Health care REITs offer haven for the jittery

They offer solid returns, high yields, less risk from economic downturn

Apr 21, 2008 @ 12:01 am

By Janet Morrissey

Health care real estate investment trusts may be just what the investment doctor ordered.

The REITs, which own medical office buildings, seniors residences, hospitals, nursing homes and other health-care-related facilities, have generated returns of 9.4% so far this year, ahead of equity REITs' 7.8% and the 7% decline of the Standard & Poor's 500 stock index.

They also offer a safe dividend yield, currently averaging 5.3%, which exceeds the 3.55% yield on 10-year Treasuries.

"The whole sector is seen as having less risk from the economy than anything else out there in real estate," said Jerry Doctrow, managing director at Stifel Nicolaus & Co. Inc., a unit of Stifel Financial Corp. in St. Louis.

Indeed, the group posted total returns, including dividends, of 44.6% in 2006 and 2.1% last year, outpacing equity REIT returns for the same period of 35.1% and -15.7%, respectively, according to the National Association of Real Estate Investment Trusts Inc. in Washington.

"When you get sick, you're sick and you need to go see a doctor," said John Winer, a principal with Ernst & Young LLP of New York. "People's need for health care doesn't vary greatly by economic cycles."

At the same time, demographics indicate that demand will likely accelerate for seniors' residences, assisted-living facilities and nursing homes as aging baby boomers cross into their golden years.

"The baby boomers continue to turn 60, and their demand for health care is only going to increase over time," said Jan Svec, a director at Fitch Ratings Ltd. in New York.

Health care REITs do face some risk, notably fallout from the housing crisis and government cutbacks to Medicare and Medicaid reimbursement programs. Yet the group is largely insulated from the credit crunch and recession.

One of the reasons that health care REITs are able to deliver consistent earnings growth is their long-term triple net leases with health care operators. Under a triple net lease, a tenant pays rent as well as all operating expenses, maintenance and property taxes, which lowers a property owner's risk.

"Because they have triple net leases, [health care REITs] are going to have 2% to 3% [annual] rent bumps regardless of occupancy or rent growth," said Rosemary Pugh, a senior associate at Green Street Advisors Inc., a REIT research firm in Newport Beach, Calif.

And despite the credit crunch, health care REITs have little trouble accessing cash.

"In most cases, health care REITs are trading above their net asset values, so they can issue equity. Many other REITs are reluctant to do so, because they're trading below net asset value," Mr. Doctrow said. He estimated that health care REITs are currently trading at a 22% premium to NAV on average, while equity REITs are trading at a 12% average discount.

Still, health care REITs aren't without risk.

In the late 1990s, the sector fell out of investor favor — posting double-digit losses — over concerns about government cuts to Medicare's reimbursement program, bankruptcy filings by several health care operators and other issues. The government cutbacks at the time were aimed at cracking down on waste, abuse and fraud within the health care sector but instead wound up driving cash-strapped operators into bankruptcy. The government then revamped the program and increased funding.

Government reimbursements affect nursing homes the most. Roughly 60% of revenue in the nursing-home sector comes from Medicare or Medicaid payments, Ms. Pugh said. If operators aren't sufficiently reimbursed, they aren't able to pay rent to the health care REITs that own their facility.

Medicare and Medicaid reimbursement levels currently don't pose a problem for the sector. But uncertainty looms as to how the new presidential administration will handle health care spending.

Ms. Pugh is more concerned about cuts by state governments.

"The skilled-nursing portfolios receive a high proportion of payments from state Medicaid programs, and because of their fiscal problems, states are more likely to be scrutinizing their expenditures closely," she said.

The housing crisis also poses a risk. Seniors who are unable to sell their homes in the current slump may delay moving into private-pay seniors' residences and assisted-living facilities.

Some analysts and investors speculate that the group's ability to weather an economic downturn is already priced into the stocks.

"The prevailing wisdom has been that the health care REITs are going to be more defensive, but the prices of the health care REITs have gotten way up there. I'm not sure how much money you can make," said Robert Gadsden, portfolio manager of the Alpine Realty Income and Growth Fund of Purchase, N.Y.

Mr. Doctrow concurred."You should be buying them as a safe haven and buying them for yield — not buying them for a lot of appreciation — at this point."

E-mail Janet Morrissey at jmorrissey@investmentnews.com.

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