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When Max OOP is out for an afternoon run through the neighborhood or avoiding elevators as I make my way through the corporate office, there are usually numbers going through my head. Instead of counting sidewalk squares like I used to, I have been trying to put that time to better use by thinking about things like my healthcare REITs.
Those of us in the early retirement/financial independence community like to do fun stuff in our free time like calculating our savings rate. We then take these savings and invest them in fancy-sounding things like the total stock market index. You may know the slogan – spend less, save more, invest the difference.
A simple version of this calculation is our gross household wages minus household expenses divided by our gross household wages. Basically, the operating margin of the household for all you CPA’s out there who are much smarter than me. Pretty easy calculation once you do it a few times. If your household makes $100,000 per year and spends about $50,000, you have a rock-solid savings rate of 50%. Congratulations, invest that $50,000 savings and you are well on the way to early retirement. You can even buy medical office buildings if that strikes your fancy.
$100,000 Gross Wages – $50,000 Expenses = $50,000 Savings
$50,000 Savings / $100,000 Gross Wages = 50% Savings Rate
When someone like Max OOP starts looking at the quarterly financial statements of healthcare REITs like Physicians Realty Trust (DOC), it is a bit daunting. They are several pages long and have confusing sounding words and acronyms littered throughout the statements. My initial focus was to completely break these statements down, look for holes, and use it to help evaluate the investment.
But sometimes, we need to take a step back and look at the basics of business. I already know how Physicians Realty Trust makes me money, but that is just theory, strategy, and words on a blog. In the end, I really need more quantitative data to prove it. Just like monitoring a household savings rate, there are three very basic concepts and things to monitor when we own a REIT; Revenue, Expenses, and Income.
Revenue is easy.
I like to compare healthcare REIT revenue to the Max Out of Pocket household’s paychecks from our day jobs. We both provide a service to two different companies, and the result of that service is our wage. If our household was a business (I basically run it like one), I could go as far as to call this our household revenue. The services we provide are diversified into two different fields; teaching math and counting healthcare beans (finance).
Healthcare REITs such as Physicians Realty Trust (DOC) offer a different kind of service. They deliver a physical space to provide healthcare services, usually on an outpatient basis. Providing and managing the physical space is their product/service, and the result is a rent check from a tenant. This rent is DOC’s main source of revenue.
So let’s take a look at DOC’s revenue from the last six quarters. The average is $103.8 million and the most recent quarter came in at about $95 million (yellow).
As you can see, due to some tenant issues, Physicians Realty Trust only grossed about $95 million in revenue during the quarter ending 6/30/2019 as compared to the $105 million in revenue they usually gross. We normally see some consistency here, but this quarter took a hit on revenue. We should see this bounce back next quarter and we might even have the opportunity to re-capture come of the lost revenue in the future that resulted from our tenant issues.
Unfortunately, Physicians Realty Trust and I, as a shareholder, do not get to keep all of that rent and revenue. That’s because there are expenses that come along with owning medical office buildings that we need to back out first.
Just like owning a traditional house, when we own medical office buildings, we are going to have expenses. Expenses resulting from things like building maintenance, interest, taxes, insurance, and administrative costs for things like paying the bills. Yes, there is a cost (time) when someone is managing a household and paying bills. I generally account for my time at about $30/hour so the more I automate in my own household the better. DOC probably has a whole department dedicated to managing the administrative tasks tied to owning 250 buildings. Think about how all the rules and regulations might vary from one state to another; someone has to figure all that stuff out.
DOC breaks their expenses into four very specific categories on their income statement, but we won’t dive too deep into those categories here.
- Interest Expense
- General and Administrative
- Operating Expenses
- Depreciation and Amortization
Healthcare REITs take a depreciation expense to represent a decrease in the value of the buildings as required by GAAP. This is an expense someone like Max OOP probably doesn’t account for in our own household because real estate generally goes up at the rate of inflation or more. I mentioned this briefly when I got ahead of myself and discussed DOC’s Funds from Operations (FFO) earlier this year.
