3 Reasons Welltower Inc. Stock Could Fall

Markets Motley Fool

Healthcare real estate investment trust Welltower (NYSE: HCN), like most REITs, has underperformed the S&P 500 over the past year or so, down about 4% despite a 14% rise in the index. And while I'm a big believer in healthcare real estate as a long-term investment, there's certainly more downside risk, at least in the near term. Here are three specific factors that could cause Welltower to fall.

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Interest rates could rise faster than expected

The Federal Reserve has raised interest rates four times since late 2015, by 25 basis points each time. As it sits now, the target federal funds rate is 1.00%-1.25%. However, that's still quite low by historical standards.

The Fed sees the federal funds rate at 2.1% by the end of 2018, and close to 3% by the end of 2019. However, it's important to point out that this would still be quite low historically, as you can see in the chart. In fact, from the mid-1960s to the early 2000s, the federal funds rate barely dipped below 3% at all.

My point is that since the Fed's projections are closely followed, they are somewhat accounted for in Welltower's current stock price. However, if the economy heats up more than expected, the Fed could speed up their rate increases, which would probably put downward pressure on REITs.

Oversupply issues could plague senior housing

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Whenever you have a rapidly growing market, oversupply can become a concern. Companies see opportunity and build new properties, and they sometimes build too much to accommodate the demand. To name a current example, oversupply fears are a big reason self-storage REITs have underperformed the market recently.

According to a presentation by fellow healthcare REIT Senior Housing Properties Trust, until about 2015, the market was absorbing senior housing faster than inventory was growing. Recently, however, the opposite has been the case. Absorption rates are still very high, but new inventory is being built even faster. As a result, industry occupancy has slightly fallen from just over 90% to about 89% since late 2014. In a nutshell, oversupply hasn't become too much of a problem yet, but this is certainly a trend worth monitoring.

One of Welltower's major partners could face tough times

Welltower partners with some of the best-respected operators in the senior housing business, with Sunrise Senior Living and Brookdale Senior Living operating many properties. A less-optimistic way of saying the same thing is that large portions of Welltower's rental income is dependent on just a few companies.

As of the first quarter, 40% of Welltower's in-place net operating income came from its top five partners, which are:

  • Sunrise Senior Living (15.5%).
  • Brookdale Senior Living (7.6%).
  • Genesis Healthcare (7%).
  • Revera (5.7%).
  • Benchmark Senior Living (4.4%).

To be clear, I wouldn't call any of these a "dangerously high" concentration. Many other healthcare REITs are far more dependent on certain operators. For reference, fellow senior-housing-oriented healthcare REIT HCP relies on its top three tenants for 44% of its net operating income, as opposed to around 30% for Welltower.

Having said that, if one of Welltower's major tenant/partners ran into financial difficulty, it could certainly be a negative catalyst for the stock.

The Foolish bottom line

This isn't an exhaustive list of reasons Welltower could fall, but they are three things that could certainly happen. Even if they do, however, none of these should create a long-term problem for the company. To sum it up, Welltower is a long-term winner. However, I wouldn't be surprised to see a few bumps like these along the road.

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