Company Reports

The REIT sector in the US offers many companies that should see relatively stable cashflow growth over the next several years. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past three years with many reaching historical levels of net operating income growth, the REIT sector underperformed the broader equity markets in 2023 and into the first half of 2024. We believe that is due to the sector’s negative correlation with interest rates, as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, interest rates have fallen since the end of July, leading to a rally for the REIT sector. Still, we still view many of companies in the US REIT sector as being undervalued as the companies should continue to produce solid long-term growth.

Despite a rally over the past two months, we still view the US REIT sector as being undervalued. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors led combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past three years, with many reaching historical levels of net operating income growth, the REIT sector has underperformed the broader equity markets in 2023 and into the first half of 2024. We believe that the cause has been due to the sector's negative correlation with interest rates as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, interest rates have fallen since the end of July, leading to a rally for the REIT sector. We believe that US REITs will continue to see share price movements that are inverse of interest rate movements.

No-moat Ventas reported second-quarter results that were in line with our expectations, leading us to reaffirm our $69 fair value estimate. Senior housing same-store occupancy improved sequentially by 90 basis points to 85.6%, slightly better than our estimate of a 60-basis-point gain. Average rental rates increased 3.9% year over year, leading to same-store revenue growth of 8.0%, which was slightly below our estimate of 9.5% revenue growth. However, same-store operating expense growth for senior housing was only 4.9%, below our 7.6% growth estimate, leading to same-store net operating income growth of 15.2%, which was slightly better than our 14.1% estimate for the segment. In the second quarter, same-store NOI growth for the medical office segment was 2.8%. For the life science segment, it was 5.5%, and for the triple-net portfolio, it was 2.6%. Combined, the company reported total same-store NOI growth of 7.8% in the quarter, in line with our 7.5% estimate. Ventas reported normalized funds from operations of $0.80 per share, which matches our second-quarter estimate and is 7% higher than the $0.75 Ventas reported in the second quarter of 2023.

The US REIT sector remains significantly undervalued, in our perspective. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past two years, with many REITs reaching historical levels of net operating income growth, the sector has underperformed the broader equity markets over the past two years. We believe that the cause has been the sector’s negative correlation with interest rates as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, we don’t believe that higher rates significantly change our fair value estimates for the sector. Additionally, interest rates are down from the October 2023 highs, and REIT share prices have generally inversely followed the movements of the US 10-year Treasury.

The top healthcare real estate stands to disproportionately benefit from the Affordable Care Act. There is an increased focus on higher-quality care in lower-cost settings. The best owners and operators in the industry, which can provide better outcomes while driving greater efficiencies, should see demand funneled to them from the best healthcare systems. Additionally, the baby boomer generation is starting to enter its senior years, and the 80-and-older population, which spends more than 4 times on healthcare per capita than the national average, should almost double over the next 10 years. Long term, the best healthcare companies are well positioned to take advantage of these industry tailwinds.

First-quarter results for no-moat Ventas were slightly better than we anticipated, giving us confidence in our $70 fair value estimate. Same-store occupancy for the senior housing portfolio fell 20 basis points sequentially to 84.6%, though we recognize that the first quarter frequently sees a decline. Meanwhile, rental rates increased 4.7% year over year, leading to same-store revenue growth of 7.8%, better than our estimate of 5.3% growth. Same-store operating expenses were only up 4.6%, leading to same-store net operating income, or NOI, growth of 15.2% that was better than our 12.3% estimate. Ventas also reported same-store NOI growth of 4.7% for the medical office portfolio, 5.5% for the life science portfolio, and a 2.0% decline for the triple-net portfolio. Combined, the total same-store NOI increased 6.7%, slightly better than our estimate of 5.9% growth. Ventas reported normalized funds from operations of $0.78 per share in the first quarter, two cents better than our $0.76 estimate.

We believe that there are several attractive opportunities across the US REIT sector for investors to consider. Following the recovery of many REIT sector fundamentals from the pandemic by mid-2021, we viewed the REIT sector as fairly valued through early 2022. However, the past two years have seen the rapid rise in interest rates and a slowing economy, which has led to major valuation declines across the sector. Our analysis of the REIT sector over the past 25 years suggests that the relative stock performance of REITs is negatively correlated with interest rate movements. The second and third quarters of 2023 saw large interest rate increases with the 10-year Treasury approaching 5%, which led to the sector underperforming. This occurred even as many REITs reported same-store net operating income, or NOI, growth at historical highs in 2022 due to high inflation. Higher interest rates, lower liquidity, tighter capital market conditions, and decelerating same-store NOI growth all led to a significant correction in the stock price for many REITs.

