In my search for attractively valued investment opportunities, my attention has been drawn to real estate investment trusts (REITs). I have been interested in diversifying my portfolio and gaining exposure to real estate by investing in REITs, especially those that consistently grow their dividends. However, as a value-oriented dividend growth investor, I would prefer not to pay the premium valuations that the highest quality REITs often command. Fortunately, over the past two months there has been a strong sell-off among REITs, mainly due to fears of rising interest rates when the Federal Reserve tapers its quantitative easing. As a result of the sell-off, many REITs are now trading at attractive valuations, motivating me to look more closely at what is available.
I decided to focus my research on healthcare REITs; that is, companies that own healthcare-related properties such as skilled nursing facilities, senior housing, medical office buildings, and hospitals. A major reason for this decision is that many of these specialties, such as skilled nursing and senior housing, are likely to benefit from the aging population in the U.S. The figure below (taken from an HCP presentation) shows the projected U.S. population growth of individuals 65 years or older until 2050. This strong demographic trend bodes well for healthcare REITs.
NAREIT, 5 are on the Dividend Champions, Contenders, and Challengers list for having at least 5 consecutive years of dividend growth. These REITs are HCP (HCP), Health Care REIT (HCN), National Health Investors (NHI), Omega Healthcare Investors (OHI), and Universal Health Realty Income Trust (UHT). In the remainder of this post I will compare some quantitative data from these REITs.
Properties: The table below shows the percentages of properties in different categories owned by each REIT.
Dividends: The table below indicates the current dividend yield, the 5-year historic yield (from Morningstar), the payout ratio (based on funds from operations, FFO), the dividend growth streak in years, and the 5-year dividend growth rate (DGR).
HCP and UHT are both Dividend Champions, having increased their dividends for more than 25 consecutive years. In my research I discovered that HCN froze its dividend from mid-2000 to early 2004, NHI cut and then briefly suspended its dividend in 2000 and 2001, and OHI suspended its dividend from 2001 to late 2003. Even though NHI and OHI have re-established decent dividend growth streaks, those past suspensions are worth keeping in mind. Regarding DGRs, OHI has done very well in recent years; HCN and NHI have been decent; HCP and UHT have been weak.
Balance sheets: The table below provides some information about debt and credit (taken from NAREIT) and Value Line safety ratings if available.
Valuations: The table below indicates the current price of each stock (as of August 7, 2013), the P/FFO ratio (which is more appropriate to use for valuing REITs than the P/E ratio), the current and historic P/B values, Morningstar stars and fair value estimates if available, and Dividend Discount Model (DDM) fair value estimates. The DDM estimates used the 5-year DGR and a discount rate equal to the current yield plus the 5-year DGR. The margin of safety (MoS) reflects the percent discount of the current price from the DDM fair value estimate.
Summary: Of the healthcare REITs briefly surveyed here, there are two that I consider to be more attractive investment opportunities than the others: HCP and OHI. Regarding HCP, I like its long dividend growth track record, low payout ratio, relatively high credit rating, fair valuation, and good property diversification; however, I dislike its weak dividend growth rate. It is considered a "blue chip" REIT partly because it is "arguably the best-diversified landlord in healthcare" (according to Josh Peters of Morningstar). Regarding OHI, I like its high current yield, relatively high dividend growth rate, low payout ratio, and fair to undervaluation; however, I dislike its lower credit rating, past dividend suspension, and lack of property diversification. It is considered a "pure play" REIT because of its focus on skilled nursing facilities, offering more risk but possibly more reward than others. Brad Thomas, a REIT industry expert who writes for Seeking Alpha, has favorable opinions on both names and wrote a recent article on OHI.
Thus, if I were to invest in a healthcare REIT, then I would likely choose either HCP or OHI. I have also been looking at non-healthcare REITs. Two of the more popular names among dividend growth investors are Realty Income (O) and Digital Realty Trust (DLR). I consider O to be a well-run blue chip REIT with a solid dividend growth record, but I desire a better valuation. I consider DLR to be undervalued despite strong recent growth, but it has a higher risk/reward ratio than other REITs due to its technology emphasis. I will continue examining these and other names as I explore the REIT space. Note that if I decide to invest in a REIT, then it will likely be in my Roth IRA because REIT dividends would be taxed as ordinary income in my taxable account.