Ever since regional gaming leader Penn National Gaming (NASDAQ:PENN) spun off Gaming & Leisure Properties (NASDAQ:GLPI) in late 2013, investors have had more than a simple, straight bet of investing in casino stocks. Now they could also gamble on a real estate investment trust (REIT) focused solely on casino properties.

Instead of volatile casino earnings, investors could enjoy reliable income streams and the potential for higher payouts that come from rising rental rates in the future. 

But despite most major casinos losing to the S&P 500 over the past decade, REITs haven't quite lived up to expectations yet. Of course, they don't have much of a track record to run on as MGM Growth Properties (NYSE:MGP) was launched by MGM Resorts (NYSE:MGM) in late 2015 and VICI Properties (NYSE:VICI) was spun off from Caesars Entertainment (NASDAQ: CZR) earlier this year.

So the question becomes, should investors still bet on the casino operators or make the more exotic play and go with the REITs that own their properties?

Las Vegas Strip at night

Image source: Getty Images.

Maybe not such a good bet

There are definitely risks in investing in gaming REITs. Although it's said the house always wins, there is a long history of casinos going bankrupt, and for a REIT that owns the property, who else other than another casino operator is going to buy the place?

Casinos are largely special use buildings that, because of their location, are not readily convertible into separate retail space. For example, the Trump Taj Mahal sat idle for two years before reopening this year as the Hard Rock Casino, while just up Atlantic City's famed boardwalk, The Revel, was abandoned for four years before it reopened in May as the Ocean Resort Casino.

Siting is a major concern, and not just for the casino in question. Atlantic City has been battered by competition in bordering states, with both the Mohegan Sun and Foxwoods in Connecticut siphoning off gamblers from northern New Jersey while Las Vegas Sands (NYSE: LVS) casino in Bethlehem, Pennsylvania, and casinos in Delaware and Maryland taking gamblers from the southern half. It also blunted the ability of New Jersey's casinos to attract gamblers from other states.

The $2.4 billion Revel, which broke ground just prior to the Great Recession, closed down two years after it opened. While timing hurt its chances, so did the casino's decision to forego buffets, busing in gamblers, and the absence of a players' club. An oceanside resort where the casino was more of an afterthought wasn't conducive to attracting gamblers.

Yet the Northeast is saturated with casinos as more states approve new construction. Without sufficient demand to support all of these gaming halls, the large amounts of debt the casinos took on to construct the edifices has become more difficult to service. This may be what's fueling the growth in gaming REIT transactions.

Rolling the dice on growth

Deal-making in the casino REIT market is hot now. Nine transactions have been completed in the last 12 months for a total value of $6.2 billion, which Deutsche Bank gaming analyst Carlo Santarelli says "represents roughly half of the total volume of gaming REIT deals since GLPI's first acquisition" in late 2013.

VICI recently said it was buying its first non-Caesars property. It will acquire the land and real estate assets of the Margaritaville Resort Casino in Bossier City, Louisiana, for $261 million cash while Penn National will acquire the casino's operating assets for an additional $115 million and will immediately enter into a triple-net lease agreement with VICI.

A triple-net lease means the tenants agree to pay all real estate taxes, building insurance, and maintenance on the properties. VICI says Penn will initially pay total annual rent of approximately $23 million for 15 years, with the option of four five-year renewals.

The deal, by itself, isn't all that unique; what's noteworthy is that the REITs are more willing to buy property outside of their former parent's operations.

In addition to the real estate Gaming & Leisure Properties was seeded with when it was spun off by Penn National Gaming, it subsequently bought the real estate assets of Pinnacle Entertainment (NASDAQ: PNK) (which, coincidentally, Penn is now buying). MGM Growth Properties, which also tried to buy VICI earlier this year, recently bought the Hard Rock Rocksino in Ohio from Hard Rock Cafe for $1 billion.  

Elderly couple playing craps

Image source: Getty Images.

Find reward in risk

But casino REITs are not all risk. Like regular REITs, casino REITs don't pay income tax like regular companies do, but return most of their profits back to shareholders. In fact they are required to pay 90% of income to shareholders, which allows them to remain exempt from paying income taxes on the profits paid to investors. The yields on the dividend payments also tend to be rich. VICI Properties currently yields 5%, Gaming & Leisure Properties yields 7%, and MGM Growth Properties yields 5.7%.

MGM's REIT is a slightly different animal than either VICI or Gaming & Leisure in that it is still majority-owned by the casino operator. MGM retains a 73% ownership interest in the REIT. It ensures that the casino doesn't get yanked by non-market rate rents and is still able to redevelop properties as needed. Because the REITs decide whether to remodel a property, and that may not be in their financial interest at the time, regardless of what the casino wants or needs, it could be detrimental to the whole.

While otherwise separated from its former parent, Gaming & Leisure Properties has board members that also serve on the board of Penn National, a situation that could create conflicts of interest. Only VICI Properties is truly independent with no ownership interest by Caesars and no overlap on the board, giving it the freedom to operate as it sees fit. 

Divide and conquer

Casino REITs can minimize the risk associated with any particular casino going under in any one locale by geographically diversifying, or, like VICI Properties is doing, expanding beyond the confines of the properties of only one casino operator. Although Gaming & Leisure had that going for it too with its ownership of Pinnacle's real estate, Penn's pending acquisition of Pinnacle concentrates its risk again.

It may also come from diversifying outside of the gaming industry too, since geographic diversification still leaves these REITs highly concentrated in one industry. VICI CEO Ed Pitoniak has said the REIT will remain focused on the gaming industry, which he still views as lucrative, but after sifting as much value as he can out of casinos, he is willing to look beyond its borders.

Investors might be tempted by the yields the gaming REITs offer, as well as by the padding their portfolios will receive if the deal-making continues apace, but this narrowly focused niche hasn't proved itself to date by showing it can grow beyond the risks.

If the gaming REITs can expand beyond the confines of casinos (at which point they would no longer be "gaming" REITs), they might actually be more attractive. But investors just might do better playing the straight bet on the casinos themselves.