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Rate-Risky REITs Be Gone!

Ever since the Fed rolled out quantitative easing (QE) – not once, but now three times – in an attempt to lift the economy from its slump, money has been phenomenally “easy,” as they say.

Interest rates are lower than low. Borrowing is cheaper than cheap. And, for better or worse, the market has received an extreme juicing.

Suffice it to say, very few investors have complained. But now, the sentiment is changing, and it’s hard not to notice: Wall Street is worried sick that it might be in for a horrible hangover.

Why? Because the Fed is starting to signal that an end to QE is coming. And no one knows what’s going to result from it.

The quantitative easing program has been such a wild-eyed, left-field economic experiment, there’s almost no point speculating.

Frankly, we’re all in the dark on this one. But there are moves you can make…

The Antidote to the Fed

The best course of action is to stick with defensive, actionable moves. In other words, it’s time to exit investments that would take a direct hit from rising interest rates.

For income investors, that means mortgage REITs, because of their wide popularity.

The real estate recovery has been strong, and mortgage REITs have benefited mightily. But if rates move up, there could be some serious fallout in the industry.

A close alternative to a mortgage REIT – but one that will avoid getting whiplashed from an upswing in rates – is a healthcare REIT.

As a substitute, it’s nearly perfect.

Like real estate, the healthcare industry has enjoyed its own revitalization. Obamacare has resulted in more customers. And the aging Baby Boomer population has meant a growing need for medical services.

And unlike the low interest rate environment, neither of these forces is going anywhere any time soon.

So to help you prepare, Louis Basenese and I have identified two healthcare REITs that should protect your portfolio from the demise of QE, the end of easy money and the spike in rates that will result.

REIT #1: Health Care REIT, Inc. (HCN)

In addition to its solid 5.4% yield, the most attractive qualities about HCN are limited refinancing and interest rate risk.

Over 95% of the company’s debt is fixed-rate. Specifically, only 7.1% of HCN’s debt matures in 2013. The bulk (46.8%) doesn’t mature until after 2018.

The list goes on…

Geographic Diversity: The company’s properties are spread among 46 states, and no state accounts for more than 10% of revenue. Such diversity insulates the company from any regional downturns or regulatory changes that impact individual states.

Customer Diversity: Only one tenant accounts for more than 10% of the company’s revenue.

Low-Risk Leases: About 11% of all leases are up for renewal in the next two years. And most leases are triple-net (i.e. – tenants are responsible for all taxes, insurance and maintenance expenses). Add it up, and the company’s profit margins are highly predictable.

Consistent Portfolio Upgrades: Management actively sells older properties and reinvests the proceeds into more modern facilities. Since tenants prefer newer properties, HCN can charge higher rent. And the more money that comes in, the more HCN can pay out to shareholders.

Bottom line: HCN is better suited than most to take rising rates in stride, as well as benefit from the general boom in the medical industry. That makes its yield as safe as it is attractive.

REIT #2: Omega Healthcare Investors (OHI)

I’m going to give you the bad news right out of the gate: Healthcare REITs tend to be a bit expensive. The industry’s average price-to-earnings (P/E) ratio is hovering at 40.

Luckily, the REITs we’ve laid out today aren’tquite that expensive.

Omega, for instance, is currently trading at 24.2 times earnings. Is that still on the high end? You bet.

But remember, while screening out stocks with P/E ratios over 20 is generally a good idea, paying a bit more is a rational move when there’s serious capital appreciation, plus a decent yield.

And the generally bullish climate in the healthcare sector, coupled with OHI’s 5.7% yield – nearly 3% better than the S&P 500 average – makes this one of those times.

What’s more, the stock has been on a tear, gaining 57.1% over the last year. By contrast, the S&P has climbed 25% over the same period.

Bottom line: With triple the yield, double the performance and a growing industry, OHI offers an excellent alternative to any rate-risky REITs sitting in your portfolio.

Safe investing,

Ryan Anders