Better Buy: Welltower Inc. vs. Brookdale Senior Living

By Markets

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The U.S. population is aging rapidly, and investors have a few ways to try to capitalize on this trend. One way would be through a real estate investment trust (REIT) like Welltower (NYSE: HCN), which owns a portfolio of healthcare properties. Or you could choose a more direct investment approach, through a senior-housing operator like Brookdale Senior Living (NYSE: BKD). Here's what you need to know about these two companies, and which could be the best bet for your portfolio.

Welltower: Best-in-breed healthcare real estate

Welltower is the largest REIT specializing in healthcare properties, and currently owns more than 1,400 properties in the U.S., Canada, and the U.K., all of which have favorable demographic trends for healthcare real estate. Specifically, the 75-and-over population of the three markets is expected to double over the next 20 years, and healthcare spending is forecast to rise.

Image source: Welltower investor presentation.

As of this writing, Welltower's portfolio consists of 64% senior-housing properties, 20% long-term and post-acute-care facilities, and 16% outpatient medical properties. The business model is relatively simple: Welltower's focus is to acquire properties that are better-quality than those offered by competitors and are located in desirable markets, then partner with some of the best facilities operators in the business (including Brookdale) to run them.

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The results of this strategy have been nothing short of spectacular. In its 45-year history, Welltower has managed to increase its impressive dividend (currently yielding 5%) at an annualized rate of 5.8%. Even more impressively, the company's total return has averaged 15.8% throughout its history -- meaning that people who bought Welltower shares in 1971 are sitting on a 73,600% gain today, provided that they reinvested their dividends.

Image source: Welltower investor presentation.

Like most other stocks that have consistently produced market-beating returns, Welltower is rather expensive. Funds from operations (FFO) is the "earnings" metric of the REIT industry, and Welltower trades for 15.4 times its projected 2016 FFO. This actually isn't too expensive relative to most companies in the S&P 500, but it is historically pricey for Welltower, and is much higher than Brookdale's valuation, which we'll get to shortly.

Brookdale Senior Living: Should you buy the operator instead?

Welltower and Brookdale Senior Living's businesses are intertwined. Brookdale is one of Welltower's largest operating partners, operating more than 7% of the REIT's portfolio. In fact, a poor quarterly report from Brookdale earlier this year caused Welltower shares to plunge. In other words, Brookdale's performance should be of interest to Welltower investors, whether or not they're directly invested in Brookdale as well.

Brookdale generates the bulk of its revenue (84% so far in 2016) from its facilities and their residents.And the senior-housing business has faced some headwinds lately, including declining occupancy and Medicare uncertainty, both of which are primary reasons for the stock's 33% decline over the past year.

Although Brookdale isn't technically a REIT, real estate does make up a large part of the company's business model, as Brookdale owns about 40% of its facilities. Therefore, shareholders should focus on FFO as opposed to net income -- so don't let those negative earnings fool you. In fact, Brookdale is projecting CFFO (cash from facility operations -- a very similar metric to FFO) in the $2.45 to $2.55 range, meaning that shares trade for just 6.2 times the midpoint of the guidance. From a valuation perspective, Brookdale is cheap.

Brookdale does benefit from the same demographic trends I mentioned in the Welltower discussion, but there are a few things investors should know. First, Brookdale has a much higher debt load relative to its size. As of the second quarter, Brookdale has a total of $7.5 billion in liabilities listed on its balance sheet. For comparison, Welltower's total debt is about $12.6 billion, but Welltower's market cap is about nine times that of Brookdale.

Another reason for the low valuation isthe Medicare uncertainty mentioned earlier. The government is actively trying to curb Medicare reimbursements to private companies, which could create pressure on Brookdale's revenue going forward.

The verdict

These companies are two different ways to play the aging U.S. population, and as such are completely different kinds of investments. Welltower is a tried-and-true dividend machine, acquiring properties, leasing them out, and collecting a steady stream of rental income. On the other hand, Brookdale is a more direct play on senior housing, actually providing senior-living services and aiming to make a profit from those services.

I personally prefer Welltower out of the two, as it has a history of reliable performance and dividend growth, while at the same time delivering market-beating total returns. In fact, Welltower is one of the largest stock holdings in my retirement account. While Brookdale could indeed produce solid performance in the years ahead if things go well for the senior-housing business, I prefer to stick with the company with a stellar 45-year track record.

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Matthew Frankel owns shares of Welltower. The Motley Fool recommends Welltower. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.