Northwest Healthcare REIT

Written by Head of Research & Portfolio Manager, Jamie Murray, CFA.

We own units of Northwest Healthcare Properties REIT (NWH) in our Income Growth Fund. NWH is a globally diversified healthcare real estate investment trust (REIT) focused on owning and managing a portfolio of healthcare facilities such as medical office buildings (MOBs) and hospitals. The REIT has operations in Canada, the United States, Brazil, Australia/New Zealand and Europe (it recently divested its operation in the United Kingdom).

Healthcare assets are attractive due to the growing medical needs of an aging population and the economic resilience of healthcare spending. Medical office buildings (MOBs) cater to providers of medical services, offering features such as enhanced cleaning and sterilization protocols, upgraded HVAC and plumbing systems, laboratories and pharmacies. Hospital-like buildings are often leased to regional government health providers, ensuring stable, long-term occupancy. Also, the REIT earns management fees through joint venture arrangements. In these arrangements, NWH manages the operations and administration of property portfolios, co-owning 25-30% of the portfolio, while third-party institutional investors own the remaining 70-75%.

NWH has undergone significant restructuring over the past two years.

In 2022, NWH expanded its healthcare portfolio with the goal of growing its asset management business. However, property markets around the world began to weaken and NWH was unable to consummate deals. Compounding this issue was the use of short-term financing at variable rates. As interest rates increased, its finance expenses rose at a much faster rate than its rental income and put pressure on its profit distributions. This was a clear mismanagement of the REIT and led to a substantial decline in its unit price.

In Summer 2023, Craig Mitchell, its head of Australia/New Zealand, was installed as CEO and began the process of repairing Northwest’s balance sheet. This required a large cut to its monthly distribution from $0.067 to $0.03 per unit and the deleveraging of its capital base by selling down assets to reduce debt. Additionally, the company took steps to improve its financial disclosure and transparency.

Despite the financial turmoil of the past two years, NWH’s high-quality property portfolio has performed well.  The company has maintained high and stable occupancy rates, averaging 96% in 2024. Additionally, it has a long-term lease maturity profile (Figure 1), with only 4% of square footage up for renewal annually and more than 65% of its leases expiring post 2031. Combined with a strong rent collection rate of 99%, this lease structure is a source of stability. In addition, many of its leases include inflation-linked provisions, providing some revenue protection in the event of elevated inflation. We believe NWH’s asset base stacks up with any other REIT in Canada in terms of quality.

Figure 1. NWH Lease Maturity Schedule

As noted, NWH faced financial difficulties stemming from poor capital decisions under its prior CEO. New CEO Craig Mitchell has acted swiftly to reduce debt in his first year, as evidenced by $1.3B of property sales year-to-date. The job is almost complete. NWH has a convertible bond with a principal value of $125M set to mature in March 2025. Management is confident that it has the available liquidity to repay bondholders at maturity, with liquidity of $100M from corporate credit facilities, $200M from property currently for sale and $210M of investment securities. We estimate this refinancing could save upwards of $3M annually when completed as the interest rate on the bond is 10% versus a corporate average of 5.6%. Although many investors are concerned about the refinancing of its convertible bond in March, we view it somewhat as a formality.

By 2026, Bay Street analysts forecast that NWH’s adjusted funds from operations (AFFO) will be $0.50 per unit. AFFO, the standard cash flow metric used in real estate analysis, represents the net cash flow of the trust including maintenance capital expenditures but excluding any capital expenditures on new development or growth initiatives. This $0.50 per unit will sufficiently cover NWH’s current annual distribution of $0.36, as shown in Figure 2.

The patterned portions of the bars in the chart below represent the level of distribution per unit (a distribution is like a dividend but can have different tax implications). The solid blue portions of the bars represent NWH’s AFFO per unit. The black line represents the payout ratio, which is the distribution divided by the AFFO and is ideally below 100%, indicating the cash generation of the company can support its payout. As you can see, in 2025 and 2026, AFFO growth is projected to more than cover the distribution, with the payout ratio falling below 80%. The chart also highlights how AFFO fell below the distribution level in 2022 and 2023, necessitating the distribution cut.

Figure 2. NWH should see its payout ratio improve dramatically through 2026

As we look forward to 2025, NWH should be on firm financial footing with total debt at 54% of Gross Property Value (down from 59% in 2023) and trending lower. Its payout ratio for distribution purposes is expected to drop to close to 80% by mid-2025, compared to 100% in the past twelve months. This will provide ample breathing room for management to resume investing in the business versus putting out financial fires.

When comparing NWH to other REITs, we struggle to find another REIT with all the following attributes: a distribution yield over 7%, a payout ratio under 90% and a market capitalization over $1B. Also, analysts at CIBC Capital Markets estimate that NWH units trade at a 36% discount to their Net Asset Value (NAV), which is amongst the steepest discounts in the sector.  Comparable REITSs are trading at discounts closer to 10-20%.

If Northwest continues to improve its financial performance, we believe a yield closer to 6% would better reflect the fair value for the units. At this yield, the unit price would be close to $6.00, ~25% higher than its current price of $4.90. Moreover, as discussed earlier, there are opportunities to strategically sell more assets at higher values than implied by the market. Such accretive transactions could further improve the REIT’s AFFO.

We believe the market will start to revisit NWH in 2025, post its refinancing in March 2025 and the recruitment of a new CEO. We believe investors may find similar value to what we see today. Until then, we intend to continue accumulating shares and collecting a 7%+ dividend yield.