This is a guest contribution from Tom Hutchinson, Chief Analyst, Cabot Dividend Investor & Cabot Income Advisor
Things are looking good for the overall market. The S&P 500 is back to within about 5% of the all-time high. But the index performance doesn’t tell the whole story. Many stocks and sectors within the S&P are still floundering. One of those beleaguered sectors is Real Estate Investment Trusts (REITs), though a couple niche REITs have managed to thrive.
Historically, these conservative and high dividend-paying real estate stocks hold up relatively well in a bad economy, but not this time. The FTSE NAREIT U.S. Real Estate Index, an index of all REITs listed on U.S. exchanges, is down 17% so far this year. To give you some perspective, the S&P 500 is even for the year and the tech-heavy Nasdaq is up more than 17%.
Part of the reason for the poor performance is that REITs had been very strong performers in the two years before the bear market. Many had gotten pricey and the crashing stock market hit them hard. When the market rocketed higher, investors were attracted to other sectors. But it’s also true that certain REIT sectors are taking it on the chin during this pandemic.
Office REITs are getting clobbered as the longer-term prognosis for the properties continues to deteriorate as more people are likely to work from home on a permanent basis. Retail and Lodging/Resort REITs are being hurt badly by the lockdowns. And mortgage REITs have been decimated by falling interest rates.
But certain REITs are defying the sector. A few niche REITs with defensive and reliable businesses are bucking the trend and absolutely thriving. And two in particular will likely continue to outperform the market even after the pandemic.
Niche REIT #1: Crown Castle International (CCI)
Crown Castle International Corp. (CCI) is a REIT that leases cellular technology infrastructure. More specifically, the company leases a portfolio of properties that currently includes 40,000 cell towers, 70,000 small cell towers and 80,000 miles of fiber optic cable primarily to the three largest wireless service providers.
People are relying on cellular service like never before during this pandemic. Demand of the towers is increasing and it’s a profitable business as many providers can share the same tower. Plus, the 5G buildout will create even more demand and opportunities for growth.
Mobile data is just coming of age. It currently accounts for just 6% of all internet traffic, up from 3% two years ago. Going forward, mobile data traffic is expected to grow at a staggering rate of 36% per year through 2022.
The current 5G buildout plays right into Crown Castle’s hands. Although speed and latency will improve by staggering amounts, this generation lacks something previous ones had – range. A 5G signal only travels about half a mile, compared to several miles for earlier generations. That means that small cell towers will be needed all over the place in order to increase the range and relieve congestion.
Crown Castle is the small tower king. It’s the main reason I prefer CCI to its major competitors. By some estimates, the infrastructure REIT will have 240,000 such towers by 2025.
Its properties enjoy strong and unwavering demand and the stock is up 20% YTD. But the best days could be ahead as 5G may well become the heroes of the post-pandemic market.
Niche REIT #2: Innovative Industrial Properties (IIPR)
Innovative Industrial Properties (IIPR) is a REIT specializing in the acquisition and ownership of properties that grow legal marijuana for medical use in the United States. The company currently operates 58 properties in 15 states under long-term leases.
The growth in marijuana is undeniable.
It is already the most used recreational drug in the world. And usage is growing like crazy. Global marijuana use has grown by 60% over the last decade and more than tenfold in the U.S. in the last 25 years. In fact, the U.S. is the marijuana capital of the world and currently accounts for anywhere from one-third to one-half of global consumption, depending on estimates.
But the industry has been born from a new trend toward legalization. It became legal throughout Canada in 2018. And the drug is now legal for medical use in 33 U.S. states and recreational use in 11 states. There is speculation about legalization nationwide at some point. Regardless of whether that happens or not, the trend toward more legalization is clear and undeniable.
The Arcview Group, an investment research firm, projects that sale of legal cannabis in the U.S. will go from $12.2 billion in 2019 to $31 billion by 2024. And that’s without further legalization. Increased legalization just got a whole lot more likely as states struggle with massive budget shortfalls resulting from the pandemic. They’ll be desperate for another source of tax revenue.
The thing that truly separates Innovative from the other marijuana companies is that it is making money now and growing like crazy. Over the last three years, the company’s revenues grew 1,240% and earnings shot up 2,000%. Over the same period, the dividend grew at an average annual rate of 93.75%.
But you haven’t missed the boat. There is more torrid growth ahead. It still only has 58 properties while many REITs have hundreds or thousands. In the last quarter, the REIT revenue more than tripled from last year and earnings grew 249%. For that level of growth the stock is still reasonably priced at roughly 40% below last year’s high and paying a stellar and growing 4.56% yield. IIPR has returned over 29% YTD and its best days should be ahead.