NHI's Tenants Expected to Face Challenges from COVID-19, Increasing Uncertainty

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

National Health Investors (NHI), a healthcare REIT, has high exposure to these markets. Senior housing accounts for nearly 70% of NHI's rental revenue, and skilled nursing facilities contribute another 27%.

Based on our analysis below, we are downgrading NHI's Dividend Safety Score to Borderline Safe.

Prior to the pandemic, the senior housing and skilled nursing markets were struggling due primarily to a boom in new developments over the last five years which created a glut of supply.

As you can see, since 2015 industry occupancy rates have slumped across Independent Living (IL), Assisted Living (AL), and Nursing Care (NC).

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.

NHI recently began reporting weekly data regarding the prevalence of coronavirus across its 238 properties. On March 18, the company stated it was unaware of any positive COVID-19 tests.

But as of April 7, NHI said that 25 of its 238 buildings (about 10.5% of its properties) had at least one COVID-19 case, up from 16 sites on March 31 and eight on March 24.

Another 181 of its properties are either self-quarantined, have testing in progress, or are located in areas with more than 100 confirmed cases.

As testing increases and awareness rises (some infected people are asymptomatic), more communities could join the list.

This doesn't bode well for the industry's short-term outlook.

Ventas (VTR), which also generates most of its income 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.

Similar reports have come from healthcare REITs New Senior Investment Group (SNR) and Healthpeak Properties (PEAK). They both reported 30% to 40% declines in move-ins last month compared to earlier this year. (Senior housing entrance fees account for 21% of NHI's revenue.)

Some analysts believe senior housing demand could fall by as much as 15% and occupancy could slip to a record low.

As we discussed in our thesis, a decline could be particularly troublesome for NHI's business because its operations are relatively concentrated compared to larger healthcare REITs such as Ventas and Welltower (WELL).

In 2019, three regional tenants accounted for 46% of NHI's revenue: Bickford (18%), Senior Living Communities (16%), and Holiday (12%).

Assuming the coronavirus pandemic hurts their occupancy levels and raises their costs (more labor, protective equipment, etc.), some of them could struggle to pay their rent and eventually need to renegotiate their leases.

In the second quarter of 2016, Bickford and Senior Living Communities (SLC) had rent coverage ratios (i.e. cash flow, or EBITDARM, to rent expense) of 1.23x and 1.16x, respectively.

Last quarter, before the virus outbreak, Bickford and SLC had seen their rent coverage fall to 1.09x and 1.1x, respectively.

EBITDARM excludes management fees paid by NHI's operating partners, making it a somewhat more aggressive measure of their pre-rent cash flow.

If those fees were instead deducted from tenants' cash flow, then Bickford and SLC would likely have rent coverage ratios right near 1x, leaving little margin of safety.

NHI already had to renegotiate unsustainable master leases with Holiday at the end of 2018, when its rent coverage on an EBITDARM basis was about 1.16x.

Holiday's rent was lowered by 20% (about $10 million annually) and the lease duration was extended to 2035, improving Holiday's rent coverage (1.21x last quarter).

The good news is that NHI's payout ratio has historically sat near 80%, providing some flexibility to rework deals with distressed tenants if it gets to that point.

Prior to the pandemic, management expected NHI to generate around $230 million in AFFO this year. NHI's dividend, which was increased by 5% in February 2020, costs about $190 million annually, resulting in roughly $40 million of retained cash flow.

Bickford and SLC combine to account for around $100 million of NHI's revenue. If they each needed to reduce their rent by 20% (like Holiday did in late 2018), then we estimate NHI's payout ratio would increase to around 90%, all else equal.

But it's hard to say how many other tenants could find themselves in the same situation since these headwinds are rippling across the entire industry and NHI's number of infected communities has jumped in recent weeks.

Even if the dividend remains covered, management could desire to maintain a lower payout ratio in order to have more financial flexibility going forward.

In November 2019, Standard & Poor's assigned NHI a credit rating for the first time, giving it a BBB- rating. The firm certainly wants to keep its investment-grade mark (one notch above junk) and has stated that it will focus on leverage-neutral growth.

However, if enough tenants need rent reductions due to the health crisis, then NHI's retained cash flow after paying dividends will take a hit, requiring more outside capital (debt and equity) to acquire properties.

While NHI doesn't have an urgent need to buy new properties in the short term, management probably wants to keep expanding the firm's asset base into areas of healthcare with stronger fundamentals, such as medical office buildings (3% of revenue). An elevated payout ratio makes that harder to accomplish.

On the bright side, NHI has minimal debt maturities until 2022, and $250 million is available under its credit revolver. The firm's liquidity appears strong and supportive of the dividend, assuming management desires to maintain the current payout.

Perhaps the bigger question is whether or not the coronavirus pandemic will structurally change the outlook for the senior housing and skilled nursing industries.

If management begins to expect that NHI's tenants will remain weak 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. (Need-based senior housing such as assisted living is only half of NHI's total exposure to the industry.)

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

Overall, the pandemic has increased NHI's risk profile. The REIT has some of the highest exposure to senior housing and skilled nursing, two areas of healthcare that could face the most pressure from the coronavirus outbreak.

Coupled with NHI's small scale and its growing number of communities reporting positive COVID-19 tests, some of its weaker tenants may eventually need NHI to reduce their rent if these headwinds intensify or persist.

A dividend cut seems unlikely at this stage given NHI's liquidity and payout ratio, but these developments have increased the range of potential outcomes and are enough to downgrade NHI's Dividend Safety Score to Borderline Safe.

NHI's stock price already reflects at least some of these coronavirus-related risks, but investors should review whether they are comfortable with their position sizes given the growing uncertainty facing the industry. We will continue monitoring the situation and expect NHI's next earnings report to arrive in early May.