The top healthcare real estate stands to disproportionately benefit from the Affordable Care Act. There is an increased focus on higher-quality care in lower-cost settings. The best owners and operators in the industry, which can provide better outcomes while driving greater efficiencies, should see demand funneled to them from the best healthcare systems. Additionally, the baby boomer generation is starting to enter its senior years, and the 80-and-older population, which spends more than 4 times on healthcare per capita than the national average, should almost double over the next 10 years. Long term, the best healthcare companies are well positioned to take advantage of these industry tailwinds.

Ventas reported fourth-quarter results that were in line with our estimates, leading us to reaffirm our $72 fair value estimate for the no-moat company. Same-store occupancy improved 110 basis points sequentially to 84.9%, better than our estimate of a 40-basis-point sequential gain. Rental rates for the same-store portfolio were up 4.9% year over year, leading to same-store revenue growth of 7.0% that was slightly ahead of our 6.5% estimate. Meanwhile, same-store operating expenses increased by 4.2%, leading to same-store net operating income, or NOI, growth of 14.9% that was slightly better than our 12.8% estimate. Ventas also reported that same-store NOI grew 1.4% for the triple-net senior housing segment, 2.1% for the medical office segment, and 3.5% for the life science segment. Combined, same-store NOI for the total company was up 6.6% in the fourth quarter, in line with our estimate of 6.9% total growth. The company reported normalized funds from operations, or FFO, of $0.76 per share for the fourth quarter, which was a penny better than our $0.75 estimate.

Third-quarter results for Ventas were slightly better than our estimates, giving us confidence in our $72 fair value estimate for the no-moat company. Same-store occupancy for the senior housing portfolio improved 130 basis points sequentially to 83.6%. Senior housing rental rates increased 6.2% year over year, leading to same-store revenue growth of 7.5% that beat our estimate of 6.0% growth. Senior housing operating expenses were only up 4.0% in the third quarter, leading to operating margins improving 230 basis points to 25.1% and same-store net operating income growing 18.2%, well ahead of our estimate of 11.8% growth. The company reported same-store NOI growth of 1.7% for the triple-net senior housing portfolio, 3.0% growth for the medical office portfolio, and 3.6% growth for the life science portfolio. Combined, total company same-store NOI grew 7.9% in the third quarter, ahead of our 6.4% estimate. Ventas reported normalized funds from operations of $0.75 per share, in line with our estimate for the third quarter.

The share prices of U.S. real estate investment trusts have fallen by approximately 30% from their 2021 highs because of higher interest rates and stress in some commercial real estate sectors. We think that the correction is overdone and the current valuations offer an attractive entry point for patient investors. Our core REIT coverage is trading at a discount of approximately 25% to our fair value estimate. We estimate that the average REIT within our U.S. coverage is currently trading at a dividend yield that is 126 basis points higher than the historical average. We see marked differences in valuation across different REIT sectors in the United States. For instance, the industrial sector is fairly valued, with stock valuations already accounting for future growth, but other sectors like offices, hotels, and malls are trading at attractive discounts.

The top healthcare real estate stands to disproportionately benefit from the Affordable Care Act. There is an increased focus on higher-quality care in lower-cost settings. The best owners and operators in the industry, which can provide better outcomes while driving greater efficiencies, should see demand funneled to them from the best healthcare systems. Additionally, the baby boomer generation is starting to enter its senior years, and the 80-and-older population, which spends more than 4 times on healthcare per capita than the national average, should almost double over the next 10 years. Long term, the best healthcare companies are well positioned to take advantage of these industry tailwinds.

Ventas reported second-quarter results that were slightly below our expectations, though we didn't see anything in the quarter that would materially change our $68 fair value estimate. Same-store occupancy for the senior housing portfolio declined 10 basis points sequentially to 81.3% in the second quarter, below our estimate of a 90-basis-point sequential gain. Senior housing rental rates increased 6.6% year over year, in line with our estimate of 6.4% growth. Same-store operating expenses were only up 3.7%, leading to margins improving 160 basis points to 25.4% and same-store net operating income growing 14.0%, though that is slightly below our estimate of 16.0% growth. In the second quarter, same-store NOI grew 2.0% for the triple-net senior housing segment, 3.8% for the medical office segment, and 3.8% for the life science segment. Combined, Ventas reported total company same-store NOI growth of 7.0% in the second quarter, which was slightly below our estimate of 7.4% growth. As a result, normalized funds from operations grew 4.5% to $0.75 per share, though that came in $0.03 below our $0.78 estimate for the quarter.

First-quarter results for no-moat Ventas were mixed compared with our expectations, though we didn’t see anything in the quarter that would materially change our $68 fair value estimate. Senior housing occupancy declined 90 basis points sequentially to 81.4%, below our estimate of a 70-basis-point sequential gain. Average rate growth improved 6.8% year over year and led to same-store revenue growth of 7.8% in the first quarter, which was higher than our estimate of 6.1%. Same-store operating expenses were only up 5.1% in the quarter, which led to same-store net operating income, or NOI, growth of 17.2% for the senior housing segment, above our estimate of 8.9% growth. Same-store NOI grew 4.3% in the senior housing triple-net portfolio, grew 3.1% in the medical office portfolio, but fell 1.0% for the life science portfolio. Combined, same-store NOI for the total company grew 8.1% in the first quarter, slightly better than our estimate of 7.3% growth. However, while same-store NOI was higher than our estimate for the quarter, Ventas reported total operating expenses higher than we anticipated. As a result, normalized funds from operations came in at $0.74 per share for Ventas in the first quarter, four cents below our $0.78 estimate.

