The healthcare REIT sector offers an object lesson in the economics of supply and demand.

The laws of supply and demand, which includes factors such as unemployment, consumer confidence and technology, apply as much to real estate as to other sectors of the economy.

One way to think about supply is to consider the amount of inventory that’s available for rent. When there is a reduced amount of inventory and a growing demand for renters seeking that inventory, conditions become most attractive. In order to take advantage of the cyclical nature of the housing sector, investors must understand the driving forces – the levers – that control these two primary forces.

The Rising Demand for Health Care

Health care demand in the United States is at an all-time high. The 75-and-older cohort is growing over six times faster than the rest of the population, and according to the U.S. Census Bureau, the senior population is expected to grow by over 144% by 2050. (For more, see: A Guide to Residential, Healthcare and Office REITs.)

The Affordable Care Act (ACA) is also driving the demand for health care services in the U.S., as 25 to 35 million people become insured. Increased coverage will allow previously uninsured individuals to access health care and to expand utilization of services. And as health care utilization increases, demand for all types of providers will increase, including doctors and on-physician workers. That means more doctors' offices, hospitals, testing facilities and more.

Approximately 57% of ACA exchange enrollees were previously uninsured, most without coverage for two or more years. As a result of the increased health care demand, more consumers will visit their doctors more often, and doctors will need more support staff and infrastructure to meet that demand. Extra personnel and equipment means more office and operating space.

Owning Health Care Real Estate

Once real estate has been designated for health care use that property tends to resist macroeconomic fluctuations because demand for health care is fairly inelastic. Steady demand for healthcare services explains why healthcare REIT shares have a better track record than other REITs during recessions.

Historically, health care REITs have been core holdings for many retail and institutional investors' portfolios, often over-weighted in long-term portfolio management practices, due to the stability of the sector. 

There are 15 Health Care REITs in the US. Most specialize in various types of property sub-sectors including: senior housing (primarily assisted and independent living), skilled nursing, medical office buildings (or MOB), hospitals and life science labs.

There are three larger Health Care REITs that derive their revenues from a broad base of sub-sectors, and we call these large-cap REITs the “Diversified Health Care REITs.” These three large cap REITs have a combined market capitalization of around $57 billion, and they have a combined portfolio of over 4,000 properties.

According to Ventas, Inc. (VTR), one of the largest Health Care REITs, the domestic environment for U.S. health care real estate remains positive as the fragmented $1 trillion industry offers significant growth opportunities for landlords.

The smaller health care REITs have also generated steady growth as most of these companies specialize in a pure play platform that provides a “circle of competence.”  By staying inside the circle, the pure play REITs have been able to generate outsized returns as evidenced by the year-to-date performance of Healthcare Trust of America (HTA), up 27.6%, Omega Healthcare Investors (OHI), up 21.6%, and National Health Investors (NHI), up 17.1%.

Scott Peters, CEO of Healthcare Trust of America explains: "HTA's dedication to MOB's has enabled us to focus all our efforts at serving our physician and health system tenants, which has led to sector leading same store growth. It has also enabled us to grow externally by more than 10% each of the last several years, while still maintaining our disciplined, rifle shot approach towards high quality acquisitions. This is tremendous for investors.”

The most meaningful metric for the REIT sector is dividend performance. While many REITs were forced to cut their dividend during the Great Recession, none of the large-cap Health Care REITs did. In fact, HCP, Inc. (HCP) listed shares in 1985, and the company has paid and increased dividends for over 28 years in a row.

Other health care REITs that have demonstrated a steady flow of increased dividends include Universal Health Realty (UHT) that has increased dividends 27 years in a row, National Health Investors 11 years in a row, and Omega Healthcare Investors, which has repeated dividends 11 years in a row.

The Bottom Line: A Prescription for Durable Income

The success of the Health Care REITs can be attributed to the limited construction activities that made the buildings more attractive to tenants. New construction starts have been modest, and favorable demographics trends should propel Health Care REITs for quite some time. Debra Cafaro, CEO of Ventas, explains: “Ventas provides consistent reliable growth in cash flows and dividends from its diversified portfolio of over $30 billion of high quality healthcare assets that are benefiting from strong demographic demand. Healthcare REITs can provide investors with both safety and growth.”

The shares of Health Care REITs have historically traded at lower multiples of free cash flow (or Funds from Operations) and at higher dividend yields (4.87%) than most other sectors. The dependability of dividends is a big reason why investors should consider buying Health Care REITs. After all, low risk income helps you sleep well at night.

Brad Thomas is the Editor of The Intelligent REIT Investor. He owns shares in VTR, HCN, HTA, OHI, and DOC.

Source: SNL Financial

Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.

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