As I read over the Q1-19 earnings transcript for Ventas, Inc. (VTR) one sentences jumped out as explained by the company’s CEO, Debra Cafaro,
“I believe strongly in our ability to reignite external investment volume on top of our robust, research and innovation development that will drive future growth at Ventas.”
Recognizing that the Life Science (Ventas refers to as research and innovation development) is currently ~6% of the health care REIT’s platform (based on ABR), and the majority of rental income is being generated by senior housing properties.
I find that interesting from many viewpoints.
First off, Ventas’ office segment – that consists of medical office buildings (or MOBs) and Research and Innovation, represents 27% of net operating income. Over the years, Ventas has been diversifying away from senior housing and Ventas’ office contribution to total NOI has expanded by 12% over the past five years.
Secondly, the combined office segment (MOB and Life Science) delivered strong same-store cash NOI growth of 3.8% in Q1-19. The research and innovation platform saw a 13% increase benefiting from a lease termination fee of $1.9 million from a tenant who backfilled a space.
To compliment Ventas’ durable office platform, the MOB business saw same-store NOI grew by 1.5% with 87% retention. On a combined basis, Ventas expects the office portfolio (of R&I and MOB assets) to increase 2019 same-store cash NOI in the range of 1.5% to 2.5% in 2019.
But as I said, that one sentence jumped out at me – “the research and innovation development will drive future growth at Ventas.”
So why is that relevant?
Alexandria Real Estate (ARE) is a “pure play” life science REIT with a total market capitalization of approximately $18.4 billion. The company has delivered impressive results – from the time of the IPO (May 1997) through December 31, 2018, exceeding 1,200%, significantly outperforming various indices, including the MSCI US REIT’s 525% TSR and the S&P 500’s 342% TSR, over the same time period. Currently ARE trades at 21.2 P/FFO and a dividend yield of 2.7%.
As the chart above illustrates, ARE shares have increased by an average of 15% per year over the past 5 years, compared with VTR that has returned -3.4% per year (VTR trades at 15.7 P/FFO with a dividend yield of 5.2%).
Ventas only generates around 6% of rent from the research and innovation sector, but clearly the company is focusing development efforts on the research and innovation platform. This is what Debra Cafaro said on the latest earnings call,
“Right now, our number one capital allocation priority is really the research and innovation pipeline, and that’s clearly at the top of the list.”
Now the Overhang
Around 69& of Ventas’s revenue is generated from Senior Housing properties, broke down: 38% (based on NOI) is Triple Net and 32% (based on NOI) is Senior Housing Operating (or commonly referred to as SHOP).
In Q1-19 Ventas’ Triple Net SSNOI was +2.2% (was 2.1% in Q4-18) driven by in-place escalators and Triple Net occupancy was steady at 85.4%. The SHOP NOI was -2.2% (compared with -3.8% in Q4-18) with a 20 bps year-over-year drop in occupancy to 86.6% (due to supply and weather).
As you can see (above), the Triple Net NOI and SHOP NOI were offset, while the office sector delivered +3.8% SS NOI growth in Q1-19. Combined the office sector represents around 27% of revenue, suggesting that around one-third of Ventas’s revenue should be valued closer to 18x P/FFO (more on the later).
Over two-thirds of Ventas revenue is still tied to Senior Housing, a subsector that has experienced stagnant growth. On the earnings call, one analyst asked whether the Ventas would focus on senior housing in the future and Cafaro replied,
“Our pipeline is typically across all the asset classes, and obviously we do see the upside in senior housing and certainly would invest in that sector.”
Furthermore, Cafaro stated that Ventas is riding out the supply and demand conundrum as she explains, “we’re seeing record levels in the top 31 markets… These do not translate into financial results in the current period, but will over time translate into the powerful cyclical upside.”
Ventas maintained its full-year 2019 guidance as organic growth was modest, yer there’s another big elephant in the room that Mr. Market is ignoring.
The Fortress Balance Sheet
In Q1-19 Ventas maintained strong credit metrics: 5.5x Net Debt / EBITDA and just 4% secured debt / enterprise value (as viewed below):
In Q1-19 Ventas issued $700 million in bonds with an average of 16-year duration at just 4.1%. This provides with highly attractive cost of capital and the strength of the balance sheet if further reflected in the maturity profile (as viewed below):
Wait A Minute, Ventas Isn’t A High Growth REIT
As I said at the outset, Ventas has telegraphed a shift in strategy and the clear takeaway is that the company is focusing on its most durable drivers. Senior Housing has been a tough sub-sector, especially the SHOP assets, but to manage the risk, Ventas has curated a very high-quality portfolio.
Ventas’ management team has generated impressive stats in 2018, validating our previous strong buy upgrade (we now have Ventas at a Buy).
With that in mind, let’s take a look at current valuation metrics, starting with the dividend yield:
To be clear, Ventas has roughly 30% of revenue that is being generated from the SHOP portfolio, and therefore shares don’t justify the premium pricing (and dividend yield) of ARE. Furthermore, there’s a reason that New Senior (SNR) and Senior Housing (SNH) trade at the discounts viewed below (SNR trades at 11.7x and SNH trades at 5.8x P/FFO).
Another interesting note, Welltower (WELL) trades at 18.2x P/FFO (+13.1% vs the 5-year average) and HCP Inc. (HCP) trades at 17.3x (+40.1% vs the 5-year average). Why is Ventas so cheap?
Ventas has returned a modest +5.3% YTD, under-performing HCP (+8.1%) and WELL (+9.6%). Given the Q1-19 FFO/share beat ($.99/sh vs. consensus of $.96/sh) and shift to more durable products, we believe the CEO has signaled a catalyst supporting our bullish thesis.
In short, we are maintaining a BUY with a forecasted total return (annualized) of 12.5%. We view the office exposure as highly defensive and highly complementary to each other (MOB and Life Science).
I am/we are Long VTR
Brad Thomas is CEO and director of Research at iREIT with over 30 years of real estate experience. In addition, Thomas is the Editor of the Forbes Real Estate Investor, a monthly subscription-based newsletter.
Thomas has also been featured in Forbes Magazine, Kiplinger's, US News & World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox. He is the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, and 2017 (based on page views).
Thomas has co-authored a book, The Intelligent REIT Investor, and is the author of The Trump Factor: Unlocking The Secrets Behind The Trump Empire (available on Amazon).
Thomas received a Bachelor of Science degree in Business/Economics from Presbyterian College and he is married with 5 wonderful kids.