National Health Investors

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

National Health Investors, Inc. (NHI), is a real estate investment trust (REIT) specializing in healthcare properties, particularly senior housing and medical facilities, and provides financing through triple-net leases.

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.

NHI’s business revolves around acquiring, owning, and leasing out healthcare real estate, relying on long-term leases with operators who then run the day-to-day operations.

Business Overview: NHI operates primarily in the senior housing and medical facilities sectors, structured into four main property types: Senior Housing-Nets, Senior Housing-Managed, Medical Facilities, and Specialty Health Facilities. The company’s business model is structured as a triple-net lease agreement, where the tenant bears the responsibility of paying all property operating costs such as taxes, insurance, and maintenance. With a large and diverse investment portfolio of 385 facilities located across 34 states. The company funds their investments primarily through the use of debt and equity issuances and the primary source of revenue are the rental agreements from leases.

Unlike healthcare operators which directly provide care, NHI acts as a financial landlord for the healthcare industry.

Revenue Distribution:

Senior Housing - Triple Net Leases (NNN): The largest segment, accounting for majority of rental income, involves properties leased to operators under triple-net leases where the tenants are responsible for most of the costs. Occupancy rates were 82.8% in 2022 and 82% in 2023, with an annual rent escalation built into these contracts.
Senior Housing – Managed: This segment includes a minority of NHI’s properties, is less profitable. In this segment, the Company is more involved in operations and management decisions and can make more direct control.
Medical Facilities: These include a variety of properties such as specialty hospitals, rehabilitation centers, medical office buildings, and behavioral health facilities. As of December 31, 2022, the portfolio had 15 of these facilities.
Specialty Health Facilities: Consists of miscellaneous properties, as well as a few medical equipment loans. These facilities or loans are leased to third parties and generate a recurring rental or interest income. The total investment is usually much smaller for each such investment compared to other segments of the portfolio.

Industry Trends:

Aging Population: The aging demographics in the United States present a growing demand for senior housing, healthcare, and medical services. This trend fuels the need for NHI’s specialized properties.
Shift in Healthcare Delivery: Changes in healthcare delivery models, such as increased outpatient care and specialized treatments, influence demand for new types of medical facilities and services.
Consolidation: The healthcare industry is undergoing consolidation that is creating a more concentrated pool of large operating tenants, requiring REITs to have robust risk assessment capabilities.
Macroeconomic Pressures: Interest rate fluctuations and inflation create uncertainty for capital investments and borrowing costs for operators, thus impacting their performance and their ability to make rent payments. This can cause volatility in occupancy and payment reliability from tenants, thus, affecting NHI.
Government Regulations: Changes in government policy surrounding healthcare regulation, Medicare and Medicaid, create additional uncertainty in the industry. This can cause both revenue and expense to be unpredictable.

Competitive Landscape:

Fragmented Market: The healthcare REIT market is fragmented, but there are a few large players. Competition comes from other REITs as well as alternative financing options.
Scale Matters: Larger REITs benefit from lower costs of capital and greater diversification of risk.

Although larger REITs may be a threat, scale helps NHI to access low cost capital and also offers more geographical diversification.

Relationship Focused: Relationships with operators is a key differentiating factor since most REITs can offer similar assets, but relationships are harder to replicate and improve over time. The REIT must maintain robust relationships with operators to keep business steady for a long time.

What Makes NHI Different:

Focus on Healthcare Real Estate: NHI specializes solely in healthcare-related properties, creating a focused business strategy that could give it superior insights into the industry compared to other REITs that have diverse portfolios across different real estate sectors.
Partnerships: The company has been engaging in long-term partnerships with a few reputable operators for many years. This enables NHI to have more predictable revenues since they have long contracts in place.
History: Having a history of over 20 years in the business, coupled with a strong management team, allows for a certain amount of safety, expertise and confidence with operations.

