A Real Estate Stock With Healthy Potential

Unless you've been living in a cave, sleeping on a crate of canned food and a pillow of gold bullion, you know that the U.S. real estate market continues to weaken. Moreover, expecting the government housing plan to put a floor under residential prices looks unrealistic, at least to this Fool.

That said, I started wondering whether there might be some investment gems buried among the rubble of hard-hit companies like General Growth Properties (NYSE: GGP  ) and St. Joe (NYSE: JOE  ) . To find out, I used the Motley Fool CAPS stock screener to search for five-star-rated real estate companies with market caps greater than $500 million. The screen turned up the following names:

Company

Real Estate Sector

Geographic Focus

Dividend Yield

Jones Lang LaSalle (NYSE: JLL  )

Diversified

International

4.6%

National Health Investors (NYSE: NHI  )

Health-Care Facilities

U.S.

8.4%

Omega Healthcare Investors (NYSE: OHI  )

Health-Care Facilities

U.S.

8.5%

Data from Motley Fool CAPS and Yahoo! Finance as of Feb. 26, 2009.

Having assigned the maximum five-star rating to only three companies, the CAPS community seems to share my sentiment that the real estate market in general has a ways to go before it is brimming with bargains. However, if you're attracted by the prospect of substantial dividend income, plus modest capital appreciation, you may not have to wait for further market decline to confidently snap up shares of Omega Healthcare.

Triple-protected
Structured as a real estate investment trust (or REIT), Omega owns or holds mortgages on 255 health-care facilities, the overwhelming majority of which are skilled-nursing facilities. Omega leases to property operators on "triple-net" terms, meaning that the operator is responsible for insurance, taxes, and capital expenditures. This structure transfers the bulk of operating risk (including the risk of rising costs) to the facility operator, allowing Omega to sit back and collect fixed lease payments that include annual increases.

A recent UBS study of 50 U.S. REITs, which assessed company financial health on the basis of interest coverage (the ratio of earnings to interest expense on debt) and payout ratio, ranked Omega at No. 2 overall. Other metrics support this favorable take. Omega's debt load comes in at a low 3.2 times adjusted EBITDA, and the company doesn't have to repay any maturing bonds until 2014. Although 2008 was a big acquisition year for the company, management has taken a conservative approach for 2009, choosing to focus on the capital needs of current operators.

Unlike HRPT Properties (NYSE: HRP  ) , which cut its dividend back in January, or Simon Property Group (NYSE: SPG  ) , which chose to pay the bulk of its most recent dividend in stock, I think investors can expect a solid cash payout from Omega going forward.

Right place at the right time
In addition to competent management and a strong financial position, Omega appears well-positioned to benefit from external trends. According to the Medicare Payment Advisory Commission, skilled-nursing facilities represent the lowest-cost setting for a number of common patient services, as compared to long-term acute care hospitals and other facilities. Given that rising health-care costs have been compounded by a sinking economy, this statistic would seem to represent steady, if not increased, demand for Omega's facilities.

Simple demographics further support the bullish case. Forecasting out to 2050, the U.S. Census Bureau predicts an ongoing rise in the percentage of the population age 85 and above. Although I hope that my octogenarian years consist of nothing less pleasurable than toting my longboard to the beach every day, hey, I admit that I might be in need of some skilled nursing when I push 90. Surprisingly, the expectation of longer life and greater medical needs contrasts with a historical decline in the number of nursing facilities in operation.

At the end of the day, Omega appears well-positioned along the supply and demand curve.

Inviting Uncle Sam into your portfolio
Omega's "triple protection," we need to recognize, is not an absolute guarantee on revenue. Although Omega requires operators to demonstrate strong credit profiles and submit security deposits, an extended financial problem for an operator could impact its ability to make lease payments. And because operators rely on Medicare and Medicaid for reimbursement (in addition to private payment), potential changes to government health-care policy could crimp operators' income as a group, thereby hampering Omega's ability to raise lease rates without pushing their operators into financial distress.

In fact, at the start of the year, the Medicare Payment Advisory Commission advised freezing payments for skilled-nursing facilities in 2010. Asked about future payment issues on the recent conference call, Omega management expressed, apparently quite coolly, a wait-and-see approach. I'm guessing that there is an inside information track here, and I intend to keep researching this point.

Whatever the nature of current policy developments, an investment in Omega is a significant bet on the current and future status of government-sponsored health care. I certainly do not expect the government to put patients out on the sidewalk anytime soon, but even so, I believe it is prudent to view Omega as a stable income vehicle, more than a beaten-down growth player itching to roar back to life.

Not crazy about this REIT? There are plenty more to choose from:

Fool contributor Mike Pienciak does not hold shares in any company mentioned. Jones Lang LaSalle is a Motley Fool Hidden Gems recommendation. The Fool’s disclosure policy won't melt in the rain.


Read/Post Comments (2) | Recommend This Article (13)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 05, 2009, at 7:25 PM, RenoChang wrote:

    Why not just NHI? Look at the dang balance sheet - NHI has 100M in cash, nearly no debt, and should present much better opportunities than any other REIT play. If it goes below $20 (hey, when ya gotta sell, ya gotta sell), I'd take advantage of the opportunity and buy the darn thing!

  • Report this Comment On April 07, 2009, at 6:33 PM, XMFWhatsmyoption wrote:

    Mike, nice series on OHI, thanks for sharing. I sold OHI last year, see this for details http://www.fusioninvesting.com/2008/08/omega-healthcare-inve...

    With the big drop today, down 9% to $13.94, I've started looking into OHI again and your two articles were worth reading.

    I'll keep my fingers crossed for sub $12 on panic.

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