Sometimes investors have to look past the headlines to think about deeper trends that aren't easily apparent to Wall Street. This is often called second order thinking, and it requires understanding the companies you are researching. And when you take that deeper dive, Innovative Industrial Properties (IIPR 0.06%) and Ventas (VTR 0.11%) both look attractive today despite some headline-grabbing negatives.
1. Locked in and still growing
The cannabis space has been growing at a rapid clip, as the drug is increasingly legalized across the United States. Although it's still not legal at the federal level, that is actually a plus for real estate investment trust (REIT) Innovative Industrial Properties. That's because this landlord specializes in net lease sale/leaseback transactions.
To quickly summarize, the company buys properties from cannabis growers and then leases them back, with the seller, now the tenant, responsible for most of the operating costs. It's basically a way for the former owner to raise capital while still retaining access to a key property.
Image source: Getty Images.
Innovative Industrial, meanwhile, gets a long-term tenant out of the deal as it builds a leadership position in a new industry. Although the cannabis sector has been on the outs since early 2021, down some 85%, using Global X Cannabis ETF as a proxy, that doesn't mean that Innovative Industrial's business has been struggling. In fact, the REIT continues to expand, adding 37 properties in 2021 and increasing its dividend by 28% compared to 2020 levels. And yet Innovative Industrial Properties is down some 50% from its early 2021 peak.
But the story gets even better, given that a REIT's average lease term is a pretty impressive 16.5 years or so. If the pot industry continues to expand, as expected, Innovative Industrial's position looks pretty solid. Note that the adjusted funds from operations (FFO) payout ratio was a strong 85% in 2021.
Meanwhile, the REIT has already added some new assets in 2022, proving that its growth plans have not come to an end. If you are a long-term dividend investor, you should do a deep dive here while other investors are treating this leading pot REIT like a pariah.
2. Leveraged to the bad and the good
Ventas is one of the largest and most diversified healthcare REITs, with exposure to the office, medical research, health system, and senior housing sectors. That last category is the big one, encompassing nearly 50% of the rent roll. That was a very bad thing during 2020, as the pandemic hit older populations housed in group settings particularly hard. But there's a nuance about Ventas that's very important to understand.
The REIT's senior housing segment is broken into two distinct categories. The first is straightforward, in that Ventas leases assets to others who have to pay rent regardless of what's going on in the world. That accounts for 16% of overall rents. The other piece, at 31% of the rent roll, is what's known as a SHOP portfolio in industry lingo. That stands for senior housing operating portfolio, with the word "operating" being the important word.
Essentially, Ventas both owns and runs these assets (it actually hires companies to handle the day-to-day stuff), with property-level performance showing up on the REIT's top and bottom lines. This is a big reason why, when the pandemic crimped Ventas' SHOP business, it was forced to cut its dividend.
However, there's a silver lining on this so far dark cloud. As the SHOP portfolio recovers, the improvement will flow to the REIT's top and bottom lines. So it is leveraged to an industry upturn, which appears to be slowly taking shape. And Ventas actually bought a peer with a large SHOP portfolio during the downturn, further entrenching itself in the space and likely augmenting the eventual upturn.
Although Ventas' stock has recovered from the worst of the pandemic downturn, it's still about 10% below where it started in 2020 despite the recovery-minded acquisition it made. When the senior housing sector turns higher again, which is highly likely give the aging U.S. population, Ventas' business is going to look a whole lot more attractive.
Don't sleep on these REITs
Companies go in and out of favor over time, so you'll want to start your research today on Innovative Industrial Properties and Ventas. Although they are vastly different entities (one a growth name and the other more of a turnaround play), it is highly likely that Wall Street will eventually catch on to both stories. You'll want to make your final call before that happens.
