RBC reportNorthWest Healthcare Properties
Significant runway for growth: Closes on A$2B JV and Hospital Morumbi acquisition
Our view: Northwest Healthcare Properties REIT ("NWH") continues to grow the size/scale of its international real estate presence at a significant pace. Herein, we comment on two important transactions officially completed during the last two weeks, our favourable view on portfolio progress, the inherent platform value of the business, what we see as opportunities for deleveraging, and other matters. Increasing our price target by $0.50 to $12, we reiterate our Sector Perform rating. Key points: Closes on A$2B JV; an important endorsement of NWH's platform which should also assist in reducing cost of debt capital – On Sep-21 NWH officially seeded its new A$2B, institutional JV. Backed by a single, large SWF, the JV’s mandate is to acquire and develop high quality core healthcare real estate (hospitals and related MOBs) in Australia. NWH is the investment, property, dev't and asset manager, for which it is entitled to earn base and performance fees. Upon further reflection, we see the sovereign wealth fund’s commitment as a major reputational endorsement of the NWH platform and the REIT’s investment thesis with respect to healthcare real estate globally. We believe sovereign wealth fund’s commitment is likely to have a favourable “halo” effect for NWH in that it may spur other institutional investors, pension funds and the like to seek investments with NWH. Also, as part of the transaction, the JV also entered into a new A$500MM Loan Facility to support growth. With the 70% backing of the large SWF, we believe the JV may have access to a materially lower cost of debt capital than NWH overall and relative to many Australasian listed and private industry participants. This low cost of capital should enhance the JV’s competitiveness in acquiring properties over the four-year investment period.
FX rates likely to have an adverse impact on Q3/18 NAV/unit – Continuing the trend from H1/18, we expect erosion in BRL, Euro, NZD, and AUD (versus CAD) to clip Q3/18 NAV/unit by ~$0.60/unit. We provide the "math" and a more broad discussion of FX exposure herein. Opportunity for leverage reduction – We believe the capital markets broad preference is for listed REITs with leverage in the 25%-45% range. We estimate NWH’s Q3/18 D/GBV is ~60% (proportionate). Herein, we comment on what we see as an opportunity for NWH to raise equity to de-lever on an essentially NAV/unit and AFFO/unit neutral basis.
Price Target +$0.50 to $12; Sector Perform rating reiterated – Acknowledging what we see as good progress on the growth/ diversification/scale of the international property portfolio and in recognition of NWH’s growing “platform” value, our revised price target increase reflects an expected 5% premium to NAV/unit one-year hence versus NAV-parity formerly.
Investment summary Evolving into a global owner-manager-developer of MOB's and healthcare real estate; significant runway for growth – NWH has become a global owner, manager and developer of medical office buildings (MOBs) and private sector healthcare real estate. The needs-driven nature of patient visits to MOBs means that tenants are relatively unaffected by the ebbs and flows of the general economy. Thus, we view this as a defensive asset class. With a leadership position in Canada, NWH has identified three international regions for growth in its healthcare real estate portfolio: 1) Brazil – a high-growth albeit potentially higher-volatility market where NWH owns hospitals which are subject to long-term inflation-indexed NNN leases with experienced operators; 2) Continental Europe (Germany and the Netherlands) – fragmented markets where NWH is working to establish firstmover advantage by building scale (similar to Canada 10 years ago); and 3) Australia and New Zealand (“Australasia”) – an established market with consolidation opportunities and inflation-indexed NNN rents, where NWH’s exposure is via its ~25% stake in NZX-listed Vital Healthcare Property Trust and its 100% stake in Australia REIT.
Building an increasingly valuable fee-based asset management platform – Adhering to "best practices" in organizational and operating structure, NWH features fully internalized asset management and property management platforms. Hence, all value-creation accrues directly to unitholders. This asset management company also generates significant asset management fees (~$34MM on a TTM basis) and earnings (~$21MM of TTM FFO).
A multi-regional capital allocator – Not all property markets move synchronously and there are varying attributes to healthcare real estate across the regions in which NWH operates. Relative to most TSX-listed REITs, we believe NWH’s geographical breadth and several strong institutional relationships provide unique capital allocation flexibility/ opportunity through which to drive returns. Currently NWH is generating ~33% of proportionate NOI from Canadian MOB's and the 67% balance from Hospitals, MOBs and other healthcare real estate in international markets. Across the platform NWH is executing upon several higher-return development opportunities (Australasia) and over time, we expect more in this regard in Australasia, Canada and Brazil.
Higher-than-peer financial leverage – NWH’s Q2/18 D/GBV ratio (proportionately consolidated) was ~62%, including all convertible debentures as debt (5 series; $287MM par value). While gearing remains well above the sector average (~48%), NWH seems intent on bringing debt levels down over the midterm.