower.
The Foolish bottom line
Welltower is a leader in a growing and fragmented market. The demographic trends and international expansion possibilities lead me to believe that not only will the growth continue, it could accelerate in the coming years. Therefore, while nobody has a crystal ball, and there are lots of possible outcomes, 2016 (and every year thereafter) has the possibility to be Welltower's best year yet.
