Healthcare Realty: Forget 60/40, Buy This 6.4% Yield Instead (NYSE:HR)

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The 60/40 rule dictates that an investor put 60% of their portfolio in stocks and the remaining 40% in bonds. I’ve never been a fan of bonds, however, and have only bought CDs once in the past, as I’d much rather hold a basket of income generating stocks.

Moreover, while bonds are generally thought of as being “safe”, that safety only means a higher likelihood of getting one’s principal back at the maturity date (as opposed to equities which don’t have a maturity date). However, bonds come with duration risk due to inflation, and can introduce unexpected complexity to one’s portfolio that an investor may not want.

This brings me Healthcare Realty Trust (NYSE:HR), which may be a solid option for a well-diversified portfolio, providing both high current income and a potential growth kicker to boot.

As shown below, HR is looking rather attractive right now, after having fallen by 33% over the past 12 months and is currently trading closely to its 52-week low. This article highlights why income investors ought to take a hard look at this high yielding healthcare REIT, so let’s get started.

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HR Stock (Seeking Alpha)

Why HR?

Healthcare Realty Trust is a large self-managed REIT that grew much larger in size this year, after the closing its acquisition of its rival, Healthcare Trust of America, with its large portfolio of medical office buildings, which comprise 95% of HR’s total properties .

At present, HR’s portfolio consists of 728 properties spread across 35 US states, totaling 45 million square feet of gross leasable space. Moreover, HR has a leasing and property management services arm that serves more than 39 million square feet nationwide. As shown below, HR’s properties are in major metropolitan cities, with Dallas, Seattle, Houston, Los Angeles, and Atlanta being the top 5 markets.

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HR Top Cities (Investor Presentation)

Meanwhile, HR is demonstrating steady growth, with same store cash NOI growing by 2.8% YoY during the third quarter. This was driven in part with average in-place rent increases of 2.64% and future annual contractual increases are slightly higher, at 2.8% on new leases that commenced during Q3. The pace of same store NOI growth is also accelerating, supported by 50 basis points of YoY occupancy gains, and also encouraging, tenant retention was high, at 79%.

Importantly, HR maintains a strong balance sheet, with 86% fixed rate debt and a long-term debt to capital ratio of 43% and a net debt to EBITDA ratio of 6.3x. This is reasonable considering that medical office buildings are arguably the highest quality property type in the healthcare space, and haven’t faced overbuilding and wage inflation in the manner that labor intensive senior housing, skilled nursing, and hospitals have faced in recent times.

Near term headwinds include high interest rates and a depressed share price, which elevates HR’s cost of capital. However, management has plenty of opportunities to capture investment spreads as it works its way through the recently consolidated portfolio, by disposing of lower cap rate properties in exchange for higher cap rate ones, and can add value through G&A synergies. These attributes were noted by management during the recent conference call:

For MOB transactions, we see debt costs running in the high 5s to the mid-6s. At the moment, MOB cap rates are running about the same level. In the last three months, we’ve made tremendous progress on our top priority of asset sales. We’re pleased to report dispositions approaching $1 billion so far with a clear path to reach $1.1 billion at an overall cap rate of 4.8% by year-end. I’d like to commend my colleagues who worked tirelessly to accomplish this remarkable outcome in the current market environment.

Moving forward, we can afford to be more patient. We currently have a lot of lines in the water. You will see us sell assets selectively where it makes sense strategically and financially. Any proceeds we generate can be accretively reinvested in the development projects, selective acquisitions or opportunistic stock repurchases.

Another top priority has been integration and organizational realignment. We’ve realized nearly 50% of expected G&A savings moving into the fourth quarter. We’re ahead of schedule and on our way to realizing full annual G&A synergies of $33 million to $36 million.

Lastly, HR pays a well-covered 6.4% yield, with a 78% payout ratio, based on management’s expectation of a $0.40 run-rate normalized FFO per share going forward. I also find the stock to be attractively priced at $19.43 with a forward P/FFO of 11.3, sitting well below its normal P/FFO of 18, as shown below. Analysts have a consensus Buy rating with an average price target of $26.40, implying potentially strong double-digit annual returns, especially when including the dividend.

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HR Valuation (FAST Graphs)

Investor Takeaway

HR is a reliable healthcare REIT with a large portfolio of medical office buildings. Its balance sheet is strong and it has plenty of opportunities to capture investment spreads within its own portfolio and add value through G&A synergies. The stock appears attractively priced at current levels, offering potentially strong double-digit returns including dividend. As such, HR appears to be a solid pick for those seeking high income and a potential growth kicker.

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