Better Buy: Innovative Industrial Properties or AFC Gamma?

Real estate investment trusts (REITs) offer investors unique exposure to the budding cannabis industry. Rather than investing in a singular stock that cultivates or distributes marijuana-related products directly, REITs invest in the real estate used by cannabis companies, earning reliable revenues through rent or interest on the real estate-related loan.

While there are several cannabis REITs to invest in today, two of the most prominent are Innovative Industrial Properties (IIPR 2.21%) and AFC Gamma (AFCG -0.42%). Let's take a closer look at each company to see how they compare to determine which is the better buy today.

The case for Innovative Industrial Properties

Innovative Industrial Properties (IIP) was the first cannabis REIT to hit the market, going public in late 2016. Being the first major provider to serve this largely underserved market helped IIP achieve incredible year-over-year growth and rapid expansion.

Over the last five years, IIP grew its net operating income and adjusted funds from operations by 137% and 197%, respectively, on a compounded annual basis. These are two important metrics that illustrate a REIT's profitability. This outstanding performance allowed the company to grow its dividend by over 1,000% for a total of 14 dividend increases in six years, grabbing the attention of investors in mass quantities.

However, the last year has been challenging for this cannabis leader. A class action lawsuit concerning IIP's lack of transparency with investors over the potential default of its tenants caused share price volatility. Then, a few months after the suit was filed, one of its top five tenants, Kings Garden, defaulted. Its share price plummeted as a result, with the stock down 63% since last year.

The ongoing lawsuit and tenant default will definitely cause more volatility for the company. And being in the real estate and fickle cannabis business, there's always a chance more tenants will default in the future. But its last quarter was strong, and analyst outlooks are still positive. The company also raised its dividend again, now offering investors a juicy 7.2% yield.

The case for AFC Gamma

Having gone public in 2021, AFC Gamma doesn't have the same track record as IIP. But that doesn't mean the company isn't delivering the same explosive growth. AFC Gamma doesn't buy and lease real estate directly like IIP. Instead, it creates secured loans to established cannabis operators to fund things like business expansions, property improvements, and real estate acquisitions -- something that is desperately needed in the marijuana industry since Federal regulations restrict operators' access to capital.

AFC Gamma's yield to maturity, a common metric used to illustrate a loan's return on investment, is 18% -- which is almost unheard of in the mortgage industry. 100% of its portfolio loans are paid, and the generation of new business is booming. In the second quarter of 2022, it funded $154.7 million of new loan commitments and grew its net interest income by 128%.

The lack of available funding for cannabis companies means it should have steady business for years to come, even if legislation like the SAFE Act improves capital accessibility. Its dividend is extremely alluring at 12.3%, over 10 times the S&P 500, and still relatively safe at 81% of its distributable earnings.

Why AFC Gamma might be a better buy

AFC Gamma's dividend yield is higher and slightly safer than IIP. Plus, the REIT has more favorable pricing today, and it's not facing the same default and litigation challenges as IIP, making it the better marijuana stock out of the two today. However, I believe both companies are worthwhile long-term investments for investors who are bullish on the future of the cannabis industry and are willing to ride out more volatility.

Source: Author calculations from company's earnings and YCharts.

New marijuana legislation or regulations could negatively impact the companies in similar ways, plus both are at risk of future defaults. It's simply a part of doing business in the real estate and mortgage industry.

However, the upside potential in the cannabis industry is still massive. And for the right investor, the reward with these stocks may outweigh the risk. I believe both companies have a lot of long-term growth potential and see them majorly rebounding as the cannabis industry grows and changes.