We all know that repealing healthcare is an essential part of President Trump’s broader agenda, especially now that the Better Care Reconciliation Act of 2017 is on center stage.
The purpose for my article today is not to get into a political debate over the pros and cons of the Better Care Reconciliation Act of 2017. I intend to provide a deeper dive in the upcoming edition of The Forbes Real Estate Investor.
I think it’s important to weigh in on the property sectors that could help or hurt the passage of the bill, and I will be doing so in the newsletter.
Politics aside, there is no debate over the demographics that are driving demand for healthcare real estate, as I explained in a recent article:
When you consider the supply (demographics) and demand with the Health Care sector, it’s clear that the senior population has immense sending power and wealth. Health Care spending is projected to grow 5.8% annually (2-14-2024).
While the market perceives the operator risks that are weighing on shares in most healthcare REITs, there is little argument that the demographics provide compelling clarity that the growth in the senior population is enormous and the winning consolidators will emerge.
Today I am focusing on one such consolidator that is well positioned to benefit from the strongest catalyst in healthcare: an aging population. This REIT has all of the ingredients to become a top performer and possibly a SWAN in a due time. (SWAN stands for “sleep well at night”, and this is a term I use often in my newsletter).
National Health Investors
National Health Investors, Inc. (NYSE:NHI) was founded in 1991, and for most of the last 26 years, the Tennessee-based REIT has maintained a small asset base. However, in 2013, the company closed on $752 million in deals, followed by $571 million in 2014 and $447 million in 2016.
NHI is considered a diversified healthcare REIT, based upon the following sub-sector breakdown: Skilled Nursing (29%), Hospital/MOB (3%), Entrance Fee (20%), Independent Living (16%), Assisted Living (24%), Senior Living Campus (6%), and Other (2%).
One important footnote to the company’s past is its dividend cut in 2000.
As you can see below, NHI was forced to cut its dividend around 17 years ago as a result of a technical default. At the time, it had a large loan with a Japanese bank, and when one of the company’s tenants filed for bankruptcy, the bank called the loan. At that point, NHI did not enjoy the same financial flexibility and it had no tenant diversification.
As a result of the adversity (back in 2000), NHI’s Board has gained valuable experience, and that is the reason it has become a more disciplined enterprise.
One of the lessons learned was to maintain sound geographic and tenant-based diversification. As you can see below, NHI has a well-balanced platform consisting of 215 properties in 32 states.
The company also has a well-balanced platform that consists of 34 operating partners. Here’s a snapshot of NHI’s partners.
As you can see, 42% of the operators are publicly traded and 39% are regional partners.
National Healthcare Corp. (NYSEMKT:NHC) accounts for 16% of cash revenue and has a corporate fixed charge coverage of 3.64x. Holiday Retirement represents 15% of cash revenue and has an EBITDA and coverage (as of Q1-17) of 1.19x.
Holiday has been working on transitioning its community management model to a traditional management team. The transition is ongoing, and NHI has been in regular communication with Holiday about its transition, as well as its plan to move its corporate offices to Florida. More on Holiday at the end of this article.
Bickford Senior Living accounts for 14% of cash revenue and has an EBITDA and coverage ratio of 1.21x (for the trailing 12 months ending December 31st). Last year, NHI unwound its RIDEA joint venture with Bickford Senior Living and converted Bickford’s participation to an NNN (triple net) tenancy with assumption of existing leases and terms. NHI now has revenue from 40 Bickford facilities plus 4 in construction phrases.
As you can see below, Senior Living Communities, NHC, Holiday Retirement, Bickford, and Ensign Group (NASDAQ:ENSG) represent 70% of NHI’s portfolio (based on revenue):
The Better Care Reconciliation Act of 2017 (Senate’s version of ACA Repeal and Replace) that was announced last week is positive for skilled nursing operators like Ensign. Skilled nursing facilities are major low-cost providers of rehab services (without overhead of an acute care hospital) and Ensign is a top provider.
The changing reimbursement strategies favor a larger role for well-managed skilled nursing properties as they derive a growing percentage of income from shorter stay and rehab care.
