2020 has been a challenging year for commercial real estate (CRE), with values and revenues decreasing nearly across the board, meaning real estate investment trusts (REITs) that specialize in owning, managing, and leasing commercial real estate have had a tough few quarters.
However, industrial real estate has proven to be a resilient asset class, with numerous industrial REITs showing increase in revenues despite the ongoing economic challenges. In addition to its superior performance during these turbulent times, industrial real estate's high demand and lack of inventory in many markets means this asset class is poised for major growth in the coming decade.
Innovative Industrial Properties (NYSE: IIPR) and Prologis (NYSE: PLD) are two popular industrial REITs that have shown strong performances over the past few years and have maintained positive footing during the COVID-19 crisis, making them a compelling buy for investors -- but which is the better buy right now? Let's compare the two to see where they stand.
Innovative Industrial Properties
Innovative Industrial Properties is the only real estate investment trust that specializes in the ownership and leasing of industrial real estate for the production of medical-use marijuana. The company lives up to its name, using innovative investing models that provide liquidity to an industry that often faces many challenges when it comes to expansion and capital. Because marijuana is still illegal on a federal level, many legal and licensed growers have difficulties obtaining financing. Innovative Industrial Properties purchases their real estate, leasing it back to them on a long term, triple net lease. This means working with high-quality tenants that already have a proven track record and strong financials with turnkey operations already in place.
Although a fairly young REIT, it has shown exponential growth since it first became public in 2016. Its recent Q2 showed a 183% increase in revenues from the same quarter last year while increasing adjusted funds from operation (AFFO) by 263%. It maintained a 100% collection rate from tenants from April to July despite COVID-19 challenges, while adding 775,000 rentable square feet across eight new properties to its portfolio in Q2 of 2020.
It has very little debt on its balance sheet -- 12% total debt to gross assets with $50.2 million available in cash or cash equivalents -- meaning it's well positioned financially to maintain its dividend. Its payout ratio is currently 89%, which falls in line with REIT standards, but there isn't a ton of wiggle room to maintain dividends for a long period of time if revenues were to suddenly fall.
Prologis is an industrial REIT that specializes in the development and leasing of logistics real estate, like warehouses. The company is massive, with $136 billion under management and 963 million rentable square feet in 19 countries across North America, Asia, and Europe. The company owns and produces high-quality warehouses often used for storage and distribution from top-tier tenants like Amazon (NASDAQ: AMZN), DHL, FedEx (NYSE: FDX), and Home Depot (NYSE: HD). The growth in e-commerce over the past decade has helped the company expand while driving revenues up.
The company has achieved a 12.5% year-over-year annual growth in its funds from operation (FFO), which is a worthy feat for any company. Prologis did see dips in revenues and requests for rent deferrals from certain tenants as a result of the COVID-19 pandemic. Its occupancy rate at the end of Q2 2020 was 95.7%, a 0.75% decrease in average occupancy.
Currently, it has a debt-to-(EBITDA) of 4.17x, which means it has a relatively low debt balance, and has $549 million in available cash or cash equivalents. Its current payout ratio is 52%, which is conservative by REIT standards. This means that if revenues continue to dip, the company should be able to sustain dividend payouts.
Prologis has a large market share of a very necessary and growing sector. A recent study conducted by Oxford Economics found that goods flowing through the real estate owned and managed by Prologis is $2.2 trillion, which is roughly 3.5% of the gross domestic product (GDP) of the 19 countries in which it operates. E-commerce is definitely a growing industry, but it's a market reliant on global production and consumption, making Prologis more vulnerable during economic recessions. Overproduction is also a potential risk, as industrial development has increased greatly over the past few years, which could lead to oversupply in the near future.
Which is the better buy?
Both companies are in a market that has major growth potential with strong track records, well-balanced financials, and high-quality assets under management. But given the current uncertainty in the market, I believe that IIPR is the better buy. I do own shares of Innovative Industrial Properties and hope to buy more shares in the future. I believe it's in a great position to continue to participate in the vastly expanding medical marijuana industry with a solid portfolio and balance sheet. However, its current share price of $120.89 isn't providing investors with huge returns in the present moment (a 3.5% dividend yield) and is a pretty pricey purchase for a growth stock.
While it is positioned to grow, investors shouldn't expect the same returns as those who purchased shares a year or two ago at much lower prices. It's also important to consider the risks this company faces, such as new regulations that could restrict how the company or its tenants operate.
IIPR's limited impact from the coronavirus, low debt thresholds, and opportunity for expansion as more states legalize the use of medical marijuana puts it as my top pick out of the two. However, both companies are worthwhile investments with have high-quality portfolios.