Real estate investment trusts (REITs) play a vital role in the healthcare industry. Healthcare REITs operate many of the specialized facilities that healthcare systems and other health-related institutions need to deliver the best care for patients.

Here’s a closer look at healthcare REITs . We’ll consider the advantages and risks of investing in these REITs. We’ll also explore some attractive healthcare REIT options that investors should consider. Image source: Getty Images. Understanding healthcare REITs

Healthcare REITs own, operate, manage, acquire, and develop healthcare-related real estate . These facilities include senior living communities, hospitals, medical office and outpatient facilities, life science innovation and research properties, and skilled nursing facilities.

Most healthcare REITs make money by leasing space in their facilities to tenants such as healthcare systems, primarily under triple net leases . This lease structure requires the tenant to cover maintenance, real estate taxes, and building insurance. Because of that, these REITs collect a very predictable stream of rental income.

Some healthcare REITs also operate the facilities they own, such as senior living communities. They typically hire a third-party manager who earns a fee for managing the property’s day-to-day operations. The healthcare REIT generates net operating income from the fees paid on behalf of patients for their housing and any services provided. The income can vary due to the impact of fluctuations in occupancy levels and rates. However, it also has more upside potential from rising rates. Advantages of investing in healthcare REITs

Healthcare REITs benefit from the massive and growing healthcare industry, one of the largest stock market sectors . While overall healthcare spending in the U.S. declined by 2% due to the COVID-19 pandemic in 2020, it should start growing again in 2021. After peaking at $3.8 trillion in 2019, U.S. healthcare spending is on track to top $6 trillion by 2028.

That forecast suggests demand for healthcare-related real estate should continue growing. REITs are likely to benefit from steadily rising rental rates on existing properties. In addition, they should be able to develop new properties to meet the growing needs of the healthcare industry.

One of the drivers of the sector’s projected growth is the aging of the baby-boom generation. Many will be turning 80 in the coming years, making that age cohort projected to be the fastest-growing age group through 2029. That should drive demand for senior housing and skilled nursing facilities. Such growth is likely to benefit healthcare REITs focused on those properties as they report higher occupancy levels, allowing them to raise their rates. Risks of investing in healthcare REITs

While healthcare REITs are less risky than other healthcare stocks because of their generally stable rental income, they’re not without risk. Here are some of the risks they face: Leverage risk: REITs borrow heavily to acquire and develop real estate. The leverage reduces their financial flexibility during economic recessions.

Interest rate risk: REITs are highly sensitive to changes in interest rates. Higher rates increase their cost of debt, given the sector’s use of leverage. In addition, higher interest rates give income-focused investors more investment options that offer a yield, which can weigh on REIT stock prices.

Oversupply risk: Healthcare REITs need to match their development plans with demand. Given the highly specialized nature of most healthcare facilities, REITs need to be careful not to build too much supply or it might sit vacant.

Tenant risk: Healthcare REITs rely on their tenants to pay rent and manage senior living facilities effectively. However, healthcare margins are relatively thin, which can cause operators to run into financial trouble if they’re not careful. That can affect rental receipts and force a healthcare REIT to find a new tenant for their facility if an operator can’t meet financial obligations.

Pandemic/flu season risk: Virus outbreaks can significantly affect healthcare REITs, especially those focused on senior housing. It can cause occupancy to decline as more patients check out than are admitted.

3 healthcare REITs to consider in 2021

According to the National Association of Real Estate Investment Trusts (NAREIT), 16 publicly traded REITs focus on healthcare-related real estate. That gives investors interested in the sector multiple options. A few stand out for their strong performance in recent years, including:

Here’s a closer look at these top-performing healthcare REITs. Community Healthcare Trust

Community Healthcare Trust owns a diversified portfolio of healthcare facilities across tenant, geography, healthcare facility type, and industry segments. The company’s portfolio includes acute inpatient behavioral facilities, physician clinics, behavioral health centers, specialty centers, inpatient rehabilitation facilities, long-term acute care hospitals, medical […]

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