3 Reasons Welltower Inc. Stock Could Rise

By Matthew Frankel Markets Fool.com

Leading healthcare REIT Welltower (NYSE: HCN) is not only the largest healthcare-specific REIT, it's one of the largest REITs of any kind. Over its 46-year history, Welltower has delivered fantastic returns for its investors, and it has done a great job of managing risk throughout a variety of economic environments. With that in mind, here are three reasons Welltower's strong performance could continue.

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Welltower's investors could be very happy if these three things happen. Image Source: Getty Images.

Industry growth could lead to big opportunities

I've written an entire article about the growth opportunities Welltower will have in the decades ahead, as it's perhaps the most compelling reason to invest in healthcare real estate for the long term.

For starters, the 65-and-over population in the U.S. is projected to roughly double by 2050, and the 75+ and 85+ age groups are growing even faster. Similar trends are expected in the U.K. and Canada, Welltower's international markets. This should benefit Welltower in particular, as senior housing is its bread-and-butter, and the type of property that the company plans to focus on in the coming years.

Image Source: Welltower.

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Second, the healthcare real estate industry is highly fragmented, and is in the early stages of consolidation. No other healthcare REIT has a market share higher than Welltower's 3%, and it's estimated that no more than 12-15% of all healthcare properties are REIT-owned. Even without future growth, the healthcare real estate market is about $1 trillion in size, so this represents a substantial opportunity to grow, just with existing inventory.

Finally, healthcare spending is expected to rise at a rate greater than overall inflation. This is one of the reasons many people are pushing for more "realistic" cost-of-living adjustments for senior citizens' Social Security payments. While the politics of this issue are another matter, for our immediate purposes, my point is that commercial real estate derives most of its value from its ability to generate income. Growing healthcare costs (and rising rental income potential) could, in turn, make Welltower's properties more valuable.

If Welltower's portfolio repositioning is a success

Along with its third-quarter earnings report, Welltower announced a major shakeup of its portfolio. Specifically, the company decided to dispose of more than $3 billion worth of properties, including $1.9 billion of long-term and post-acute care properties.

The main goal is to reduce the dependence on long-term and post-acute properties, as these facilities tend to be dependent on government reimbursement programs such as Medicare and Medicaid, and are generally less stable and predictable than private-pay dependent healthcare properties. Because of these sales, private-pay revenue sources will make up 92.4% of Welltower's income, up from 89.4%.

Image Source: Welltower.

In addition, the disposals include $1.7 billion of properties operated by Genesis Healthcare (NYSE: GEN), and Welltower also plans to sell additional Genesis properties in 2017. This will reduce Welltower's dependence on Genesis as a tenant from 13.8% to 7.1%. Tenant diversification is a smart way to reduce risk. After all, if a major tenant (like Genesis) goes bankrupt, it's far better to have 7% of the REIT's revenue at risk than nearly double that amount.

In short, these changes should allow Welltower to continue to do what it does best -- pursue value-adding acquisitions of stable, predictable healthcare properties.

Interest rates could remain low for longer than expected

As I write this, the Federal Reserve is projecting three interest rate hikes in 2017, and a Federal Funds rate of 3% by 2020 (currently 0.50%-0.75%). Well, rising interest rates are generally bad for REITs, and the current forecast is undoubtedly priced into Welltower's stock price. However, many people who analyze the economy and stock market (myself included) think that this may be a bit too ambitious of a goal, and rates could stay lower than people think.

This would be a positive catalyst for Welltower for three main reasons.

1. Most obviously, lower rates means lower borrowing costs. Welltower relies partially on borrowed money to grow, and lower borrowing rates typically mean better profit margins on acquired properties.

2. Lower interest rates make high-dividend REITs appealing to income investors, so more people buy the stocks, sending share prices upward. Think of it like this when the 10-year Treasury bond yields 2%, Welltower's 5% dividend may seem worth the added risk to income investors. If that Treasury bond was paying say, 4%? Not so much.

3. As lower rates push share prices higher, REITs get the added benefit of cheap equity financing. In addition to borrowing money, REITs also raise capital by issuing new shares. As a simplified example, if Welltower wants to acquire a $10 million property and its stock is trading for $50, it needs to issue 200,000 new shares to raise this much capital. If the stock is trading for $75, it only needs to issue 133,333 shares to fund the exact same acquisition.

The best news all of these are possible, if not likely, to happen

While things like interest rates are anyone's guess at this point, it's entirely possible that the Federal Reserve's projections will prove to be a bit too ambitious. Welltower's portfolio repositioning is almost certain to set the company up for greater stability and sustainable growth, and it's a fact that the population is aging, so it's just a question of how much more demand will be created.

Don't get me wrong -- Welltower can be a rather risky stock to own over short periods of time. In fact, in 2016 alone, Welltower plunged in early February, then proceeded to rally by 48% from that point until August, and then fell 16% from August until the end of the year. However, the company's business model is rock-solid from a long-term perspective, so be sure you have sufficient time to ride out some ups and downs before you invest.

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