Ventas: Overrated Despite Weak Fundamental Performance (NYSE:VTR)

Female healthcare professional

Solskin

Ventas was once a highly successful REIT and Debbie Cafaro was once an award winning CEO. The success led to egregious paychecks and complacent decision making. After listening to the Ventas (NYSE:VTR) earnings call, I am once again compelled to quote Gretsky:

“skate to where the puck is going… not where it has been”

Ventas is skating to where the puck has been.

Human brains are naturally wired to go toward shiny objects.

If you watch a kid’s soccer game, it is just a swarm of children clustered around the ball. At that nascent age, most lack the sophistication to recognize more nuanced strategies such as moving away from the ball to get open and present an opportunity for your team to pass to you.

Adult brains are more capable of understanding nuanced strategy but it takes effort. It is much easier to just buy properties that everyone already loves. It is much harder to do the analysis to figure out what will be the hot sector 5 or 10 years down the line and buy it now while prices are low. Ventas is merely the latest example in a broader tendency for capital to pour into the hot sector AFTER it becomes the hot sector.

Chasing and overpaying

Ventas has long been one of the “big 3” healthcare REITs and has traditionally been diversified between property types. They have had access to ample amounts of capital and maintained knowledgeable personnel across just about every healthcare asset type. They have dabbled in hospitals, LTACs, IRFs, SNFs, MOBs, life science, loans to healthcare operators, assisted living and directly operated senior housing. They were capable of acquiring any type of healthcare asset with full trust of their capital sources to allocate as they saw fit.

In my opinion, they have made poor choices with that freedom and I believe the numbers back me up.

Ventas seems to have gotten very attached to the concept of the “silver tsunami” – demographic trends indicating the 80+ age cohort is going to rapidly expand. This is its current form in Ventas’ latest slide deck.

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VTR

Similar slides have been in just about every Ventas presentation for the better part of a decade.

Factually, they are not wrong. The population is aging and the U.S. is soon to have a Japan style upside down pyramid with maybe a couple bulges at populous generations.

Presumably it was seeing this demographic wave that caused Ventas to overwhelmingly invest in senior housing. By 2015, Ventas derived 53% of its NOI from senior housing via a mix of triple net and its operating portfolio (‘SHOP’).

Demand outlook was indeed strong, but it seems that the supply side of the equation was not examined with the same vigor.

There were 3 major problems with VTR’s senior housing heavy capital allocation:

  1. Cap rates for senior housing were quite low.
  2. Cap rates for hospitals which Ventas largely ignored were quite high.
  3. No barriers to supply and a glut of development

Developers across the country sought to capitalize on the demographic trend, building astronomical amounts of senior housing. VTR’s senior housing occupancy peaked at 92% in the 4th quarter of 2014 and has largely been downhill since, dropping to 83% in 1Q22.

Over the years, VTR pivoted a few times, spinning off its skilled nursing and converted much of its triple net senior housing to SHOP.

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VTR

Over a period in which most real estate appreciated in value and grew NOI, Ventas generated a much less appealing result.

They increased overall investments in properties from ~$18 Billion to ~$22 Billion

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S&P Global Market intelligence

And yet overall NOI declined.

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S&P Global Market intelligence

Share count grew to finance the new investments.

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S&P Global Market intelligence

Debbie’s paycheck grew too:

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data from S&P Global Market intelligence

But the capital was allocated to senior housing which was starting to strain with oversupply pre-covid and collapsed during covid. Same store NOI went from tepid to having 9 quarters in a row of negative growth.

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S&P Global Market intelligence

Source: S&P Global Market Intelligence

All these actions culminated in FFO/share declining.

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S&P Global Market intelligence

Putting the struggles into perspective

It was a difficult period for healthcare. Policy and regulations changed quite significantly leaving operators scrambling to adapt. Reimbursement rates arguably did not rise enough to make up for labor costs and regulatory burden.

Despite the challenging environment, other healthcare REITs managed to perform significantly better.

Medical office REIT, Healthcare Realty, (HR) had flat FFO/share.

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S&P Global Market intelligence

Life science REIT, Alexandria (ARE) grew FFO/share

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S&P Global Market intelligence

Hospital REIT, Medical Properties Trust (MPW) grew FFO/share

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S&P Global Market intelligence

Quite simply, senior housing was a terrible asset class. In addition to the oversupply, cap rates were far too low. Senior housing assets were being bought at cap rates around 6%-7% while hospitals were available at 9%-11%. As interest rates dropped, senior housing cap rates got as low as 4% and that was during a time when there was already visibility into the glut of supply in development.

