There are some important similarities between Innovative Industrial Properties (IIPR -0.17%) and W.P. Carey (WPC -1.70%). But there are also some key differences. If you are salivating at the 9.2% yield being offered by Innovative Industrial, you might want to step back and consider erring on the side of caution with W.P. Carey's 6.4% yield. Here's how these two real estate investment trusts (REITs) are similar -- and, more importantly, different.
1. Both use the net-lease approach
A net lease is a rental contract that is normally between a landlord and a single tenant. The most important feature is that it requires the tenant to pay for most property-level operating costs, including things like maintenance and taxes. Effectively, it shifts the responsibility for the property to the tenant, which means the tenant can control the most important aspects of the asset it is occupying.
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This is actually a good thing for both the tenant and the property owner. The landlord has reduced costs and less work. The tenant has greater control of what is likely a key asset as it runs its business. In many cases, the landlord buys the property directly from the company that ends up being its tenant in what's known as a sale/leaseback transaction. The tenant generates cash from the sale to invest in its business and the landlord gets an occupied property with a tenant that has a vested stake in maintaining the property it occupies. That's as close to a win/win as you're likely to find in the property market.
Both Innovative Industrial Properties and W.P. Carey are net-lease REITs.
2. Both are heavy on industrial assets
Innovative Industrial primarily owns industrial grow houses that produce marijuana. W.P. Carey's portfolio generates 29% of its rents from industrial properties (like factories) and 24% from warehouses. That totals up to 53% of rents from assets that typically fall under the industrial property classification. So both REITs are heavily focused on industrial assets.
That said, W.P. Carey's portfolio is one of the most diversified in the REIT sector. In addition to the industrial exposure, it also generates 17% of rents from retail assets, 16% from office, 4% from self storage, and 10% from a fairly broad "other" category. Investors looking for a focused portfolio should look elsewhere, but those that prize diversification will probably like the W.P. Carey story.
3. Each has very different dividend exposure
This is where things start to get a little more interesting. Innovative Industrial Properties is offering a huge 9.2% dividend yield versus "just" 6.4% for W.P. Carey. The second-quarter 2023 adjusted funds from operations (FFO) payout ratio at Innovative Industrial was roughly 80%. That's basically the same payout ratio that W.P. Carey produced. This suggests that both dividends are equally well covered -- but there's one more dividend difference to consider.
Innovative Industrial is a relatively young REIT. So while the dividend has been increased annually since 2017 (when it started paying dividends), that streak pales in comparison to W.P. Carey's dividend, which has risen each year since its 1998 IPO. W.P. Carey has a proven track record of rewarding investors with dividend growth through multiple market cycles. Innovative Industrial is still really just beginning to prove it can be counted on by dividend investors.
4. Each has different levels of diversification
W.P. Carey is one of the most diversified REITs you can own -- and Innovative Industrial is one of the most focused. The company's business model is specifically to provide capital via sale/leaseback transactions to the marijuana industry, because pot companies have limited access to traditional sources of cash (like banks). The still-changing legal environment around the drug is a key factor, given that it remains illegal at the federal level.
There's a couple of big takeaways. First, with such a tight industry focus, Innovative Industrial's perception on Wall Street will tend to track along with that of the broader marijuana space. With the industry going through a consolidation period, the mood among investors here is negative. Second, if something changes in the marijuana sector, like federal-level legalization, Innovative Industrial's business model could be at risk. While it is possible that federal legalization will be a benefit, there's a huge risk that the REIT will suddenly see an influx of competition as banks open up their lending windows. That would be a net negative for the REIT.
W.P. Carey's broad property-type diversification is accompanied by wide sector diversification. A change in any single industry won't upend its broader business. In other words, W.P. Carey is the more conservative option.
Most should err on the side of caution
There's nothing wrong with Innovative Industrial per se, though it has had to deal with struggling tenants during the marijuana sector's consolidation. But it is a high-risk property bet on the pot sector, and there's really no way around that fact. This simply won't be appropriate for all, perhaps even most, investors. Although W.P. Carey's yield is lower, it has proven itself over a longer time period, has a more diversified portfolio, and at 6.4%, the yield is still well above the 4.4% you'd get from the average REIT.
