Low US interest rates and the Patient Protection and Affordable Care Act, aka Obamacare, are likely to make health care Real Estate Investment Trusts (REITs) a very good place to be in 2013.
Starting January 2013, US hospitals will be increasingly scrutinized on how well they serve and heal their patients. Under Obamacare, for example, Medicare payments will be gradually reduced to those hospitals that are weak on key outcome metrics, such as the level of re-admisions per patient for the same medical condition.
What’s more, Obamacare will mean some 30 million more Americans will be newly insured and thus more likely to seek hospital services. And at the same time, the US population is aging, as more of the Baby Boomers enter their 60s.
This means that out of the 5,000 US hospitals, more will need to invest in personnel, technology and equipment in order to put patient care first while becoming more cost-efficient.
Enter Medical Properties Trust (NYSE: MPW). Based in Birmingham, Ala., MPW buys healthcare facilities and leases them back to the former owners. This is an increasingly popular way for medical providers—and especially hospitals—to fund things such as technology and staff upgrades, while lowering their overall operating costs. In some instances, MPW actually builds the facilities and recovers its investment through long-term leases.
MPW currently owns some 80 facilities worth more than $2 billion and leased to 21 different hospital-operating companies in 24 states. Its largest concentration is in the NY/NJ metro area, Texas and southern California.
As a REIT, MPW pays out at least 90 percent of its earnings to shareholders in order to avoid taxes. At the current rate (20 cents per share quarterly), MPW shares yield 7 percent—considerably more than the 6 percent of the typical healthcare REIT and the 4 percent of regular REITs.
We do not see the MPW’s payout as being at risk. In fact, it should rise from here due to continued acquisitions. For the first nine months of 2012, MPW invested some $780 million in purchases.
Many of the REIT leaseback deals have returns of around 10 percent, are “triple-net” leases (the lessor pays for maintenance and insurance) and they allow for annual inflation increases.
In general, healthcare REITs are perceived as being riskier because of their lack of diversification and outlook being tied to the financial health of the medical providers.
However, any changes that affect the profitability of the providers are not likely to have a material impact on healthcare REITS, unless the problems are so severe that they cause a default. MPW’s clients are well-established hospital operators, many of them with award-winning facilities.
What’s more, only about 1 percent of US hospitals close in any one year. Most hospitals have been around for decades and have close ties to their communities making closure or relocation unlikely.
MPW also does not fund or own any medical office buildings, outpatient or assisted living facilities, which have traditionally been the focus of healthcare REITs and are more likely to suffer economic downturns.
An added benefit for investors: as a REIT, substantial portion of MPW’s dividend is not taxed because it’s considered a return of capital to investors. In 2012, for example, MPW will pay out 80 cents per share: 47 cents are untaxed as return of capital; 30 cents are taxed as ordinary income; and 3 cents are treated as capital gains.
REIT payouts did not benefit from the Bush-era tax cut on dividend income, which is likely to be phased out. So the tax playing field is likely to be leveled again, and perhaps tipped in favor of REITs, since a big chunk of REIT payouts is considered return of capital.
MPW is a small stock (market capitalization is just over $1.5 billion). And it is smaller than many of its competitors, such as Health Care REIT (NYSE: HCN). But it has a much higher growth rate.
For the first nine months of 2012, MPW’s funds from operations (FFO) came in at $85.5 million, up 48 percent from the year-earlier period, on revenue of $145 million, up 42 percent. FFO—earnings before depreciation and amortization are deducted—is considered a good measure of a REIT’s near-term payout ability. (See chart, below.)
In the third quarter, the company reported FFO of $0.25 per share, up from $0.18 a year ago. This was MPW’s second consecutive quarter with FFO growth of more than 35 percent.
Looking ahead, the company expects FFO of $0.90 per share for 2012 and $1.08 for 2013.
A Clean Bill of Health
Medical Properties Trust has a lot going for it: focused and consistent management, strong growth, few comparable competitors and a target market that’s about to see unprecedented expenditures.
MPW’s price may not have a lot of upside at current levels (near a 52-week high). But with a 7 percent return coming from the payout, just a bit of a price increase in 2013 will get you more than a 10 percent total return.
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Todd Johnson publishes Dividend Lab, a web site focused on income investing.