The novel coronavirus pandemic has created chaos for businesses and Wall Street. While a changing market dynamic may have created a lot of opportunities for investors looking for high- yield investments, it has also created a lot of "yield traps," or dividends that look high on paper but are at serious risk of getting cut in the near future.
Ventas (NYSE: VTR), a healthcare-focused real estate investment trust (REIT), has seen its stock plummet in recent months, and its dividend yield stands out at a remarkably high 10.4%. Is Ventas another case of the stock market overreacting to news headlines and actually a fantastic buying opportunity? Or is it very much a yield trap waiting to blow up your investment thesis? Let's take a look at Ventas to see whether this REIT is a buy.
The portfolio stands on some shaky legs
Healthcare and commercial real estate tied to healthcare tends to be one of the more stable businesses in which you can invest. Most healthcare is non-discretionary spending, and therefore, business tends to be steady. Also, tenants of healthcare properties like hospitals, medical offices, and research labs tend to be long-term customers with low turnover.
About 44% of Ventas' properties fall into this category. These properties include medical offices, research labs, and acute and post-acute care facilities that are leased out to operators with triple net leases in place. This portion of Ventas' portfolio is rather stable under normal operating conditions, and net operating income (NOI) from these properties has been relatively steady over the past few years.
The other 55% of Ventas' portfolio, though, is in owned and operated senior living facilities. While there are several favorable trends for senior care facilities as America's aging population requires more care, it's a competitive industry that has to consistently bring in new tenants to replace residents that have "moved out," as the senior living industry likes to call it (generally a euphemism for a resident passing away).
So as a property type, it's a more difficult one to manage, especially for Ventas as it operates the facilities instead of leasing the buildings to operators. Even before the coronavirus outbreak began, Ventas was already dealing with high operating expenses that were eating into the bottom line. In fiscal year 2019, Ventas' same-store cash NOI for its operated senior housing segment was negative 4.4%. Furthermore, management was already predicting same-store cash NOI for operated senior living to drop between 4% and 9% before the novel coronavirus hit.
Dealing with the virus outbreak has added two headaches to Ventas' already stressed senior housing segment:
- It expects higher operating costs for increased cleaning and sanitation services as well as labor costs.
- It expects higher vacancy rates. According to Ventas' press release: "Tours and move-ins are beginning to slow, and the pandemic raises the risk of an elevated level of move-outs."
Ventas, like many other businesses, has withdrawn financial guidance for 2020 as it tries to assess the longer-term impacts of COVID-19. Based on the initial signs, though, it doesn't look great.
Battening down the hatches (with cash)
The outlook for Ventas doesn't look great at the moment, but its management team has been making some changes and preparing for tough times ahead. The company was able to raise about $600 million with the offering of Ventas Life Science and Healthcare Real Estate Fund, L.P. It also recently drew a substantial amount from its business credit lines. The proceeds from this sale and credit withdrawals will give Ventas about $2.75 billion in cash on hand to weather the storm.
The other silver lining here is that Ventas' balance sheet doesn't appear to be stretched too thin. At the end of 2019, the company's debt-to-asset ratio was about 61%. Withdrawing on its credit lines will lead to a higher debt-to-asset ratio, but it appears the company has some wiggle room there.
The bottom line
The good news is that the moves Ventas' management has made will likely keep the company out of trouble. It has some real operational concerns with its senior housing segment, but the amount of cash on the books should help it address these issues.
There is a big difference between a company that will survive a major disruption to its business and one worth making an investment in, though. The amount of cash going out the door for higher operating expenses at its senior care facilities and meeting its now higher debt obligations will be substantial. Paying these higher costs while also dealing with lower occupancy rates at its senior care facilities and likely a few strained tenants at its other properties is going to make cash a precious resource. As a result, there's a decent chance that management will have to cut its dividend.
If you're looking for steady income, then investing in a REIT that could likely cut its dividend in the near future isn't the best option right now. There are certainly other REITs on the market with more stable outlooks and better financials than Ventas. Perhaps the company will be able to address its senior living segment issues. Until it does, though, the company's sky-high dividend yield doesn't appear to be worth the reach.
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