I've written before about healthcare real estate investment trust HCP, Inc. (NYSE: HCP) and how it could be a big beneficiary of the aging U.S. population over the next few decades. While I certainly feel like HCP is an excellent long-term investment, before you buy any stock, it's important to understand how the company makes its money.
In HCP's case, it may seem logical that virtually all of the company's income would come from leasing its properties to tenants -- after all, it's a real estate investment trust, and that's how REITs typically make money. However, in the case of HCP, it's not quite that simple.
Continue Reading Below
A look at HCP's revenue sources
We can get a good idea of how HCP makes its money by looking at its most recent financial statements. For the second quarter of 2017, HCP generated $458.9 billion in revenue, which was distributed among five categories:
As you can see, the vast majority of HCP's revenue comes from just two categories. The first one, rental income, shouldn't be much of a surprise. As I mentioned in the introduction, the primary method of income generation for most equity REITs is leasing properties to tenants and collecting rental income, and HCP is no exception.
What might be surprising is that rental income accounts for less than 60% of HCP's revenue. More than 27% comes from a category titled "resident fees and services."
This is because of how HCP's senior housing portfolio is structured. Senior housing properties make 45% of HCP's net operating income, but just over half of this comes from properties that are leased to tenants. About 45% of HCP's senior housing properties, or 20% of the total portfolio, are structured as operating partnerships, where HCP and property operators both benefit from the performance of the properties.
How this mix could change in the future
The market for healthcare services, especially senior housing and medical offices, is expected to grow tremendously over the coming decades as the population of senior citizens in the U.S. rises. In fact, according to U.S. Census Bureau data, the 75-and-over age group is expected to grow by roughly 50% during just the 10-year period from 2020 through 2030.
Because of this, HCP sees a lot of development and redevelopment opportunities, particularly in the medical office area.
HCP also sees a major opportunity to acquire existing healthcare properties, as the healthcare real estate industry is highly fragmented and in the early stages of REIT consolidation. In fact, the company believes there is an investable universe (meaning properties that would fit into HCP's investment strategy) of roughly $250 billion worth of senior housing properties, $360 billion of medical offices, and $50 billion of life science facilities. So, HCP plans to keep expanding its portfolio and therefore its revenue stream.
However, while there's no way to know what properties HCP will end up acquiring, it's possible that the operating-partner portion of the revenue will disproportionally increase going forward. In its discussion of the "investable universe" that I just mentioned, HCP says that triple-net (leased) property opportunities are limited, and that senior housing operating partnership (SHOP) opportunities are more attractive.
The Foolish bottom line
The key takeaway here that HCP investors should be aware of is that in addition to simply collecting a stream of rental income, a substantial portion of HCP's revenue is actually tied to the performance of its senior housing properties. Therefore, the company could benefit tremendously if the senior housing properties stay occupied and generate more revenue, but it is also vulnerable to things like oversupply risk and unstable revenue in the SHOP portion of the portfolio.
10 stocks we like better than HCPWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and HCP wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of August 1, 2017