WHY THIS IS THE TIME TO INVEST IN HEALTHCARE REITS

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Never before in world history has such a large—and wealthy and entitled—population moved into their golden years, as presently in the United States.

Throughout world history, “old age homes” have been synonymous with straitened circumstances, or even poverty. But the 76 million people born in the US from 1946 to 1964, and additional immigrants now in their senior years, are, if anything, better financially off than younger cohorts, and generally entitled to Medicare benefits to boot.

Stating the obvious, spending on healthcare is hardly discretionary, especially for those with silver hair. Whatever dollars or resources on command the oldsters have, healthcare and related outlays will get top consideration.

That said, investing in health care is hardly a turkey-shoot. Some medical treatments will be replaced by better and cheaper ones, and other healthcare enterprises will fail. Practitioners and providers may strain under slow-paying insurers or government cutbacks.

But there is a way to get financial exposure to the tsunami of healthcare dollars in decades ahead that is somewhat insulated from the market and regulatory turmoils: Property rented to medical enterprises, such as hospitals, senior living facilities, or outpatient treatment centers.

Medical facilities, in general, must be near major population centers, and the rent must be paid, by contract and lease. Owning properties rented by the healthcare sector is an excellent manner to capture the upside and avoid much of the risks.

There are 16 healthcare real estate investment trusts (REITs) traded on Wall Street that own portfolios of medical properties that pay dividends to shareholders, and that over time, generally appreciate in value.

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WHAT SHOULD POTENTIAL INVESTORS UNDERSTAND ABOUT HEALTHCARE REITS?

First, healthcare REITs, like all listed REITs, pay out 90% of their taxable income to shareholders, in the form of dividends. In essence, REIT shareholders collect rent from the healthcare industry.

More broadly, healthcare REITs own and develop healthcare-related real estate, usually farming out management and operations to industry experts and providers. REIT-owned facilities include senior living communities, hospitals, medical office and outpatient facilities, life science R&D properties, and skilled nursing facilities.

The healthcare REITs generally rent their facilities out through “triple net” leases. This lease structure requires the tenant to cover maintenance, real estate taxes, and building insurance—thus, a lot of the variable risk is pushed onto the lessees. Because of that, healthcare REITs collect a predictable stream of income.

Like any investment, there are risks associated with healthcare REITs. The big one is tenants do not pay, but in general, REITS lease to large commercial tenants with good credit ratings who honor contracts.

There is the risk of oversupply and lower lease rates, but in general new construction in the US is becoming more tangled in red tape, not less. Plus the main target population, particularly seniors, is growing, not shrinking.

There is also interest-rate risk for all REITs. Higher interest rates will both make rival bonds more attractive to investors, and raise REIT borrowing costs. Healthcare REITs, like nearly all REITs, grow on borrowed money.

That said, higher inflation (often the cause of higher nominal interest rates) will lessen the drag of existing debts (as revenues rise with inflation) and also tend to limit new competition. And historically, REITs have outperformed the S&P 500 in times of higher inflation, reports the National Association of REITs, or NAREIT.

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THE THREE BIG REASON TO BUY HEALTHCARE REITS

1. RECESSION RESISTANT

To state the obvious, healthcare spending is largely non-discretionary, perpetual, and in the US often financed by the government or employment-connected insurance. So, people who need to go to a doctor, hospital, or medical facility do so, and moreover, often have only minor or no financial incentive not to.

And as mentioned, healthcare REITs are largely insulated from what vicissitudes exist in even this steady marketplace, by leasing facilities to creditworthy tenants. There are risks in any investment, but healthcare REITs are about as risk-free as the private sector can get.

2. AGING AMERICANS

Almost all residents need healthcare, especially older residents. And American is aging: The number of Americans ages 65 and older is projected to nearly double from 52 million in 2018 to 95 million by 2060, and the 65-and-older age group’s share of the total population will rise from 16% to 23%, according to the Population Reference Bureau.

It is better to be in a growth industry than not, and America’s healthcare REITs are perched in front of a tsunami of demand.

In addition to the general aging of the population, there will be a spike in some of the oldest age categories. “The number of adults ages 85 and older, the group most often needing help with basic personal care, will nearly quadruple between 2000 and 2040,” recently advised The Urban Institute.

3. PANDEMIC EFFECTS

While the 2020-2022 pandemic had mixed results for the healthcare REIT industry, the long-run impact is likely to be positive. Although too soon to make bold predictions, in general, Western governments will likely recognize the need to bulk up medical facilities and bed capacities in the event of future pandemics.

Senior-living facilities have faced challenges in the pandemic as customers stayed away, even as certain compliance costs rose, as did wages due to labor shortages. But given the set-in-stone demographics, and the eventual conclusion of the pandemic, such hurdles will likely recede into the past.

OTHER ASPECTS OF INVESTING IN HEALTHCARE REITS

On the plus side, REITs in general and healthcare trusts, in particular, can add ballast and diversity to the investor’s portfolio. Indeed a 2019 study from Tilburg University found that healthcare. REITs do in fact boost portfolio diversity.

In general, the empirical analysis implies that investors are able to reach desired diversification benefits when healthcare REITs are added in a mixed-asset portfolio,” concluded the study, entitled, The Role of Healthcare Real Estate Investment Trusts in a Multi-Asset Portfolio.

In brief, not only do individual healthcare REIT stocks offer generally good reward-to-risk ratios but adding such REITs to a portfolio tends to boost the overall reward-to-risk profile.

Healthcare REITs pay dividends, at an average of a little more than 4% in 2021, reported NAREIT.

