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How CON Laws Created My Favorite Real Estate Investment

By Rob Fannon, editor Phase 1 Investor
Friday, November 16, 2007

I've never had so many people call me an idiot at the same time...
This July, when much of the commercial real estate sector was crumbling, I devoted an entire issue of the Medical Investor to... investing in the real estate sector. Many of my readers were furious.
Didn't I know real estate stocks are coming off years of huge gains? Or that they're expensive? Or that the housing bust will send all real estate stocks lower?
The thing is, the real estate stocks I covered are all up 10%-15% since then. That's because these real estate investment trusts focus exclusively on medical buildings. Health care REITs are the only safe haven in real estate right now and perhaps the best way to invest in the mushrooming medical industry. Let me explain...
First, of all real estate investments, health care REITs are the least dependent on the macro economy. They collect rent checks from hospitals, medical office buildings, assisted-living centers, and drug companies. Our aging population will still need to be cared for, and Americans will not stop getting sick and heading to the doctor if we enter a recession.
Second, health care leases are more favorable than most commercial property agreements. Contracts cover up to 20 years and are typically "triple-net" structured. This means that the tenant is responsible for all property expenses, including utilities, taxes, and insurance. And almost every medical lease includes automatic annual rent increases of 2%-4%.
So health care REITs are hedged against both recession and inflation. But what you might not realize is that the biggest players are government backed...
You see, not any old Joe construction company can go out and build a surgical suite or hospital. In order to ensure adequate access to medical care, the government mandated that new medical construction demonstrate a "certificate of need." These "CON laws" prohibit builders from cherry-picking the wealthiest zip codes for new medical businesses... and create significant barriers to entry in the medical real estate market.
In essence, the government has created an artificially constrained supply. Meanwhile, demand for long-term care and private-pay retirement homes is annually outstripping supply by as much as 90%. So established health care REITs are left to grow and benefit.
That's great news for shareholders. The average dividend yield for health care REITs is roughly 6%, heads above the industry average of just over 4%.
There are only about a dozen and a half publicly traded health care REITs. You probably won't go wrong investing in any of them. However, as I told Medical Investor subscribers, there are a few things to look for:
  • A diversified portfolio – a healthy geographic mix and no over-reliance on certain property types. For example, tenants highly dependent on fickle government-sponsored insurance plans like Medicare make for unreliable income.
  • Good leadership – making the right acquisitions, at the right price, is key to success in this industry.
  • Sound capital management – taking on the proper amount of leverage can make or break a REIT, in a hurry.
  • A strong history of reliable and increasing dividend payouts – this speaks for itself.
Health care REITs are recession-proof, inflation-proof, have government-backed unlimited demand... and pay the highest average dividend of all real estate investment trusts. This is one of the safest, best ways to cash in on the health care boom.
Good investing,
Rob Fannon

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