Investing in Healthcare REITs – Motley Fool

A deep dive into investing in healthcare REITs.

Matthew DiLallo

Real estate investment trusts (REITs) play a vital role in the healthcare industry. Healthcare REITs operate many of the specialized facilities that healthcare systems and other health-related institutions need to deliver the best care for patients.

Here’s a closer look at healthcare REITs. We’ll consider the advantages and risks of investing in these REITs. We’ll also explore some attractive healthcare REIT options that investors should consider.

People near a healthcare facility.

Image source: Getty Images.

Understanding healthcare REITs

Healthcare REITs own, operate, manage, acquire, and develop healthcare-related real estate. These facilities include senior living communities, hospitals, medical office and outpatient facilities, life science innovation and research properties, and skilled nursing facilities. 

Most healthcare REITs make money by leasing space in their facilities to tenants such as healthcare systems, primarily under triple net leases. This lease structure requires the tenant to cover maintenance, real estate taxes, and building insurance. Because of that, these REITs collect a very predictable stream of rental income.

Some healthcare REITs also operate the facilities they own, such as senior living communities. They typically hire a third-party manager who earns a fee for managing the property’s day-to-day operations. The healthcare REIT generates net operating income from the fees paid on behalf of patients for their housing and any services provided. The income can vary due to the impact of fluctuations in occupancy levels and rates. However, it also has more upside potential from rising rates.

Advantages of investing in healthcare REITs

Healthcare REITs benefit from the massive and growing healthcare industry, one of the largest stock market sectors. While overall healthcare spending in the U.S. declined by 2% due to the COVID-19 pandemic in 2020, it should start growing again in 2021. After peaking at $3.8 trillion in 2019, U.S. healthcare spending is on track to top $6 trillion by 2028.

That forecast suggests demand for healthcare-related real estate should continue growing. REITs are likely to benefit from steadily rising rental rates on existing properties. In addition, they should be able to develop new properties to meet the growing needs of the healthcare industry.

One of the drivers of the sector’s projected growth is the aging of the baby-boom generation. Many will be turning 80 in the coming years, making that age cohort projected to be the fastest-growing age group through 2029. That should drive demand for senior housing and skilled nursing facilities. Such growth is likely to benefit healthcare REITs focused on those properties as they report higher occupancy levels, allowing them to raise their rates.

Risks of investing in healthcare REITs 

While healthcare REITs are less risky than other healthcare stocks because of their generally stable rental income, they’re not without risk. Here are some of the risks they face:

  • Leverage risk: REITs borrow heavily to acquire and develop real estate. The leverage reduces their financial flexibility during economic recessions.
  • Interest rate risk: REITs are highly sensitive to changes in interest rates. Higher rates increase their cost of debt, given the sector’s use of leverage. In addition, higher interest rates give income-focused investors more investment options that offer a yield, which can weigh on REIT stock prices.
  • Oversupply risk: Healthcare REITs need to match their development plans with demand. Given the highly specialized nature of most healthcare facilities, REITs need to be careful not to build too much supply or it might sit vacant.
  • Tenant risk: Healthcare REITs rely on their tenants to pay rent and manage senior living facilities effectively. However, healthcare margins are relatively thin, which can cause operators to run into financial trouble if they’re not careful. That can affect rental receipts and force a healthcare REIT to find a new tenant for their facility if an operator can’t meet financial obligations.
  • Pandemic/flu season risk: Virus outbreaks can significantly affect healthcare REITs, especially those focused on senior housing. It can cause occupancy to decline as more patients check out than are admitted.

3 healthcare REITs to consider in 2021

According to the National Association of Real Estate Investment Trusts (NAREIT), 16 publicly traded REITs focus on healthcare-related real estate. That gives investors interested in the sector multiple options. A few stand out for their strong performance in recent years, including:

Top Healthcare REITs

Ticker

Market Cap

Description

Community Healthcare Trust

(NYSE:CHCT)

$1.2 billion

A diversified healthcare REIT.