By the way, healthcare REITs returned a total of 20.6% in appreciation and dividends in 2021, a solid return despite it being a challenging year in which the pandemic boosted a variety of health and labor costs, yet also kept customers away from some medical facilities, especially in senior care.

With prospects for higher interest rates in the 2020s, there will be some pressure on healthcare REIT shares, since many investors buy REITs for the predictable dividends. On the other hand, about of higher interest rates may also present a rare buying opportunity.

A FEW HEALTHCARE REITS TO CONSIDER IN 2021

1. CARETRUST REIT (CTRE)

CareTrust primarily owns and leases out skilled nursing, seniors-housing, and other healthcare-related properties, nationwide. The $1.7 billion market-cap CareTrust is excellently poised to gather business from the gaining demographics of America and owns 191 triple-net leased facilities across the country, with a good geographic spread.

Despite being in the right place at the right time, CareTrust shares have roughly traded sideways on Wall Street for years, although shareholders have been rewarded by solid dividends since the REIT was listed on the Nasdaq eight years ago.

The REIT’s dividend yield tops 6%, and dividends could be hiked in years ahead, particularly after pandemic issues ease.

There are reasons investors earn such a high yield, and that is due to some risk in CareTrust shares. Credit-rating agency Fitch in 2021 rated the company’s credit at “BB+” which is considered a speculative-grade, but with a “stable” outlook. CareTrust, like many REITs, has borrowed to make acquisitions, and then ran into higher compliance and labor costs during the pandemic.

Nevertheless, the REIT has maintained its dividend and plans to shed some less-desirable assets, as management has explained in recent earnings conference calls.

In addition, CareTrust has kept net debt to recurring operating EBITDA (earnings before taxes, interest, depreciation, and amortization) well under “Fitch's 5.0x negative rating sensitivity,” said the credit-rating agency. In other words, CareTrust can likely handle its debt loads.

For investors who like yields and are willing to wait for appreciation, CareTrust is worth a look. With interest-rate concerns and geopolitical tensions, a buying opportunity may present itself.

2. MEDICAL PROPERTIES TRUST (MPW)

One of the largest owners of hospitals and other medical facilities, Medical Properties Trust has 438 properties in its portfolio, with 43,000 licensed beds, primarily in the U.S. and the United Kingdom. It rents the properties out through “triple net leases,” in which the tenant pays property taxes, insurance, and maintenance.

The REIT pays a 5.5% dividend, and shares have roughly traded sideways on Wall Street for the last two years.

Moody’s gave Medical Properties Trust a “Ba1” Rating in late 2021, considered one notch below investment grade, but with a “positive” outlook.

The REIT does have large exposure to a single tenant, Steward Health Care System LLC, and medical facilities, in general, have been challenged by the pandemic environment. Medical Properties Trust has borrowed heavily over the years to make acquisitions but has also consistently raised dividends.

Of 14 Wall Street analysts who covered the REIT in early 2022, eight had “hold,” “underperform” or “sell” ratings.

Still, for investors looking for dividends in the post-pandemic outlook, Medical Properties Trust is an intriguing option. The REIT’s profits rose in 2021, a pandemic year.

While rising inflation may raise nominal interest rates, and increase this REIT’s new borrowing costs, the higher prices and revenues will also decrease the drag or burden of existing debts. This REIT could pay great dividends for many years to come.

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3. COMMUNITY HEALTHCARE TRUST (CHCT)

This REIT primarily owns acute-care and outpatient healthcare services facilities in target non-urban sub-markets throughout the U.S. The REIT owns 153 facilities in 33 states and has a market cap of about $1 billion.

In its six years as a listed public REIT, Community Health Trust has steadily raised its quarterly dividend from just under $0.37 to just under $0.44. The REITs current dividend yield is near 4.1%.

In the fourth quarter of 2021, the REIT posted an increase in adjusted funds from operations (or AFFO, a REIT metric that is akin to adjusted EPS for non-REITs) to $0.61, up 8.9% from $0.56 a year earlier, and achieved that increase in a tough, pandemic year.

Despite a good track on income growth and paying dividends, Community Health Trust earned only a “B-” rating from Fitch in late 2021, a non-investment grade mark considered “highly speculative.”   Like all REITs, CommunityHealth Trust borrows money to make acquisitions and thus is leveraged.

Perhaps of interest, in 2021 ratings-agency Fitch reported that Community Health Trust had completed “two transactions that Fitch determined were distressed debt exchanges in June 2018 and December 2019.” Yet the REIT also managed to keep paying rising dividends to shareholders. Fitch also said the REIT has been improving profit margins and shedding assets to pay down debt.

Like other healthcare REITs, Community Health Trust may face higher interest rates in coming years, and that will tend to suppress share values—and this after the REIT’s stock has already traded mostly sideways for four years.

However, as experienced investors know, the time to buy is not when the sun is shining and financial clouds chase over the horizon. Given the inflation outlook and geopolitical tensions, a contrarian investor might place a bet on CommunityHealthcare Trust.

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THE BOTTOM LINE: WHAT ALLIANCE CAN DO FOR YOUR INVESTMENT FUTURE

Alliance Group offers investors pathways into owning the most secure yet solid-yielding and appreciating real estate in the country.

Historically, Alliance Group has earned a long-term  21% internal rate of return for investors, easily topping average results for stock and bond investors.

Alliance Group is co-invested with our investor partners on every deal and combs the national real estate market for the best triple-net leased properties possible.

Are you looking to learn more about Alliance Group? If so, contact us today!

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