Health Care REITs, an Attractive Pipeline for Dividends

NEW YORK ( TheStreet) -- With the Bush tax cuts likely to expire at the end of the year and all current "qualified dividends" (i.e., on non-REITs) soon to be taxed as ordinary income, REITs -- having always been taxed the same way -- should soon be viewed as a "level playing field" alternative. Accordingly, Obama's re-election should be viewed as a positive for health care REIT stocks with meaningful exposure to hospitals medical office buildings.

Also investors should expect rates to stay low which will make the REIT dividend that much more attractive vs. the 10-year (already lower) and corporates, and continue to provide a low cost of debt tailwind for commercial real estate and REITs.

Health care REITs are predominantly considered a defensive sector due to the non-cyclical nature -- namely, people do not tend to change their health care spending patterns depending on the economy. Accordingly, health care REITs indirectly participate in the defensive nature of their tenants through their lease payments.

Before the election, there was considerable uncertainty about the future of the Affordable Care Act. This all went away with the re-election of President Obama. As a result, health systems and doctors will now be able to move forward with the certainty they need to make major decisions such as leasing, capital expenditures, and other investments.

The Affordable Care Act is projected to add an additional 35 million to 45 million insured patients into the marketplace. These individuals are expected to increase their utilization of health services which should bode well for hospitals and physicians volumes -- a net positive for hospitals and the owners of on-campus medical office buildings.

These additional patients are expected to be somewhat funded by Medicare and Medicaid cuts to providers. In total, the increased volume for hospitals and physicians is expected to offset any reimbursement cuts. However, skilled nursing facilities are expected to face difficulties from the cuts.

Health Care REITs Should Outperform

Due to the non-cyclical demand for their product and above average costs to relocate, health care tenants also prefer long-term leases to make their expenses predictable. As investors, this serves as a defensive governor on earnings because landlords are less likely to be forced to renew leases at a time when the market is weak. Consequently, rents do not fall as much as in other real estate sectors during economic downturns and, alternatively, they do not rise as much during economic upswings.

Several health care REITs that I recommend include Ventas ( VTR) , Healthcare Trust of AmericA ( HTA), Omega Healthcare Investors ( OHI) and Medical Properties Trust ( MPW). Each of these REITs is differentiated by sector and they all provide unique operating fundamentals.

Starting with Medical Properties Trust, based in Birmingham, Ala. In a CNBC "Mad Money" interview with Jim Cramer, MPT Chairman Edward Aldag, Jr., explains his company's differentiated health care model:

"There are a lot of hospitals... the market is huge out there. There's about a half a trillion dollars of available hospital properties out there... the pipeline is huge and we think that 2013 will be another big growth year for us."

Hospitals are the focal point of the health care delivery system and that produces a more stable and predictable value proposition. As Edward Aldag, Jr. explained (on "Mad Money"):

"If you look at the history of this country we have a lot of presidents... it doesn't matter who the president is going to be. Hospitals are going to be there. Hospitals are at the top of the pyramid in the delivery system for this sector. We're going to have hospitals regardless of whether it's Romney or whether it's Obama. So we're in a very good position throughout the election and beyond."

Medical Properties Trust pays an attractive dividend yield of 7.05% -- the second highest dividend yield in the health care sector and also one of the highest dividend yields in the equity REIT sector.

Since 2004, MPT's dividend has been paid every quarter and the dividend has increased by 18.2% compounded annually since 2004. In addition, since the company's IPO, MPT has returned 53.5% (compared with the MSCI U.S. REIT Index of 42.2%) and the three-year return (to 2011) was 90% (compared with 73.9% for the MSCI U.S. REIT Index).

Omega Healthcare is the "big dog" of the health care dividend dynasty. The Maryland-based REIT has a market cap of $2.48 billion and its current dividend yield is 7.95%. As of the third quarter, the company owned or held mortgages on 460 skilled nursing facilities, distributed among 47 third-party operators, in 33 states.

Omega reported third quarter FFO available to common stockholders of $56.7 million, or 52 cents per share, compared to $44.5 million, or 43 cents per share, a year-ago. AFFO totaled $58.7 million, or 54 cents per share, up from $49.2 million, or 48 cents per share, a year ago. The company also raised its full-year guidance in its earnings report.

Omega has maintained and increased its dividend yield for more than 10 years and the year-to-date total return is 23.42%.

Ventas, an S&P 500 company, is one of the leading health care REITs today and also the largest owner of senior housing and health care assets.

Its diverse portfolio of more than 1,400 assets in 47 states (including the District of Columbia) and two Canadian provinces consists of seniors housing communities, skilled nursing facilities, hospitals, medical office buildings and other properties.

At quarter end, Ventas has a fortuitous balance sheet with around $1.6 billion in available liquidity.

Ventas's strength in liquidity should allow the company to take advantage of opportunities and be a safe haven for investors in a disrupted market.

Ventas is currently paying a 3.91% dividend yield and the company's annual dividend growth has been 10% over the past 10 years.

That dividend and dividend growth is an important component to Ventas's consistent superior total return to shareholders (year-to-date total return is 18.71%).

Healthcare Trust of America, based in Scottsdale, Ariz., is the "new kid on the block". In June HTA listed its shares on the New York Stock Exchange and the company's portfolio today consists of around 12.5 million square feet in 27 states. The market cap is $2.15 billion and the company boasts a dividend yield of 5.74 % -- almost three times the sector average.

HTA is focused almost exclusively on the medical office building sector. Within the health care sector, medical office is considered to have the lowest risk profile. It has the lowest exposure to government reimbursement. It also is driven by traditional real estate fundamentals and is not dependent upon the success or failures of a single operating company. Additionally, it allows HTA to concentrate all of its efforts on maintaining and building relationships with health systems and developers in this sector.

Health Care REITs: Attractive for Dividend Repeatability

REIT earnings suffered over the last few years as real estate operating fundamentals -- rent growth and occupancy levels -- declined dramatically. With the economy starting to recover, both rent growth and occupancies have started to improve, but REIT earnings are still low relative to a normal market environment.

Investors like REITs not just because they have strong current dividend yields relative to other income assets, but also because investors expect their operating earnings to grow strongly as the economy improves.

The health care REITs mentioned in this article offer unique operating platforms and the denominator is that they all should capitalize on the attractive tailwinds of low interest rates and the new certainty of the Affordable Care Act.

As a fixed-income alternative, REITs have become more mainstream today as the benefits for investing in these high-quality alternatives include high yields (average 15-year dividend yield is around 8%), simple tax treatment (REITs send form 1099-DIV to their shareholders, containing a breakdown of dividend distributions), liquidity (shares are bought and sold on a stock exchange), and diversification (adding REITs to a diversified investment portfolio increases returns and reduces risk since REITs have little correlation with the S&P 500).

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.