Theoretically, this will mean that the healthcare industry will have an incentive to work together more closely to ensure that all of a patient’s doctors and caregivers are coordinating care to prevent things like hospital readmissions after surgeries or heart attacks.
Of course, it could also mean that certain extremely sick patients might be shunned as “too sick to treat,” and/or result in more variable pay to the healthcare industry.
This basically means that companies like Genesis and Brookdale Senior Living may face a few lean years as they attempt to adapt to yet another new payment paradigm.
Fortunately for Welltower, government funding makes up just 10.8% of its cash flow, meaning that even in another doomsday scenario, such as 2002, the dividend would likely remain secure and covered by unaffected private payer supplied cash flow.
However, the company’s dividend growth would almost certainly take a deep hit, potentially resulting in several years of little to no growth and weak stock performance.
Speaking of poor performance, let’s examine the last risk, rising interest rates, of which Welltower investors could be harmed in two ways.
First, like all REITs, Welltower has a lot of debt on an absolute basis. This is a natural component of the REIT business model, in which, by law, 90% of taxable profits must be paid as dividends.
Thus, in order to fund growth, Welltower must resort to selling new shares and taking on debt. While Welltower’s conservative corporate culture has proved masterful at avoiding excess leverage, nonetheless the company has benefited immensely from the lowest interest rates in human history.
I am not saying that rising interest rates will cause Welltower’s long-term dividend growth thesis to collapse. After all, the company was founded in 1970 and has been growing its dividend at a compound annual growth rate (CAGR) of 5.8% for the past 45 years, including during times when interest rates hit an all-time high of 14.1% in 1980.
That’s because rising interest rates can temporarily depress property prices. That in turn makes the cash yield on new investments, including the loans that make up a portion of Welltower’s asset portfolio, potentially more, or at least as profitable as its current opportunities.
However, there is one aspect of higher interest rates that can’t help but hurt Welltower’s, as well as all REITs. As interest rates rise, the risk free rate of return (i.e. the yield on US Treasuries), also rises. This means that there is less pressure from yield-starved investors to go into high-quality bond alternatives such as blue chip REITs.
In other words, a big reason that Welltower’s current 5.0% yield looks so good to so many investors is largely because the 10- and 30-year Treasury yield is a pathetic 1.7%, and 2.5%, respectively.
If rates meaningfully rise, it’s reasonable to expect some investors to rotate out of bond-like stocks, many of which have been bid up strongly in recent years, and go into less volatile investments. As a result, the dividend yield across all REITs would presumably rise.
And since yield and share price are inversely proportional Welltower’s shares would need to decline, potentially hurting investors who are counting on selling shares in the next few years to fund obligations such as retirement living expenses.
I’m not saying that the threat of rising rates should scare anyone away from high-quality REITs. Especially since the futures markets are predicting a far slower pace of rate increases than the Fed is projecting.
Their dividends should largely remain safe, and rising rates would most likely be a signal of an improving economy, which means rising rental rates and solid occupancy rates.
In addition, anyone with a long enough time horizon should be thrilled at the prospect of being able to buy Welltower at a yield of 6% or higher, which would result in superior long-term total returns.
However, with Welltower trading near all-time highs and many bond-like stocks trading at premium valuation multiples relative to history, short-term, more risk averse investors need to keep in mind the risk of a short to medium-term correction if rates do begin to rise and cause capital outflows for bond-like stocks.
Dividend Safety Analysis: Welltower
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Welltower’s dividend and fundamental data charts can all be seen by clicking here.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
