A diversified REIT for your retirement planning portfolio

Invest in REITs Like HCP, Not Property

Some Other Benefits of HCP

The fact that the medical industry is steadily growing – in good times and bad – seems to be the obvious reason for a conservative investment in HCP. But the structure and terms of leased medical properties make them even more secure.

Think about it. Obviously, a hospital or retirement home isn’t going to sign a one-year lease like an apartment tenant. Instead, they often sign for a decade or more. Furthermore, while a tenant in an apartment building expects the landlord to handle most issues, medical buildings are often leased under triple-net leases. In short, a triple-net lease is a landlord’s dream. The tenant pays his rent, along with the property taxes, the insurance, and the maintenance of common areas.

Since the tenant takes care of so much, the actual rent is typically less than in a normal lease agreement. However, this works perfectly for medical REITs, as it takes risk off the table. If a landlord leases a property for over ten years, there’s a significant risk of unexpected costs along the way. In most cases, property taxes and insurance will be more expensive in the future, not less. However, it’s hard to predict how much more. With a triple-net lease, the landlord can enter into long-term contracts without the uncertainty of future costs.

Nearly every single property owned by HCP is leased on a triple-net basis. The only segment excluded from this is the medical-office segment, which has only 48% of properties in triple-net leases. Since these leases take a lot of the risk off long-term contracts, around half of HCP’s leases will expire in 2022 or later. It’s nice to have revenues locked in so far in advance. Below is a chart showing the lease expirations:

You might be thinking to yourself: “Wait, aren’t you missing one of your five points: inflation? Isn’t holding a long-term fixed lease a bad thing in the face of inflation?”

Of course, that’s right. However, HCP’s leases are written to either adjust to the CPI or sometimes to include a fixed annual increase. Here’s an example of one of its recent contract provisions to protect against inflation:

“The contractual rent will increase annually by the greater of 3.7% on average or CPI over the initial five years, and thereafter by the greater of 3.0% or CPI for the remaining initial term.”

We’ve noted our issues with the CPI before, but nonetheless this is better than nothing. If inflation is tame, real rents will actually increase. If it gets worse, they will at least adjust.

Dividends, Yield, and Pricing

Here’s a pleasant surprise to finish off our analysis. HCP is a member of the S&P 500 Dividend Aristocrats Index. To be part of this Index, a company must have consistently increased dividends for at least 25 years. HCP has done so for 27 and has no plans of stopping now. (Note also that it is the only REIT on the Index.)

As you can see in the chart, the dividend increases aren’t always very large, but they are consistent. Last year, the firm paid out $2.00. In 2013, we wouldn’t be surprised to see around $2.07 per share, which would give us a 4.5% dividend yield.

HCP has been in our portfolio for a few months now, and even before then the company was mentioned in our special report Money Every Month. but we hadn’t officially pulled the trigger at that point.

While we still think the company is a solid pick, there isn’t too much meat on the bone here under current conditions. For the stock to move upward, something new needs to happen, like another push up in the real-estate market. Looking at the trend thus far, there’s a good chance of that happening.

The good news is that the downside isn’t particularly large. The stock could retrace its steps a bit, but I don’t see it dropping 20% overnight. So put in a 20% trailing stop, pick up some regular dividends, and keep an eye on this stock.