Healthcare, including all its components, is the largest industry in the United States; it currently constitutes around 17% of gross domestic product, and that proportion is expected to rise to over 20% by 2015, due both to growth in demand for healthcare services and the new federal healthcare act. As the ‘baby boomers’ age, they will require more healthcare services, and that will increase demand considerably, since the baby boomers are such a large part of the population. Besides investing in pharmaceuticals, healthcare delivery companies, and other health service providers, investors can take a position in this growing sector through an income-oriented instrument.
Healthcare REITs are similar to other real estate investment trusts in that they are required to pay out at least 90% of their taxable income in dividends in order to retain their tax-exempt status. As income investments, they compete with bonds, master limited partnerships, and utility stocks for investors’ dollars. Historically, REITs have yielded around two hundred basis points more than the 10-year Treasury note. With the 10-year note yielding around 3.30% today, REITs appear reasonably priced, if not in bargain territory.
The largest healthcare REIT is HCP (HCP), which has announced a major acquisition that will boost its assets by about 50% and, with the associated stock issuance, its market capitalization to around $11 billion. Other large names include Ventas (VTR), Health Care REIT (HCN), and National Health Properties (NHP), all with market capitalizations over $4 billion. At the small end, Cogdell Spencer’s (CSA) market cap is around $300 million.
Healthcare REITs own property in one or more of five sub-segments: senior housing, hospitals, skilled nursing, medical office buildings, and life sciences (laboratories). Most of the 12 publicly traded healthcare REITs have operations in at least two types of healthcare real estate. Rather than operate the properties themselves, as do other types of REITs, healthcare REITs lease facilities to operators, usually under medium- and long-term “triple net leases”, who deliver the services. Major service providers include Brookdale Senior Living (BKD), Kindred Healthcare (KND), and Five Star Quality Care (FVE). Since a 2008 change in the law, healthcare REITs are allowed to form taxable REIT subsidiaries (TRSs) to manage their properties; that could garner them a bit more profit, though the law still limits the proportion of profits that can come from TRSs.
Healthcare REITs have both public and private sources of income. Most senior living rents are ultimately paid from private insurance and savings, with little government regulation. In contrast, skilled nursing and specialty care services are paid for largely by governments. Medicare and Medicaid payments can be reduced, which could pressure rents for these properties, while the recent recession has reduced occupancy of senior living facilities as people find it more difficult to get a good price for their houses in order to move to retirement communities. The new health insurance law will probably affect the different segments in differing ways. Since around 30 million more people will have health insurance, demand for doctors’ office space should rise, supporting rents in medical office buildings. Hospitals and skilled nursing facilities should see lower bad debts. But since senior housing is largely private pay, the new law will probably have little effect on this segment.
Healthcare REIT stock prices have generally retreated a bit from their highs of last summer, though not enough to constitute real bargains. Their average yield is about 5.5%, compared with about 2% for the Value Line universe. With demand for healthcare services certain to grow at an above-average rate, this industry seems set to prosper.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.