Welltower (WELL): Aging Gracefully Or Out Of Touch? Stock That’s Priced For Perfection

Introduction

Shares of Welltower Inc. (NYSE:WELL) have performed exceptionally well for investors who’ve been able to hold on over the most recent one year period. Over the last twelve months, shares are up 49% on top of the steady 2% dividend the company pays to shareholders. While a large part of this total return is due to the overall market moving higher as well as lower interest rates expected going forward (a factor that’s generally seen as a positive tailwind for REIT and other real estate related companies), Welltower has outperformed the REIT sector by wide margin. In my view, while the business fundamentals have improved and can likely continue to do so over the next few years, I have concerns that the valuation may too high at this point.

Welltower At A Glance

Welltower is a real estate investment trust (REIT) that focuses on owning healthcare facilities and properties, playing a role in owning the infrastructure that is used to support seniors housing operators, post-acute providers, as well as government health care systems through their ownership of real estate assets.

At the most recent quarter end, Welltower had nearly 2100 total properties in its portfolio, which includes 1005 Seniors Housing Operating facilities, 664 Triple-net properties, and 446 Outpatient Medical facilities. About 81% of the company’s total real estate asset value can be attributable to its largest segment in Seniors Housing, and over two-thirds of its development projects are in Seniors Housing.

Geographically, Welltower’s properties are spread out across North America, with nearly 85% of revenues derived from the United States. In addition to Canada and the U.S., the company also has a small presence in the U.K.

Favorable Demographic Trends

One of the big drivers for Welltower’s long-term growth is an aging population. For example, in North America, the proportion of seniors has been growing as a percentage of the population. Back in 2010, the percentage of the population 65 and older was 14.1% which has now increased to 19.0% in 2022. By 2030, estimates suggest that figure 22.5%. With more seniors, demand for seniors housing is expected to rise.

According to some analysis of market data conducted by Lument for their 2024 Seniors Housing and Healthcare market outlook report, inventory growth has started to moderate as occupancies have been increasing. Occupancy gains have been driven higher by strong absorption, and this trend of continued lower levels of inventory growth compared to absorption bodes well for 2024 and beyond. Lument predicts that it is likely the seniors housing occupancy rate will approach pre-pandemic levels as 2024 progresses. Similar forecasts, like the one from Cognitive Market Research, suggest that this could be a longer-term trend that lasts for several years, with the senior living market expected to grow at 8.4% from 2024 to 2031

In my view, for a company like Welltower that already has a significant portfolio of seniors housing properties, this is a tailwind that should benefit their operations and financial performance.

Dividend Growth, But What About AFFO Growth?

However, one of the concerns that I have with Welltower is that even though it has benefitted from favorable demographic trends, this hasn’t translated into meaningful AFFO growth on a per share basis, and it looks like dividend growth could stall a bit in the future.

While Welltower’s dividend is fairly low today at a 2.2% yield, it’s demonstrated a solid track record of regular dividends for the last 34 years, a trait I think that is attractive to investors who look for a balanced combination of both growth and income. Moreover, with the exception of the financial crisis in 2009 and the COVID-19 pandemic in 2020, it’s often increased its dividends year to year, rewarding long-term shareholders.

In my view, with a cash dividend payout ratio of 75% and an AFFO payout ratio of 73%, the pace of dividend growth is likely to slow down from here. In addition, if Welltower were to payout 100% of its AFFO as a dividend, the dividend would barely be above 3%. So this is an expensive stock.

Looking at the company’s AFFO over the last decade, we can see that while AFFO has increased 50% in this period, this hasn’t materialized into meaningful AFFO growth on a per share basis, in large part due to the fact that the share count has grown considerably alongside this figure. Without a high enough growth rate in AFFO on a per share basis going forward, it’s hard to justify Welltower being a solid dividend payer that you’d want to hold for the long term.

Recent Results

When looking at the latest quarterly results for Welltower, the company reported total revenues of $1.82 billion, which was 9.5% higher than last year’s quarter (8.6% on a same-store basis). This figure was below the company’s 6.4% expense growth, which led to same-store NOI growth of 22%. In the company’s senior housing business, same occupancy was up 280bps year over year and 30bps sequentially clocking in at 84.9%.

