HCP(NYSE: HCP) is a real estate investment trust, or REIT, that specializes in healthcare properties. Specifically, HCP owns a total of 776 properties, most of which are divided among its three core property types: medical offices, life sciences, and senior housing.
HCP makes its money by leasing its properties out to high-quality tenants or by partnering with top-notch operators such as Brookdale Senior Living. It grows through a combination of acquiring existing properties and developing new ones from the ground up.
Pills on top of spread-out hundred-dollar bills.
Image Source: Getty Images.
Why HCP?
There are a couple of main reasons I prefer HCP to the other big players in the industry such as Welltower(NYSE: WELL) or Ventas(NYSE: VTR). While I don't think either of them is a bad investment by any means, HCP has the most diverse portfolio of the three and also has the highest concentration of private-pay healthcare tenants, which generally have more predictable revenue streams than those reliant on government reimbursements.
Over the past few years, HCP has done an excellent job of transforming itself and boosting its long-term sustainability. It got rid of its riskiest assets by spinning off its skilled nursing properties into a new REIT (which was recently acquired by Welltower), improved its balance sheet, and reduced its concentration to its largest tenants.
Metric
Q3 2016
Today (Pro Forma)
Skilled nursing as % of portfolio
26%
0%
Net debt/adjusted EBITDA
6.5x
6.0x
Top 3 tenant concentration
54%
30%
Data Source: HCP.
An amazing long-term opportunity
There are three main reasons I'm excited about HCP's potential over the next several decades: demographic catalysts, consolidation opportunities, and value creation through development.
First and foremost, some important demographic trends are very conducive to healthcare growth:
The number of U.S. senior citizens (65 and older) is expected to increase by 19% by 2030. Seniors visit medical offices an average of 6.6 times per year -- about 145% more than people under 45.
The oldest segments of the population are growing even faster. The 80-and-older population is expected to increase by 56% by 2030 -- that's just 12 years from now.
These demographic trends will benefit all three of HCP's core property types. Medical offices will benefit from increased visit frequency as the average age of patients increases. Senior housing will obviously benefit from the rapid growth in the oldest age groups of the U.S. population. And finally, an aging population will create an even greater market for life-saving drugs and medical treatments, which will be developed in life-science facilities. In fact, venture capital investment in the life sciences has roughly doubled over the past decade.
In addition to favorable demographic trends, HCP also benefits from a massive opportunity for consolidation within the current $1.1 trillion healthcare real estate market. Only about 15% of healthcare properties are REIT owned, and there's a particularly high rate of physician-owned medical offices that HCP could capitalize on over the coming decades.
Finally, HCP is ramping up its development efforts, which has lots of potential for value creation. Simply put, it's often cheaper to build a new property than to buy an existing one. And HCP has aggressively increased its development spending over the past few years, targeting $300 million to $400 million per year starting in 2019. Not only do developed properties generate higher yields than existing ones (7.5%-8% stabilized yields versus 4.5%-5.5%), but they can create instant equity for HCP upon completion.
In a nutshell, there's a lot to like about HCP's growth potential over the next few decades.
Challenges and short-term risk factors
No stock capable of double-digit returns is without risk, and HCP is no exception. There are some macroeconomic and industry-specific risks investors should be aware of before jumping in.
Interest rates are a big short-term risk factor. In a nutshell, rising interest rates are negative catalysts for high-dividend stocks, so if rates rise faster or higher than expected, it could push HCP's share price downward.
In terms of the healthcare real estate industry, one big risk is oversupply. We're already seeing this in some senior housing markets -- properties were simply built faster than demand had grown. Over time, the demographic trends I mentioned should help work this out, but for the time being, it remains a concern.
The dividend -- will it grow again?
One other factor worth mentioning is HCP's dividend growth, or more specifically the lack thereof. After decades of consistent growth, HCP's dividend has been at a standstill since the QCP spinoff in 2016.
This certainly makes sense. The company has reduced its leverage and exposure to riskier assets, so it seems reasonable that there's less income available for distribution now. And to be clear, that's a good thing in terms of long-term financial responsibility.
However, people often invest in REITs for their long-term dividend growth potential, so while I believe HCP will ultimately get back on track with its dividend growth, there has been quite a pause that investors should be aware of, and it isn't over just yet.
The verdict
If you couldn't already tell, I'm a big fan of HCP as a long-term investment. While there are sure to be some ups and downs in the stock price along the way, particularly as interest rates rise, the stock has the potential for market-beating long-term total returns for decades to come.
