Will 2017 Be Welltower's Best Year Yet?

By Matthew Frankel Markets Fool.com

Leading healthcare REIT Welltower's (NYSE: HCN) stock had a turbulent year in 2016, but ended the year almost flat. Despite the bumpy road for the stock price, Welltower's business continues to do well and the company recently made some smart moves to set itself up for future growth. After the underperformance of 2016, can investors expect a big rebound in 2017?

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2016 was an up-and-down year

Welltower's stock price was all over the place in 2016. The stock got crushed early in the year (along with most other healthcare REITs) as many facility operators showed signs of financial trouble. The stock rebounded shortly after, and rose with the rest of the REIT sector thanks to persistently low interest rates. Then, as it looked like rates would rise sooner rather than later, prices of most income-generating assets like bonds and REITs started to drop in anticipation.

HCN data by YCharts

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As you can see, while 2016 was quite a roller-coaster rise for Welltower and its investors, the overall performance was pretty flat. The stock lost 1.6%, but the total return for the year, which includes dividends, was a mediocre 3.4% -- far below the company's 15.6% historical average.

One smart move going into 2017

As a Welltower shareholder, the news that made me happiest in 2016 was the portfolio repositioning that the company announced at the same time as its third quarter earnings report. You can read a thorough discussion of this move in this article, but here's an overview of why this could be a positive catalyst going forward:

Welltower announced that it would sel) $3.3 billion worth of assets during the fourth quarter, including $1.9 billion of long-term/post-acute care properties. This is expected to increase the concentration of private-pay revenue sources in Welltower's portfolio to 92.4% from 89.4% Private-pay healthcare, as opposed to healthcare dependent on government reimbursements, is generally more stable.

Because of these asset sales, Welltower expects its overall leverage ratio to drop considerably, from 39.5% to 34.4%, thereby increasing its liquidity and strengthening the balance sheet. Finally, since $1.7 billion of the properties involved in the sales are operated by Genesis Healthcare, it will reduce the concentration of that tenant by about half, to 7.1% of the portfolio. Generally, less reliance on any single tenant is a good thing for REITs looking to lower risk.

Interest rates could be a drag going forward

I already mentioned interest rates as a drag on REITs, so let's take a closer look at why this is.

For one thing, it makes borrowing money more expensive. Welltower relies on borrowed money (such as from its revolving credit line) to acquire new properties, and higher borrowing costs typically translate to lower profit margins.

Also, when rates rise, income investors expect higher yields from their investments -- especially those perceived as risky, like REIT stocks. Think of it like this: When 30-year Treasury bonds pay 3%, a 5% dividend from a REIT may be compelling enough to take on the additional risk. If that Treasury's yield spikes to 5%, investors may want to see 7% yields before they'll buy REITs. This creates selling pressure on REITs during periods of rising rates, and causes prices to fall. In fact, check out the performance of Welltower as compared with the 30-year Treasury yield since July 2016 -- you'll notice the performance is almost the exact opposite.

HCN data by YCharts

2017: Welltower's best year yet?

As I've written before, I feel that Welltower's business is rock-solid, and the company's latest portfolio repositioning is a positive long-term development, I simply don't see 2017 as an above-average year for Welltower and its shareholders. Interest rate uncertainty could weigh on the stock's price, and if rates do rise, it can make it push the share price down and make it more difficult for Welltower to find attractive acquisition opportunities.

Even so, as I've written before, I think Welltower is a great long-term investment. Any weakness in the share price in 2017 shouldn't scare investors. Rather, I'd look at any weakness as an opportunity to add shares at a discount.

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Matthew Frankel owns shares of Welltower. The Motley Fool recommends Welltower. The Motley Fool has a disclosure policy.