All of this is history, but I bring this up because I think Ventas it doing it again. They seem to once again be pivoting into the hot asset class AFTER it is the hot asset class.

Great to be in life science, but too late to get in

Alexandria has come out with one blockbuster report after another in which they are rolling up rents on their life science properties by as much as 40% on new leases. This level of growth draws a lot of attention with private equity and other major capital players clamoring to get into the space. Properties are transacting at cap rates in the 4s.

This is fantastic for those already in life science.

  • City Office (CIO) had a transformative gain on sale of its Sorrento Mesa life science campus.
  • Alexandria is netting Billions in gains on its dispositions.

It is less good for those trying to get in.

Ventas is executing both acquisitions and development to up its exposure to life science. It has announced 5 acquisitions since the close of 2021.

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S&P Global Market intelligence

Along with 2 R&D facilities in development presently

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S&P Global Market intelligence

Each pathway has its own set of challenges. Development of such complex buildings takes a long time making it uncertain what the leasing environment will be like upon completion. VTR has partially pre-leased, but to make them truly accretive it will need to find tenants for the rest of the space.

I can get on board with developments as a worthwhile endeavor since cap rates for development are a couple turns higher.

Acquisitions, however, seem a bit foolish to me at peak pricing when so much money is entering the space. It is chasing the hockey puck.

Premium valuation

Just as valuation matters at the property level, it matters to investors at the REIT level. On a relative basis, VTR is grossly overvalued. Trading at 16.2X 2022 FFO, Ventas is among the highest multiple healthcare REITs.

It is likely trading at a high multiple in anticipation of a post-COVID rebound in senior housing. While there is potential for some occupancy recovery, costs remain elevated and the property sector remains oversupplied. The end of COVID, if there is such a thing, does not fix oversupply.

If occupancy does recover to around 90% it will help FFO a bit, but not anywhere near enough to justify this kind of a premium.

Healthcare is perhaps the most mispriced sector

To demonstrate this claim I want to compare Ventas with the 2 healthcare REITs that I think are most undervalued, MPW and Global Medical REIT (GMRE).

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S&P Global Market intelligence

at 16.2X VTR is trading at nearly double the valuation of MPW at 8.7X and a significant premium to GMRE at 12.3X.

Such a differential should normally correspond to the higher valuation company substantially outperforming fundamentally. However, if you look at the 2Q22 reports which recently came out, the opposite is true.

VTR’s NAREIT FFO was down 23.1% year over year, but adjusting for 1 time items, normalized FFO was down 1.4%.

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Earnings release

In contrast, MPW and GMRE grew FFO/share 7% and 9%, respectively.

On the risk side of the business, Ventas’ tenant coverage of rent which is usually measured by EBITDARM is rather low. Its senior housing has an average of 1.1X coverage with many tenants below 1.0X and its post-acute care has 1.6X coverage.

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VTR

In both cases, VTR’s tenant coverage is declining.

MPW has EBITDARM coverage of 2.4X while GMRE has 5.0X for its full portfolio consisting of 6.5X on medical office and 3.4X on its other segments.

These results have been tabulated below.

Company

FFO/share growth year over year

EBITDARM coverage

Ventas

-1.4%

1.1X SH 1.6X PAC

MPW

+7%

2.4X

GMRE

+9%

6.5X MoB – 3.4X non-MoB 5X overall

With better coverage and better growth, GMRE should trade at the highest multiple of this group. MPW should be in the middle and VTR should be the low multiple.

Thus, with VTR at 16.2X FFO, either it is grossly overvalued or the other 2 are vastly undervalued. My guess is that it is a bit of both.

What about VTR’s life science growth potential?

Life science is a great property type. It has significant growth in tenant demand as increasingly more capital is allocated to R&D. The properties and locations are specific enough that supply is somewhat constrained which should allow the demand growth to flow through to NOI growth.

As such, the portion of VTR’s portfolio that is already in life science will likely do well, it just isn’t big enough to really move the needle. VTR is attempting to increase this allocation with its new acquisitions, but that isn’t as effective because in buying life science today you are paying for that growth.

If you like life science real estate (which I do) ARE strikes me as a much better investment.

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