The Balance Sheet
NHI’s strategy is to deploy a careful mix of debt and new equity to maintain a low leverage profile. As of Q1-17, its debt capital metrics were net debt-to-annualized EBITDA of 4.5x, weighted average debt maturity at 5.8 years, weighted average cost of debt at 3.62% and fixed charge coverage ratio at 5.7x.
At the end of Q1-17, it had $187 million outstanding on the revolver with an available capacity of $363 million.
Earlier in 2017, NHI sold roughly 1.12 million shares of common stock through its ATM program, and the shares were sold at an average price of $72.31 per share, resulting in net proceeds after commissions of $80 million.
Net proceeds were used to fund a portion of the acquisitions, the ongoing development pipeline and loan commitments, and to maintain low leverage metrics.
In Q1-17, NHI sold the remaining 250,000 shares in LTC Properties (NYSE:LTC) common stock, resulting in net proceeds of $11.7 million. As we move through 2017, the company’s sources of capital will continue to be cash flow from operations, cash flows from loan receivable or repayments, revolver proceeds, term debt proceeds, and equity issuances from the ongoing ATM program.
Although NHI has no investment grade rating, I consider the debt “unofficially” rated as BBB. I like the fact that it maintains frugal practices like not forking out over $400,000 annually to a rating agency or supporting its corporate offices in an owned office building outside of Nashville.
Note: NHI has just 15 full-time employees and continues to outsource functions such as legal, internal audit, tax, compliance, IT, and payroll to other professional firms. This business model is very efficient.
The Latest Results
For Q1-17, NHI’s normalized FFO increased to $1.25 per diluted share compared to $1.16 for the same period one year ago, and normalized AFFO increased to $1.13 per diluted share compared to $1.04 one year ago.
The company’s total revenues for the first quarter showed strong growth of 12.5% over the same quarter in 2016. This growth has been primarily fueled by new investments with The Ensign Group, Bickford Senior Living, Senior Living Communities, and East Lake Capital Management.
In February, NHI announced the purchase of two assisted living and memory care facilities totaling 86 units in Hendersonville, North Carolina, to Ravn Senior Solutions, which is led by Steve Morton and Ted Turner.
The neighboring facilities now known Carolina Reserve have a lease term of 15 years at an initial lease rate of 7.35% plus annual fixed escalators. With this purchase, NHI was granted a purchase option of a third building in the Raleigh/Durham market.
In early March, the company announced the acquisition of a 126-bed skilled nursing facility in New Braunfels, Texas, for an investment of $13.9 million. The facility was leased to an affiliate of The Ensign Group. The acquisition is the first of four that NHI had previously committed to, and will be added to the existing lease at initial rate of 8.35% plus annual lease escalators, based on inflation.
During the first quarter, NHI also announced the purchase of a 102-unit assisted and memory care facility in Portland, Oregon, for $26.2 million that was leased back to Prestige Senior Living. This facility was added to the existing Prestige master lease that is comprised of three skilled nursing facilities and one assisted living facility and has a remaining term of 12 years. The new investment has an initial cash yield of 7% plus annual fixed escalators.
Towards the end of the first quarter, NHI announced the purchase of five memory care facilities totaling 223 units. The facilities located in Texas and Illinois were purchased for $61.8 million and leased back to the LaSalle Group, which operates its facilities under the Autumn Leaves. The LaSalle Group is a family-owned company which develops, owns and operates 46 memory care communities across the US. The lease term is 15 years at an initial cash yield of 7% with annual fixed escalators.
NHI’s guidance ranges have remained unchanged. The normalized FFO guidance range is $5.06-5.12 per share, and the normalized AFFO range is $4.61-4.65 per share. The company does not include an estimate of investment volume in the guidance range.
Can NHI Move the Needle?
In terms of FFO/share growth, Physicians Realty Trust (NYSE:DOC), CareTrust, and Community Healthcare Trust (NYSE:CHCT) offer the best growth prospects; however, NHI compares favorably, as illustrated below:
As mentioned earlier, NHI has around 15% exposure to Holiday Retirement, and it seems logical that it would have an interest in New Senior Investment Group (NYSE:SNR). As I explained in a recent article:
Although SNR is less vulnerable to government pay risks, the company does have outsized risks related to its concentration with Holiday…the REIT derives around 75% of its revenue from Holiday and around 12% of revenue from Blue Harbor.
