Over the long term, health care REITs have been one of the best investment vehicles in the market. A relatively high dividend yield combined with price gains have provided investors with solid returns for nearly 20 years. For the 11 health care REITs that we follow, the total returns (inclusive of dividends) in 2006 ranged from a low of 26.8% to a high of 52.5%, beating most every market index. One of the best recent years was in 2003, when the total returns ranged from 22.1% to 153.5%, with six of the 13 REITs posting returns in excess of 50%.
This year, however, is shaping up to be one of the worst this decade. Just in the month of June alone, all 11 health care REITs suffered price declines, ranging from 1% to 15%, with six of them dropping by 10% or more in the month. By the end of June, every health care REIT was down for the first six months of the year, ranging from a drop of just 2% to 30%. And so far in July, seven of the 11 have dropped a bit more. Out of 15 different REIT sectors, health care REITs rank second to last in total return year-to-date (includes dividends) with a weighted average return of -10.7%, according to Morgan Keegan. To highlight the abrupt change, health care REITs ranked second out of 15 REIT sectors in total return in 2006. And, the current average dividend yield for health care REITs is 200 basis points higher than the average for all the other REIT sectors combined.
Why the sudden change? The simple answer is rising interest rates. But the reality is that they have not risen so much to have this large an impact, and they have not had the same impact on the other REIT sectors. Health care REIT fundamentals are still strong, the seniors housing and care industry is still in good shape, and, in something that health care REITs don’t talk about much, the theoretical value of any seniors housing and care properties they have purchased from 1995 to 2004 has increased dramatically because of a combination of the increased cash flow (in most cases) and the significant drop in cap rates over the past three years. Unless, of course, they overpaid for the properties originally, something that everyone has been guilty of at one time or another.
The more complicated answer may be that investors are seeing a top in the seniors housing and care market, and have thus concluded that we are at a top in the health care REIT market. While we do not think that most investors in health care REITs get this analytical, and associate the two, there may just be a gut herd mentality going on here, especially after the strong returns they made last year. This over-reaction from investors appears to have resulted in a buying opportunity, especially with the attractive dividend yields in place. That won’t be the case if interest rates jump in the second half of 2007, but not many economists have been predicting that of late. Another issue may be that investors think that private equity firms have been crowding out health care REITs, and will continue to do so, for the most attractive and large acquisition targets. The purchase of Manor Care by The Carlyle Group could certainly be looked at as symbolic of this attitude. But then Carlyle may end up selling some of Manor Care’s real estate to REITs to pay off the acquisition debt. There is certainly no panic right now, but 2007 is shaping up to be one of the worst years for health care REITs this decade.
