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Are Healthcare REITs Risky Right Now?

Aug 24, 2020 by Kevin Vandenboss

Healthcare real estate investment trusts (REITs) were one of the hardest-hit REIT sectors from the COVID-19 onslaught. These REITs were hit from many directions, and some will likely never be the same again.

Some of these REITs were already facing some inevitable problems before the outbreak. Senior housing and assisted living properties have been overbuilt the past few years, creating more beds and units than are needed in many areas. Several hospitals have also been losing revenue due to an increased number of procedures being conducted in outpatient facilities.

Not all healthcare REITs are the same

Healthcare real estate encompasses a range of property types. REITs like Omega Healthcare Investors (NYSE: OHI) and National Health Investors (NYSE: NHI) primarily invest in senior housing and skilled nursing facilities. Other REITs, like Physicians Realty Trust (NYSE: DOC), focus more on properties like medical office buildings, hospitals, and other medical facilities.

While pretty much all healthcare REITs have been facing COVID-19-related challenges, the reasons vary.

Healthcare properties such as senior housing, assisted living, and skilled nursing facilities didn't suffer as much from quarantines and business shutdowns as retail and lodging REITs. Their blow came from large outbreaks from within the properties themselves.

These outbreaks not only caused a great deal of fear but also lowered occupancy rates. Many facilities had to make the choice to stop tours and limit or stop new intakes. Even facilities that were still taking on new residents saw a significant decline in new move-ins.

Facilities that would normally have residents placed after surgical procedures saw a decline as non-emergency surgeries were being delayed. Other people simply avoided moving into senior housing or assisted living out of fear of the virus.

Hospitals have struggled from reallocating resources to COVID-19 patients while putting off the surgeries and procedures that bring in the majority of their income. Even hospitals that didn't have to save space and resources for COVID-19 patients suffered from patients choosing to postpone these procedures and surgeries to avoid exposure to the virus.

Physicians, dentists, and other medical-related businesses were forced to close to prevent the spread of COVID-19. This has had an obvious financial impact on these businesses, which has caused the same issues for the REITs that own these properties as other office and retail REITs have faced.

Does this mean healthcare REITs are risky right now?

It's definitely necessary to be more cautious of healthcare REITs right now and to be selective of the ones you invest in. This doesn't mean they should all be on your list of REITs to avoid, though.

Healthcare REITs that have been preparing for changing trends and focusing on acquiring high-credit tenants have put themselves in a better position to continue growing through a changing healthcare environment.

Management teams that were quick to respond to the pandemic and make decisions to protect themselves, their operators, and residents have been experiencing a faster recovery while maintaining the health of their balance sheets.

Physicians Healthcare Trust is one REIT that has been preparing for the changes in the healthcare industry and patient care. Their approach has been to invest in more outpatient facilities, specialized hospitals, and medical office buildings since patients and providers have been demanding more efficient and affordable healthcare options.

National Health Investors is one healthcare REIT that experienced very little impact from the pandemic because their properties are all leased to operators under a triple net lease. The triple net lease model allows them to receive the same lease payments each month from their operators, no matter what has happened to the occupancy rate in the property.

The future of healthcare real estate

Even though many healthcare REITs have had a bumpy ride this year, the fact is that the industries operating out of their properties will continue to have an increasing demand. The aging population is growing every day, which means a need for more beds in senior housing and assisted living facilities. It also contributes to an increase in medical procedures and surgeries.

The industry will still thrive in the end, but not everyone will still be standing to see it. The strength of a REIT's management team is more important than ever. Knowing the best way to manage capital and debt right now will be one of the major deciding factors on which REITs will come out on top.

Being smart with your healthcare REIT investments

There are some fantastic opportunities with healthcare REITs right now, but you have to be thorough in your due diligence.

Pay close attention to the amount of debt a REIT you're looking at has taken on during the start of the pandemic. While it's normal for REITs to regularly take on debt, watch for higher debt/EBITDA ratios than previous quarters.

You'll also want to look at changes in the payout ratio. Sharp increases in the FFO payout ratio could mean that dividend cuts may be on the horizon or more shares may be sold to raise more cash. I would feel more comfortable with a REIT that made dividend cuts early on than one that has stretched themselves too thin to avoid it.

Most importantly, look at the properties and the operators. No matter how great a REIT might look on paper, they're still only as strong as their portfolio. Be cautious of portfolios that have a high percentage of rent coming from properties that are losing demand. You should also take the time to look at the operators to gauge how sustainable their business is. The operators are the ones bringing in the rental income, so their strength is almost as important as the REIT's.

The bottom line

The perfect storm of a virus outbreak, an economic crisis, and significant changes in the healthcare industry have been shaking things up in the healthcare real estate market. This has made healthcare REITs more risky in general, but it's also creating rare opportunities for the investors who take the time to understand the market and make wise choices on where to invest their money.

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Kevin Vandenboss has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Physicians Realty Trust. The Motley Fool has a disclosure policy.