Healthcare Realty Trust Incorporated

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Healthcare Realty Trust Incorporated (HR) is a real estate investment trust (REIT) that owns, manages, acquires, develops and redevelops income-producing real estate properties associated primarily with the delivery of outpatient healthcare services throughout the United States.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

HR’s business centers around owning and operating medical office buildings, with the main focus on outpatient facilities. These facilities are typically used for physician practices, outpatient surgery centers, diagnostics, and other health care providers.

Business Overview

Revenue Distribution: HR’s revenue primarily comes from rents received from tenants in their healthcare properties.
Industry Trends: The healthcare industry is experiencing a shift towards outpatient care, which benefits HR. Patients are increasingly choosing outpatient centers over traditional hospitals for their convenience, and to lower their own costs. The outpatient healthcare industry itself is booming and is set for growth in future years. Aging population and increasing chronic illnesses are also drivers of demand.
Competitive Landscape: The medical office real estate market is fragmented, with several large REITs, smaller regional companies, and individual owners competing for properties.

HR’s management team has a solid track record and good experience in health care industry, helping their understanding of the industry and the companies that operate in it. However, there is a concern about occupancy rates, as shown by one quarter’s occupancy dipping to 94.8% from previous level of 96.9%. This is a cause for concern, although company expects occupancy to recover in future quarters. In other words, if their properties are not fully occupied, this will hurt the profit.

What Makes the Company Different

Focus on Outpatient Facilities: HR’s specialization in outpatient facilities provides it with a level of expertise that other REITs may not possess.
National Footprint: Although HR has a national footprint with operations in many states, the majority of assets are in the southeast.

Financials

Revenue Growth:

In recent times, HR has managed to generate organic growth which is quite an important factor. They have also increased their pricing and are able to grow their properties rents by ~3% yoy. This is a good thing to see in a business like REITs.

The company has shown positive organic revenue growth over the past 10 years in general.
For the three months ended March 31, 2023, rental and related revenues increased to $306.0 million, from $287.2 million for the three months ended March 31, 2022.
For the nine months ended September 30, 2023, rental and related revenues increased to $919.0 million, compared to $862.6 million for the nine months ended September 30, 2022.
Profitability & Margins:
The company’s net income was $34.8 million for the three months ended March 31, 2023.
For the three months ended September 30, 2023, the company’s net income decreased to $54.8 million from $63.1 million in the prior year.
The decrease in net income was primarily the result of increases in operating expenses and, particularly, interest expense.
Capital & Leverage:
- The company’s average debt-to-capital ratio is 42.2%, while their target is closer to 35%. This implies that the company is taking on more debt.
- The debt-to-EBITDA ratio is also on the higher side at ~6.8x, which implies the company is levered.
Dividend Policy: HR pays a consistent and predictable dividend, a key factor for income-seeking investors. However, dividend is not high as seen in some other REITs.

Moat Analysis

HR does possess a limited moat, mainly stemming from its established presence and relationships within the healthcare industry. This provides some protection from competition, but it’s not an insurmountable barrier, hence a 2/5 moat rating.

Sources of Moat:

Customer Relationships: It appears that HR has established good long term relationships with many of the large clients and has good retention rates.
Scale: HR is a well-established national player in this field, which has its advantages over smaller REITs, though it isn’t enough to provide a strong moat.
Barriers to Entry: Regulatory approvals and other factors of setting up facilities create barriers to entry in the business, giving HR a slight edge.

Why this is a Low Moat:

Replicable Business: While HR has good operations, the REIT business model itself is easily replicable. Competitors can purchase similar properties and manage them efficiently, giving limited advantage to HR.
Limited Pricing Power: As a real estate owner, HR doesn’t have much pricing power over hospitals, as the price of medical facilities is influenced by various factors. This limits its ability to generate huge profits.
Competition: There is high competition in the space.

Risks to the Moat and Business Resilience

Interest Rate Risk: As a real estate company that is heavily dependent on borrowings, the company is highly sensitive to interest rate risks. Higher rates could reduce the company’s profitability.
Regulatory Risk: As seen from the latest reports, changes in government reimbursements for healthcare services can reduce the demand of outpatient facilities, which would then affect rent revenues.
Economic Downturn: If the economy undergoes a recession, there would be less demand for healthcare, which may affect HR’s occupancy rates and revenues.
Technological Obsolescence: Although unlikely, new disruptive technologies that change the needs of patients may force demand to go into other types of facilities rather than the existing properties that HR has, threatening the long term value of the company.
Tenant Bankruptcy: In a bad economic environment, some tenants may file for bankruptcy and may default on payments, affecting the income.

While management has tried to diversify tenants by providing properties for many different types of healthcare, the company still faces a risk as they are highly concentrated in the healthcare industry.

Understandability: 2 / 5

The company’s core business model is fairly straightforward: owning and leasing medical office buildings, which could make it an easy to understand business. However, there are a few factors which increase complexity.

Understanding the impact of external factors such as interest rates, industry trends, and regulations on REITs is complex.
Furthermore, REIT accounting practices require some knowledge of financial analysis and accounting. As some ratios, such as leverage and debt have an oversized impact on its finances, they are quite hard for a casual investor to understand.

It is also important to understand the impact of lease expiration on the income statements as well.

Balance Sheet Health: 3 / 5

HR’s balance sheet could be classified as moderately healthy, with a few noteworthy points. * The company has high debt level, leading to high leverage. They do have an investment grade rating, but are highly susceptible to changes in interest rates. * The company is generating healthy cash from operations, however most of the profits are paid out as dividend, thereby the company’s reinvestment opportunities are limited. * The asset value is correlated with current real estate market value. If the real estate market tanks, then the asset value may also decrease, and the company may face problems in repaying the existing debt.

Key Takeaways

HR operates in a booming market and has tailwinds from industry and secular trends. However, there are many factors that affect this industry, and investors must be aware about them while investing in the company.
It may not have a particularly strong moat, however it still remains attractive due to its established operations and market reach.
It has moderate financial health, and its future depends a lot on management of debt.