CareTrust REIT

(NASDAQ:CTRE)

$2 billion

A healthcare REIT focused on skilled nursing, assisted living, and independent living facilities.

Medical Properties Trust

(NYSE:MPW)

$12.1 billion

A healthcare REIT focused on hospitals.

Data source: Google Finance and company websites. Market cap as of Oct. 25, 2021.

Here’s a closer look at these top-performing healthcare REITs.

Community Healthcare Trust

Community Healthcare Trust owns a diversified portfolio of healthcare facilities across tenant, geography, healthcare facility type, and industry segments. The company’s portfolio includes acute inpatient behavioral facilities, physician clinics, behavioral health centers, specialty centers, inpatient rehabilitation facilities, long-term acute care hospitals, medical office buildings, and surgical centers and hospitals.

The company’s diversified approach has paid big dividends over the years. The REIT has produced more than 20% annualized total returns during the past five years. As of late 2021, it had increased its dividend payment every quarter since its initial public offering in 2015. 

The factor driving this growth is a steady stream of acquisitions. Community focuses on smaller off-market or lightly marketed transactions. By avoiding a competitive bidding process, it can acquire properties at higher cap rates (the net operating income yield on the investment).  

The healthcare REIT is in an excellent position to continue increasing shareholder value. It has a conservative balance sheet, giving it the financial flexibility to acquire a diverse array of healthcare properties. Future deals should supply it with additional cash flow to continue increasing its dividend.

CareTrust REIT

CareTrust acquires and leases senior housing and healthcare properties. Most of its portfolio consists of skilled nursing facilities. However, it also owns assisted living facilities, senior living facilities, and campuses that include skilled nursing and assisted living facilities. CareTrust primarily owns net lease properties, with only three operated facilities out of its 194 property portfolio as of late 2021. That lease structure provides it with steady income.

The REIT’s strategy has paid off over the years. It has been one of the top three best-performing healthcare REITs over the past one-, three-, and five-year periods. Aside from focusing on net lease properties, the other major driver of CareTrust’s success in creating shareholder value is its investment strategy. It invests about $200 million per year, focusing on opportunities with higher cap rates. It leverages its deep industry relationships to acquire off-market and lightly marketed properties. 

CareTrust should be able to continue growing in the coming years. It had the lowest leverage ratio in the healthcare REIT sector at the end of 2020, giving it ample financial flexibility to keep making acquisitions. Meanwhile, it has a steady pipeline of investments as it leverages its relationships to find attractive opportunities.

Medical Properties Trust

Medical Properties Trust focuses on owning hospitals in the U.S. and abroad. As of late 2021, it was the second-largest non-government owner of hospitals in the world. In addition to hospitals, the REIT also owns behavioral health facilities and freestanding urgent care facilities.

The company’s focus on hospitals has paid off over the years. As of the end of May 2021, the REIT had outperformed the S&P 500 since its 2005 initial public offering (IPO). It has also outperformed other healthcare REITs during the past three-, five-, and 10-year periods and since its IPO. One factor driving that outperformance is that Medical Properties Trust has increased its dividend in each of the past eight years, including expanding it at a 5% annual rate since the end of 2018. For comparison’s sake, dividends in the healthcare REIT sector have fallen by an average of 10% over the past few years, mainly because many have reduced their payouts during the pandemic.

Driving the REIT’s growth has been a steady stream of acquisitions. The company has delivered transformative growth since 2019, acquiring $11.7 billion worth of real estate and creating an estimated $3.8 billion of shareholder value. With a solid balance sheet, growing funding sources, and a massive market opportunity, Medical Properties Trust should be able to continue increasing shareholder value in the coming years.

A unique way to invest in the healthcare sector

Healthcare REITs will be one of the beneficiaries of the healthcare sector’s continued growth. These companies should continue raising rents while benefiting from healthy occupancy levels as baby boomers age. Those features make it an excellent sector for investors to consider.

Matthew DiLallo owns shares of Medical Properties Trust. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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