One of the nice things about Welltower’s business is that rental rates generally grow faster than your average REIT, because of those demographic tailwinds I mentioned earlier. In addition, some of its leases in its senior housing and healthcare facilities have built-in rent escalations or annual increases. As these agreements come into effect, Welltower’s rental income can grow over time, boosting its net operating income.

Outside of Seniors Housing, the During the quarter, same-store NOI grew 4.3% for the triple-net senior housing portfolio, 2.7% for the skilled nursing portfolio, and 2.1% for the medical office portfolio.

From a balance sheet perspective, I think Welltower looks to be in good shape. At quarter end, the company had a Net Debt to EBITDA ratio of 3.7x, which should be about 4.3x pro forma after their net investment activity in new projects that they estimate will cost about $2.7 billion.

Regarding the company’s capital structure, most of the debt, or about $12.2 billion, is in senior unsecured notes while just $1.8 billion is secured. Compared to other REITs I’ve looked at in the past, the balance sheet seems to be well-structured and manageable. The major credit rating agencies S&P and Moody’s both moved their outlooks on their ratings of BBB+ and Baa1, respectively, to positive outlooks. This underscores that Welltower’s financial position is robust and capable of supporting its strategic growth initiatives and investment in new development, which, I think, should enhance investor confidence in its long-term stability and performance.

Growth Rates Don’t Support Valuation

In my view, Welltower’s latest quarter wasn’t anything to wasn’t anything to write home about, but was more of a reaffirmation of some of the long-term trends the company is seeing. Improving occupancies in the post-COVID era, lower supply growth, and an aging population are all factors that are driving growth for the company. However, I’m not sure this future growth will be enough to justify the company’s current valuation; my biggest gripe when it comes to the investment thesis on Welltower.

At an implied 6.6% cap rate on Welltower’s overall portfolio, I think Welltower is more than fairly valued. According to data from CBRE, for seniors housing real estate, cap rates have started to increase and now sit at 7.2% and 8.7% for Class A and Class C assets, respectively. This seems to indicate that even if we assume that all of its assets are the best of the best and are all Class A, Welltower is at least 10% overvalued.

It also seems to suggest that if the company’s portfolio doesn’t significantly outperform the broader market or if there are unforeseen challenges, investors could face a situation where the premium valuation doesn’t align with the returns realized. In my view, given that historical AFFO hasn’t grown much above 5%, I’m not comfortable underwriting a valuation that assumes more aggressive growth expectations. Thus, while Welltower’s growth outlook is positive and should benefit from long-term tailwinds, I believe the valuation might not offer sufficient margin of safety for potential investors.

At a forward P/AFFO of 33.3x and P/FFO of 29.0x, well above the sector median of 16.8x and 14.6x, respectively, Welltower is one of the most expensive names in the space. As such, I’d advise caution for potential investors of Welltower, particularly when we consider that shares have risen 35% year to date.

In addition, looking at sellside estimates over the next few years for FFO growth on a per share basis, Welltower is only expected to grow its FFO from $4.16 this year to about $8.34 by 2033. So even if we underwrite sellside estimates of 8.0% growth in FFO per share by 2033, Welltower is still a very overpriced stock at 14.5x 2033 FFO! Therefore, it’s hard for me to see any meaningful upside from current levels.

Conclusion

Altogether, I think Welltower latest quarter has shown that it is capable of growing its bottom line; something it has struggled with over the last decade. With lower interest rates, an aging population, and favorable industry tailwinds related to low supply, AFFO growth is likely to be higher over the next decade than it’s been in the prior decade. However, even though I think Welltower’s business results could be better going forward, the stock’s elevated valuation, driven by significant share price increases and lofty P/FFO and P/AFFO ratios, may limit future upside potential. With AFFO growth lagging behind and high valuation multiples relative to industry peers, I think Welltower’s stock appears to be more than priced for perfection. For these reasons, I rate Welltower as a ‘sell’.