The real estate investment trust (REIT) sector swooned in 2023, but it has been coming back to life lately. For some of the biggest and best known REIT stocks, that means the investment opportunity that arose may be very close to over. But there are still some REITs where opportunity remains, like Alexandria REIT (ARE -1.29%) and Innovative Industrial Properties (IIPR -3.68%). Here's a quick look at each.
1. Alexandria isn't really an office landlord
Shares of REIT Alexandria are more than 40% below their 2022 high-water mark. One of the big problems is that investors view the REIT as operating in the office sector. Offices have been troubled since the work-from-home trend and social-distancing efforts of the early coronavirus pandemic period. Although social distancing has ended, work from home has managed to linger. Thus offices have been under pressure because they just aren't being used as much, meaning employers need less space.
That's a very real problem for traditional office landlords, but Alexandria owns medical research facilities. These are highly specialized assets that are nothing like a traditional office. And while there is an office aspect to the portfolio, it is generally tied to the market for research and laboratory space. You don't write reports in the highly technical lab area; you write them in the attached office space, so you need both. Occupancy at the end of the third quarter was a fairly solid 93.7%.
The REIT has increased its dividend for more than a decade. The annualized rate of growth over those 10 years was roughly 7%, and the funds from operations (FFO) payout ratio was a very reasonable 55% in the third quarter. FFO is seen as a better reflection of a REIT's ability to generate cash than net income. Meanwhile, despite recent improvements in the share price, the 3.9% yield is toward the high end of the range over the past decade, suggesting the shares are still on sale.
2. Innovative Industrial is still in a strong position
Shares of industrial REIT Innovative Industrial are down more than 60% from their 2021 highs. A big part of that drop has come from the shift in investor perception about the marijuana sector, which was once favored but now is not. There's a good reason for that, since the area attracted a lot of early players and the weakest companies are now being wrung out of the system. That has forced Innovative Industrial to deal with some lessees that are in financial trouble. It has been selling assets, renting properties to new tenants, and renegotiating leases. These are all the things you would expect management to do. In the third quarter of 2023, the company collected 97% of the rent it was owed. That's really not such a bad number.
What's notable is that marijuana grow houses, which is largely what Innovative Industrial owns, are not your typical industrial asset. Like medical research facilities, they are highly specialized. So there is material value in a property based on its zoning and grow-house specific features.
Despite the headwinds, the REIT's adjusted FFO payout ratio was 79% in the third quarter. That isn't exactly low, but it does offer a decent cushion against adversity. And, notably, Innovative Industrial has low leverage relative to the largest industrial and net-lease REITs. (Net leases, which are what the REIT favors, require tenants to pay for most property-level operating costs.)
However, the really notable issue is the growth that's still expected in the pot sector as more states legalize the drug. Innovative expects legal marijuana sales to grow from $26 billion in 2022 to $43 billion in 2027, which is roughly an 11% compound annual growth rate. It is a key provider to the companies that will benefit, and thus seems highly likely to benefit along with them. There is risk here, of course, but the 7.2% dividend yield will likely attract a lot of investors. The dividend was increased again this month, marking the fifteenth increase since the company started paying a dividend in 2017.
Less risk than meets the eye
At the end of the day, both Alexandria and Innovative Industrial are fairly unique REITs that have been caught up in sector sell-offs that aren't perhaps as meaningful to their businesses as investors seem to believe. Are there risks to monitor? Sure. But so far both are handling any adversity they have faced in relative stride, while still managing to reward investors with reliable dividends. As the REIT sector rebounds from a broad sell off, it would be a brilliant move to step back and reexamine these two laggards again.
