I’ve been getting a lot of questions about NorthWest Healthcare Properties REIT NWH-UN-T, which we recommended in my Income Investor newsletter in October, 2020.
I understand the concern. The price is about half what it was a year ago and the yield has soared to 12.2 per cent. What’s going on?
NorthWest was originally concentrated in Alberta, B.C. and the territories. Now it’s an international operation with properties in the United States, Brazil, Europe, Australia and New Zealand, as well as here in Canada. The trust owns 233 properties that offer 18.8 million square feet of gross leasable area. These are medical facilities of various types, including hospitals, labs and offices.
Last summer, this security traded as high as $13.72. But until recently it was on a steady downtrend since, losing over half its value in the process.
Since the distribution has not changed (6.667 cents a month), the yield soared to more than 13 per cent at one point. A recent rally in the unit price has reduced it to 12.2 per cent, but that’s still high and normally a signal that the market sees a cut coming. But is it? Most health care REITs are faring reasonably well. What’s gone wrong here?
For starters, rising interest rates are bad news for REITs, which carry heavy debt loads, mainly in the form of mortgages. As a result, they are heavily leveraged, and any floating-rate debt translates into higher costs each time the Bank of Canada boosts its target rate, which it did this month for the 10th time since March, 2022. Any new borrowings will also be at significantly higher rates than a year ago.
The interest-rate problem is common to the whole real estate sector. Compounding the difficulties for NWH was the announcement last month that a $276-million joint venture with an unnamed British investor will not be proceeding. The venture would have been owned 70 per cent by the investor and 30 per cent by the REIT, which would also have managed the properties.
The joint venture was seen as a key part of the REIT’s international expansion program. Its collapse has left those plans in disarray and damaged NWH’s credibility.
Management said it continues to believe in the attractiveness of the British health care real estate market and will continue to seek an alternative partner to recapitalize its British portfolio.
First-quarter results showed strong revenue growth but a decline in earnings. Revenue was $135.3-million, up 29.5 per cent over the same period last year. Net operating income (NOI) increased by 24 per cent from the first quarter of 2022. Occupancy for the quarter was 97 per cent, the same as last year.
However, higher interest rates, temporarily elevated the cost of debt servicing, and lower transaction volumes within the REIT’s fee-bearing assets resulted in adjusted funds from operations dropping from 21 cents a diluted unit in 2022 to 16 cents a unit this year. That’s well below the quarterly distribution of 20 cents a unit. The REIT can sustain this on a short-term basis, but if the discrepancy continues, the board will have some tough decisions to make.
To reduce costs, the REIT implemented a hedging program to fix the interest rate on $901-million of foreign-currency debt carrying a floating rate. For the partial quarter for which the hedges were in place, the REIT achieved interest savings of $3.7-million.
Management believes the units are highly oversold and has implemented an aggressive buyback policy. The TSX has approved a normal course issuer bid for a maximum of 22,224,257 units, or approximately 10 per cent of the REIT’s public float.
In a news release, management said “the current unit price does not reflect the fundamental value of the REIT’s high quality, defensive health-care real estate portfolio or the value of its global asset management platform. As a result, the REIT believes deploying excess capital towards acquiring units under the NCIB is the most accretive use of capital at the current unit price.”
I believe NWH is oversold. The yield is very attractive, and the core business appears to be solid. There is risk if earnings do not recover to previous levels. But for investors seeking an unusually high cash flow and capital gains potential, this could be a security to consider. The units closed on Tuesday at $6.75.
Disclosure: I own units of this security.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.
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