A healthcare real estate investment trust (REIT) is a company that owns, manages and collects rent from real estate in the healthcare industry. Healthcare REITs can include medical office buildings, hospitals, life sciences research facilities, senior living facilities and skilled nursing facilities.
Healthcare REITs’ growth potential and opportunity for high dividends can offer promise for investors. However, there are some risks involved with investing in healthcare REITs. Through this comprehensive guide, investors can take an informed approach to healthcare REITs.
What is a Healthcare REIT?
A healthcare REIT is a trust that acquires, owns, manages, operates and develops healthcare-related real estate while collecting rent on it. It is a total return investment that usually provides high dividends and potential for long-term capital appreciation.
Publicly traded healthcare REITs are open to the public and grant investors dual exposure to both healthcare spending and real estate. This exposure benefits investors because real estate can occasionally diverge from the stock market, protecting it from times when the stock market suffers from price declines. REITs can include the following facilities:
- Urgent care facilities/emergency rooms
- General hospitals (acute care)
- Skilled-nursing facilities
- Medical office buildings
- Senior housing
- Psychiatric hospitals
- Research/laboratory spaces
- Various outpatient facilities
REITs can earn income through various activities, such as:
- Owning and operating a healthcare facility
- Owning the land and allowing tenants to operate the facility and handle operating costs
- Providing extra financing options in addition to standard tenant agreements
When investors invest in these REITs, they can make money through this earned income.
Triple Net Leasing (NNN) is when a REIT owns a property, but its tenants maintain it and pay insurance, taxes and other associated expenses. Investors often prefer the NNN REIT model because it frees capital and allows the REIT to expand. Landlord-tenant agreements in the healthcare industry are often long-term. Many rent agreements include steady rent increases known as escalators. Some rent escalators are connected to an index such as the inflation-indexed Consumer Price Index (CPI), while others are fixed.
There is a demand for REIT services. Healthcare business owners can often benefit more from renting a property from REITs than they would by owning property. REITs have the goal of making income on the properties, which often involves ongoing investment and property care to encourage higher rent values.
This investment creates a mutually beneficial relationship with healthcare organizations. As REITs provide care and development for their properties, healthcare organizations can save time on property management and focus on providing higher quality patient care and related services. Managing a healthcare property is a substantial responsibility. Working with an REIT who also has growth in mind can offer success for both parties.
Pros and Cons of Investing in Healthcare REITs
Healthcare REITs can provide low-risk investment opportunities with significant reward potential when investors approach them as long-term investments. However, REITs come with risks, so investors should educate themselves about the pros and cons before investing in healthcare REITs.
The healthcare system is huge and continuously growing. It is one of the stock market’s largest sectors and employers, and the demand for healthcare-related real estate is expected to continue growing. The demand for skilled nursing facilities and senior housing is expected to increase as the Baby Boomer generation ages in the coming years. Healthcare REITs that focus on these properties will benefit as occupancy levels increase and allow property owners to increase rates.
Rental rates steadily rise each year, and the healthcare industry will continue to need new properties as healthcare services expand. Healthcare will always be a necessity. However, investing in Healthcare and medical REITs can also pose the following risks:
- Tenants: Healthcare REITs rely on tenants to manage facilities and pay rent. Tenants can face financial difficulties and fail to pay rent, forcing the healthcare REIT to find a new tenant.
- Leverage: REITs borrow significant funds to acquire and manage healthcare-related real estate. This leverage decreases their financial flexibility during recessions.
- Interest rates: REITs are sensitive to interest rates fluctuations. Higher interest rates raise debt costs depending on the sector’s leverage use. Higher interest rates also present more investment options that offer a yield to income-focused investors. Increased interest rates can affect REIT stock prices.
- Oversupply: If healthcare REIT development plans build a supply that exceeds demand, the REIT could become vacant.
- Flu season and pandemics: Pandemics and other virus outbreaks can negatively impact healthcare REITs such as senior housing because outbreaks can reduce occupancy.
- Competition: The increased need for various healthcare services has created competition within the healthcare industry and among healthcare professionals. Qualified worker shortages are possible, which could force property owners to pay their employees higher salaries and leave fewer funds to pay rent on their properties.
Overview of the Healthcare REIT Industry
It’s important to consider the industry’s current state and the outlook for upcoming years. Each healthcare REIT sub-sector can perform differently under various circumstances. For example, the COVID-19 pandemic affected each healthcare sector in different ways.
Housing occupancy rates for older adults lowered due to the pandemic. Skilled nursing facilities began to experience significant staffing shortages during the fourth wave of the pandemic, partially due to uncompetitive wages, unemployment benefits and vaccine mandates. The staff shortages have forced many facilities to turn away new business.
Despite the loss of staffing and business in some senior housing facilities, healthcare REIT recovery in the senior housing sub-sector has slowed rather than completely stalling or reversing. The population of individuals requiring senior housing will likely increase in the future because Baby Boomers — the second largest generation — are reaching retirement age.
While the pandemic slightly altered outpatient healthcare delivery patterns with an increase in telehealth services and remote work, healthcare REITs faced better outcomes during COVID-19 than the hospitality industry. These factors could potentially decrease the demand for medical office building REITs in the coming years.
Acute care facilities and hospitals experienced temporary elective surgery suspensions during the pandemic, which affected budgets. However, these facilities also received relief funds. Overall, the healthcare REIT sector has a positive long-term outlook due to the aging Baby Boomer generation and the prediction for an increase in healthcare demand. Investing in medical REITs has the potential to help investors gain high dividends and capital and some risks that should be noted.