Spiking inflation has been one of the major storylines this year. Rising prices are making many goods and services cost more money.
However, some industries are relatively immune to the impact of inflation. For example, the real estate and healthcare sectors often benefit from inflationary pressures. That's evident at Medical Properties Trust (MPW 0.53%), a healthcare-focused real estate investment trust (REIT). Its inflation-protected income stream makes it a potentially excellent hedge against inflation.
Image source: Getty Images.
Inflation-protected rental income
Medical Properties Trust is a healthcare REIT focused on owning hospitals. It leases these properties back to hospital operating companies under triple net leases (NNN). This structure makes the tenant responsible for maintenance, building insurance, and real estate taxes. That helps insulate the REIT's rental income from those inflationary costs, enabling it to generate stable cash flow.
Meanwhile, all of its leases have an annual rental rate escalation clause. They typically start with fixed escalation rates of 2% annually at a minimum. Leases eventually switch to an inflation-based escalation clause, usually at the 10-year mark.
Those inflation-linked escalators are really starting to pay dividends this year. During the first quarter, the company's normalized funds from operations (FFO) rose 12%. That's due to a combination of acquisitions and rising rental rates on legacy hospital properties. "The organic growth benefits provided by our inflation-protected leases were realized early in 2022, as average cash rents for the majority of our portfolio increased by roughly 4%," CEO Edward Aldag pointed out.
These escalating rental rates have contributed to the company's ability to steadily increase its dividend over the years. It delivered its ninth straight raise in early 2022, boosting the payout by another 4%. Aldag noted, "Our history of consistent dividend growth has no doubt been driven by accretive acquisitions, but it is equally the product of the uninterrupted and compounding annual cash rent increases that are embedded in virtually 100% of our leases."
Inflation-protected tenants
While having inflation-linked rental rate escalators is a nice feature, there're always two sides to a rental agreement. Even though Medical Properties Trust's leases give it the right to increase rents as inflation rises, its tenants have to be able to afford the higher rental rates, especially as they battle inflationary pressures on their other costs.
Aldag discussed inflation's impact on its tenants during the company's first-quarter conference call. He noted inflationary pressures on labor, supplies, food, utility, and other expenses have driven up these costs for most of its tenants. However, he said that while costs are up, "an important historical note to recognize, on a cumulative basis, Medicare reimbursements to hospitals have always exceeded inflation." Because of that, their income should continue to rise faster than inflation. That will enable them to maintain a comfortable cushion since most of the REIT's tenants generate enough earnings to cover their rent by at least two times. As a result, they should have no problem continuing to make their rental payments during this inflationary environment.
A healthy inflation hedge
Medical Properties Trust is relatively immune to inflation. Its leases protect it from the inflationary pressure of some real estate costs. While that means its tenants bear those inflationary costs, the government tends to boost reimbursement rates faster than inflation so they can more than cover their rising costs. That includes rent, which Medical Properties Trust can often increase at the inflation rate, given the escalator clauses in its contracts.
Because of these factors, the REIT should generate steadily rising rental income to support continued increases of its 6.3%-yielding dividend. Add in its ability to continue buying inflation-protected cash-flowing hospital real estate, and this REIT looks like a solid inflation hedge.
