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I’ve been getting a lot of questions about NorthWest Healthcare REIT (TSX: NWH.UN), which was 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 11.7%. 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 U.S., 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 ($0.06667 per month), the yield soared to over 13% at one point. A recent rally in the unit price has reduced it to 11.7%, but that’s still high and normally a signal that the market sees a cut coming. But is it? Most healthcare 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 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. 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 U.K. investor will not be proceeding. The JV would have been owned 70% by the investor and 30% by the REIT, which would also have managed the properties.
The JV 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 U.K. healthcare real estate market and will continue to seek an alternative partner to recapitalize its U.K. portfolio.
First-quarter results showed strong revenue growth but a decline in earnings. Revenue was $135.3 million, up 29.5% over the same period last year. Net operating income (NOI) increased by 24% from the first quarter of 2022. Occupancy for the quarter was 97%, the same as last year.
However, higher interest rates, temporarily elevated leverage, and lower transaction volumes within the REIT’s fee-bearing capital platforms resulted in adjusted funds from operations (AFFO) dropping from $0.21 per diluted unit in 2022 to $0.16 per unit this year. That’s well below the quarterly distribution of $0.20 per 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 floating rate, foreign currency debt. 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 (NCIB) for a maximum of 22,224,257 units, or approximately 10% of its public float.
In a press release, management said, “the current unit price does not reflect the fundamental value of the REIT’s high quality, defensive healthcare 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 were trading on Aug. 1 at $6.84.
Disclosure: I own units of this security.
Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investor newsletters, which are available through the Building Wealth website. To receive the special report “The Tumultuous Twenties,” when you subscribe, go to https://bit.ly/bwGP20s.
Follow Gordon Pape on Twitter at https://twitter.com/GPUpdates and on Facebook at www.facebook.com/GordonPapeMoney.
Notes and Disclaimer
Content © 2023 by Gordon Pape Enterprises. All rights reserved. Reprinted with permission. The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting, or tax advice. Always seek advice from your own financial advisor before making investment decisions
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