Meditrust Corp.
Dow Jones Newswires -- October 15, 1999
DJ TALES OF THE TAPE: Healthcare REITs' Growth Prescription
By Janet Morrissey
NEW YORK (Dow Jones)--Mention the word "healthcare" in the real estate investment trust world and investors get queasy.
But market watchers believe that recent political steps taken in Washington, clarity provided by bankruptcy filings made by some high-profile healthcare operators and the group's high dividend yield may be the prescription that calms investor jitters and lures them back to the battered-down sector that many believe has bottomed out.
"(These factors) should provide stabilization and relief to the share price," said Prudential Securities Inc. analyst Jim Sullivan, who believes healthcare REITs have the potential to climb 20% to 30% over the next year as they rebound.
"The sector's been oversold. The market has overestimated the risk (of healthcare operators) to REITs," said Legg Mason Wood Walker Inc. analyst Jerry Doctrow. He predicts the stocks could jump 10% to 20% by the end of 2000. "And when you add the dividend yield of 10% to 15%, you're looking at total returns of 20% to 30%," he said.
Healthcare REIT total returns, which include dividends, are off 18.9% in 1999 while REITs in general are showing negative total returns of 6.6%, according to the National Association of Real Estate Investment Trusts.
But healthcare REITs are also posting attractive dividend yields of 11.8%, outpacing the average REIT yield of 8.6%.
Healthcare REITs slipped off investors' screens in 1999 over concerns about government changes to Medicare's reimbursement system and their impact on nursing home operators.
Under Medicare's new method, called the Prospective Payment System or PPS, which took effect Jan. 1, healthcare providers are paid a flat rate per patient per day. In the past, Medicare simply reimbursed for the cost of each service provided. This change has cut into the revenue of some healthcare operators, especially ones that focus on nursing homes and special ancillary services, and healthcare REIT investors became nervous that cash-strapped operators would not be able to make their rent payments to the REITs.
Whispers on Wall Street escalated into screams that a number of healthcare operators would not survive. This gloom-and-doom scenario prompted investors to pull out of healthcare REITs in droves over concerns that REITs would take in significantly less money from rent and possibly be forced to cut their dividends.
"Stock prices of healthcare companies were trading as if they were all bankrupt companies and healthcare REITs are trading as if their funds from operations will drop 20% and their dividends are in jeopardy," said Steve Brown, a buy-side analyst with Cohen & Steers Capital Management.
Even healthcare REITs having little exposure to nursing homes and the PPS issue were hammered.
Those focusing on assisted living facilities, whose FFO growth is tied to new development, found themselves shunned by investors. Part of the investor pullout was simply fallout from the PPS issue while the rest was due to concerns about overbuilding in certain markets and to higher interest rates making the cost of new development more expensive.
But several events are emerging on the horizon that market watchers believe could be the long-awaited catalyst investors have been waiting for to breathe new life into the group.
First, Congress appears poised to offer relief to troubled heathcare operators by restoring at least some of the Medicare reimbursement payments that were snatched away through the PPS system and other cuts within the 1997 Balanced Budget Act.
The balanced budget law was to chop Medicare spending by about $115 billion over five years: About $15 billion to $20 billion of those cuts were within the PPS system.
A House plan offers caregivers about $15 billion in relief over five years while a Senate proposal calls for $10 billion to $15 billion over the next decade. Although the two plans differ, the proposals have left healthcare lobbyists optimistic that relief of some kind will be passed by Congress by year end.
The government's cost-cutting was aimed at cracking down on waste, abuse and fraud. But nursing home operators and those that specialize in ancillary services, such as speech and occupational therapy, have been hit hard by the cuts in the first year.
That has led to the second potential catalyst for gains in healthcare REIT stocks: bankruptcy filings by a number of healthcare providers. Healthcare REITs were buoyed by the news because it removed market uncertainty over rent payments and leases, analysts said. The decision by Vencor Inc. (VCRI) and more recently Sun Healthcare Group Inc. (SHGE) to file for Chapter 11 comforted restless investors by spelling out specifically what facilities would be impacted and how much rent reductions REITs would face.
Also, REITs are placed "at the top of the credit heap" during bankruptcy proceedings, giving them a greater chance of reaching rent agreements with the healthcare operators, said Legg Mason analyst Jerry Doctrow.
The bankruptcy filings help the market to quantify the impact on the REITs, added Prudential's Sullivan. "And ultimately the reality is not as bad as feared," he said.
Indeed, Ventas Inc. (VRT), which leases almost all of its properties to long-term hospital care operator Vencor, saw its shares rise 28% after Vencor filed for Chapter 11. Under the terms of Vencor's restructuring, Ventas gave up about $45 million in annual rent concessions, which worked out to about a 20% rent reduction, but it also received a 15% equity stake in the reorganized Vencor, which analysts had not expected. The terms removed a cloud of uncertainty that had been hovering over Ventas' stock, analysts said.
Rumblings that Sun was poised to file for Chapter 11 had reverberated through the market for months before it finally took the step this week. REITs with the biggest exposure to Sun are LTC Properties Inc. (LTC), Meditrust Corp. (MT), and Omega Healthcare Investors Inc. (OHI).
LTC had signed a deal with Sun prior to the filing to cut its exposure to the troubled healthcare operator. The agreement lowered LTC's annual FFO by 4 cents a share.
Omega, in a pact with Sun, agreed to take back the leases on four properties that are leased to Sun. If all four are not re-leased, Omega's annual FFO would be cut by about 9 cents a share. But that impact would be reduced if new operators are found for the properties, the company said.
"We're talking about a few pennies a share, not 25 or 30 cents a share," said Cohen & Steers' Brown.
PaineWebber Inc. analyst Jonathan Litt sees the Sun filing as positive for Meditrust, which owns 42 properties that are operated by Sun. "Meditrust is trading at about 4 times 2000 FFO. It's a joke," he said. The company expects to quantify the impact of the Sun bankruptcy within 30 days.
"We were looking for the other shoe to drop and now it has," said Brown, noting that Sun is the largest operator of nursing homes in the country. He said investors can now focus on the financial impact of the restructuring and bankruptcy on healthcare REITs.
Analyst Warner Griswold from Green Street Advisors of Newport Beach, Calif., speculates the bankruptcies may prompt faster political action in Washington.
Other healthcare operators struggling with losses that analysts speculate could take the Chapter 11 route are Mariner Post-Acute Network Inc. (MPN) and Integrated Health Services Inc. (IHS). Healthcare REITs that could be affected by these operators include Senior Housing Properties Trust (SNH), National Health Investors (NHI) and Omega.
Legg Mason's Dowtrow speculates that investors may want to see the impact of these bankruptcy filings on the REITs' subsequent quarters before diving back into the stocks. As a result, he sees the biggest upside coming in the second half of 2000.
But some healthcare REITs, such as Nationwide Health Properties Inc. (NHP), American Health Properties Inc. (AHE) Health Care Property Investments Inc. (HCP) and Healthcare Realty Trust Inc. (HR), are more diversified, analysts said, and will likely have little negative impact from troubled nursing home operators and the Chapter 11 filings. Although their fall was not as steep as others in the sector, some speculate their rebound may be faster.
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