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No. of Recommendations: 43
Hey, guys...I haven't been around for a few weeks, and wanted to make a contribution. I wrote the following to share a new REIT idea with you. New REITs are often problematical, but this one now has a 2-year track record - and they've done pretty well. If interested, read further...

Medical office buildings (MOB) are a hybrid of healthcare and office property types; these buildings are, of course, leased to physician groups. Distinguishing features include low sensitivity to recession, low cash flow risk due to longer-term leases with a stable physician tenant base, modest upside when leases roll over, and slow growth of new supply. Changes brought about by Obamacare include pressure on doctors’ earnings and increased space demand due to an influx of new patients. Preferred assets are those located on a healthcare “campus” or affiliated with a strong healthcare organization.

There are a couple of fairly well-known players in this space, including Healthcare Realty (HR) and Healthcare Trust of America (HTA), with market caps of about $4B and $5B, respectively. I don’t follow either very closely. The “Big 3” healthcare REITs (HCN, VTR and HCP) each have a significant presence in the MOB space, but they are much more diversified and their MOBs comprise only about 15% to 19% of their gross assets.

This week I learned of a fairly new MOB REIT, which has piqued my interest: Physicians REIT (DOC). DOC went public in July, 2013 at $11.50 per share. It’s a smallish REIT, with a current market cap of about $1.1B; it specializes in MOBs (about 85% of GLA at the end of Q1, with a lesser exposure to hospitals and LTACs (6.8% and 7.8%, respectively)). It is led by CEO and President John T. Thomas, who was previously Executive VP – Medical Facilities Group for HCN. Jeff Theiler, who was the senior healthcare REIT analyst at Green Street Advisors, has recently joined DOC as CFO.

The company’s strategy is “to acquire, selectively develop, own and manage healthcare properties that are leased to physicians, hospitals and healthcare delivery systems.” Their competitive advantage is that ownership of these properties is very fragmented, and smaller acquisitions in which the “Big 3” healthcare REITs would have little interest can really “move the needle” for DOC. They have been buying properties in established markets, with good quality tenants, at cap rates averaging close to 7% (vs. sub-6% for the Big 3).

DOC is growing rapidly and has a substantial acquisition pipeline (they expect to acquire between $500MM and $700MM in properties this year). They can do so without stretching the balance sheet, as their debt was only about 15% of total assets (at book value) at the end of Q1; they will add debt as they close their acquisitions this year, but intend to maintain a conservative balance sheet and are seeking an investment grade rating so that they can borrow for longer terms at low interest rates. I am expecting CFO Theiler to keep them on this low-leverage course.

Equally as important, DOC’s stock trades at a premium to its book value of $12.33 at the end of Q1; thus they can raise additional equity capital accretively. Properties are acquired both off market and, occasionally, via an open bid process; they have a modest competitive edge here, as they are flexible with respect to property management (often allowing the seller to manage the acquired property). I have not, of course, seen any of the properties in person.

FFO per share was $.20 in Q1, and AFFO (per DOC’s own calculation) was $.18. These run rates don’t cover the current $.90 dividend, but (based on what I was told by Mr. Theiler) if they are successful in reaching their acquisition targets the dividend will be covered by current cash flows by the end of this year.

DOC is seeking to interest dedicated REIT investors and other institutions in the stock. Mr. Theiler believes that they will be successful due to the fact that DOC is now a $1B+ REIT and has an interesting growth strategy with, now, a strong 2-year track record; DOC stock has easily outperformed both HR and HTA over the past two years.

I believe that DOC is a very interesting newcomer to REIT world and a promising investment. Although I don’t invest on the basis of dividend yield, I do look at it. The current yield is 5.6% and should be supported by free cash flow by year-end. The fact that the stock trades at a premium to NAV is both good and bad – good as it allow the REIT to raise equity at accretive prices to continue its rapid growth, but bad as we are not able to buy the stock at an NAV discount. Like a handful of other rapidly-growing REITs, the stock is difficult to value on an NAV basis. I have just made a modest investment in this REIT and hope to add if management performs well. The stock is presently trading at $16.04 (ex-dividend), well below its 2015 high in late January of $17.85. But, year to date, the stock is down only 3.4%, outperforming both HCN and VTR.

Negatives and risks include higher-than-average overhead costs as a percentage of assets (typical for smaller REITs), inability to meet acquisition targets, a drop in the stock price to below book value or NAV (which would impact DOC’s acquisition strategy), failure of a major tenant, or an unexpected and substantial supply of new MOBs. Also, remember that healthcare REITs tend to sell off more substantially when investors and traders become fixated on interest rate and bond yield increases.

Ralph
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