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Innovative Industrial Properties(IIPR-N)

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Better Buy: Innovative Industrial or W.P. Carey?

Motley Fool - Sun Oct 1, 2023

A look at the performance of W.P. Carey's (NYSE: WPC) stock as compared to Innovative Industrial Properties(NYSE: IIPR) can tell investors a lot. W.P. Carey's long-term consistency will probably be more attractive for conservative dividend investors, despite a recent dividend cut announcement. But here's a deeper look at the numbers to back that up.

A terrible year for W.P. Carey

Over the past 12 months, W.P. Carey's stock is down roughly 25% or so. Innovative Industrial's shares are off by about 20%. Here's the thing: The two real estate investment trusts (REITs) were both down by around the same amount until W.P. Carey announced that it was spinning off its office portfolio (and selling the offices that don't get spun off) and cutting its dividend. Unsurprisingly, investors reacted poorly to the news.

IIPR Chart

IIPR data by YCharts

Notably, W.P. Carey had an enviable dividend streak prior to the cut (which won't happen until the fourth quarter). It had increased the payment annually since its 1998 initial public offering (IPO). That streak held up through multiple big shifts in the business, including the conversion from a master limited partnership (MLP) to a REIT and the company's exit of the asset management business (at one point it created and managed non-traded REITs). However, office properties account for around 16% of W.P. Carey's rent roll, so exiting the property type will make the current dividend unsustainable. A reset is the only solution.

The benefit is that W.P. Carey will be getting out of a difficult asset class. It comes with high costs and hard-to-release properties. So W.P. Carey's portfolio will be stronger once this shift is complete. Think of the dividend cut as the pain of ripping off the bandaid. After it has made this business transition, the REIT will have brighter long-term growth prospects.

There are several reasons for this. First, the company's industrial properties, which are performing better than its office assets, with have a greater impact on business performance. Second, the REIT will be able to generate more internal funds for investment (thanks to the lower dividend). This is far cheaper money than it could raise by selling stock or debt. In fact, it hopes to use the transaction to lower its debt load, which would help to reduce costs right up front. And, third, the company expects investors to provide it with a higher valuation without the drag of its office portfolio. That remains to be seen, of course, and the dividend cut will probably require some time before it is forgotten (a swift return to dividend growth would help), but eventually Wall Street is likely to view W.P. Carey in a different light than before.

All in, W.P. Carey is a highly respected REIT with a long history of slow and steady growth. It is attempting to position itself for an uptick in its growth prospects, which, despite the pending dividend cut, it is still probably the better option for conservative dividend investors.

IIPR Chart

IIPR data by YCharts

Innovative Industrial is facing its first real test

By comparison, Innovative Industrial's stock is shockingly volatile. Why? The answer is that it has also gotten caught up in the swings of emotionally driven Wall Street. Investors were hot on the stock because it directly serves the marijuana sector. But when pot stocks corrected, investors got worried that Innovative's tenants would stop paying rent.

That is exactly what happened, so the fears weren't unfounded. But the company is still collecting 98% of the rent it is owed. And it's dealing with the small number of troubled tenants exactly how you would expect. It's offering temporary concessions to some, leasing properties to new tenants in other situations, and, when there's no clear solution, selling properties. This is what all REITs do when faced with a tenant that isn't paying rent. Despite the headwinds, year-over-year adjusted funds from operations (FFO) still rose 6%.

Where W.P. Carey is a tortoise, Innovative Industrial is a hare, relatively speaking. And the pot sector is still growing as the drug continues to be legalized in more locations. That suggests that Innovative, which also has a much smaller portfolio, will be able to continue growing its business at a more rapid clip than W.P. Carey. This is happening as W.P. Carey purposely shrinks its portfolio. If you are looking for more growth potential, Innovative is the better choice despite the current headwinds it's dealing with in the marijuana sector.

What are you looking for?

Both W.P. Carey and Innovative Industrial are out of favor today. But that doesn't make either of them a bad REIT. They will, however, be attractive to very different types of investors. After the office spin-off and dividend cut, W.P. Carey will likely return to slow and steady, though hopefully slightly faster, growth (of the portfolio and, in time, the dividend).

Innovative Industrial, meanwhile, is still growing relatively quickly, and that's likely to continue even as it muddles through the marijuana industry shakeout. At the end of the day, it, too, will probably end up in a stronger position after the near-term headwinds subside.

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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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