Where to find the one bright spot in the property market

With the credit crunch hitting banking balance sheets across the world, most firms have been finding loans hard to come by. But US banks have been happy to open their doors to medical groups. With ageing baby boomers seeking cheap outpatient care, and nursing homes reaching full capacity, firms building or investing in medical facilities have been able to secure large revolving credit lines, says Sui-Lee Wee in The Wall Street Journal.

It’s not too surprising that banks see them as a sound bet, even in the downturn. Around 35 million people aged 65 and over were living in the US at the turn of the century. That number will more than double by 2030. That means the queue of greying baby boomers demanding treatments will only get longer for the foreseeable future.

That’s why healthcare real estate investments trusts (Reits) have proved the one bright spot in the property sector in the past year. These firms pool money from investors to purchase, renovate and manage properties – medical office buildings, laboratories, patient outcare and nursing homes. Just like other Reits, they can forgo paying some corporate taxes on the understanding that they pay out most of their earnings to shareholders in the form of dividends.

But the big difference between a medical building and, say, a shopping mall, is that a healthcare tenant is likely to stay put for longer. Changing locations can be hard for physicians, for example, with pricey medical equipment installed in their units. And doctors tend to form strong bonds with their local hospital and patients. So while your average office lease is three to five years, says Alex Seagle in his Contrary Investor newsletter, medical office leases are routinely in the eight-to-ten-year range. Medical office sales have grown from $857m in 2002 to over $3bn last year, according to Real Capital Analytics, a real-estate research firm.

That doesn’t mean that every medical facility is worth investing in, though. Most American medical Reits pay a solid dividend – many ranging between 3.5% and 4.5%. But those sitting on remote hospitals and run-down nursing homes aren’t going to give you much value – they’ll find it harder to attract patients and therefore income.

And with the big healthcare Reits set to build $675.9m of new properties by the year’s end, from $236.5m in 2007, there’s a danger they’ll misjudge demand, warns Deutsche Bank’s Louis Taylor. That mistake cost developers dearly in the late 1990s. In the last quarter of 2007 alone, developers added 5,363 beds, even though total demand was for 3,485 units, reports a survey by the National Investment Center for the Seniors Housing & Care Industry.

So it’s far better to invest in companies who are specialising in thriving arms of the medical industry. This includes those buying up offices for medical laboratories, for example, then renting them out to pharmaceutical groups, high-end private care, or biotechnology firms looking for facilities to test their new drugs. Because just as nursing homes and hospitals will benefit from ageing baby boomers, so will the companies involved in testing the drugs and techniques that will keep them healthy in their old age. We have a look at two firms set to benefit below.

The two best bets in the sector

One small player in the medical Reit sector in the right place at the right time is Biomed Realty Trust (NYSE:BMR). Biomed largely focuses on renting out laboratory and office space to the biotechnology industry, which, as Dr Steve Sjuggerud of the Daily Wealth newsletter points out, is embarking on its next big bull market. Biomed owns, or has an interest in, about 69 properties, with about 10.4 million rentable square feet of laboratory and office space. It has a further 1.9 million square feet in development. The $1.86bn firm reported rental revenues of $50.3m for the first quarter, representing a 6% increase year-on-year, allowing it to pay out a dividend yield of 5.1%. The shares are valued on a forward p/e of 12.4.

Another specialist healthcare Reit that looks interesting is Medical Properties Trust (NYSE:MPW). The group owns 25 healthcare facilities, including long-term acute care hospitals, heart surgery centres, orthopaedic hospitals and cancer centres. Growth in these sectors might not be as strong as that seen in the biotech sector, but with a healthy dividend yield of 9.5%, you will be more than compensated. Medical Properties Trust recently invested a further $92.6m, picking up five hospitals in Southern California, after securing a $220m credit line. The stock is valued on a forward p/e of 8.6.