As the compelling demographics of an increasing aging population suggest, healthcare REITs have been a growing industry whose growth should continue. The healthcare REITs own everything from nursing homes to medical offices, yet fewer than 10% of medical properties are owned by these companies. With M&A activity heating up in the group, is this an attractive industry for investors?

TUTORIAL: 20 Investments: Real Estate Investment Trusts (REITs)

Getting Bigger
When Ventas (NYSE:VTR) announced its all-stock deal for Nationwide Health Properties (NYSE:NHP), Ventas was creating the largest owner of assisted living in the country. The deal was for $5.7 billion, and followed a year that saw acquisitions in the sector reach $11.25 billion in 2010. Last year's major deal was HCP (NYSE:HCP), which bought HCR Manor Care for $6.1 billion. Ventas made four other deals last year in the run up to its major buy of NHP. Questions are whether a bigger healthcare REIT, in this case Ventas, is a better one, and whether this trend of consolidation is the friend of investors.

Scale and Protection
Debra Cafaro, CEO of Ventas, described the buy of NHP as a strategy to lower the debt of Ventas and to strengthen the balance sheet.The addition of NHP will also reduce a worrisome risk in the industry: tenant concentration. This could provide better protective diversification to Ventas' portfolio of properties. Of course with a more massive business entity, the earnings add on will accrue, but ultimately it's clear the investment yields will go down. (For more check out our Earnings Quality Tutorial.)

Where the scale with a diversified property portfolio works to dampen risk, outright size is going to make growth rates, derived from the spread of borrowed capital versus its invested return, eventually diminish. Weighed against this, though, is a stronger company with an overall lower cost of capital. So investors should get a bigger, stronger, though likely a less vigorously growing Ventas going forward. (Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality, check out Investors Need A Good WACC.)

Acquisition Candidates
The small and mid-size healthcare REITs are the obvious candidates to be acquired. Some that have been mentioned are Omega Healthcare Investors (NYSE:OHI) or Universal Health Realty (NYSE:UHT). REITs that have done deals and may do more might include Health Care REIT (NYSE:HCN), though it's important to understand that this is just speculation and logic, there's nothing known to be imminent.

Healthcare REITs Appeal
Investing in a healthcare REITs rather than, for example, a biotech stock with an unproven product pipeline, has a certain appeal. Healthcare REITs are ideally a source of steady, stable income. Ventas pays a 4.4% dividend, which is fairly representative of the industry average of 5.2%, though many of the healthcare REITs pay even more.

There's also a chance of capital appreciation, though earnings growth is not always robust. Yet, consider the demographic elephant in the room, that the population over the age of 65 is expected to add roughly 70 million boomers in the coming years. While risks include possibilities for less government reimbursement, the overall growth of potential of this industry is hard to deny. Institutional investors are coming aboard; these companies deserve a look from individual investors, too. (Find out why funds from operations is a superior measure of REIT performance, read How To Assess A Real Estate Investment Trust (REIT).)

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Tickers in this Article: VTR, NHP, HCP, OHI, UHT, HCN

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