2021 was an incredible year for real estate investment trusts (REITs). These special types of stocks, which invest in real estate and real estate-related securities, managed to outperform the S&P 500 by a whopping 12%, producing a nearly 40% return for investors over the last year. Despite the real estate market remaining as strong as ever, recent stock market turbulence has erased some of those gains and left a number of high-quality REITs down notably.
For example, Innovative Industrial Properties (IIPR -0.72%) and Digital Realty Trust (DLR 0.41%), two dominating stocks, are down 26% and 15%, respectively. Despite wavering confidence over where these companies could be headed, here's why I'm not worried about them at all.
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Innovative Industrial Properties
Innovative Industrial Properties (IIP) was the first REIT to specialize in purchasing, developing, and leasing real estate within the cannabis industry. Growing from just a single property in 2016, IIP now has ownership and interest in 105 properties across 19 states that are 100% leased to licensed, experienced medical marijuana operators.
It didn't take long for IIP to become one of the hottest stocks to invest in as revenues grew at accelerated rates year over year. Share prices went from a meager $20 per share at IPO to over $286 at its peak, a 1,300% increase in just five years' time. But recent concern over federal Legalization has pushed share prices down 32% from its November 2021 peak.
Legalization at the federal level would certainly impact the company's business model, which is largely made possible by the inability of cannabis operators to finance their business in federal institutions like banks because marijuana is still considered a Schedule I drug.
However, I believe it's not as big of a deal as many people think. To start, Federal legalization is likely still a long way off. As history has shown us, bipartisan approval for a bill as big as this isn't easy to achieve. But even if it does get passed within the next five to 10 years, IIP still has the benefit of using long-term net leases. Its average lease term is 16.6 years, meaning its income should well outlive the potential period of legalization.
It also isn't stopping its growth in the meantime. It recently sold 2.578 million shares of stock to help raise capital for expansion in the coming years. I expect 2022 to fall in line with its past performance, which means high double-digit growth. Today's discounted share price means IIP is more accessible to investors than it has been for a long time. Shares are still somewhat richly valued with their price being around 29 times its adjusted funds from operation (AFFO), but if the momentum is maintained as it has in the past -- investors shouldn't be disappointed.
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Digital Realty Trust
Data center operators like Digital Realty Trust are becoming an increasingly important part of our technological world, helping store and process data. 2020 and 2021 were incredibly strong years for data center operators.
The pandemic motivated companies to make the digital switch, adding new software and virtual solutions to adapt to the pandemic workplace. People spent more time on their phones, computers, and TVs during long periods of self-isolation, meaning the social media, streaming services, and internet-based tenants that lease data storage space from companies like Digital Realty Trust had a greater demand for its services.
Advances in technology are only adding to the demand, meaning Digital Realty Trust has a robust pipeline of demand to help it grow well into the future. However, short-term headwinds surrounding supply chain disruptions for chips, which play a critical role in the function of data center technologies, is causing alarm for Digital Realty's 2022 performance.
The global chip shortage isn't just impacting data centers, it's causing shortages and manufacturing delays for cars, laptops, cellphones, TVs, and cameras. Digital Realty Trust is tackling the issue head on by having a well-established supply chain in place that helps reduce lead time from suppliers by as much as 70%. Even if the chip shortage worsens, its priority placement with suppliers gives it a competitive edge.
Plus, Digital Realty Trust is one of the few remaining data center REITs in the market. Several large equity firms and fellow REITs went on a buying spree over the past year, acquiring three of the five publicly-traded data center REITs in late 2021 and early 2022. As one of the bigger players in this business it puts the company in a prime position moving forward.
Both companies have their fair share of challenges, but short-term issues certainly aren't enough to take down these dominating stocks. Investors should use today's market volatility to their advantage, snagging shares in these companies at a discount. While it could be a bumpy ride, I see these companies making a big comeback in the next few years.
