Whenever I see a company use “America” in its name, it makes me think of the power of scale. A few examples come to mind, such as:
- Extended Stay America (STAY), a lodging business
- Advance America, which deals in payday loans
- Great American Homes, a housing company – obviously
- American Airlines (AAL), an airline – also obviously
- American Express (AXP), a credit card issuer you might very well have featured in your wallet even now.
There’s plenty more along those lines, but you get the point.
Of course, when a company utilizes “America” like that, it had better deliver on the promise behind the name, of building a nationwide footprint powered by scale and cost of capital.
That second factor especially is an extremely important pillar to any enterprise. Just take a look at the list of names I referenced above. Without a competitive cost of capital, these firms never would have been able to generate adequate scale.
I intentionally included Extended Stay America, Advance America, and Great American Homes because I know their founders and have watched firsthand as they’ve generated scale via competitive cost of capital.
Meanwhile, we all know American Express, of course. It’s an extraordinary credit card and travel-related firm that has evolved into a global service company with key competitive advantages, including trust, integrity, quality, and customer service. However, without such a strong financial footing to begin with, it never could have grown into such a massive enterprise.
Then there’s American Airlines, my airline of choice. Sometimes I miss the “dividend miles” and less frequent first-class upgrades I enjoyed with U.S. Air, but there’s no doubt that American Airlines has become a dominant brand rooted in superior customer service.
So today, in honor of that red, white and blue tradition, I’ve decided to focus my efforts on an all-American real estate investment trust, or REIT. Who knows? One day, this company could become as big as American Express or American Airlines. Though, in order to get there, it must continue to differentiate itself and produce the kind of all-American dividends that help us all “Sleep Well At Night,” or SWAN.
So let’s get started…
An All-American REIT Durable by Design
REIT investors in the healthcare sector are typically looking for a combination of solid, defensive current income and the opportunity for steady cash flow growth. While surveying the list of 15 healthcare REITs in my Intelligent REIT Lab, I’m constantly seeking the best-quality companies that generate the most durable sources of income.
The healthcare sector will benefit tremendously from the significant increase in outpatients accessing care, which is driving very strong employment growth for healthcare practitioners – primarily nurses, physician assistants, and other technicians.
Healthcare is moving evermore to outpatient services as practitioners focus on cost-effective care paid for by private insurers and government providers. At the same time, procedures are becoming more cost-effective as well, making medical office building (or MOB) REITs a primary beneficiary.
Today, REITs own around 11% of all healthcare properties in the U.S. And within the MOB sector specifically, less than 20% of properties are owned institutionally. This means there’s enormous opportunity to scale.
Despite a 50-100 basis-point (bps) increase in interest rates, capitalization rates have remained at historic lows thanks in large part to private investor demand. Given the relative cash flow performance of MOBs, buyers are keeping cap rates from moving up.
Collectively, demographics point to MOBs as the most core, critical assets with the highest tenant demand among almost all property sectors).
Then there’s our particular play…
Healthcare Trust of America (HTA) first listed shares on June 6, 2012 as a fully integrated, self-administered healthcare REIT that was founded in 2006 as a non-traded REIT. It’s currently the largest owner of MOBs in the U.S., with a portfolio of 434 buildings and over 23.2 million square feet in 32 states.
HTA’s investments are targeted to build critical mass in 20 to 25 leading gateway markets that generally host leading university and medical institutions. This translates to superior demographics, high-quality graduates, intellectual talent and job growth.
These strategic markets support a strong, long-term demand for quality medical office space. And HTA utilizes an integrated asset management platform consisting of on-site leasing, property management, engineering and building services, and development capabilities to create complete, state-of-the-art facilities in each one.
As its CEO, Scott Peters, explained on the recent earnings call,
“We are concentrated in 20 to 25 key growth markets and now have nine markets of approximately 1 million or more square feet and 15 markets with 500,000 square feet or more. Given this concentration and scale, HTA can continue to leverage our unmatched full-service asset management platform that provides property management, building services, leasing, construction and development services to our tenants.”
All-American Balance Sheet
HTA maintains a fortress balance sheet with low leverage at 5.6x net debt to EBITDA (earnings before interest, taxes, depreciation and amortization) and significant liquidity of almost $1.1 billion. The company has limited near-term debt maturities and is rated BBB by S&P.
For the record, HTA is boasting the lowest leverage it’s seen in the last few years.
On its earnings call, the company said it recently closed or entered into exclusive agreements on over $100 million of opportunities, with a going-in yield of approximately 5.7%. The company has a guided $250 million worth of acquisitions for 2019.
All-American Earnings Results
In Q1-19, HTA’s same-store growth came in at 2.7%, driven by 2% base revenue growth and 70 bps of rental margin expansion. The quarter-ending same-store leased rate was flat year over year at 91.9%, while occupancy increased 10 bps to 90.8%.
HTA also said it signed for almost 1.1 million square feet of leases during the quarter. That includes 207,000 square feet of new re-leases and almost 900,000 square feet of renewals. The total tenant retention was a solid 86%, while releasing spreads increased to 5.9%, the highest in the company’s reported history.
These Q1-19 leasing results “include the early renewal of over 500,000 square feet of leases with a single tenant that was originally scheduled to expire in 2021. This lease had been flat for over seven years, and HTA was able to renew this rent up more than 10% while also establishing annual escalators and keeping TI at $2 per square foot per year of new term.”
HTA’s annual escalators (on all leases signed in Q1-19) was 2.7%, increasing the average escalator in the portfolio to over 2.4%. That’s up from the low 2% range it sported three years ago. And its normalized FFO per diluted share was $0.40, which was flat on a sequential basis from Q4-18 and down from the prior year. The company said that, “This growth was driven by rental revenue growth of 2% and margin expansion of 70 basis points.”
HTA has averaged 4.8% annualized FFO per share growth since 2012, the highest of all healthcare REITs. It expects normalized FFO per share in 2019 to be between $1.62 to $1.67, with the main catalyst being the timing and amount of acquisitions.
A Healthy All-American REIT to Help You Sleep Well at Night
As I explained in the beginning of the article, the key to becoming an all-American company is to be able to scale the business with the lowest cost of capital. As viewed below, HTA is positioned to pursue MPB’s with cap rates in the 5.5% to 6% range.
The company has multiple uses of cash for capital, with two primary targets for growth: acquisitions and development. It also has the ability to repurchase shares if and when necessary, as it’s already proven. In the first part of the year, HTA saw an opportunity to buy back shares at a very attractive rate and took advantage of that.
For the full-year, the REIT is hoping to return to its historical 4% to 6% annual FFO growth, which seems likely given its acquisition and development forecast, and highly flexible balance sheet.
The stock is currently trading at 17x P/FFO – the same as its closest peer, DOC – and lower than HR at 18.9x. From a 5-year trailing historical perspective, HTA trades at a -4.4% discount.
Factoring all of that in, we are maintaining a BUY on HTA. With that said, shares were trading at a wider margin of safety in 2018, and value investors may want to wait on a lower entry price. There’s clearly no bargains to be had in the MOB sector at the moment.
Then again, there aren’t too many SWANs we can buy today that are forecasted to generate double-digit returns. Compared with other SWANs, HTA has an attractive 4.4% yield with likely 5-6% growth forecasted. We have witnessed this company’s disciplined management style in the past, and we’re now witnessing the power of its scale advantage.
How about you?
I own shares with HTA.