Medical Office REITs Should Outperform in 2013

NEW YORK ( TheStreet) -- According to Rosen Consulting Group, the U.S. privately owned medical office market totaled about 478 million square feet in 2011. An estimated 74.2 million square feet, or 15.5%, of that total was owned by publicly traded health care real estate investment trusts.

According to the last comprehensive survey of buildings from the U.S. Energy Information Administration, the total square footage of all outpatient facilities was 1.3 billion in 2003.

With the Affordable Care Act adding around 35 to 45 million insured patients to the marketplace, the utilization of health services should increase. This bodes well for hospitals' and physicians' volume and is a net positive for hospitals and the owners of on-campus medical office buildings.

Although coverage for these additional new patients is expected to be funded in part by Medicare and Medicaid cuts to providers, the increased volume for hospitals and physicians is expected to offset any reimbursement cuts.

Medical Offices Should Become Most Favored Asset Sector in 2013

Medical office buildings (typically classified as either on-campus, for facilities located on or connected to a hospital campus, and off-campus, for facilities outside of the hospital campus) have increased in popularity because many leases are long in duration and are triple net, meaning the tenant is responsible for taxes, insurance, and common area maintenance fees.

The triple net feature allows for a more predictable cash flow stream because the building owner is not burdened with having to pay for the variable costs. Often a triple net lease will contain contractual annual rent escalations, providing the REIT with steady cash flow growth over time.

Also, physicians are increasingly attracted to medical office space on or very near hospital campuses in order to leverage hospital services and increase traffic to their practices. Additionally, some physicians are affiliated with hospital systems and require proximity to their campuses. A limited amount of medical office supply in these areas drives strength in related medical office market fundamentals and significant investment opportunities.

Hospital systems have been facing limitations on expansion and as a result, more procedures are being performed in outpatient facilities, which have lower overhead costs than hospital space. Insurance companies and government health care programs also have been formulating their reimbursement policies in order to direct patients to less costly outpatient care, as opposed to expensive inpatient procedures, driving increased outpatient surgeries and physicians' office visits.

Additionally, changing consumer preferences and increasing reliance on specialists and preventative and alternative care providers (such as cosmetic surgery, nutritionists, acupuncture) have been driving health care employment in these areas, leading to accelerating demand for medical office facilities. This decentralization of health care systems has allowed for an expanded range of patient services, as well as opportunities for medical office development and acquisition by private sector real estate owners and operators.

Two Focused Medical Office REITs to Consider in 2013

In 2011, publicly traded REITs held only 15.5% of all privately owned medical office space and a much smaller percentage of all health care-related real estate, according to Rosen Consulting Group. Additionally, private and public medical office owners, including hospital systems, may struggle with liquidity in the near term as the lending environment remains stringent and state and local governments trim their budgets. Divestiture of real estate is one way these institutions may choose to raise funds, providing acquisition opportunities for specialized real estate owners and operators.

Publicly traded REITs continue to be active buyers of medical office properties. Strong demand for properties, an increasing pool of capital and competition for assets should drive up the price of medical office properties and allow for increased liquidity for long-term holders of medical office real estate.

Today there are just two "pure play" medical office REITs, and both are considered defensive companies. Healthcare Realty Trust ( HR), based in Nashville, Tenn., has a market cap of around $2.08 billion and currently pays a dividend yield of 5.03%. Healthcare Trust of America ( HTA), based in Scottsdale, Ariz., has a market cap of around $2.31 billion with a current dividend yield of 5.34%.

In an interview on CNBC's "Mad Money" with Jim Cramer, Healthcare Trust of America's CEO Scott Peters explained:
"With 30 to 40 million more insured coming up, you want to find the most affordable locations to offer those (health care) services. Those are medical office buildings, they're on campus, and I think over the next 10 to 20 years they will be core critical real estate."

In 2013, core defensive health care REITs should also be considered as these REITs have historically recorded more positive and stable returns, likely a result of the stability and attractiveness of the medical office sector. Additionally, the advantageous tax structure and capital-raising abilities of REITs in the current environment should contribute to strong returns, as compared with private investments.

HTA listed its shares earlier this year (June 6) and the company's shares have risen more than 17% over the least 90 days. HR has returned 35.3% year to date.

At the time of publication, Thomas had no positions in securities mentioned.

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

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