Health Care REITs – Are They Healthy For Your Portfolio?

A few weeks ago, we discussed the great potential (and tax advantage) of investing in the Best Canadian REITs. As of the beginning of 2011, REITs were almost only the only investments able to keep their income tax advantage of distributing their revenues before paying taxes. In a time where bonds and GICs pays very little interest, REITs seem a very interesting option. There are different ways to invest in REITs as each of them have their own specialties:

– Commercial buildings

– Important shopping malls

– Smaller, strip shopping malls

– Health Care properties

I’m taking a look at the latest category, the Healthcare REITs. I wanted to know if it was interesting to invest in a specific real estate field.

What is the difference of investing in Health Care REITs

Health Care REITs are no different than other REITs in a sense that they manage properties and strive to yield a high payout to their shareholders. The main difference is that health care REITs are required to pay about 90% of their taxable income in dividends. Therefore, they become very limited in their financial moves (while investors are pretty happy to receive a high yield dividend payout on their shares!).

The Future Looks Bright for Health Care REITs

At first glance, the health care property management field seems promising to me. I’m thinking; people are aging, they will need more health care facilities, health care REITs will surely be able to grow. In fact, I think that there is a definite opportunity for any company operating in proximity to health care (pharmacy, pharmaceutical, health care REITs, etc.).

Health Care REIT Concerns

But then, I went a little bit deeper in my analysis. This is when I found a few glitches in the high yield paradise of health care REITs.

a) Payout ratio

Receiving a high payout is always fun. However, the party may end faster if the high payout is combined with a high payout ratio! At a 90% payout ratio and more (you can see some financial stats of health care REITs at the bottom of this post), it’s like putting handcuffs on the management teams. They are left with no margin for error.

b) Sensitive to interest rates

Health care property investments require a lot of funds. Since health care REITs give most of their profits to investors, they have no other choices but to finance expansion (if any) through equity and debts. This put them in a very sensitive situation regarding interest rates hikes. As we are still in a low interest rate environment, this is not a problem… for now!

c) Growth Potential

Here again, low liquidity, high debts, I’m wondering if you can really believe in growth when you invest in health care REITs. I see little to no growth for most of them because of their unique financial situation.

d) Legislation

I found out that Health Care REITs can’t operate health care facilities by themselves. This is why they act as owners and hire third party firms to handle property management. This legal situation puts them at risk since they don’t have the complete control of their assets; the health care properties.

e) Where is the Dividend Growth?

By looking at the table at the end of this article, you will notice that dividend growth is very shaky for health care REITs. I find these stats pretty hectic while some REIts show positive dividend growth over 5 years while other showing double digit cuts in their dividend payouts.

Health Care REITs Final Thoughts

I think Health Care REITs can be somewhat useful in a balanced portfolio that is seeking revenues. The biggest advantage of Health Care REITS is the fact that they pay very high dividends (usually over 5%). Therefore, it doesn’t hurt to hold one REIT in your portfolio. However, since I am young and am looking for capital and dividend growth, I will not buy any Health Care REITs anytime soon.

If you want to take a look at some health care REITs, I’m leaving you with my usual dividend analysis template (numbers only):

Health Care REITs Analysis