Healthcare investments appear likely to grow due to increased demand as the nation ages, and also as medical advancements continue to improve quality of life and longevity. Healthcare REITs are a way to invest in this probable growth by providing income related to the leasing of property for hospitals, rehabilitation facilities, senior retirement centers and research laboratories.
Generally, REITs are chosen for income and as a real estate allocation. REITs must provide 90% of corporate income to shareholders as an ordinary dividend, which is taxed as income and not at the lower qualified dividend rate. This makes REIT income more like the income from a bond than the usual corporate stock. Also, because most of the income is being distributed, REITs generally issue secondary stock offerings when pursuing expansion.
Medical real estate is an interesting and highly specific industry, with varying niche sub-industries such as those mentioned above, among others. Leases tend to be lengthy when compared to residential property, with rent escalation often occurring at set rates. This can mean less substantial potential rate increases, but also more consistent occupancy and often more predictable future revenue stream growth.
Examples of healthcare REITs would include companies like HCP (NYSE:HCP), HCN (NYSE:HCN) and Ventas (NYSE:VTR), which are both large and highly diversified in terms of facilities and clients. While these companies attempt to have large and diverse portfolios, some specialize. For example, Omega Healthcare Investors (NYSE:OHI) primarily owns long-term care facilities, and Senior Housing Properties Trust (NYSE:SNH) primarily owns senior and assisted living facilities. Another specialist would be BioMed Realty Trust (NYSE:BMR), which focuses on high tech facilities for biotech and pharmaceutical research.
Many healthcare REITs currently pay out a yield of around 5 percent, and the above-mentioned companies all yield between 4.5 and 6.9 percent. These dividends are not all necessarily secure, as many REITs are highly sensitive to future interest rate changes, but the effect from any potential future margin compression should be somewhat short term. There are also many unknown potential issues that could change present demand for healthcare real estate. It is still quite possible that several will increase payouts this year, depending on financing rates and funds from operations performance.
Most healthcare REITs performed poorly in 2013, because REITs broadly underperformed the market along with most income oriented investments. The underperformance of healthcare REITs was also in stark contrast to the general outperformance of most healthcare investments in 2013, where the biotech, pharmaceutical, health insurance and other related industries. See a 1-year chart for the above-listed healthcare REITs: (click to enlarge; Source: Google)Click to enlarge
As the chart above shows, five of the six listed healthcare REITs declined over the last year. These companies fell by between 9 and 22 percent, over the last year, but since the start of 2014, these companies have all outperformed the broader market. So far in 2014, five of the sex companies have appreciated by at least ten percent. See a YTD performance chart: (click to enlarge; Source: Google)Click to enlarge
Despite these strong moves so in Q1 of 2014, these healthcare REITs still appear likely to outperform the broader market in the rest of 2014. If the group were to return to their year-ago prices, the portfolio would appreciate by about 15 percent. This is in addition to the dividends, as well as the potential for some slight dividend increases.
In the near term, healthcare REITs appear likely to outperform the broader market, with a greater margin of safety too. In the long term, these REITs should be a welcomed addition to a broad portfolio. For these reasons, investors should monitor healthcare REITs and consider accumulating positions on any weakness.
Disclosure: I am long HCP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.