After seeing significant occupancy declines in 2020 due to pressures created by the coronavirus pandemic, occupancy in the senior housing industry has steadily recovered over the past two years. Senior housing fell from around 88% at the end of 2019 to a low point around 79% in the first quarter of 2021, but that figure has since recovered to 83% as of the end of 2022. Industry utilization has fully recovered to prepandemic levels with approximately 7.5% of all the over 80 population in the US living in a senior housing facility as of the end of 2022 despite dipping to 7.0% at the nadir of the pandemic. Therefore, the reason occupancy has not fully recovered to prepandemic levels is due to continued supply growth, with newly developed buildings contributing 3% additional units per year in 2020 and 2021 despite the decline in demand those years.

The top healthcare real estate stands to disproportionately benefit from the Affordable Care Act. There is an increased focus on higher-quality care in lower-cost settings. The best owners and operators in the industry, which can provide better outcomes while driving greater efficiencies, should see demand funneled to them from the best healthcare systems. Additionally, the baby boomer generation is starting to enter its senior years, and the 80-and-older population, which spends more than 4 times on healthcare per capita than the national average, should almost double over the next 10 years. Long term, the best healthcare companies are well positioned to take advantage of these industry tailwinds.

No-moat Ventas reported fourth-quarter results that were relatively in line with our expectations, leading us to reaffirm our $68 fair value estimate. Senior housing occupancy rose 140 basis points year over year to 82.5% and, combined with rate growth of 6.5% in the quarter, led to same-store revenue growth of 8.3% for the segment. Operating expenses only increased 5.1% year over year, leading to same-store net operating income growth of 19.1% for senior housing that nearly matched our 18.9% estimate. While the triple-net senior housing segment only grew 1.8% in the quarter, that matched our expectations. The medical office segment saw same-store NOI growth of 3.7%, in line with our 3.9% estimate, and the life science segment saw same-store NOI growth of 6.3%, in line with our 6.7% estimate. As a result, Ventas reported total company same-store NOI growth of 8.5% that was in line with our 8.8% estimate. However, due to higher interest expenses and higher administrative costs in 2022, Ventas reported funds from operations of $0.73 per share that matched the same figure reported in the fourth quarter of 2021.

The top healthcare real estate stands to disproportionately benefit from the Affordable Care Act. With an increased focus on higher-quality care being performed in lower-cost settings, the best owners and operators in the industry that can provide better outcomes while driving greater efficiencies should see demand funneled to them from the best healthcare systems. Additionally, the baby boomer generation is starting to enter its senior years and the 80-plus age population, an age range that spends more than 4 times on healthcare per capita than the national average, should almost double in size over the next 10 years. Long-term, the best healthcare companies are well-positioned to take advantage of these industry tailwinds.

Third-quarter results for Ventas were slightly below our expectations, though we don't believe anything from the quarter will materially change our $69 fair value estimate for the no-moat company. Senior housing occupancy improved 80 basis points sequentially and is up 260 basis points year over year to 84.7%, in line with our estimate. While same-store revenue growth of 8.7% for the senior housing portfolio matched our estimate of 8.9%, same-store expense growth of 7.6% was slightly higher than our estimate of 4.6%. As a result, Ventas reported same-store net operating income growth of 13.0% that was below our estimate of 19.0% growth. Ventas also reported that same-store NOI was down 0.1% for the triple-net senior housing portfolio, worse than our estimate of 2.5% growth. However, results for the life science and medical office segments were slightly better than we anticipated, with same-store NOI growth of 3.4% for life science that beat our 2.6% estimate and same-store NOI growth of 1.5% for medical office that beat our 1.1% estimate. Combined, Ventas reported same-store NOI growth of 4.8% for the total company that was below our estimate of 7.5%, which led to the company reporting normalized funds from operations of $0.76 per share, which is $0.03 better than the $0.73 figure reported in the third quarter of 2021.

With the United States experiencing historically high inflation growth, many investors are wondering if real estate provides a natural hedge against inflation and if the REIT sector should therefore outperform the broader equity market. Many REITs in our coverage have reported rent and revenue growth at or near historic peaks over the past several quarters, with inflation being one of the largest reasons for the high growth. Given this and some historical evidence that REITs outperformed in the 1970s and early 1980s when inflation was similarly high, some investors are questioning why REITs have not outperformed in 2022.