A Health Care REIT With Healthy Dividends

03/04/2009 10:57 am EST

Focus: REITS

Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters, editor of Morningstar DividendInvestor, and analyst David Rodziewicz find a REIT in the health care area whose dividends appear to be pretty safe.

Health Care REIT (NYSE: HCN) concentrates on medical office buildings (MOBs) and senior living, which contribute about 26% and 66% of revenue.

The company targets MOBs near hospital campuses or affiliated off-campus properties, both of which are more desirable than unaffiliated stand-alone properties. In senior living, HCN attempts to vertically integrate by obtaining properties that offer multiple levels of care, [reducing] the incentive for patients to switch care providers as their needs change.

A high senior-living and MOB concentration has the added benefit of reducing Medicare- and Medicaid-reimbursed patient mix, which is vulnerable to government reimbursement cuts. In addition, private-pay senior living and MOB patients tend to pay higher rates for the same services, generating greater profitability for HCN’s tenants and potentially higher rents for HCN.

[Also], HCN leases properties to a diverse group of relatively stable tenants. The company’s top five tenants account for 28% of revenue, and no one tenant exceeds 7%, reducing the risk that one tenant bankruptcy would materially affect portfolio performance.

Additionally, tenant rent coverage remains stable, and nearly 87% of properties are master leased, which further contributes to stability by preventing tenants from vacating one property without violating contractual agreements at other properties with the same owner.

Senior living operators are often highly leveraged, making them more susceptible to weak economic conditions. Also, about one-third of tenants’ revenue comes from government sources; [so] a negative change in reimbursement rates could affect tenant profitability significantly.

Furthermore, nearly $1.1 billion in projects are scheduled to deliver in 2009 and 2010. These properties are likely to come on line while economic headwinds are at their greatest, reducing initial returns on those investments. Our high uncertainty rating reflects this risk to our fair value estimate of $50, of which about $20 represents the net present value of development projects.

Medical spending growth has averaged in the mid-single digits, which should continue as the population shifts towards an older demographic, increasing demand for HCN’s health-care space in the long run.

HCN maintains a strong balance sheet and should be bolstered by long-term tail winds in health-care spending. HCN’s ratio of debt/property at cost is 45%, and the company has ample liquidity to meet its $600 million in development and debt maturity commitments in 2009 and 2010.

Unlike many of its real estate investment trust peers, we think conservative HCN is structured for reliable shareholder income.

While HCN is geared to pay out most of its funds from operations (roughly 80% to 90% this year) to shareholders, we believe cash collections from existing properties will continue to provide a reliable cash dividend.

Though we expect trend-line 2% to 3% dividend growth to persist in the near term, with a pause in growth not out of the question, we expect HCN’s dividend growth to accelerate toward 4% to 5% in the long run. (It closed above $29 Tuesday, yielding 8.8%--Editor.)

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