National Health Investors Inc. (NYSE:pediatric) is a senior housing and nursing REIT. This sector, which was the rage before COVID-19, ran into a lot of trouble after March 2020. The sector faced challenges from high mortality rates caused by COVID-19 in its main users. It also faced added costs from maintaining a secure environment. Labor costs then exploded in 2022 and that was another problem to deal with. As a REIT, the “sit and collect the rent” model did not work for NHI or any other REIT in the sector. In fact, if you go back and look at the last 10 years, this model hasn’t really worked. Tenants generally had poor rent coverage and their low-margin business required ongoing subsidies and bailouts. But the REIT has grown and addressed these obstacles. We look at where NHI stands today and if anyone can make a good investment case for this 7% yield.
NHI just released its Q3-2023 results, and normalized funds from operations (FFO) improved modestly to $1.08 per share. Funds available for distribution, or FAD, also improved and the FAD payout ratio moved slightly lower to 81.1%.
Despite a stronger-than-expected quarter 3-2023, NHI cut its guidance for FFO and normalized FFO. Due to a slightly lower amount of leased incentives, FAD guidance increased.
However, the numbers do not materially change the story. At $4.30 of NFFO, NHI is easily covering the dividend. More importantly for investors, NHI claims to be on the other side of the “hump” in terms of handling its problems. In evaluating the validity of the above statement, it is where the investment case should be made. So let’s see it.
The first thing that NHI has successfully done is selling off distressed properties. You can see that in the 3.2% “cash yield” and $353.9 million sale price.
In essence, NHI was able to sell properties at what would be called very low rates. These properties often had a tenant who paid no rent or paid part of the rent. It was one of the best illustrations of real estate holding its value. Even when the property had zero attraction using conventional metrics of rent generation from existing tenants, perhaps other factors such as replacement cost or alternative use value came into play. Of course, replacing the tenant with a stronger one can also be a motivating factor, but if it was that easy, NHI would have done it, rather than selling the property. The bottom line is that this was done and NHI got valuable cash flow when it needed it most.
Brickford and Holiday were two more problem kids and they weren’t easy to get rid of. NHI gave Brickford a major lease reset and also transitioned Holiday into a SHOP environment.
For those who are not aware, SHOP stands for an operating portfolio of senior housing and NHI has both upside and downside on those properties. It’s not just about collecting rent anymore.
NHI did steps one and two in such a way that they offset the impact of leverage. The very low cap rate sales offset the rent reductions and passed through to SHOP (which was immediately EBITDA negative).
The bottom line has been quite impressive, and perhaps the best metric here is tenant health as measured by the EBITDARM metric (earnings before interest, taxes, depreciation, amortization, rent and management fees). You can see below that we’re seeing some consistent 12-month improvements in every single category.
Outlook & Verdict
NHI’s balance sheet looks in good shape with debt to adjusted EBITDA at just 4.4X.
Some may argue that this is too low for a REIT, but this is not a triple net retail REIT. Tenants here are notorious for rent abatement issues and requests. So 4.4X is good, but definitely nothing to write home about. The maturities are also well separated. Note that the credit line has sufficient capacity to absorb the entire 2025 maturity schedule, although we doubt it will be needed.
The stock has a yield of 7% and a payout ratio of 80%. While it trades at a small premium to estimated NAV, this is lower than what we’ve seen over the past decade.
The 12X FFO multiple isn’t too bad either, and reflects the general apathy toward REITs.
Currently, we think NHI is a worthy consideration to add to any portfolio lacking sufficient REITs. While we’re warming to this, we don’t see a runaway bull market here. Using a conservative buy point would probably involve looking for an entry price below $47.00. Alternatively, investors can estimate their returns and reduce their risk by using $50 covered calls. Currently, the longest dates available are for April 2024. This coupled with relatively low implied volatilities means we are still on the sidelines. We rate this as a wait noting the potential for good returns from here. We also think the 2031 bond with a 7.57% yield to maturity is worth considering.
If you get an 8.0% plus yield to maturity on these in a merger, we may buy these as well.