By Danny Prosky
The aging of baby boomers and the attendant growth trend in health care spending has been one of the more influential drivers of our economy and markets. Health care spending as a percentage of overall U.S. GDP has increased from 13 percent in 1996 — when the first boomers turned 50 — to 18 percent in 2015, as the number of boomers entering retirement continues to accelerate.
For financial advisors who serve retail investors seeking consistent income in a yield-starved environment, health care related REITs have represented one of the most attractive asset classes for client portfolios.
But today, the ongoing debate over the fate of the Affordable Care Act and the beginning of a new era of fiduciary responsibility for financial advisors — regardless of what happens to the Department of Labor (DOL) rule — have driven new levels of uncertainty about the future of the health care REIT space.
- Are leverage levels low enough to suggest the manager has "skin in the game"? For REITs, leverage is part of the business model. The more leverage a manager employs, the larger the portfolio they can build. Excessive leverage, however, can make REIT portfolios more difficult to exit (and hurt returns) since end buyers are typically more hesitant to purchase assets that carry too much debt. Additionally, excessively high levels of leverage could potentially encourage REIT managers to shift toward more risky assets as a result of having less skin in the game.
- Do the REIT managers "eat their own cooking"? A second gauge of a manager’s commitment to end clients’ interests is the manager’s own investment in the REITs they oversee. In particular, financial advisors should look for a consistent track record of higher-than-average ownership of their own REITs. This can be an obvious and powerful sign of a management team that is on the same page as its investors.
- Does the manager sufficiently emphasize long-term perspective and the big picture with respect to policy uncertainties? As experienced managers in the health care REIT sector know, policy uncertainty has been a fixture of the health care world for decades, from sizable cuts in reimbursement rates to psychiatric hospitals and skilled nursing facilities in the 1990s to the “doc fix” that had to be re-enacted 17 times between 2003 and 2014 to prevent Medicare provider reimbursement rates from being cut.
None of those examples of policy overhang changed the core demographic trends that have contributed to consistent growth in health care spending in the United States over the last 25 years — and which will continue to drive expansion in the sector for the foreseeable future.
Financial advisors and investors seeking sound health care REIT investments would be well-served to identify managers who share this sense of perspective, and who have consistently demonstrated the fortitude and judgement needed to stick with a strong investment strategy regardless of shifts in the policy landscape — no matter how significant those shifts may appear.
For income-focused clients and their advisors, few tools in the investment toolbox provide the combination of stable income and long-term potential for capital appreciation as health care focused real estate, thanks to its crucial role in the long-term demographic story of increasing U.S. health care expenditures.
By seeking out REIT managers who prioritize alignment between their own interests and those of end investors, and who have the perspective and wherewithal to remain focused during periods of policy-related upheaval, advisors and clients can continue to reap the benefits of deploying capital to this sector with confidence, rather than sitting on the sidelines.
Danny Prosky is Founding Principal of American Healthcare Investors in Irvine, California, one of the most active buyers and managers of healthcare real estate in the United States.