Cannabis Equity REIT or Mortgage REIT: The Difference Between Both Investment Vehicles
The desire for stable yields is almost as timeless as the stock market itself. Which is why Real Estate Investment Trust (REIT) investing is popular with a significant subset of investors. Not only does real estate tend to increase in value of time, this providing asset underlying the security, most REITs provide a reliable yield which stand the test of time. And there are different varieties which cater to individuals own personal investing goals.
Equity REIT vs. Mortgage REIT
Perhaps the REIT most familiar to investors is the equity REITs (eREIT). These issues primarily invest in and own income-generating real estate properties and generate revenue through rental income from properties such as residential apartments, office buildings, shopping malls, and industrial facilities. Equity REITs typically aim to provide consistent dividend income to investors based on the rental income generated from their real estate holdings.
The important thing to identify is that many eREITs generally own the own property, thus profit from the leasing of the property and the capital appreciation of the property in a rising market. While the latter is generally a positive thing, it also subjects these securities to interest rate and market risk, in periods of falling real estate values.
Thus at certain periods of the economic cycle, it’s not uncommon for eREITS to lose more equity value than it generates in yield. This fact may be unappealing to certain investors.
Mortgage REITs (mREIT), on the other hand, invest in real estate mortgages and mortgage-backed securities of the properties. Instead of owning physical properties, they provide financing for real estate by purchasing or originating mortgage loans.
Mortgage REITs earn income through the interest spread between the cost of their borrowing and the interest they receive from the mortgages they hold. They generally aim to generate income through interest payments rather than rental income. Thus, the risk incurred is different that the equity REIT and shifts more towards the credit risk associated with the mortgages they hold—with some interest rate risk attached.
Additionally, both investment vehicles raise money is different ways to build up its asset base: mREITs tend to issue debt while eREITs tend to issue new shares through prospectus offerings on the capital markets.
Here’s a simplified data table comparing equity REITs and mortgage REITs:
|Own income-generating real estate properties
|Invest in real estate mortgages/securities
|Own physical properties
|Do not own physical properties
|Based on rental income generated
|Based on interest income earned
|Market conditions, property valuation
|Interest rate risk, credit risk
In the cannabis industry, by far the largest eREIT is Innovative Industrial Properties, which trades on the New York Stock Exchange under the symbol ‘IIPR’. Since inception, the company has acquired, owns and manages specialized industrial properties leased on a long-term basis to state-licensed operators for their regulated medical use cannabis cultivation facilities.
While IIPR’s quarterly cash distribution has steadily increased over time, its stock price has produced outsized volatility over the past couple of years due to correlation with volatility in the multi-state operators that it serves. To wit: the stock is down ↓25.62% YTD and ↓72.62%from its $275.28 weekly close in November of 2021. (Note: IIPR is higher by ↑293.62% since its opening day close price of $19.15 per share on December 1, 2016)
No dividend exists that can make up for such poor equity performance in a downdraft period.
The Pelorus Fund — Consistent Capital Appreciation For Investors
Meanwhile, Pelorus Capital Group operates on of the most successful mREITs in North America today. Its flagship Pelorus Fund targets an internal rate of return (IRR) of between 12-15%, and has achieved these returns in every year of operation since inception—save for 2021 when it ‘only’ produced 11.90% IRR.
The not-so-secret sauce of Pelorus’ operating model is its origination and underwriting methods, which bring stable borrowers into the fold and keep default risk to a minimum.
Specifically, Pelorus’ approach is to lend on the value of underlying cannabis operator real estate assets, but at a discount to fair value. By lending capital based on collateralized real estate assets (but at less that fully appraised value, 60-75% of value of the asset) the firm has a built-in buffer of protection in case the loan becomes non-performing.
As it were, Pelorus Capital Group maintains senior secured creditor status on the loans that it issues. By definition, this means any creditor or lender associated with an issuance of a credit product that is backed by collateral. Should the unforeseen happen and a loan goes into default, the asset may be sold to cover the debt, to which Pelorus would be first in line to receive payback.
Not to be outdone, there is also an equity component to the deals Pelorus closes, which can provide additional returns beyond mortgage income.
As part of negotiated ‘sweeteners’ in some of its deals, the Fund controls equity warrants on its book which may be exercised in favorable market climates. It is a virtually risk-free way to boost returns beyond the lending interest the Fund receives on the mortgage debt.
Whether your a fan of the equity REIT model or mortgage REIT model—or a combination thereof—is a matter of personal preference. Both models have their strengths, weaknesses and risks. It all comes down to investment objectives (growth vs. income), market conditions, risk tolerance and more.
However for investors that prize stability (a.k.a. lack of volatility) and strong yields above all, the Pelorus Fund may be worth looking into.
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