Healthcare: The Last Men Standing

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There is a much needed push to change the way healthcare is delivered in the United States. While there is, and should be, great debate about the future of the industry, there is one group of healthcare companies that will always have a special place, Healthcare real estate investment trusts.

A Changing Industry
The Obama presidency will very likely go down in history as the first time that the United States tried to address what many view as a flawed healthcare system. While there are many who disagree with the approach taken, there are few who think that inaction is the correct course. This is, then, a tipping point.

Time and politics is likely to change the current law and the healthcare industry will have winners and losers. However, healthcare will always be a hands on process. True, one can read an x-ray in any part of the world. However, a broken bone can only be mended in the location of the broken bone. Surgery can only be performed on the person who needs it. This aspect of healthcare simply can't change.

Since healthcare will always be centered around the patient in some way or form, it means that some form of building will also be needed. If you need buildings, than real estate investment trusts (REITs) will be there to own them. This makes owning healthcare REITs a great way to invest in healthcare.

Healthcare REITs
The healthcare REIT industry isn't all that large, totaling less than 15 publicly traded companies. That number is highly likely to get larger in the coming years. For example, Aviv, a large nursing home operator, reintroduced plans for an initial public offering late in 2012 after shelving similar plans following the severe 2007-2009 recession. With over 250 properties across 29 states, it is a perfect example of the type of public companies that are likely to come.

Healthcare is a perfect fit for the REIT structure. For starters, most properties are leased so that the occupant is responsible for taking care of all maintenance issues (called a triple net lease), resulting in simplified business structure and low ongoing costs for the REITs involved. Second, healthcare properties are highly specialized and tenants generally stay for long periods of time. After all it is hard to move an entire hospital. Third, by leasing a healthcare property, healthcare providers can save themselves the usually immense cost of buying or building one themselves.

The Future
Demographically speaking, now is a great time for the healthcare REIT business. Indeed, the baby boomer generation is retiring, which means there will be a huge influx of people who will need an increasing amount of healthcare. While drugs, home care, and the Internet will help reduce the need for in-patient care, increased use of healthcare facilities is virtually inevitable.

In addition, with the funding of healthcare likely to change materially, many providers that own their own facilities will likely seek to free up cash via sale/lease back transactions. In this way, the healthcare provider gets to stay in the buildings it occupies, but doesn't have capital and costs tied up in owning it. This should give healthcare REITs a notable source of growth.

Diversified Giants
Healthcare REITs generally come in two different varieties, generalists and specialists. While the latter is appropriate for investors looking to benefit from specific issues, like housing the elderly, the former provides greater exposure and a reduced risk profile. Clearly, a generalist can put money to work where it sees the best opportunities and pull money from areas that are less compelling. Every investor looking at this area should own at least one of the big generalists.

HCP (NYSE: HCP), formerly Health Care Property Investors, is one of the largest industry participants. The company's portfolio spans the country and includes properties in the senior housing, post-acute/skilled nursing, life science, medical office, and hospital sectors. Essentially, it has exposure to every institutional healthcare property market. The company has increased its dividend annually for the last 10 years, showing the resiliency of the property type. HCP's size, diversification, and financial strength haven't gone unnoticed by the market, and it is often afforded a premium valuation. That said, even with a yield only slightly above 4%, it should be on conservative investors' watch lists.

Ventas (NYSE: VTR) has tripled in size in a very short period of time. Today it has properties in 46 states and in Canada. The company owns facilities in the senior housing, skilled nursing, medical office, and hospital sectors. Recent acquisitions appear to have positioned Ventas as more growth oriented than many of its competitors, resulting in a yield just under 4%. Still, with an impressive history of dividend increases and the continued integration of recent acquisitions, the company is worth considering for more aggressive, and growth minded, REIT investors.

Health Care REIT (NYSE: HCN) is the highest yielding of the three REITs here, with a dividend yield of nearly 5%. The company has a long history of regular dividend increases. Its properties can be found in almost every U.S. state and in Canada, representing exposure to the senior housing, medical office, inpatient and outpatient medical center, and life science segments of the industry. The company recently acquired Sunrise Senior Living in a nearly $2 billion transaction, that should give management a few things to keep on top of over the near term. However, longer-term, Health Care REIT is well positioned to continue growing its portfolio and shareholder value.

Risks
There are always risks to an investment. First and foremost, like every healthcare related company, these three REITs are still exposed to the healthcare laws that are in flux today. Owning the properties should reduce the impact of any adverse changes, to some degree, but it won't eliminate the risk. Second, their yields have fallen considerably as REITs have become more mainstream investment options. So valuations should be monitored.

Still, for investors looking to enter the healthcare REIT space, it makes sense to look at a diversified giant instead of a focused specialist. As an analogy, one would get much more diversification buying Johnson & Johnson (NYSE: JNJ) than Pfizer (PFE).

While Pfizer provides drug exposure, JNJ's broad portfolio allows investors to participate in pharmaceuticals, medical devices, and consumer products. It is really an all-in-one company. That exposure and its strong operating history also, generally speaking, leaves the company's shares with a premium valuation. Just like the REITs above. Sometimes, however, the extra expense is well worth it.

Yours,

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ReubenGBrewer has position in HCP and Health Care REIT. The Motley Fool recommends Health Care REIT and Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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