What are the catalysts for M&A? Here’s what I said:
What makes this REIT (SNR) particularly compelling is that is suffering from what I call the “triple whammy”. This simply means it has (1) external management, (2) high leverage, and (3) little tenant diversification.
The high leverage ($2.2 billion of total debt and $3.3 billion in assets) makes it difficult for NHI to acquire SNR, but withstanding the capital constraints, this deal makes some sense. On the recent earnings call, Eric Mendelsohn, NHI’s CEO, responded to an analyst question regarding the Care Capital Properties (NYSE:CCP)/Sabra Healthcare REIT (NASDAQ:SBRA) merger:
… in the meantime, as we wait for the right mega deal to come along, we just continue with our twos and threes which on any given year could add up to between $300 million and $500 million, which is not a bad way to grow.
… being a REIT, our hands are constrained by our leverage metrics. And unless we’re willing to make some assumptions on future performance and lever up a deal beyond our comfort zone, we’re not going to be able to be competitive with private equity.
A proposed New Senior deal would be transformational for NHI, but the transaction would catapult the company to a $5 billion+ REIT, a move that would certainly move the needle for the “sleepy” southern REIT hoping to carve out a slice of the highly fragmented healthcare REIT pie.
I’m a shareholder in SNR, and I don’t see the company internalizing anytime soon. The recent lawsuit against New Senior could spark interest in a planned sale of the externally managed REIT.
How Does NHI Compare?
I have been “in and out” of NHI, and currently I’m on the sidelines. Let’s look at the REIT based on its dividend yield:
The dividend appears “soundly valued”. In the first quarter, NHI reported a 5.5% increase in the quarterly dividend to $0.95 per share, or $3.80 on an annual basis. The company estimates that total dividends for 2017 will result in a normalized FFO payout ratio in the low 70% range and a normalized AFFO payout ratio in the low 80% range. Now let’s compare the P/FFO multiple:
As I said, I do not own NHI now. Instead, I prefer to own Ventas, Inc. (NYSE:VTR) and LTC as my “diversified” healthcare REIT holdings (in addition to “pure plays” DOC, Healthcare Trust of America (NYSE:HTA), SNR, CCP, Omega Healthcare Investors (NYSE:OHI), and CHCT).
I don’t see anything wrong with NHI. I just believe VTR is a better vehicle for me, and I like to own REITs with the lowest overall cost of capital. However, given the recent SBRA/CCP deal (proposed), I believe NHI is well positioned to become a consolidator.
Yet, M&A is not a catalyst, and I believe that NHI is “soundly valued”. This simply means I would recommend “nibbling” but remaining a bit cautious until the Better Care Reconciliation Act is passed. I am upgrading NHI from a Hold to a Buy with a target entry price of $76.00 per share (which equates to a dividend yield of 5%).
In the July edition of the Forbes Real Estate Investor, I will be providing a dashboard for WACC for all Net Lease REITs.
Author’s note: Join me at the DIY Investor Summit, where I share detailed tips on my core investment strategies, top advice for DIY investors and specific ways I’m positioning for the second half of 2017. Sign up here.
Other REITs mentioned in the article: LTC, HTA, VTR, Welltower, Inc. (NYSE:HCN), CTRE, Healthcare Realty Trust (NYSE:HR), Universal Health Realty Income Trust (NYSE:UHT), SBRA, DOC, HCP, Inc. (NYSE:HCP), OHI, Medical Properties Trust (NYSE:MPW), Senior Housing Properties Trust (NYSE:SNH), SNR, CHCT, CCP, Quality Care Properties (NYSE:QCP), and Global Medical REIT, Inc. (OTC:GMRE).
Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.
Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).
Sources: F.A.S.T. Graphs and NHI Investor Presentation.
Disclosure: I am/we are long APTS, ARI, BRX, BXMT, CCI, CCP, CHCT, CLDT, CONE, CORR, CUBE, DLR, DOC, EXR, FPI, GMRE, GPT, HASI, HTA, IRM, JCAP, KIM, LADR, LTC, LXP, O, OHI, PEB, PK, QTS, ROIC, SKT, SNR, SPG, STAG, STOR, STWD, TCO, UBA, VER, VTR, WPC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.