5 Signs HCP's Best Days Are Ahead

By Matthew Frankel Markets Fool.com

Healthcare real estate investment trust HCP, Inc. (NYSE: HCP) underwent a pretty dramatic change in 2016. It started the year with about one-third of its portfolio made up of unstable assets leased to a troubled operator, and ended with a solid portfolio of about 800 high-quality properties. Here are the details of the transformation, and why I think HCP has a bright future ahead.

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Image Source: Getty Images.

1. A smart portfolio move

After it caused a surprise loss for the company in the fourth quarter of 2015, HCP announced plans in early 2016 to spin off its HCR ManorCare portfolio of skilled nursing and assisted-living assets into a newly created real estate investment trust (REIT), which is now known as Quality Care Properties (NYSE: QCP), or QCP for short.

You can read about the spinoff here, but the general idea is that, by getting rid of the riskier assets, HCP can focus on a portfolio of the highest-quality healthcare real estate, most of which are private-pay assets, which are generally more stable than those reliant on government reimbursements.

Image Source: HCP investor presentation.

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The move produces an instantly improved overall asset quality for HCP, as well as increased financial flexibility to take advantage of high-quality growth opportunities as they arise.

2. Plans are in motion to further improve the company

HCP didn't stop its improvement ambitions after the spinoff was completed. In fact, the day after the spinoff was completed, HCP announced that it had agreed to sell 64 of its properties that are leased to Brookdale Senior Living. After the spinoff, Brookdale made up an uncomfortably large portion of HCP's remaining portfolio, and this move will help diversify the tenant base, bringing Brookdale's concentration down to 27% from 35% immediately after the spinoff.

Furthermore, HCP aims to continue to lower its debt levels and improve its balance sheet in 2017 and beyond, with the goal of eventually regaining its Baa1/BBB+ credit ratings. The company has made good progress already, and anticipates further improvement over the coming year.

Image source: HCP investor presentation.

3. The healthcare industry will grow rapidly for decades

I've written about healthcare real estate as a great long-term investment before, and continue to have a positive outlook over the long run, especially in regards to private-pay senior housing, HCP's bread-and-butter.

Simply put, the U.S. population is aging rapidly. With the continued retirement of the baby boomer generation, the 65-and-older age group is expected to roughly double by 2050. Higher age groups (75+ and 85+) are growing even faster.

Image source: HCP investor presentation.

What this means is a steadily growing stream of demand for HCP's core property types, especially senior housing and medical offices.

4. Lots of opportunity for consolidation

One other reason I love healthcare real estate as a long-term investment is because it's still in the early stages of REIT consolidation, a fact that was pointed out by fellow healthcare REIT Ventas (NYSE: VTR), another REIT favorite of mine, in its latest investor presentation.

Image source: Ventas investor presentation.

According to Ventas, a maximum of 15% of existing healthcare properties are owned by REITs, well below other property types. For example, as much as 50% of malls and 55% of hotels are REIT-owned. If healthcare real estate continues to get acquired by REITs, it creates lots of room to grow among the existing inventory, on top of the overall industry growth I already discussed.

5. It's cheap

The best measurement of REIT earnings is funds from operations, or FFO. Based on its P/FFO multiple, most healthcare REITs are trading rather cheaply right now, and HCP is no exception.

As of this writing, HCP trades for 16.1 times the midpoint of its 2017 FFO guidance. Compare this to REITs in other sectors, such as retail REIT National Retail Properties or apartment REIT AvalonBay Communities, which trade for 18.4 and 21.7 times FFO, respectively.

To sum it up, HCP has done a great job of improving its portfolio and financial condition, and continues to do so. The industry is growing and has lots of opportunities for expansion, and healthcare real estate trades at a lower multiple than other forms of real estate. So now could be a great time to get in on the new and improved HCP.

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Matthew Frankel owns shares of HCP and Quality Care Properties, Inc. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.