We recently published a market update discussing the Fed’s latest rate hike and what it means for REITs.
You can read it here by clicking here.
The short version is that this is clearly a short-term setback for REITs. Higher rates raise borrowing cost concerns, put pressure on property values, and make fixed income more competitive relative to REIT dividend yields. That is why REITs sold off so sharply in 2022 and 2023, and it is why they are again facing pressure today.
But as we explained in the market update, we do not think this changes the long-term thesis. This rate hike was largely caused by a temporary energy shock related to the escalation of the war in Iran. It may delay the recovery, but it does not change the structural forces that have pushed inflation and interest rates lower for decades. It also does not change the fact that higher rates are further reducing new real estate supply, which should eventually lead to better rent growth and stronger pricing power for existing landlords.
This is not our first rodeo. We have gone through periods of interest rate volatility before, and our approach remains the same. As long as the long-term thesis has not changed, we use the volatility to accumulate shares in the REITs that we think offer the best risk-to-reward.
That does not mean that we try to call the bottom. We cannot predict how the market will behave next week or next month. REITs could certainly remain volatile for a while longer if rates keep rising or if sentiment worsens further. That is why we do not put all our available capital to work at once. Instead, we buy in phases, making smaller additions over time as new opportunities appear.
This week, we are adding more capital to two of our Core Portfolio holdings and two of our Retirement Portfolio holdings.
Core Portfolio Addition #1: National Health Investors
We are adding more shares of National Health Investors (NHI).
We will soon publish a full updated investment thesis on NHI, so we will keep this recap short for now. The main reason we are buying more is that the recent dip has created another opportunity to add to a REIT that we think has become much stronger, while the market remains too focused on the temporary earnings disruption caused by its portfolio recycling.
NHI has made several shareholder-friendly moves this year. It completed the sale of 35 master-leased properties operated by National Healthcare Corporation for $560 million at roughly a 7% cap rate, which also eliminated conflicts of interest between NHI and NHC. It has also completed additional dispositions, while reinvesting heavily into senior housing assets, especially SHOP properties. Private pay senior housing is now close to 80% of the portfolio, and pro forma leverage should fall to only about 2.5x debt to EBITDA once recent disposition proceeds are reinvested.
This matters because senior housing is one of the few property sectors where the supply and demand setup is exceptionally favorable. Demand is benefiting from the aging of the baby boomer generation, while new supply remains extremely constrained because construction costs and interest rates are too high to make many new projects pencil out. NHI’s management notes that senior housing supply under construction is now near recession-level lows, at only about 0.5% of total inventory.
The market is focused on the fact that NHI’s portfolio recycling is causing a small near-term dip in FFO per share. We are more focused on what the company will look like after this transformation is complete. NHI will have a cleaner portfolio, lower leverage, much more exposure to senior housing, and a stronger organic growth engine than it had in the past.
Despite that, NHI still trades at a discounted valuation, at just 13.5x FFO, a 25% discount to NAV, and a 5.5% dividend.
This is unusually low for a well-capitalized senior housing REIT. We think the stock deserves a much higher multiple and it will re-rate once the market recognizes that NHI is no longer the same slow-growth triple-net healthcare REIT that it used to be. Management has created a stronger company, but the market has not yet rewarded it appropriately. You may recall that something similar happened with W.P. Carey (WPC) after it sold its office portfolio. The market was first slow to recognize that it had become a higher-quality REIT, giving us a chance to accumulate a larger position, and this ultimately paid off for us.
We expect the same to happen here, and we are using the current weakness to buy more. We expect 30-50% upside from here.
Stay tuned for our new investment thesis.
