Can Healthcare REITs
Calm Queasy Investors?

NEW YORK -- Healthcare real-estate investment trusts have been the antidote for queasy investors seeking safe havens during a stomach-turning economic environment. With much uncertainty still plaguing the U.S. economy, some investors believe the prescription remains effective.

Healthcare REITs delivered returns of 26% in 2000, 52% in 2001, and 11% in 2002, according to the National Association of Real Estate Investment Trusts. They've advanced another 23.3% so far in 2003, outpacing the Standard & Poor's 500, which is up only about half as much as of July 29.

If the economy stays sluggish and employment remains flat, investors will likely continue to loiter in the sector. It doesn't hurt that what the REITS own -- nursing homes, medical office buildings, hospitals and seniors' residences -- are expected to be in more demand as the nation's Baby Boom population ages.

One portfolio manager, Sam Lieber, co-chief executive of Alpine Woods Investments LLC and president of Alpine Funds, expects the group to deliver further 5% to 10% returns in the second half of 2003.

Mr. Lieber, who holds shares in seven healthcare REITs, moved into the sector for its "relatively stable cash flow" and attractive dividend yield.

"We picked up most of them in the past year," he said. His holdings include Senior Housing Properties Trust, Nationwide Health Properties Inc., Health Care Property Investors Inc., Health Care REIT Inc., Ventas Inc., Healthcare Realty Trust Inc., and Universal Health Realty Income Trust as other picks.

Many investors jumped into the group for its high dividend yield, low valuation, non-cyclical nature and bullish outlook. Currently, healthcare REITs boast a 7.6% dividend yield on average, according to NAREIT.

Healthcare REITs are seen by analysts and investors as stable and safe -- a far cry from their dark days in 1999, when they posted negative total returns of 25%. Back then, investors shunned the group over concerns about troubles within the healthcare industry -- in particular government cutbacks to Medicare reimbursement programs, overbuilding, rising labor costs, a flurry of bankruptcy filings from operators and other issues.

Although healthcare REITs don't operate the healthcare facilities, many investors worried that bankrupt operators would be unable to make rent payments to the REITs. But the group weathered the storm, and investors began migrating to the sector.

However, healthcare REITs took a hit earlier this year after investors learned that another operator, Centennial Healthcare Corp., had filed for Chapter 11. Although the news primarily affected only one REIT -- Health Care Property Investors -- the entire group got hammered.

Investor concerns were fueled further when news broke about accounting scandals and financial uncertainties at two other healthcare companies, HealthSouth Corp. and Tenet Healthcare Corp. On top of that, many worried that governments, in a bid to reduce budget deficits, would slash Medicare and Medicaid reimbursement programs. However, many of those issues have since been resolved: Medicare reimbursement rates will increase 6.2% in fiscal 2004 and major cuts to state Medicaid programs have not yet materialized, said Prudential Financial analyst Jim Sullivan.

When will the other shoe drop? "Most shoes have probably dropped by now," said Mr. Lieber. "It's a reasonably defensive place"

Mr. Sullivan, seizing on the low valuations, upgraded the sector to perform from underperform on April 9. Since then the group has traded up about 24%, he noted.

Mr. Sullivan now believes the group is fully priced.

The potential upside for the healthcare REITS going forward tends to depend on how bullish one is about an economic rebound.

Mr. Lieber said there are conflicting projections being bandied about among economists and even Federal Reserve Board governors about the timing and speed of an economic recovery.

"If the economy is weak, it's a safe place. If the economy really picks up steam and we see employment growth, then [healthcare REITs] will be relative underperformers" compared with other REITS and growth stocks, he said. He sees the group delivering returns of 5% to 10% in the second half of 2003.

Legg Mason analyst Jerry Doctrow said business fundamentals in the healthcare REIT sector are sound, and the dividend yield remains attractive. Even if the economy is rebounding now, he said, other real-estate sectors, such as office and industrial properties, tend to lag the overall economy in their recovery. As a result, healthcare REITs, with their stable growth and dividend yield, continue to remain attractive. He names Healthcare Realty Trust, Ventas and LTC Inc. as his top picks.

Bob Steers, co-portfolio manager at Cohen & Steers Capital Management Inc., is more bearish on the group. He sold off many of his healthcare REIT shares at the beginning of 2003 in anticipation of an economic rebound. As the economy improves and interest rates tick up, he said, he tends to seek out more growth-oriented REITs that will reap the benefits of an economic rebound.

"We have no doubt the economy has turned," said Mr. Steers. And he tends to target "cyclical" REITs, whose earnings growth will blossom as the economy rebounds.

The exception is Ventas, which is expected to generate funds from operations growth of 13% in 2003 and 15% in 2004, said Mr. Steers. Ventas has a unique relationship with its key healthcare operator, where "programmed growth" is locked in, he said.

An opportunity fund, Starwood Capital, recently invested more than 4% of its holdings in senior housing. Vice President Tim Fox said demographics are favorable, and he expects annual returns to average more than 20% over the six-year period that he holds the properties.

Mr. Doctrow owns shares in Healthcare Realty Trust. His firm has had an investment banking relationship with Healthcare Realty and Ventas.

Mr. Sullivan does not own shares in any of the healthcare REITs nor has his firm had an investment banking relationship with them.

-- Janet Morrissey covers the housing, REITs and mortgage-finance industries for Dow Jones Newswires.

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