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The Best REIT You've Never Heard Of

April 10, 2013 7:18 am
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As an income investor, chances are you are already familiar with real estate investment trusts (REITs). At the very least, if you do not currently hold any REITs in your portfolio, you are probably aware that the asset class is prized not only for its robust yields, but some useful tax advantages, too.

While REITs are unique from both the dividend and corporate structure points of view, the group shares something else in common with ordinary stocks. That being the largest names are also the most familiar. Just as technology investors hear plenty about the likes of Apple (NASDAQ: AAPL) and Google (NASDAQ: GOOG) everyday, REIT investors are arguably most familiar with names such as Simon Property (NYSE: SPG) and Federal Realty (NYSE: FRT).

Those are fine stocks, but income investors can do much better when it comes to REITs. In fact, formerly obscure Omega Healthcare Investors (NYSE: OHI) could potentially be THE income investment of 2013 regardless of asset class or sector. Omega is “formerly obscure” because after surging 31.6 percent to start 2013 and over 54 percent in the past year, it is fair to say the stock has its fans. Still, with a market value of around $3.6 billion, Omega does not attract the same level of mainstream media coverage that larger REITs do.

Being popular does not mean being profitable for investors. Fortunately, Omega is not “unpopular,” but it has certainly proven profitable and the stock could have more gas in the tank. Arguably, Omega is sitting in the sweet spot of its cycle right now. The company is a direct, fundamental play on the aging U.S. population. Translation: Omega is in the nursing home business, but not on the operational side.

Rather, Omega invests in long-term care facilities and leases those properties to the operators under triple-net leases. As of February, the company held interests in 460 such properties in 33 states. The bulk of Omega’s are leased out as skilled nursing facilities while the remainder are in the long-term care business.

Alright, so there is the meat and potatoes of Omega’s business, but the truly compelling part of this story is, of course, the dividend. Omega units currently yield 5.9 percent and the payout has more than doubled since the fourth quarter of 2005. Since the first quarter of 2010, Omega has boosted its distribution eight times. Predictably, that type of dividend growth often makes investors wonder for how long the good times can last.

To effectively answer that question pertaining to REITs, the metric to look at is funds from operations (FFO). In the essence of time, we’ll spare you the Harvard Business School definition of FFO and just say it is the most important metric when it comes to evaluating the sustainability of a REIT’s dividend. The good news is Omega’s FFO has been predictable and steady over the years, growing at an average annual clip of 8.3 percent since 2005. In 2009, 79 percent of the company’s FFO was paid out in dividends, rising to 83 percent the next year, 85 percent in 2011 and 89 percent last year.

Importantly, Omega may be up for another dividend increase this year. The CEO said as much on the most recent quarterly earnings conference call.

Aside from the dividend, two other growth stories highlight Omega’s potential. First, due to Medicare cuts, the number of skilled nursing facilities in the U.S. is shrinking. Second, the number of folks in the U.S. age 85 and older is expected to steadily increase in the coming decades. That bode wells for Omega’s occupancy and rent coverage ratios.

Another way of looking at Omega is “Come for the dividend, stay for the potential capital appreciation.”

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