Cash in Hand


Why You Should Sell Health-Care REITs Now

Jeffrey R. Kosnett

This investment category's winning streak looks to be nearing its end.



If you think all beer is beer, toothpaste is toothpaste and REITs are REITs, think again. Over the past ten years, real estate investment trusts that own health-care-related properties, such as hospitals and nursing homes, have delivered annualized total returns of 19.9%, on average. Over the same period, property-owning REITs as a group returned an average of 11.4% a year, and Standard & Poor's 500-stock index was flat. Moreover, the average health-care REIT boasts a current dividend yield of 5.0%. That compares with 3.5% for the average property REIT and 2.0% for the S&P 500.

Medical REITs showed their mettle during the credit crisis of 2008 and 2009. Although prices of health-care REITs sank, the declines were not nearly as severe as for other REITs. While 20 REITs of various kinds paid dividends in stock instead of cash in 2009 and many others chopped their cash payouts, only two health-care REITs trimmed cash distributions.

Steady Tenants

The consistency of medical REITs makes sense. They are not closely tied to consumer spending, travel and job growth, so they hold up in bad times. Over the long term, hospitals, nursing homes, medical labs and assisted-living residences are solid cash generators, so they're steady tenants for the REITs that own health-care facilities.

But just as a healthy thoroughbred can pull up lame, so can a winning investment category. For the first time in at least a decade, the outlook for medical real estate is less than stellar. Avoid investing new money in the sector. And if you're sitting on big gains, consider cashing in your chips.

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What's the problem? For starters, medical REITs are expensive. As a group, they sell at record-high prices relative to funds from operations, the REIT industry's preferred method of measuring profits (FFO is essentially earnings plus depreciation). Over the years, the price-to-FFO ratio for health-care REITs has ranged from 8 to 13; today, it's about 17. Moreover, a bunch of medical REITs recently issued gobs of new stock or are planning to do so. This suggests that REIT executives may think that now is a better time to sell shares than to buy.

Investors worry about overexpansion and, as you might expect, the effects of health-care reform, particularly its impact on government insurance programs. Although it's true that "you can't throw Grandma out of the nursing home," says John Roberts, a REIT analyst for Hilliard Lyons, a brokerage in Louisville, Ky., "the major tenant is the government" -- either directly (through ownership of medical facilities) or indirectly (through Medicare and Medicaid payments).

In addition, hospital-owning REITs often expand in partnership with universities and medical schools. But state and federal agencies are often involved in financing these ventures, adding another element of uncertainty stemming from health-care reform. Some REITs lease property to facilities that rely on patients who pay out of pocket and, in theory, aren't affected by coming changes in health insurance. But this, too, isn't a sure thing. Take Ventas (symbol VTR), which owns hospitals, nursing homes and senior-housing facilities and has delivered amazing returns (31.2% annualized over the past ten years). Ventas recently paid more than $3 billion in cash, stock and the assumption of debt for the real estate assets of Atria, a chain of 118 luxury assisted-living residences, at a time when this business is struggling and overbuilt.

Ventas CEO Debra Cafaro says the deal will boost Ventas's earnings and dividends by 2012. But Atria's occupancy rate is already 87%. Rents average a stiff $4,300 a month, so it will be hard to generate much higher revenues. There's no way this buyout will be a bonanza for Ventas. With its share price elevated, Ventas has little margin for error. The same goes for all medical REITs.



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