Why is Universal Health Realty’s dividend so high?

Universal health reality (UHT -0.91%) has a very impressive dividend history and currently offers an attractive dividend yield of 6%. Before you jump in, though, there are some good and bad things you should know about this real estate investment trust (REIT).

First the good stuff

Any company that manages to increase its dividend for 38 consecutive years is doing something right. You simply don’t create a record like this by accident, and it shows a real commitment to returning shareholder value by increasing dividends, in good markets and bad. Universal Health Realty’s incredible record of annual dividend increases is probably one of the most attractive features of this REIT.

Image source: Getty Images.

Another thing to love about Universal Health Realty is its focus on medical properties. Generally speaking, medical care is a necessity, not an option, giving the property niche a solid foundation. Additionally, with the baby boom generation entering retirement, a time when higher medical needs are quite common, there will likely be a boost in demand for the types of properties this REIT owns. In this sense, Universal Health Realty has a strong focus, about 70% of its portfolio, on medical office space located near or even on the grounds of hospitals. These are the types of properties that doctors like to be in and generally provide easy access for patients.

Meanwhile, the REIT’s dividend was $0.715 per share in the fourth quarter of 2022, compared to funds from operations (FFO), which is essentially profit for REITs, of $0.90 per share. This amounts to an FFO payout ratio of around 80%. That’s not exactly low, but it still leaves room for downside before there’s a dividend cut. In fact, Universal Health Realty increased its dividend last November. And the dividend yield is currently at the upper end of the range of stock returns over the past decade, so the stock also looks historically cheap.

UHT chart

UHT data from YCharts

So far, the story here seems pretty desirable. But there are some company-specific issues to consider that cloud the picture.

The bad news

The most pressing issue today for investors is likely Universal Health Realty’s FFO decline. In the fourth quarter of 2021, the REIT’s FFO reached $0.93 per share and, as noted, it was $0.90 in the last stanza of 2022. A decline of $0.03 per share is not much – that’s roughly a 3% decline – but highlights a larger trend. For the full year 2022, Universal Health Realty’s FFO came in at $3.54 per share, down from $3.69 in 2021. That’s only a 4% decline, but again, things are clearly moving in the wrong direction.

Part of the reason for this is that Universal Health Realty is dealing with some issues at the property level. Leases have ended without renewal for the tenant, leaving him with some vacant properties. This will be a delay in performance until he can either sell the assets or release them. Thus, it appears that 2023 is unlikely to be a recovery year for FFO, which may actually get worse before it gets better.

The REIT also entered into an asset swap with its largest tenant. While this will likely turn out to be a net positive over time, it highlights an interesting fact about this landlord. Universal Health Realty is managed externally by Universal health services (UHS -0.18%) which is also its largest tenant. This raises the conflict of interest issues that tend to worry investors in the REIT sector. If you are not comfortable with this arrangement, this healthcare REIT is definitely not for you.

The final factor investors should consider is that the most recent dividend increase was approximately 1.4%. That’s a somewhat paltry increase, although it seems realistic given the decline in FFO in 2022. But the average annual increase over the past three years has been 1.4%. In five years it was 1.4%. And over the past decade, the average increase was… you guessed it, 1.4%. This is not even enough to keep up with the historical growth rate of inflation. So the historically high yield may not be as attractive as it seems, as the purchasing power of the dividend has declined over time.

Overall, this reliable dividend payer has some pretty significant negatives to consider along with the positives. After all, it’s not shocking that investors would be unhappy with the stock today. In fact, a better question might be why investors were so bullish a few years ago that yields hit a low point in the 2% range.

Probably not worth it

Looking at Universal Health Realty’s pros and cons, even the 6% dividend yield offered today seems too low. The vacant properties, potential conflicts of interest given that its biggest tenant is also its outside manager, and minimal dividend growth over time just don’t add up to a screaming buy. Perhaps if the yield was 10%, a level it has reached in the past, this REIT would be attractive. But right now, even with an impressive record of annual dividend increases, dividend investors can probably find more attractive alternatives.

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