How Risky Is Welltower, Inc.?

Healthcare REIT Welltower (NYSE: HCN) has a 45-year track record of steady dividend increases and strong total returns for investors. And while no stock capable of turning $5,000 into $3.8 million in 45 years is without risk, you may be surprised at how safe Welltower is. Here's an overview of what makes Welltower safe, and the risks shareholders need to be aware of.

Image source: Getty Images.

Welltower's business is designed to be low-risk

First, the good news. There are several factors that make Welltower a relatively low-risk investment.

For starters, healthcare real estate is, by nature, a defensive asset. When recessions hit, people can stop going to the mall, paying for self-storage units, and staying at hotels. On the other hand, they'll always need access to healthcare.

Welltower's portfolio is more stable than most because it's composed primarily of private-pay assets. Private-pay healthcare, as opposed to facilities dependent on government reimbursements, is typically more stable and predictable. In fact, after a major portfolio shake-up announced in November, Welltower's private-pay asset mix will rise from 89.4% to 92.4%.

In addition, the market for healthcare real estate is growing and is in the early stages of REIT consolidation. In fact, just 12-15% of all healthcare properties are estimated to be owned by REITs, as compared with 40-50% of malls and 50-55% of hotels. There are plenty of opportunities to consolidate, and Welltower is the largest player in the industry with an enterprise value of about $41 billion, and has more financial flexibility to grow than most peers.

Finally, and perhaps most importantly, the healthcare real estate market is projected to grow significantly as the population ages. In Welltower's markets (U.S., U.K., and Canada), the 65-and-older population is expected to roughly double by 2050, and the older age brackets are growing even faster. In fact, over the next two decades, the 75-and-older age group, is expected to double.

Image source: Welltower.

To sum it up, not only is healthcare real estate a defensive asset that has yet to be fully capitalized on by REITs, but the market is going to grow quickly over the coming decades.

But, that doesn't mean it's risk-free

Over the past 45 years, Welltower has managed to increase its dividend at an average rate of 5.7% per year, and has delivered impressive total returns averaging 15.6% per year. No stock that is capable of returns like these is without risk, and Welltower is certainly not an exception. While it's impossible to name every single thing that could potentially go wrong, here are some of the company- and industry-specific risk factors:

  • Welltower has many joint ventures in its portfolio, leaving it vulnerable to the performance of other companies.
  • The market for senior housing could grow slower than expected, resulting in more supply than demand. This could lead to a reduction in private-pay senior housing rates, and as such, lower market value of senior housing properties.
  • One or more of Welltower's facility operators could face financial difficulties, and find themselves unable to pay rent. For example, Genesis Healthcare will account for 7.1% of Welltower's portfolio even after the shake-up I already mentioned. If that company became unable to meet its obligations to Welltower, it could create a serious profitability problem.
  • Since Welltower has substantial investments in the U.K. and Canada, the company is susceptible to foreign exchange fluctuations.
  • Real estate investments are illiquid, meaning that Welltower may not be able to immediately sell a property to raise cash if it needed to.

Again, this is not meant to be an exhaustive list of all of Welltower's risks. To be clear, I don't think any of these things are likely to happen anytime soon. However, they are important for investors to be aware of before adding Welltower to their portfolio.

In addition to company-specific risks, one factor that could adversely affect Welltower's stock price is interest rate fluctuations. Specifically, rising interest rates tend to cause REIT prices to drop for a couple of reasons.

First, it makes borrowing money more expensive, which generally translates into lower profit margins. Second, it creates selling pressure on REITs, as rising rates mean that investors will demand higher dividend yields. And lower share prices produce higher yields. In fact, speculation of higher interest rates is a main reason REITs underperformed during the latter half of 2016.

The bottom line

As I mentioned in the intro, Welltower isn't a risk-free stock. The stock's price could certainly drop, and quite frankly, I expect it to do so if interest rates rise faster than the market anticipates. However, any negative catalysts should be short-lived, and I feel that the long-term return potential more than justifies any risks involved with owning the stock.

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