Shannon Jones: Let’s turn our attention to
the two stocks I pulled out from the market. The first one is actually a type of equity
that, Todd, you and I don’t talk about a whole lot, but I certainly think
this one has its place. That is a healthcare real estate pick,
specifically a company called HCP, Inc. It is what is known as a REIT,
or real estate investment trust. Oftentimes, many of our listeners
aren’t familiar with what a REIT is. Just to give you an overview, traditionally,
most of us, myself included, can’t just go out and buy real estate at will. But what we can do is pool our resources together
as investors and buy a collection of properties or real estate assets.
That’s exactly what REITs do. REITs also have a very special tax status,
which basically requires them to pay out at least 90% of their income as dividends. If they do, they aren’t taxed at the
corporate level like most other businesses. The business model for an equity REIT in
particular — which is what we’re talking about, not a mortgage REIT, which you certainly want
to stay away from — they buy properties, lease those properties to tenants. This provides a nice, steady stream of income,
most of which is then passed to us, the shareholders. Todd Campbell: What’s really interesting about
these REITs is, you look at other REITs, like mall operators, and how e-commerce is
causing places like Sears to abandon stores. Those mall operators are under pressure. I’m not going to say you wouldn’t have closures
or high vacancy rates with healthcare REITs like this, but I think it’s less likely. Healthcare is relatively
inelastic to the economic cycle. If you need healthcare,
you’re going to go out and seek healthcare. Right now, there’s a tremendous amount of
money that’s sloshing around in drug development and specialists, you name it,
providing care to all those baby boomers. As a result, that’s leading to these companies
having pretty stable and high occupancy rates. Jones: Absolutely. To put some stats behind that,
right now, $1.1 trillion worth of healthcare real estate is in existence, but only 15%
of this is actually REIT-owned. Compare that to commercial real estate, like you were
mentioning, Todd, like retail shopping centers, malls, even hotels —
that’s about 40% REIT-owned. So, I feel like the opportunity
is certainly massive for healthcare REITs. You mentioned the aging
baby boomer population. We know that’s going to be a massive growth
opportunity in the healthcare space. You also mentioned the economy. If things start to turn south, generally healthcare
expenses are one of the last to go. Also, we talked about it on last week’s show
with our telemedicine, telehealth show — you see insurers and payers favoring a lot more
of these off-site, lower-cost facilities. That’s what a lot of these really strong REITs
are going after, are these assets that are not hospital-based, but they
are separate, standalone facilities. That’s why I think healthcare REITs in particular
make such a compelling investment. HCP has been an interesting
equity to follow for a number of reasons. I’d say No. 1 is that it’s truly
a turnaround story if there ever was one. If you go back to 2016, this particular stock
was down, I want to say, almost 40% at one point. A lot of that was because of its
exposure to skilled nursing facilities. Skilled nursing facilities are basically
long-term care for patients who have difficulty doing regular, day-to-day activities. Back then, HCP’s portfolio was heavily
concentrated in these skilled nursing facilities. In 2016, it was about 26% or so. They’ve actually now diversified their real
estate portfolio to move away from those skilled nursing facilities. The reason is because those facilities are
much more dependent on government reimbursement. Now, they are much more focused on private
payers, which provides a much steadier stream of income, and also allows
for a much more diversified base. Campbell: Right. And those contracts have built-in
escalators and those types of things that can help offset some of your rising costs. One of the concerns that some people have
had lately is that in a rising interest rate environment, some dividend
stocks look less attractive. Now, you can go out and you buy short-term
bonds and get relatively competitive yields to what the S&P 500 may be yielding, especially if rates
continue to climb over the course of the next year. That’s made some of these
higher-dividend-paying stocks more attractive. If I earn less than 2% on the S&P,
why would I want to take on that risk? I can go out and I buy this
short-term bond instead with lesser risk. Now, if you’re talking about a much higher dividend
than that, it becomes a little bit more compelling. Jones: Absolutely. Right now, their dividend, I believe they’re
right at about a 5% yield, which is pretty impressive, especially for those that are
looking for a steady stream of income. The shares are trading
for about $29 a share. You did see in January and February of this year most
REITs going back to the interest rate sensitivity. Most REITs did take a hit
as the Fed has continued to raise rates. What’s been interesting with HCP in particular
is that they’ve been able to not only recover those losses but are actually doing quite
well even after the tumble they took in October. At $29 a share, they’re up about 40% from
its lows from January and February. This really does go against conventional
wisdom with REITs, where the mantra truly is, stay away when the Fed
interest rates are at play. This stock has a lot to offer
in terms of long-term growth. I would also add, there were some management
missteps along the way that I think got them into a portfolio that was so heavily
concentrated in an area that was declining. But they’ve been able to spin off assets. They spun off their skilled nursing assets
into a newly-created REIT called QCP. They did sell a substantial amount of its
Brookdale occupied properties, transitioned 35 others to new operators,
and also exited several other non-core investments. Strategically, now this company is much more
in line to have predictable revenue streams, now a much more diversified
and focused company. It has three core areas: senior housing,
life science properties, and medical offices. Those areas that I mentioned are much less
reliant on government reimbursement, but also are the core areas that you
see the industry transitioning to. Campbell: Yeah. I think those
properties are increasingly valuable. Sometimes they have to be built out specifically
with things like ventilation, certain ventilation, etc, etc. That creates a stickiness with the people
who are renting those spaces from you. Obviously, in in the future, you’ve got to
keep an eye on things like what’s going on with the National Institute of Health’s funding budget,
and how much money is going into research. You have to keep an eye on how much money
is going to venture capital that’s allowing some of these university researchers to spin
off and create their own new businesses. Those kinds of things will play a role in
determining vacancy rates in the future. But for now, like you said, this company is doing
a pretty good job in getting itself back on track. Jones: Yeah. And not only that,
the balance sheet is also improving. HCP has basically been
paying down a lot of its debt. Its net debt to adjusted EBITDA has dropped
from 6.5X to 6X on a pro forma basis. This actually led to an improved
credit rating from the S&P recently. That’s freed up a lot more cash for them to
go after a lot of these strategic moves and go into those more lucrative
assets. Definitely one to watch. I do think, like the other company,
this will be a bumpy road ahead. We’re still in a rising rate environment. The Feds are expected to raise rates in 2019
at least three more times from what I’ve heard. Still in a transformation phase,
still has a long way to go. But I think this company
is certainly one to watch.