Some readers have wanted to know what healthcare REITs remain attractive investments at this time. Stalwarts like Ventas (VTR) have gotten crushed by their Senior Housing Operating segments and are guiding for near-zero growth in 2020. Medical Office Building-focused REITs like Healthcare Trust of America (HTA) or Healthcare Realty Trust (HR) appear overvalued. Our frequently touted pick Medical Properties Trust (MPW) is up 35.8% YTD, and while it has great prospects for continued growth and dividend growth, it certainly isn’t cheap. Global Medical REIT (GMRE) has naturally been the subject of many readers’ questions due to its blazing fast growth and high dividend yield. In this article, we look at why GMRE does or does not make a good investment despite its eye-popping 66% trailing 1-year total return.
Image from finviz.com
The business model of GMRE is very simple: it pursues primarily medical office buildings and inpatient rehabilitation facilities, among other healthcare facilities, and does so in secondary markets. GMRE then rents these properties out on long-term triple-net leases.
Image from Q3 2019 GMRE earnings presentation
As you can see from the picture above, these secondary markets allow GMRE to achieve cap rates that are a little higher than the industry norm yet still maintain plenty of rent coverage (4.9x) much like the game plan of popular REIT Stag Industrial (STAG). These leases require the tenants to pay for any maintenance and things like property tax and offer a high level of stability. The weighted average lease term of 8.9 years with an average rent escalator of 2.1% ensures organic earnings growth uncoupled from US economy turbulence.
I also want to point out that GMRE’s occupancy is a perfect 100%, which is quite a bit better than the industry norm of high 80s to low 90s percentage. For example, Healthcare Realty Trust has same-store occupancy of 88.8% and Ventas has a 90% occupancy for their office portfolio.
Image from GMRE investor presentation 11/14/19
GMRE mitigates their tenant risk through diversifying out their holdings both geographically and through many different operators. They also are wisely in the triple net lease business which we have already mentioned how durable these leases usually are for producing reliable cash flows. As a healthcare professional, I am encouraged by their portfolio comprising the types of assets in healthcare that make the most sense financially to own, namely MOBs/outpatient surgical and various length of stay hospitals. These typically have much better cash flows and rent coverages than the dreadful Skilled Nursing Facilities and Senior Housing that are dragging down other healthcare REITs:
HR investor presentation 11/22
This has led to a situation where people are investing in healthcare stocks that they think are safe, acyclical assets but not understanding how risky their underlying holdings are. GMRE, on the other hand, looks well-insulated from tenant issues.
The most apparent negative to fundamental investors such as myself is the fact that the dividend is not covered by funds from operation, the primary metric for judging the strength of a REIT. GMRE has not covered its dividend since Q4 2018, paying out $0.20 per share per quarter but coming up a bit short (0.17, 0.18, 0.19) for the past three quarters. The amount that the dividend is under-earned is not a huge amount, but some investors consider this a deal-breaker. More importantly, this implies that the massive growth that we have witnessed has been completely fueled by equity issuance and debt.
Total share and unit count has increased by 62.7% YoY which is pretty substantial. They just issued 6 million more shares on December 11th, 2019 (the reason for the dip in the charts) at $13 a share for ~$78 million. This new capital will most likely be deployed at similar cap rates to their previous acquisitions (around a 7.5% cap rate), and since it was above my back of the napkin NAV estimate (~12.50-13.00), it should be an accretive issuance. Another way to look at it is that the company will be investing the cash at a 7.5% cap rate (with escalators) and will be paying 6.1% a dividend yield on the equity raised.
External management is incentivized to use equity issuance to grow the company because their base management fee is 1.5% of stockholders’ equity. While they would like to make wise financial decisions in the best interest of shareholders, they will get paid more regardless for pulling the stock issuance lever as opposed to using more debt. This conflict of interest is why most people avoid externally managed companies in favor of internally managed ones.
Image from GMRE investor presentation 11/14/19
By issuing more shares they improved the appearance of their debt to equity ratio, lowering it from 1.1x to 0.7x, which is why net debt to EBITDA is a little more useful for evaluating financial strength. Net debt to EBITDA comes in at about 9.3x, which is pretty high, even for triple net lease REITs that can utilize higher leverage due to the predictability of the cash flows.
The other reason for issuing more equity is that it meant that shareholders’ equity has surpassed the $500 million mark, triggering an internalization process. I like it when the terms of the buyout are clearly agreed upon ahead of time, and while a value of 3 times the annual base management fee plus incentives will hurt, it’s a pretty standard amount for internalization (Jernigan Capital (JCAP) just came to a similar, but slightly less pricey amount).
Based on the TTM base annual fee of around $6 million and the fact that no incentives were earned over the past year, we can estimate a cost of around $20 million. $20 million in stock would be about 1.5 million shares at current prices. This represents less than 4% dilution to internalize the manager, which is a paltry sum. For this reason, the internalization cost should not warrant a significant discount when considering GMRE for investment.
Global Medical REIT has had a phenomenal year and due to its performance and the unattractive valuations of its peers, many investors have had their eye on the stock. We have provided a cursory glance at the company and have come away from our digging as feeling pretty neutral on the company as a whole. For income investors, the 6.07% yield is pretty enticing, and the reliability of the triple-net leases means that this truly is one of the more defensive healthcare REITs.
For value and fundamental investors, this is one of those REITs that will sit in a watchlist and always look too expensive, especially given its 105% payout ratio and 66% past year run-up. The preferred stock, (NYSE:GMRE.PA) does not seem particularly attractive either, since it has a call date of 9/15/22, current yield is 7%, and it’s trading at a 6.76% premium to par. For those readers that are eager to add another healthcare holding they could dip a toe into GMRE but I would caution them to look for more compelling valuations or reconsider their need to increase their exposure to healthcare.
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Disclosure: I am/we are long JCAP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.