Sleep Well at Night with the Highest Paying Health Care REIT

NEW YORK ( TheStreet) -- The issue facing investors today is to find stocks that can give you the best total returns in any economic environment? It can come in the form of dividends, or growth of course, but perhaps right now we can have both. Sort of like having our cake and eating it too.

However, as dividend seeking investors, we are more focused on the income component -- the essence of a "sleep well at night" value proposition. Today investors are looking for the strongest repeatable sources of income while also focusing on a fundamental policy of principal preservation.

REITs offer that combination: A unique asset category that provides reliable and sustainable income and strong potential for capital appreciation. Accordingly, with all of the uncertainty investors' face, REITs could offer a safer haven.

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

Omega Healthcare Investors ( OHI), a pure play nursing home company, is the highest paying health care REIT. The Maryland-based company invests principally in long-term healthcare facilities. Omega has a market capitalization of $2.573 billion with a current dividend yield is 7.67% and year-to-date total return of 27.93%.

The company owned or held mortgages on 460 skilled nursing facilities, assisted living facilities and other specialty hospitals with approximately 51,117 licensed beds located in 33 states and operated by 47 third-party healthcare operating companies.

I had an opportunity to catch up with C. Taylor Pickett, CEO of Omega Healthcare Investors, (he has served in this capacity since 2001). Pickett is also a director and has served in this capacity since 2002.

Thomas: What does the Affordable Care Act mean for OHI investors?

Pickett: The Affordable Care Act will have a minimal impact on patients in skilled nursing facilities. The vast majority of SNF patients are already covered by Medicaid and/or Medicare.

Thomas: Omega invests primarily in long-term, healthcare facilities (97.3% skilled nursing). How will Medicare cuts impact your tenants -- skilled nursing operators?

Pickett: If there are SNF Medicare cuts, then our tenant operators will have reduced revenue. A 1% Medicare cut would reduce our cash flow to rent coverage ratio by approximately 0.03. The potential 2% sequestration cut would reduce our rent coverage ratio by 0.06. Our current trailing 12 month rent coverage ratio for the period ending June 30 is 1.58. Our operator coverages provide significant cushion to absorb rate reductions. Importantly however, this is not the case for the industry as a whole.

Thomas: Omega has a well-balanced portfolio of 460 facilities, 47 operators, in 33 states. How do you intend to expand and what geographic markets are most attractive?

Pickett: Omega will continue to expand by allocating capital to our existing tenants and, to a lesser extent, allocating capital to new tenant relationships. Omega will also look to strengthen market positions in our existing geography.

Thomas: Your largest operators are Communicare (11.4%), Sun (11.1%) and Airamid (7.9%). Do you believe these three operators will be impacted with revenue cuts? Do you see any operators in your portfolio that are concerning?

Pickett: All of our large operators continue to perform well. Assuming rate cuts, if any, are not draconian, then all of our operators should continue to do well. As I mentioned earlier, there is a large portion of the SNF industry that would not be viable if rates were significantly reduced.

Thomas: Your company's occupancy rate is around 84% and it has been fairly stable. Do you expect to maintain that number, or potentially increase it next year?

Pickett: We expect our operator's occupancy to remain stable.

Thomas: I consider rent coverage to be the most important metric for your sub-sector. Today Omega has an enviable coverage ratio of 1.58 EBITDA. Is that sustainable?

Pickett: We expect that our cash flow to rent coverage ratio will remain above 1.5, assuming no Medicaid or Medicare rate cuts. I mentioned earlier that a 2% Medicare rate cut reduces coverage by 0.06.

Thomas: Omega has sound financial fundamentals (leverage at 4.8 times). How do you intend to utilize your balance sheet in the future?

Pickett: We expect that Omega will continue to maintain a conservative balance sheet with debt to EBITDA leverage of 4 times to 5 times.

Thomas: Omega has the highest dividend yield (7.7%) in the healthcare sector. In my opinion, partly due to under-valuation and also due to higher risk assets. How would you describe your company's value proposition?

Pickett: I believe that our equity is undervalued. However, the SNF industry is very cyclical, with cycles typically driven by investor views on reimbursement risk. We happen to be in a cycle of high perceived reimbursement risk.

Thomas: Omega has increased its dividend by 14.2% in 2010, 13.1% in 2011, and 9.3% in 2012. Is this growth sustainable?

Pickett: Our investment strategy has remained the same for the last 9 years and we have delivered great financial results. The strategy has not changed and there are many industry opportunities. We are optimistic about our future growth prospects.

Thomas: Do you see trends of skilled nursing customers to transition into in-home services? If so, could this be problematic for your tenants/operators in the future?

Pickett: In-home services have grown dramatically over the last decade. During the decade, SNF occupancy has remained stable, while patient acuity in SNFs has gone up. Our view is that the care delivered in the SNF setting cannot be delivered less expensively in the home. We believe in-home services and SNF care are compatible versus competitive settings.

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.