Image source: www.myfuture.com.
I've written before that healthcare real estate will be an excellent investment over the next several decades, thanks to favorable demographic trends and increased healthcare spending. Welltower (HCN +0.24%) and HCP (HCP +0.12%) are the two leading healthcare REITs in the market, and both have a lot in common. If investors want to invest in healthcare real estate right now, which should they choose?
Why healthcare real estate?
Basically, the demographic trends hugely favor the continued success of healthcare real estate as an investment.
According to the U.S. Department of Commerce, the population of people 65 or older is expected to nearly double by 2050, creating a huge demand for healthcare. And, since over 40% of current healthcare costs are incurred by this age group, there will be a lot of money to be made in the decades to come.
Image source: Welltower.
In addition, healthcare costs are rising as a percentage of GDP. So, there is a combination of higher demand for services whose costs are increasing.
Image source: Welltower
Finally, the market for healthcare real estate is extremely fragmented. Welltower and HCP are the sector leaders, and neither holds more than a 3% share of the $1 trillion U.S. healthcare real estate market. So, not only will the market expand over the coming decades, but there is already plenty of room for growth by consolidation.
About the contenders
Both REITs have a lot in common. For starters, both are similar in size -- Welltower has around 1,400 properties in its portfolio, and HCP has about 1,200. Both have been in business for decades, and have long-standing partnerships with some of the best healthcare facility operators in the business. And, both companies have similarly strong balance sheets and investment-grade credit ratings.
Their investment portfolios are slightly different in composition. The majority (64%) of Welltower's portfolio is senior housing, while this makes up just 39% of HCP's. HCP also has a few property types that are absent from Welltower's portfolio -- most notably life sciences, which Welltower exited last year, and medical office properties -- both of which make up 14% of HCP's portfolio.
In short, Welltower and HCP look quite similar on paper -- so let's take a look at their history and valuation.
Dividend and growth history
It's tough to declare a clear winner in this category, either. As far as dividends go, HCP has the clear advantage right now, with an impressive 7.2% yield. Even more impressively, HCP has increased its payout for 31 consecutive years and is the only REIT in the S&P 500 High Yield Dividend Aristocrats index.
Welltower's dividend history is rather impressive as well, with a 5.2% payout that has been increased consistently throughout the company's 45-year history (although not every year).
Image source: YCharts.
As far as overall investment performance goes, Welltower has produced impressive total returns averaging 15.6% per year since its 1970 IPO. However, HCP wasn't around at that point, so to compare them on an even playing field we can compare their performance over equal time periods.
|
Welltower Average Annual Return |
HCP Average Annual Return | |
|---|---|---|
|
5 Years |
9.9% |
1.6% |
|
10 Years |
12.2% |
7% |
|
20 Years |
13.3% |
10.2% |
|
30 Years |
13.7% |
13.4% |
Data source: YCharts.
Notice how HCP's performance over the shorter time periods has lagged. Keep in mind that HCP's latest earning report was considered a huge disappointment by investors, and HCP's share price is down more than 17% in 2016 -- a big reason for the short-term difference. However, over the longer periods of time, we see that the performance is nearly identical.
Valuation
When comparing REITs, net income or earnings per share are poor metrics to use, for reasons explained here. The best metric to look at is funds from operations (FFO), which we can think of as the "earnings" of the REIT world. With that in mind, here's a comparison of Welltower's and HCP's current valuation based on 2015's FFO and 2016's projected FFO.
|
Company |
Current Price |
2015 FFO (Adjusted) |
P/FFO (TTM) |
2016 FFO (Guidance) |
Forward P/FFO (Midpoint) |
|---|---|---|---|---|---|
|
Welltower |
$65.86 |
$4.38 |
15.0 |
$4.50 to $4.60 |
14.5 |
|
HCP |
$31.90 |
$3.16 |
10.1 |
$2.74 to $2.80 |
11.5 |
Stock prices as of 3/10/2016. Data source: Welltower and HCP's year-end earnings press releases
So, at first glance, HCP seems like the better value, but there are a couple of things to keep in mind. First, HCP's FFO is expected to fall next year, while Welltower's is expected to rise at a healthy rate. Second, HCP has a lot of uncertainty in the coming year, mainly thanks to weak performance from its HCR ManorCare properties, which make up the vast majority of its post-acute care portfolio. This represents about one-fourth of the REIT's total properties, and while nothing catastrophic is likely to happen here, it does create uncertainty in regards to the company's future earnings potential.
The point is that although Welltower's valuation may seem like the more expensive of the two, strength and stability is definitely worth a premium, and right now Welltower simply has more of it.
The verdict
Of these two leading healthcare REITs, the better buy for you depends on your specific objectives and risk tolerance. At the present time, Welltower is the safer choice of the two, and at 15 times earnings, it is actually rather cheap for such an established and sector-leading REIT. Plus, its 5.2% dividend should continue to grow for decades to come.
On the other hand, if you aren't reliant on your stock portfolio for current income, and have the patience and stomach to wait out the tough times, HCP still looks like a solid long-term play on healthcare real estate. Just keep in mind that the next year or two could be a little turbulent as the market digests the HCR ManorCare issues.
