Undervalued by 25% and Yielding 5%, This Stock Is a Buy

With a portfolio focused on healthcare facilities, Healthpeak Properties DOC stands to benefit from a key long-term trend: an aging US population. And as the Federal Reserve eases monetary policy and interest rates fall, real estate investment trusts like this one should outperform. In fact, REITs have already started to rally: Healthpeak is up more than 18% in the past three months. Yet its shares remain significantly undervalued, suggesting that plenty of upside remains. Healthpeak offers income-seekers a high yield, too. Healthpeak is among Morningstar chief US market strategist Dave Sekera’s 4 Stocks to Buy as the Fed Cuts Interest Rates. It also makes our list of The Best REITs to Buy this month.

The top healthcare real estate stands to benefit disproportionately from the Affordable Care Act. With an increased focus on higher-quality care performed in lower-cost settings, the best owners and operators should see demand funneled to them from the best healthcare systems. Additionally, baby boomers are entering their senior years, and the 80-plus population, which spends more than 4 times on healthcare per capita than the national average, should almost double in size over the next 10 years. After Healthpeak reinvested the proceeds of its senior housing sales, life science and medical office assets are now prominent in its portfolio. The REIT has high-quality assets in top markets that attract credit-grade tenants in both segments, so we believe it makes sense to focus on the segments where it has an advantage. The company also completed a merger with Physicians Realty Trust in March, adding 16 million square feet of high-quality medical office buildings.

Key Morningstar Metrics for Healthpeak

• Fair Value Estimate: $30.50
• Star Rating: 4 Stars
• Economic Moat Rating: None
• Uncertainty Rating: Medium

Economic Moat Rating

While Healthpeak operates in sectors that use a triple-net lease structure, which can include long contracts with annual rent increases, these contracts are often renegotiated if the underlying tenant operations are under pressure. Therefore, we don’t think this structure inherently confers an economic moat to those assets. Medical office and life science buildings have qualities that could support a moat for the best-quality assets, but the initial rents and rent increases from these properties compared with the initial capital investment produce returns that are well below Healthpeak’s weighted average cost of capital, leading us to conclude that they do not quantitatively support a moat. Healthpeak has historically shown an ability to drive higher internal operating income growth than peers in some sectors, but we see this as more of an attribute of the management team building relationships with top tenants than qualities inherent in the properties themselves.

Read more about Healthpeak’s moat rating.

Fair Value Estimate for Healthpeak Stock

Our fair value estimate implies a mid-5% cap rate on our forward four-quarter net operating income forecast, 17 times multiple on our forward four-quarter funds from operations estimate, and a 3.9% dividend yield based on a $1.20 annualized payout. The rent, occupancy, and margin assumptions for each sector drive total company annual same-store NOI growth averaging 2.8% across our 10-year forecast. We project an average of $200 million in acquisitions annually at an average cap rate of about 5.8% and $80 million of dispositions at a 6.7% cap rate as the company looks to recycle lower-quality assets to help fund the acquisition of higher-quality assets. We expect Healthpeak to invest an average of $500 million annually in new development and redevelopment projects at a 7.5% average yield. We estimate its net asset value to be approximately $28.50 per share.

Read more about Healthpeak’s fair value estimate.

Risk and Uncertainty

The pressure to increase quality of care at a lower cost does not favor all healthcare assets. Healthpeak’s performance is highly dependent on the future of the healthcare industry and regulation, including the Affordable Care Act. If changes to the ACA cause the healthcare subsectors that Healthpeak invests in to fall out of favor, then the performance and asset values of the company’s portfolio will suffer. Additionally, the performance and asset values of the portfolio will suffer if Healthpeak’s operating partners fail to provide superior care or the assets fail to retain the top tenants. Tenants of Healthpeak’s life science portfolio include many companies in the pharmaceutical, biotech, and tech industries, which historically possess greater volatility.

Read more about Healthpeak’s risk and uncertainty.

Healthpeak Bulls Say

• Healthpeak enjoys industry tailwinds including an aging population and regulatory changes that expand the pool of participants in the healthcare system.
• A diverse strategy allows the company to consider a range of opportunities across property types and business models as a means for growth.
• Development projects across the life science portfolio should be completed at development yields above the weighted average cost of capital and could drive strong internal growth over the next decade as they stabilize.

Healthpeak Bears Say

• The new management team doesn’t have the same operational experience or relationships as peers, which could make it difficult to achieve the same internal growth.
• The life science portfolio is entering a mature growth phase, with same-store NOI growth in the low single digits. The company may have difficulty replicating the growth it experienced in the sector over the past decade.
• Healthpeak faces significant reinvestment risk as it redeploys capital from the sale of senior housing assets into medical office and life science assets.

This article was compiled by Susan Dziubinski and Sylvia Hauser.