Omega Healthcare Investors Inc (NYSE:OHI) should be a name to avoid right now, at least speaking theoretically.

Not only have interest rates been on the rise, the Federal Reserve is widely expected to ratchet up the Fed funds rate a couple more times this year.

[ad#Google Adsense 336×280-IA]Since income-producing holdings like OHI stock or other REITs are largely treated like bonds — not to mention they have to borrow to grow — a rising-rate environment doesn’t bode well for Omega.

We don’t live in a theoretical world, though.

In the real world, the inverse relationship between REITs and interest rates isn’t a reliable one.

Moreover, even if higher interest rates were going to create a headwind for REITs, OHI stock is uniquely positioned to shrug it off.

What’s Omega Healthcare?

Omega Healthcare, for those not familiar with it, is a real estate investment trust that backs assisted living facilities and skilled-nursing facilities. It has nearly 1,000 facilities under its umbrella, most of which are in the United States but a healthy handful of which are also located in the United Kingdom.

As REITs go, it’s a good one. Its dividend is reliable and a consistent grower. It’s also the second-best overall performer among healthcare REITs for the past 10 years, and the ninth best among all REITs for the same period.

That said, those who know OHI well will recognize there’s a dark cloud looming, as the framework for payments from Medicare shifts from fee-based reimbursement to a so-called “bundled” plan that rewards results rather than strictly reimburses activity. The approach puts the onus on caregivers, and as is so often the case, has been developed as a way for the federal government to get more and pay less.

Still, if any healthcare REIT can make it work to its advantage, Omega Healthcare can. It’s picky — in fact, very picky — about the operators of facilities it funds.

Besides, it has the added benefit of catering to a growing market.

It’s no secret that people are living longer; nor is it a secret that the swell of baby-boomers that began to leave the workforce in droves a few years ago are now starting to make their way into skilled-nursing and assisted-living facilities.

What is largely unknown is how big this market is going to be in the very near future. Here’s the biggie… the number of people 85 years old and older in the United States is expected to increase from 2011’s 5.7 million to 14.1 million by 2040. The U.K. sports similar stats.

That’s a lot of potential business.

Rising Interest Rates

And what about rising interest rates? Don’t they work against REITs like OHI? Not as much as you might think.

As noted above, in a theoretical sense rising interest rates not only increase the cost of capital for a real estate investment trust, they make REITs less attractive relative to alternatives like dividend stocks and bonds.

In the real world though, the theoretical ignores one key factor: rates generally rise when an economy is growing, and that growth enhances pricing power for Omega Healthcare’s facilities. In fact, number-crunching historical performances indicates there’s very little correlation (good or bad) between a REIT’s overall performance and interest rates. Example: Between 2004 and 2006, the Fed ratcheted interest rates up from 1.0% to 5.25%, and though stocks remained red-hot during that period, REITs still managed to outperform stocks.

In other words, don’t get hung up too much on the timing, otherwise you might miss out on the impressive yield of 8.1% that OHI is currently dishing out.

Bottom Line for OHI Stock

Don’t misread any of the message. Like any other stock or REIT out there, Omega Healthcare is going to ebb and flow, and at times be a little scary. For a true long-term investor who can leave it alone though, OHI is one of the top REITs out there, addressing a market that’s not going to go away.

You could certainly do a lot worse, with the S&P 500 now priced near 22 times its trailing earnings and sporting a yield of 1.85%.

— James Brumley


Source: Investor Place