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Innovative Industrial Properties(IIPR-N)

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2 Ultra-High-Yield REITs to Buy Hand Over Fist and 1 to Avoid

Motley Fool - Thu Sep 21, 2023

You can admit it: A double-digit yield gets your mouth watering. That's fine -- it's just the nature of dividend investing.

What's important is that you step back and consider the company behind the yield. Often you'll find that ultra-high yields aren't sustainable, or they come with risks that are just too high.

Which is why you'll probably want to avoid real estate investment trust (REIT) Annaly Capital Management(NYSE: NLY), but might want to buy Innovative Industrial Properties(NYSE: IIPR) and W.P. Carey(NYSE: WPC).

Annaly has been a big dividend letdown

Annaly Capital Management is a mortgage REIT, which means that it owns mortgages that have been pooled into bonds (often a collateralized mortgage obligation, or CMO) instead of physical properties.

It is a very different kind of investment, since what it owns is basically a portfolio of CMOs. There are a lot of nuances and complications that you could focus on here, but the company's dividend history tells more than enough of a story to warn you away.

NLY Chart

NLY data by YCharts.

Over the past decade, the dividend has headed steadily lower, and the stock price has followed along for the ride. What's notable in this is that dividend yields and stock prices go in opposite directions. So even though the dividend has been collapsing, the yield has remained around 10% for the entire time.

If you only looked at the yield, you would be missing a very troubling income story. Not only have investors been left with less income, due to all the dividend cuts, but they have lost principle, too. That's the worst possible outcome if you are trying to live off the income your portfolio generates.

Dividend growth is what you want to see

By comparison, W.P. Carey has increased its dividend annually since its initial public offering in 1998, and Innovative Industrial Property's dividend has increased each year since it started paying a dividend in 2017. To be fair, those are two drastically different time periods.

W.P. Carey has proved that its net lease business model (tenants pay for most property-level operating costs) can withstand the test of time, at least partly thanks to its highly diversified portfolio.

It owns assets across the industrial, warehouse, office, retail, and self-storage sectors (there's also a rather large "other" category in the mix). And it generates nearly 40% of its rents from outside the United States. Basically, it has the wherewithal to switch gears and invest where it can find the best opportunities, allowing it to adjust to just about any market environment.

Innovative's record is a lot shorter, but that makes sense given that it was created to support the growth of the marijuana sector. It's also a net lease REIT, but it effectively provides capital to pot growers that, at least for now, have limited access to other options, like banks. That's because of the still murky legal status of marijuana on the federal level.

However, there's a shakeout going on in the pot industry that has left Innovative dealing with some troubled tenants, but it has managed this headwind capably. For example, the adjusted funds from operations (FFO) payout ratio was a solid 80% in the second quarter of 2023 even though a small number of tenants aren't paying rent.

Things could get worse before they get better in the pot industry, highlighting that the high yield here reflects the broader pessimism. But so far, Innovative is proving in real time that it can withstand the industry's weakness.

What's most attractive about W.P. Carey and Innovative Industrial Properties, however, are their fat dividend yields. W.P. Carey is currently rewarding investors with a 6.6% yield while Innovative's yield is an even higher 8.4%.

While neither are as lofty as Annaly's 12.5% yield, it's highly unlikely that an investor could sleep well at night with that yield given the mortgage REIT's terrible dividend history.

A yield is only good if you get paid

To be fair, Annaly operates in a niche sector of the REIT industry, so its dividend cuts aren't actually all that shocking given the trends in the mortgage space. Things could turn around for the business.

But dividend investors looking to live off the income their portfolios generate probably shouldn't make a bet like that. It's far safer to stick with companies that have proved they can withstand a hit while continuing to pay their shareholders well, like W.P. Carey and Innovative Industrial Properties.

That said, of the two, W.P. Carey is probably the better bet for more-conservative types given its far longer history of dividend success.

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Reuben Gregg Brewer has positions in W. P. Carey. The Motley Fool has positions in and recommends Innovative Industrial Properties. The Motley Fool recommends W. P. Carey. The Motley Fool has a disclosure policy.

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