Looking to make money investing in health and healthcare? You should be. Consider these facts:
- 10,000 baby boomers are turning 65 every day -- and will be through 2030. Those folks will need more healthcare as they age.
- The U.S. uninsured rate has fallen by almost half -- to 11% from a high of 18% in late 2013 -- as of 2015's first quarter. Folks with insurance, not surprisingly, are a lot more likely to use healthcare services.
- According to the National Institute of Diabetes and Digestive and Kidney Diseases, more than two-thirds of Americans are overweight or obese.
Put a different way, there are massive trends that should continue driving demand for health services -- hospitals, medicines, gyms, nutrition, you name it -- for the foreseeable future. It's a big opportunity to improve folks' quality of life and also make a solid profit.
That said, investing in healthcare companies is difficult. And if sorting through biotech trial data and trying to decode the jargon on analyst calls isn't your cup of tea, there's a simpler way to invest in healthcare -- and get paid with a big dividend while you're waiting for those trends to do the real moneymaking. As I dug in to look at investing opportunities in the healthcare space, one surprising company stood out to me: Realty Income Corporation (NYSE:O).
Retail is great business
Realty Income is a real estate investment trust, meaning that it's required by law to pay out 90% of its taxable income in dividends to shareholders. That's why it sports a 5% dividend yield -- a dividend that the company has raised 81 times since 1994 and that sports a healthy payout ratio of 84%. Realty Income invests primarily in freestanding retail buildings and currently owns 4,452 properties in 49 states, which it leases out to household names such as Regal Entertainment, FedEx, Dollar General, and Sam's Club.
Its triple net lease structure, which means the tenant pays for everything -- utilities, insurance, maintenance, taxes -- means that Realty Income isn't stuck picking up the tab for much of anything and can instead sit back and watch the lease money pile up. It's a good business model, especially given that 48% of its tenants have investment-grade credit ratings, meaning we can be pretty confident that these businesses will be around to meet their debt covenants and pay leases for a long time.
But what about health?
What I've described probably doesn't sound anything like a healthcare investment. Sure, maybe it sounds interesting -- who doesn't like a 5% dividend yield that's grown consistently over the past 20-plus years? -- but it's not really tied in with the big trends I highlighted.
Dig a bit deeper, though, and the connection becomes clear. Walgreens Boots Alliance is Realty Income's No. 1 tenant, representing 7.1% of square footage leased. And drugstores on the whole represent 10.7% of its occupied space, making them the No. 1 industry by square footage for Realty Income Group. Health and Fitness -- think health clubs such as LA Fitness -- are the No. 4 industry, at 7.2% of the Realty Income portfolio.
This move is an intentional one, because management has recognized the big trends driving healthcare and health services. Here's what CEO John Case had to say in the most recent quarterly call about the drugstore and health and fitness industries (quotes come from a transcript provided by S&P Capital IQ):
- "The drugstore industry continues to be an area we favor, given the aging of our population and today's healthcare trends."
- "We continue to like health and fitness given the favorable demographics supporting this industry."
Helping people live healthier is big business. And, as these health-related companies continue to grow and increase their footprints, Realty Income Corporation is a natural beneficiary. This is especially true given that the vast majority of Realty Income's building purchases -- 90% so far this year -- are based on relationships with existing tenants that then expand over time to include more leases. For example, a tenant that owns some other properties might choose to sell those buildings to Realty Income and then take the space back on a long-term lease. It's a good deal for both parties -- the tenant frees up capital to reinvest in the business, while Realty Income is happy to buy since the properties are leased out and can provide stable cash flows over a long time horizon.
Thinking more broadly
Rising interest rates are a concern for all REITs, as the spread between financing costs and the return on investment they can get on buildings they purchase is essentially their profit margin. However, Realty Income is actually reasonably insulated given its enormous size and great credit rating (its debt is rated BBB+ by Fitch), it should have an easier time accessing cheaper capital than many of its competitors. And there's always the possibility that a big tenant or class of tenants could get squeezed -- think quick-service restaurants, which represent 4% of the Realty Income portfolio and have struggled to respond to the big trends in favor of fast-casual competitors.
Nonetheless, given its broad diversification, Realty Income is well insulated from a trend affecting any one industry. But that diversification comes at a price: It also dilutes any gains Realty Income could make from a particular industry. So even though the company is in a good spot to benefit from the health and healthcare boom, it's probably not going to shoot to the moon as a result (unlike, say, those biotechs I mentioned earlier on). Taken all together, Realty Income is a solid stock for dividend-focused investors, and it's well positioned to benefit modestly from the renewed focus on health here in America.