Welltower's Outlook Clouded by Coronavirus But Dividend Looks Safe For Now

The coronavirus pandemic is disrupting many industries in the short term, including senior housing.

Welltower (WELL) generates over 60% of its net operating income, or NOI, from this industry (primarily senior apartments, independent living, and assisted living).

About two-thirds of the REIT's exposure to senior housing comes from properties Welltower runs directly by partnering with an operator (43% of NOI).

This exposes the firm to the ups and downs of the industry more than if Welltower solely collected rent from outside operators.

The company's remaining senior housing exposure (20% of total NOI) is run under triple-net lease agreements with tenants who pay Welltower rent.

Prior to the pandemic, the senior housing market was struggling due to a boom in new developments over the last five years which created a glut of supply.

Looking at Welltower's senior housing operating properties, you can see that their occupancy rate declined steadily since 2012 as more supply hit the market.

On the triple-net lease side of the business, some of Welltower's tenants are also struggling. Their average rent coverage (i.e. ratio of cash flow, or EBITDAR, to rent expense) fell from 1.16x in 2012 to 1.03x at the end of 2019, indicating that their cash flow was barely enough to cover rent in many cases.

With new construction moderating and America's population continuing to age, senior housing REITs were hopeful that 2020 would be the year that industry supply and demand came into balance, ushering in stronger fundamentals.

The coronavirus outbreak seems likely to prevent that from happening this year, and perhaps further out as well.

On March 16, Welltower reported that two of its residents tested positive for COVID-19. While access to testing remains limited, that figure grew to 116 residents by April 1, impacting about 7.4% of Welltower's senior housing operating communities.

As testing increases and awareness rises, more communities could join the list.

For example, National Health Investors (NHI), another senior housing REIT, has reported weekly data through April 7 showing a growing portion of its 200-plus properties reporting at least one positive test.

Ventas (VTR), which also generates most of its NOI from senior housing, reported recently that tours and move-ins have begun to slow, and it believes "the pandemic raises the risk of an elevated level of move-outs."

The company also said that its partners' operating costs are increasing given the need for more workers, cleaning supplies, and protective equipment, and these trends are expected to accelerate.

None of this bodes well for the industry's short-term cash flow outlook. Some analysts believe senior housing demand could fall by as much as 15% and occupancy could slip to a record low.

Welltower has kept its dividend frozen since 2017 as it contended with the industry's soft fundamentals and an elevated payout ratio (see below).

While the environment is very fluid, it would not be surprising to see the REIT's payout ratio exceed 100% this year, especially if weaker tenants need to renegotiate their leases due to falling occupancy and rising costs.

But that doesn't necessarily mean that Welltower's dividend is in trouble.

Ventas was in worse shape heading into the health crisis, yet it declared its regular dividend on March 19 despite these uncertainties.

Welltower's commitment to its dividend is unusually strong and includes a nearly 50-year streak of uninterrupted payouts.

The company's adjusted funds from operations (similar to free cash flow for REITs but excludes growth capex) was projected to be about $1.5 billion this year, covering Welltower's $1.4 billion dividend.

If the REIT's cash flow fell by 20% (an extreme scenario) to sit at $1.2 billion, it would be $200 million short of its dividend, plus whatever it needed to spend on property acquisitions and development projects.

Welltower entered the year expecting to be a net seller of properties, and management recently said that some development activity could be delayed (around $470 million was initially planned in 2020) to preserve cash.

Welltower's $3.5 billion of liquidity could, in theory, cover a fairly sizable cash flow deficit until industry fundamentals improve, assuming management desires to maintain the payout. Welltower doesn't have any material unsecured debt maturities until 2023, too.

Coupled with the company's BBB+ credit rating, Welltower seems positioned to maintain reasonable access to capital markets given its relatively small needs.

Perhaps the bigger question is whether or not the coronavirus pandemic will structurally change the senior housing industry's outlook.

If management begins to expect that Welltower's cash flow won't recover for a long period of time and access to capital markets becomes restricted, then the dividend could come under pressure.

Prior to the virus outbreak, the average age of people entering senior housing was already rising and aging-in-place technology was advancing, making it easier for folks to live at home longer.

The coronavirus could exacerbate these trends by dealing a psychological blow to some people who were considering living in these communities in the near future.

Meanwhile, property operators may need to deal with higher costs going forward to ensure they retain enough qualified workers and keep their facilities exceptionally clean and prepared for future potential outbreaks.

On the bright side, new construction activity could slow further, and America's supportive demographic trends will continue. This could set the industry up for better times within a couple of years.

Overall, it's too soon to understand the full range of potential consequences for the industry. Welltower's dividend coverage will likely come under some pressure this year, but its solid liquidity and balance sheet make a dividend cut seem unlikely at this stage.

We will learn more when the company reports earnings in a few weeks. If the firm's outlook is worse than we expect, then it's possible we could downgrade Welltower's Dividend Safety Score to Borderline Safe. 

Following the sharp rally in REIT stocks since late March, income investors should make sure they remain comfortable with the size of their investment in Welltower given the industry's uncertain outlook. We will continue monitoring the situation.