Leading healthcare REIT Welltower (NYSE: WELL) has sharply rebounded from its lows, and is up about 20% over the past two months. While the stock is obviously not as attractively priced as it was then, that doesn’t mean that long-term investors have missed out. Here’s why Welltower is still a compelling investment for them.
Welltower: The one-minute version
Welltower is the largest real estate investment trust (REIT) that specializes in healthcare properties. With nearly 1,300 properties in its portfolio, Welltower is one of the largest REITs of any kind and has a senior-centered portfolio.
Specifically, 72% of Welltower’s income is derived from senior housing properties, and another 11% comes from long-term care facilities. The other 17% of Welltower’s income is from outpatient medical facilities, a rapidly growing form of healthcare property that, while not senior-specific, disproportionately serves older patients.
Welltower is in the process of acquiring Quality Care Properties (NYSE: QCP), which owns skilled nursing properties and recently acquired its primary tenant, HCR ManorCare, in legal proceedings. This will add more than 300 properties to Welltower’s portfolio, and further emphasizes senior-specific healthcare in the company’s strategy.
A big growth opportunity
Why the big emphasis on senior housing and other senior-focused healthcare properties? For starters, senior citizens are the fastest-growing segment of the U.S. population.
Without getting too deep into the statistics behind this expected trend, here’s the quick version of why this is. The massive baby boomer generation is gradually reaching retirement age over the next decade and a half or so, and life expectancies continue to increase. Not only will there be a surge in the number of Americans becoming senior citizens, but those seniors will also live longer and longer lives.
As a result, the 65-and-older age group is expected to roughly double over the next 35 years. But the really rapid growth will be in the oldest segments of the population. In fact, the 85-and-up age group (the primary demographic for senior housing) is expected to double in size in just 20 years.
In addition to just senior housing, older Americans tend to use healthcare facilities more often than younger ones and tend to spend more when they do. The average American spends $7,100 per year on healthcare, but the average person in the 85-and-up age group spends $34,800, or nearly five times as much.
The one-sentence version of Welltower’s strategy is this: The company aims to build a portfolio of healthcare properties that are superior to those owned by competitors, and located in high-barrier, affluent markets. To give one key statistic, 95% of Welltower’s senior housing operating income comes from the 31 largest metropolitan areas in the U.S.
Development is also a big part of Welltower’s strategy, as it has the financial flexibility to pursue opportunities that are prohibitively costly for many competitors. For example, Welltower is building a senior housing facility in midtown Manhattan, where the current availability of assisted living is one-fifth the U.S. average.
As a final thought about strategy, it’s important to point out that Welltower’s approach has evolved significantly over its 47-year history. Over the past eight years alone, the company’s portfolio has changed significantly, as you can see in this graphic:
However, it is the company’s proven ability to adapt to the ever-changing healthcare environment that has allowed it to generate such strong results. Since 1971, the company has generated 15.2% annualized total returns for shareholders — a remarkable level of performance to sustain for nearly a half-century. To put this into perspective, a $10,000 investment in Welltower at its inception would have grown to a staggering $7.7 million today.
Risks to be aware of
No stock that’s capable of double-digit returns is without risk, and Welltower is certainly not an exception. Just to name a few of the factors investors should be aware of:
Interest rate risk: All REITs are vulnerable to interest rate risk. Specifically, when bond rates rise (the 10-year Treasury is a good REIT indicator), investors expect the yields from their income investments like REITs to rise accordingly, which puts downward pressure on their stock prices.
Regulatory risk: The healthcare industry is also extremely vulnerable to regulatory risk, as there’s no telling how the U.S. healthcare environment will change over the coming decades.
Oversupply risk: Finally, there’s the risk that properties are being built faster than the market can absorb the demand. We’re already seeing this in the senior housing industry. Developers naturally want to take advantage of the projected demand growth. And with the combination of cheap financing and expensive real estate, it’s been cheaper to build new properties than to acquire existing ones in many cases.
Is Welltower a buy?
Even taking the risk factors into account, it’s tough to make a solid case against Welltower as a long-term investment. To be clear, there’s likely to be a bumpy road at times from interest rate fluctuations and the struggles to find the optimal supply-demand balance as the industry grows. However, there’s an undeniable long-term opportunity here, and Welltower is in a strong position to take advantage. And even though the stock is up by 20% over the past two months, it still trades for a cheap valuation of less than 15 times its expected 2018 funds from operations.
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