High-Yield Specialty REITs: There’s More to Real Estate Than Residential

The residential real estate sector is still mired in the massive deleveraging process that helped spark the Great Recession. But real estate is a broad realm that offers income-oriented investment opportunities beyond traditional residential and commercial real estate.

Real estate investment trusts (REIT) are the rough equivalent of mutual funds for real estate holdings. In contrast to mutual funds, many REITs are not merely passive holders of their portfolio of properties; they are also involved in their operation.

REITs are structured as “pass-through” entities, which means that they avoid taxation at the corporate level as long as they distribute at least 90 percent of their profits to unitholders. REIT distributions include components such as dividends derived from operating income, capital gains distributions from the sale of properties, and the return of capital.

As a result, REITs typically boast sizable yields. But it’s important to note that their favorable tax treatment at the corporate level means that the dividend portion of this distribution is subject to taxation as ordinary income.

Traditional office, retail, residential and industrial real estate comprise the four major REIT sectors. But there are niche categories of REITs that specialize in real estate ranging from medical office buildings to timberland.

Health Care REIT (NYSE: HCN) manages a $13 billion portfolio of nearly 900 health care real estate properties that span everything from senior living communities to inpatient and outpatient medical centers.

The REIT has been on an acquisition spree for the past two years, spending close to $7 billion on acquisitions and development during that period. Health Care REIT’s $2.4 billion acquisition of Genesis HealthCare’s skilled nursing assets in a sale-leaseback transaction in early 2011 added some concentration to an otherwise diversified portfolio—its new tenant now accounts for roughly a fifth of its portfolio. Meanwhile, Health Care REIT’s acquisitions during the third quarter were focused on private-pay senior housing assets and medical office buildings affiliated with health systems.

The company leases the majority of its properties on a triple-net basis, meaning that tenants are responsible for insurance, maintenance and taxes in addition to the rent itself. Although its tenants could be adversely impacted by the government’s shifting reimbursement policies, the increased demand of an aging baby boomer demographic should offset much of that risk. Additionally, the tight supply in skilled nursing should also provide its tenants with stability.

Health Care REIT’s funds from operations (FFO)—a REIT metric similar to earnings per share—grew 13 percent during the third quarter from the year-ago period. The REIT currently yields 5.3 percent and the company’s board recently approved a 3.5 percent increase to its dividend for 2012.

Plum Creek Timber Co (NYSE: PCL) manages 6.8 million acres of timberland holdings in the US and harvested roughly 15 million tons of timber in 2011. As the world proceeds further into the digital age, lumber assets have been adversely impacted by a secular decline in paper demand. But Plum Creek’s timber harvesting operations could stand to benefit from a significant decline in Canadian pine supply over the next five years.

And management believes that roughly 1 million acres of its holdings are of sufficient quality that they can be sold for recreational use or developed. The company has also enjoyed some success in selling less valuable holdings to fulfill conservation efforts by state governments and nongovernmental organizations.

Plum Creek’s shares yield 4.6 percent, but some analysts are concerned that it’s become increasingly reliant on sales of timberland to cover its dividend. Even so, the company’s third-quarter earnings increased 56 percent to $50 million from the prior-year period.