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By Jeremy Glaser and Philip J. Martin | 12-12-2012 02:00 PM

The Best REIT Opportunities Are in Health Care

For investors wanting extra yield from real estate, REITs that focus on health-care providers have several advantages in their favor.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. With investor interest in real estate investment trusts remaining high, I wanted to sit down with Philip J. Martin, our director of REIT research, to get an overview of the sector and where there might be opportunities today.

Philip, thanks for talking with me.

Philip J. Martin: Yes. Thank you.

Glaser: So, let's just give a brief overview of what REITs are just for investors who may not be familiar with the structure?

Martin: Well, REITs are living, breathing corporations. They own diversified portfolios of real estate assets. There are certainly equity REITs that own and control the underlying asset. There are also mortgage REITs that provide mortgage financing to owners of real estate or operating companies that own real estate or commercial real estate properties.

Glaser: A lot of people think of income and REITs together, why is that? Why are REITs known for kind of paying out relatively large dividends?

Martin: Well, REITs are a tax-advantaged vehicle. They do not pay tax at the corporate level as long as they pay out 90% of their GAAP defined net income in the form of dividends to investors. So, they differ from C corporations in that they retain far less cash and are more reliant on the capital markets for growth financing.

Glaser: Why has there been this investor interest in REITs? Is it that the yields are high? Is it a diversification effect? What has really been piquing  people's interest there?

Martin: Well, it's yield. It's yield, yield, yield. On top of that I think, when the yield play was taken advantage of and continues to get taken advantage of in a good way for investors, investors started to realize that there were healthy balance sheets here, that there were cash flow streams that were improving and able to support incremental dividend growth of 5% annually in the next several years. And you have a good growth and income vehicle here. You certainly recently have the income that is inflation-protected due to the underlying asset, due to leases that have fixed rental-rate increases often tied to the Consumer Price Index. But you also have these portfolios--such as health care, commercial office, retail, and multifamily [properties]--leveraged to the economy. So, you have a good growth and income vehicle here that is attracting more and more long-term investors.

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