Australian Lifestyle Property

Everyone knows that the aging baby boomers will likely create unprecedented demand for health care services. Yet a whole host of reasons — product recalls, patent expirations, thin drug pipelines, Medicare and Medicaid cuts, and uninsured patients — increase the risk of investing in health care stocks.

Investors seem to agree: The Health Care Select Sector has underperformed the S&P 500 the past three years. Volatility is high, with small changes in the industry landscape producing large swings in stock prices.

How can investors gain exposure to health care without opening themselves up to unmitigated risk?

Luckily, one such way exists. By buying shares of health care real estate investment trusts, investors can play the aging American demographic while avoiding most of the downside associated with health care services companies.

Health care REITs own hospitals, skilled nursing facilities, independent and assisted-living facilities, medical office buildings, or any type of health care real estate.

Because of federal laws, REITs cannot provide health care services, so they hire operators to perform these services. As a result, the actual residents of these facilities are not particularly important to the REIT; the trusts are more concerned about the quality of the operator, which helps determine the REIT’s credit rating.

Health care REITs were created in the mid-1980s when health care services companies spun off their real estate; most REITs have since diversified their portfolios so their parent companies account for less than half of revenue.

Like other REITs, a health care REIT must pay out at least 90 percent of its taxable income as dividends, making for hefty dividend yields of 4 percent to 7 percent.

The REIT’s revenue is effectively guaranteed by its long-term leases. Operators sign leases ranging from three to 20 years that hold them responsible for property operating expenses (utilities, insurance, taxes, etc.) and include annual 2 percent to 4 percent rent escalators.

The leasing structure also makes it difficult for an operator to break its lease. First, it’s against the law to stop providing health care services, and second, the REIT is in constant contact with the tenant and is aware if its financial condition deteriorates.

Perhaps the smartest way health care REITs reduce business risk is by lowering their exposure to Medicare and Medicaid, which are prone to government cuts.

Health care REITs have an excellent track record of investing in properties that generate returns well above their cost of capital. These firms’ return on real estate assets regularly reaches 13 percent, which towers over our REIT universe average of about 10 percent.

By HEATHER SMITH Morningstar.com

All Times Union materials copyright 1996-2006, Capital Newspapers Division of The Hearst Corporation, Albany, N.Y.

http://timesunion.com/

Posted: Friday, November 3rd, 2006 Under: Finance. | RSS 2.0 | Home |