Financials:

Revenue: Consistently growing over time, with a 6% increase in rental income, year over year in the latest quarter. These have been driven by contractual rent increases and new properties entering into operations.
Operating Expenses: In the first three quarters of 2023, NHI incurred total operating expenses of $195.3 million. When compared to the same period in 2022, this is an increase of 7.87%, which can be a cause for concern if growth of revenues lag behind expense growth.
ROIC: Return on Invested Capital (ROIC) has varied across the recent periods, but for the latest quarter, is at 11.1% on an annualized basis, a level that implies value creation if the weighted average cost of capital is lower than this.
FFO: Funds from operations (FFO) remains a significant metric, which has increased 7.4% per share year over year.

FFO is a key financial metric used by REITs to measure income generated from property operations.

Net Income: The company had a net income of $107.8 million in the latest quarter, representing a significant decrease from the $154.2 million that it earned during the same period last year.
Leverage: The company’s debt-to-EBITDA ratio has reached 5.7, as compared to the previous quarter of 5.6, which is still under control, but the company should keep it from rising rapidly.

Moat Rating: 2 / 5

Limited Moat: NHI’s moat is primarily based on the economies of scale stemming from its large portfolio of specialized healthcare properties. The size of its portfolio can be considered a moat, since a new entrant would need a huge sum of capital to create an equivalent size portfolio, but, since REITs are popular investment vehicles, this would not be impossible. Furthermore, it lacks a unique business model, where anyone with enough capital can simply build similar buildings and rent them out. Also, it relies on third parties for operations, so the company doesn’t have control on the efficiency and profitability of those operations.
Lack of Pricing Power: The company has a limited power to raise prices because the increase in rents is determined by their contracts with the tenants rather than by their own decisions.
Switching costs: For tenants, the costs to switch locations could be high for them in terms of capital as well as operational costs. This makes it unlikely that the company will be easily displaced, but not strong enough to make it a dominant force.
No network effects or strong brand: The company is not a technology company and does not have a strong brand. This makes it difficult to create a truly dominant moat.

Risks to the Moat and Business Resilience:

Interest Rate Risk: Rising interest rates can increase the company’s cost of borrowing, which would impact returns and increase the debt burden. This directly impacts its profitability as a borrower and its cost of operations. Furthermore, an increase in borrowing rates would make its own equity offering less appealing to investors and make it difficult to raise capital in the future.
Tenant Financial Stress: If a major tenant experiences financial difficulties, this could lead to nonpayment of rents or a facility closing, negatively affecting NHI’s revenues and profitability. If any of the major tenants become unviable, this would cause a significant decrease in the business.
Changing Regulations: Changes in government healthcare policies can affect the reimbursement rates for operators, reducing their profitability and ability to pay rents, which would further hurt NHI.
Economic Downturn: Economic recessions may lead to lower occupancy rates as residents cut down on spending. A downturn in the economy could make it difficult for patients to pay for these services.
Tenant Dependence: Since the company uses a small number of large operators, it increases dependence and also causes loss in business if that operator isn’t able to perform well.

NHI’s performance is closely linked with that of their operators. If any operator encounters financial problems, or suffers from a downturn, then NHI would be significantly impacted.

Reliance on Debt: The company uses debt to fund operations, and this could make it more susceptible to economic downturn.

Understandability: 3 / 5

The company’s operations are straightforward: they acquire real estate, lease it out to operators, and collect the rents from them.
The complexity arises in the accounting standards and the many different type of contracts that the company has with the operators.
The company relies on long term relationships, a detailed knowledge of the healthcare industry, and a keen eye to not buy real estate that is overvalued. These would be hard to understand for the average investor.

Balance Sheet Health: 4 / 5

The company has been maintaining a comfortable amount of liquidity. The cash in hand is sufficient enough to cover short-term obligations.
Debt levels have been consistently stable, and under management limits. Although, a rise in leverage can make it more sensitive to economic changes.
The company is good at utilizing equity.
Current assets significantly outweigh current liabilities, which would allow the company a good cushion in times of volatility.
Overall, the company’s balance sheet is considered relatively healthy, but some risk remains.