Consider Healthcare REITs for Income

 | Dec 04, 2013 | 1:00 PM EST
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I wrote last week about the income opportunities available in some of the diversified mortgage real estate investment trusts that were heavily invested in the residential sector and that have had substantial corrections to their market prices resulting in high dividend yields.

 I'll consider today a few of the healthcare-related REITs for the same purpose. These are not buy recommendations at this point but they deserve to be tracked for potential buying opportunities within the next six months.

The market price of healthcare REITs, like the residential mortgage REITs, are cyclically-sensitive to changes in longer-term Treasury yields, specifically the 10-year. As the 10-year yield rises, the market price of the REITs declines, and vice versa.

The healthcare REITs, however, have not declined as much in price since the 10-year yield began to rise last May, as the residential REITs have.

The reason for that is because the differences in the sensitivity of improved residential and commercial real estate to the economic cycle, which I will address in a bit.

Specifically to the healthcare REITs, there is substantial support to the market prices due to the aging demographic profile of the U.S. and the passage of the Affordable Care Act.

 This support will likely prevent the market prices of the healthcare REITs from declining to levels that would provide the dividend yields currently offered by the residential mortgage REITs. But there is still the possibility of immediate further downside for market prices if the Treasury yields continue to rise.

Still, it is prudent at this juncture for income-seeking investors to become familiar with the healthcare REITs and I will return to this issue on a regular basis.

Economic expansions and contractions are bracketed by the performance of residential and commercial real estate. Expansions are led by positive performance in residential real estate, which is the largest consumption product in the economy. Once an expansion has begun, the last sector of the economy to respond positively is typically commercial real estate. As consumption increases, the demand for production to meet it increases as well. The result is the need for more commercial real estate.

The fundamental problem right now in trying to invest on such logic is the same as it is with all economically-sensitive asset classes -- determining whether a secular expansion has begun.

This has been exceedingly difficult to determine over the past five years and has caused REIT speculators and investors to have to rely on the signals provided by the bond market.

As is the case with the residential mortgage REITs I wrote about last week, when the long end treasury yields rise, the value of the REITs declines, and vice versa.

This is somewhat bizarre behavior, however. In a normal economy, one in which the Fed Funds rate is above 0 and QE is not being used, rising long end yields should be considered a signal by the bond market that the economy is strengthening. That should be positive for all real estate-related investments.

 As if that is not enough of a conundrum for investors to have to deal with, for the past five years as the Fed has intermittently implemented several rounds of QE, the Treasury yields have performed exactly opposite of the Fed's intentions; as I wrote about Tuesday.

For investors trying to make rational decisions about income vehicles, the past five years have not only been confusing, they've been downright frightening.

Watching the bond market's reaction to Fed monetary policy measures over the past five years has been a bit like watching a female bird of paradise not responding to the male bird's colorful mating rituals. But the male bird keeps trying.

  This means that the prospects are increasing for a Janet Yellen-led Fed to start trying to stimulate the economy by withdrawing monetary support. I don't know if that will happen but the prospects for such are there as the Fed now has five years and five rounds of data correlating market response to their nontraditional interventions.

For now income seeking investors should put these two healthcare REITs on their watch list; HCP, Inc. (HCP), and Omega Healthcare Investors Inc. (OHI).

They are both large and liquid with market caps of about $16 billion and $4 billion respectively. They are both profitable with dividend yields of 5.5% and 5.9% respectively. And, the market price for both has declined since the 10-year Treasury yield began rising in May, by about 35% and 8%, respectively.

They also have the lowest trailing 12-month price-to-earnings ratios of the sector, at about 18x and 23x, respectively.

Given the uncertainty of the economic trajectory and Fed policy in the immediate, however, the yields offered do not yet compensate for the potential risks to principal. 

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