How to Capture 6.5% “Retiree” Yields

Right now a little fewer than 40 million Americans — that’s almost 15% of the country — has reached retirement age. But that’s the tip of the iceberg. Every day, almost 8,000 Americans turn 65. In just a decade, seniors in the United States will number 55 million. That’s a +39% increase in 10 years.

Without a doubt, that means more healthcare spending. At age 65, the average senior spends around $11,000 a year on healthcare — by age 85, that spending more than doubles to nearly $26,000.

And keep in mind, we’re also living longer — much longer. The 85 and older age group is the fastest-growing segment of the population in the U.S. Their numbers will double by 2030.

If that growth sounds like an opportunity, you’re right. There’s a group of stocks paying out heady yields thanks to the boom in the retirement age population: healthcare real estate investment trusts (REITs).

More spending on healthcare is great news for healthcare real estate. It means more demand for hospitals, assisted-living communities and medical offices — and healthcare REITs own all these types of property. They simply take in rent from tenants in the medical field and spit out cash to investors.

No investment is recession-proof, but healthcare REITs come close — spending on health care rose even during the recession. And while healthcare reform affects other medical businesses, it shouldn’t have much impact these REITs. That’s because the REITs don’t operate healthcare businesses. Instead, they simply act as landlords.

But what about stability? After all, real estate has been a rough place to be in the past few years. There’s good news on that front, too.

Lease terms of 12 to 15 years are common and many leases are on a “triple-net” basis. Triple net is an industry term meaning the tenant pays operating costs, including property taxes, insurance and maintenance costs. The long-term, low-expense nature of the leases means high and stable cash flow for the REITs. [Read about my colleague Nathan Slaughter’s favorite REIT play.]

As a result, some healthcare REITs were even able to boost dividends during the recession. Omega Healthcare Investors (NYSE: OHI), for example, yields about 6.5% and has grown its dividend +38% since the start of 2007.

As with any high-yield play, it’s important to make sure the company can afford the distributions it pays. For REITs, it’s best to compare funds from operations (FFO) to distributions paid. Funds from operations provide a more accurate look at how much a REIT is earning, as net income is hit by non-cash items like depreciation.

Action to Take –> So let’s review. Healthcare REITS will benefit from the soaring number of aged people… they sign long-term leases… and they pay minimal amounts when it comes to taxes, insurance and maintenance. What’s not to like?

But there’s one more bullish factor.

I’m sure you’ve heard about the potential for a rise in dividend taxes. I actually think rising taxes would be good for healthcare REITs. Currently, like all REITs, healthcare REITs don’t qualify for the reduced dividend tax rate. If dividend taxes rise, then healthcare REITs won’t be hurt. In fact, they may look more attractive to investors, which could fuel share price gains. [How to Hide From the Dividend Tax Increase]

That does bring up one negative for these REITs, however. Dividends are taxed as ordinary income, so it’s best to hold these securities in a tax-deferred account.

Remember the golden rule of investing in any REIT: property type is key. If you’re looking for properties offering stability with increasing demand for decades to come, it doesn’t get much better than high-yield healthcare REITs.

P.S. — If you’re interested in healthcare REITs, you’ll love my October issue of High-Yield Investing. There, I nailed down two of my favorite plays in the sector. One pays nearly $3 per share each year.