FAD is arguably the most important metric for Welltower investors to track because it’s the equivalent of the company’s free cash flow, and thus the source of its dividend’s security and growth.
Welltower Inc (NYSE:HCN) has been able to earn higher profits from the same properties over time primarily because of the contracts management is able to strike with its partners. Not only are they usually very long in duration, but they also include annual rent escalators to offset inflation.
In addition, management is extremely skilled at allocating shareholder capital. For example, management continues to find attractive investment opportunities, not just in new properties that offer attractive cash yields, but also by working with numerous partners via joint ventures to remodel its existing assets and construct brand new buildings from the ground up.
Some of these investments can result in cash flow yields in excess of 8%, which is extremely high for real estate returns, especially in today’s market where property prices have risen, driving down overall profitability.
And lest you think that these past two quarters have been a fluke, Welltower actually has a long track record of generating some of the best same store growth in the industry.
Better yet, that is likely to continue thanks to management’s recent $1.15 billion acquisition of 19 senior, assisted living, and memory care facilities in California. This is a classic move by Welltower, which has spent over 50 years consolidating the fast growing, but highly fragmented medical property market.
And thanks to management recently increasing the size of its short-term credit facility, Welltower has a total of $2.77 billion in available liquidity to continue growing in the years to come. Even more impressive, thanks to the strong balance sheet and its economies of scale, Welltower has some of the lowest costs of capital of any medical REIT. For example, $2.3 billion of its liquidity is from its revolving credit facility at rates of LIBOR +0.9%, or about 2.5% today.
With Welltower’s share price sitting near all-time highs, the company is able to also sell additional shares, a natural part of the REIT business model, at extremely favorable rates.
A relatively low cost of capital means that the 7% to 8% cash yields management is getting on its invested projects and acquisitions is resulting in high levels of NOI and FAD per share growth. This bodes very well for the future growth prospects of one of the safest payouts in the entire REIT industry.
With the U.S. health care real estate market being an estimated $1 trillion in size, Welltower’s market share is just 2.6%. While the company has invested $28 billion since 2010 to nearly quintuple in size, there should be plenty of opportunities for continued growth.
Welltower’s quality real estate in quality markets, access to low-cost capital, and strong focus on private pay sources (89.2% of facility revenue mix) should continue to serve it well for many years as the healthcare market grows.
Key Risks
There are four main risks that I’m watching for, although only two are specific to the company.
The first company-specific risk is Welltower’s exposure to the UK in a post-Brexit world. Fortunately that risk is small and at most threatens only the dividend growth rate, and even then only if the UK is plunged into a worst case, deep recession once it exits Europe in 2019.
As you can see, the short-term effects of Brexit, which are mainly from a far weaker Pound, will likely mean an insignificant increase in Welltower’s payout ratio for 2016.
Sources: Earnings Release, 10-Q
