This Stock Has an 8.2% Dividend and Room to Grow

This healthcare real estate company pays a massive dividend, but is it safe?

Healthcare real estate investment trust Senior Housing Properties Trust (NASDAQ:SNH)pays a dividend yield of 8.2%. Generally, when a dividend looks too good to be true, it is — however, that may not be the case with this one. Here’s a breakdown of Senior Housing Properties Trust’s business, why it could be a great long-term investment, and the risk factors investors should know about.

 

Senior Housing Properties Trust: The quick version

Despite its name, Senior Housing Properties Trust invests in more than just senior housing. In fact, only 53% of the portfolio is in senior housing. Forty-one percent is in medical office buildings, such as life science facilities and physician offices, and there are smaller holdings of skilled nursing and wellness facilities.

IMAGE SOURCE: SENIOR HOUSING PROPERTIES TRUST.

Its portfolio consists of a geographically diverse collection of 431 properties, and the company is always looking to buy and sell assets to maximize value for shareholders. For example, in the most recent quarter, it sold four medical office buildings and one skilled nursing facility and acquired (or planned to) one medical office building and two senior living communities. In addition, it spent a substantial amount of capital improvements designed to help its existing communities generate more income.

Why invest in healthcare real estate with Senior Housing Properties Trust?

There are a few good reasons to invest in healthcare real estate, and Senior Housing Properties Trust in particular. For one thing, healthcare is a defensive type of real estate, meaning that it generally performs well in good times and bad. Senior Housing Properties Trust has an extra layer of safety, as 97% of its assets are private pay, as opposed to being dependent on government reimbursements. This is one of the highest private-pay percentages in the industry, and this type of asset is often much more stable and predictable.

Furthermore, the healthcare industry is expected to grow rapidly over the coming decades, and the need for healthcare real estate will grow with it. It shouldn’t come as a surprise that older people use healthcare services more than the rest of the population. Well, the population is aging fast. In 2015, there were approximately 47 million people aged 65 or older. By 2030, this number is expected to soar to more than 70 million, resulting in a huge jump in healthcare spending.

IMAGE SOURCE: SENIOR HOUSING PROPERTIES TRUST.

Additionally, the healthcare real estate industry is in the early stages of REIT consolidation. Less than 15% of all healthcare properties are owned by REITs, as compared with 40%-50% for other property types like malls and hotels. In other words, not only is the industry growing, but there is significant room for growth among the existing supply of properties.

As a final reason to consider Senior Housing Properties Trust, the stock trades at a cheap valuation. As of this writing, shares trade for just 10.4 times trailing-12-month funds from operations (the REIT version of earnings). Other stocks in the healthcare real estate industry trade for significantly higher multiples, such as industry heavyweights Ventas (15.9 times FFO) and Welltower (14.7 times FFO).

Is the dividend safe?

Senior Housing Properties Trust pays one of the highest dividends in the real estate sector. At the current share price, the annual dividend of $1.56 represents a yield of about 8.2%.

The good news is that it appears to be safe. Not bulletproof but safe. The best metric of REIT earnings is funds from operations (FFO), and the company only paid out 82.5% of its FFO as dividends over the past 12 months. (Note: It’s common for a REIT to pay out most of its FFO as dividends. As long as it’s well under 100%, there’s usually no immediate cause for concern.) In fact, the current payout ratio is historically low for the company.

IMAGE SOURCE: SENIOR HOUSING PROPERTIES TRUST.

The bad news is that unlike most other healthcare REITs, investors haven’t gotten a raise in quite some time. As you can see in the graphic above, the last time the company increased its dividend was back in 2012. It represented a significantly higher payout ratio back then, so a dividend increase wouldn’t be out of the realm of possibilities. However, the point is that if you’re looking for a stock that consistently raises its dividend without fail, look elsewhere.

Risk factors

There are a few major risk factors shareholders should be aware of before investing. Interest rates are a big one, and are the main reason the real estate sector underperformed the market by a wide margin in 2016.

Not only do rising interest rates make it more expensive for REITs to borrow money to finance acquisitions, but they also create downward pressure on REIT shares. When rates rise, investors expect higher yields from “riskier” assets such as REITs. I believe Senior Housing Properties Trust’s high dividend yield would help mitigate this risk, but a spike in rates would likely mean a drop in price.

One company-specific risk factor worth mentioning is debt. As of the end of the third quarter, the company’s debt-to-assets ratio is 42.9%. This isn’t a “high debt load” by any means, but there are less levered options in the industry. For example, industry leader Welltower’s debt only makes up about 31% of its total capitalization, and the company recently announced plans to de-lever to less than 27%. The higher debt level adds an element of risk, because a highly leveraged company may have more trouble paying its obligations and its dividends if profits were to drop.

The bottom line

No stock that can quintuple investors’ money in less than 15 years is without risk, and Senior Housing Properties Trust is no exception. However, in this case, I believe the growth potential and cheap valuation make up for the risks and then some. Senior Housing Properties Trust is a stock I’m strongly considering adding to my portfolio in 2017, and if I do, I’ll plan to hold on to it for decades to come.

Matthew Frankel owns shares of Welltower. The Motley Fool recommends Welltower. The Motley Fool has a disclosure policy.