Physicians Realty Trust’s total expenses over the last six quarters have been hovering at about $93.4 million per quarter but dropped this last quarter to $90.6 million.
Healthcare REIT Income
Income is nice for math teachers like Mrs. Max OOP because we get to use an equation. In this particular equation, we take revenue minus expenses to get our income.
Revenue – Expenses = Income
We can actually plug in our variables from above to come up with DOC’s income for the second quarter of 2019 ending 6/30/2019.
$94.9 million revenue – $90.6 million expenses = $4.3 million income
So DOC’s quarterly income for the quarter ending 6/30/2019 was about $4.3 million dollars. This comes out to a “savings rate” of about 4.48%. They usually run about 11% so this wasn’t a great quarter mostly due to our tenant issues. There is a pretty cool footnote in their financial statements that I won’t review here, but I am expecting some of that revenue to come back in a future quarter. Here is the income from the last six quarters.
Here is a nice look at the same information directly from their 2019 Q2 supplemental.
If you are going to run an experiment, it is good to understand the fundamentals. Healthcare REITs can get complex, but in the end, they run just like any other business or household. When you look at a granular business like this, it is almost easier to understand than the total stock market index. I know all the companies in the stock market are trying to make money and do a great job at it. But seeing revenue, expenses, and income in action at a company level like this is nice. Getting to touch the dividends that result is even better.
Now there are certainly more variables to consider. For example, one thing that can often impact income is the sale of a medical office building where DOC makes money on the sale. Those transactions are not included in the numbers above. But just looking at these operating numbers can give us a pretty good idea where things stand.
I have always wanted to completely dissect a company that I don’t work for, and I am doing that now. I am exposing myself to risk in doing so, but it is also just a small sliver of my portfolio. Expensive hobby? Maybe. I am staying with DOC at this point because I think management has handled the tenant issues and may even be positioned to recapture some of that revenue.
REIT Experiment Update
This is my first post on the experiment since August 6th when I discussed where I am keeping all of these medical office buildings. Since then I have invested another $2,900 into healthcare REITs through DOC. These happened through two separate transactions on 8/16/2019 and 8/30/2019. This medical office building investment is projected to net about $1,700 in dividends over the next 12 months, and in total is worth just north of $31,000. The last few transactions have been through my brokerage account since we want to see how the taxes on about $100 in dividends will hit my 2019 tax return.
I forgot to buy DOC yesterday! It was really busy at work yesterday and I was emersed in several different projects and all of a sudden it was after 4 pm and the market was closed. I usually try to squeeze this type of business in on my lunch break, but I just forgot. So I will either make an off-cycle purchase on Monday or pool the money for two weeks and roll it into my next purchase. Here is where we stand:
Healthcare REITs: Where Do We Go From Here?
I mentioned during my August update that I was likely going to slow down my coverage of the healthcare REIT experiment but continue to dollar-cost average into it every payday throughout the rest of the year. My post frequency will likely drop to about monthly. I am considering building this portfolio up to the point to where I can cover my max out-of-pocket costs in any given year with the dividends it generates. It would technically be a partial form of ‘healthcare financial independence’ and completely separate from my overall retirement portfolio. I am starting to think there might be some advantages to carving out our healthcare costs and developing a unique portfolio to deal with them. I expect we will continue to see out-of-pocket healthcare costs in the United States, even in a Medicare For All scenario.
As of today, my ‘one stock’ healthcare REIT portfolio and its $1,700 in dividends will cover about 25% of my 2019 max out-of-pocket. My 2019 max out-of-pocket comes in at $6,600 and will likely increase again in 2020 so I will need to adjust the goal at that point. As of today, our 2019 out-of-pocket costs for healthcare are holding at $0.00, not including premiums. We are lucky to be healthy.
Usual disclaimer: This is not a recommendation to buy this or any other stock/healthcare REIT. You are responsible for your own investment decision and buying a single undiversified stock like this is almost never a good idea.