2 Undervalued Healthcare REITs

Kevin Brown: We are lowering our moat rating for the big three healthcare REITs--HCP, Ventas, and Welltower--to no moat from narrow moat. However, we maintain our Exemplary stewardship for Ventas and Welltower and believe there is significant value to be found in these companies' high-quality, well-diversified portfolios. Of these three companies, Welltower is currently our favorite name in the space.

The first baby boomers will turn 75 in three years and the 80-plus population will double over the next decade, increasing demand when they first start to move into these properties. High current supply and a severe flu season are causing senior housing fundamentals to turn negative in 2018. However, construction start data suggests that we are currently at peak supply, the severity of the flu season is a one-time event, and these issues are more than offset by long-term baby boomer demand. We remain confident that these companies are well-positioned to benefit from the increasing healthcare needs of an aging population.

Rising rates have also weighed heavily on these companies' stock price. However, we think that the sell-off from rising rates is an overreaction and misses the long-term value that the healthcare companies have spent years cultivating. The companies are all trading below their net asset values, indicating that the public market is pricing these companies below where the private market values the underlying real estate.

Our fair value estimate for Ventas and Welltower is above our net asset value due to our belief that the Exemplary stewardship that these companies exhibit will create value through leveraging relationships and operational expertise to drive higher internal growth. Finally, all three healthcare companies currently have dividends in the mid-6s that are well covered.

If investors are willing to overlook some short-term supply disruption in the senior housing space, we believe these companies are well-positioned to benefit from long-term demand for their assets.