It's much easier to build wealth by purchasing quality companies in a growing industry than in a dying industry. That's because there are more opportunities to reinvest retained earnings into growth opportunities in a thriving industry.
And with the U.S. legal cannabis market projected to almost triple from $27 billion in 2021 revenue to $72 billion by 2030, being landlords to legal cannabis operators appears to be promising. This is precisely the niche that the real estate investment trusts (REITs) Innovative Industrial Properties (IIPR -0.82%) and NewLake Capital Partners (NLCP 0.92%) fill in the industry.
1. Innovative Industrial Properties
With 111 properties spread throughout 19 U.S. states worth approximately $2.4 billion as of early September, Innovative Industrial Properties (IIP) is the largest cannabis REIT. In the very early innings of the U.S. cannabis industry's growth, IIP seized upon the opportunity to establish its dominance in the industry. How did the company do so?
Due to the illegality of marijuana at the federal level in the U.S., licensed cannabis operators had no real financing options to help grow their businesses until IIP's founding in 2016. Upon its formation, the company positioned itself as the first legitimate source of financing for licensed cannabis operators. IIP began purchasing the real estate of licensed cannabis operators in sale-leaseback transactions. Tenants sold their real estate and leased it back from the REIT to raise the capital necessary to expand their operations.
These leases also have terms that are especially attractive to IIP, including 15- to 20-year lease terms, annual lease escalators, and all property expenses are paid by the tenant. Paired with the encouraging industry outlook, this sets the company up for low-double-digit annual adjusted funds from operations (AFFO) per share growth over the next few years.
This isn't to say that IIP won't experience bumps in the road along the way. The company's fourth-biggest tenant, Kings Garden, defaulted a couple of months ago. For context, this tenant comprises roughly 8% of IIP's rent revenue.
But with the dividend payout ratio coming in under 82% in the second quarter, the REIT has room to continue growing its massive dividend. And income investors can scoop up IIP's 7.9% dividend yield at a trailing 12-month (TTM) AFFO-per-share multiple of just 11.8. This low valuation arguably builds in an adequate margin of safety for investors seeking a hybrid of both income and growth. This makes IIP a buy for investors with the capacity to tolerate its risk profile.
Image source: Getty Images.
2. NewLake Capital Partners
If investors are seeking a company similar to IIP that's in its infancy, NewLake Capital Partners (NLCP) is an interesting choice.
NLCP boasts a real estate portfolio of 31 properties in a dozen U.S. states valued at over $400 million. The vast majority of the company's annualized base rent (ABR) is derived from licensed cannabis growers (92%), while the remaining portion of its ABR comes from licensed cannabis retailers.
NLCP possesses four striking similarities to IIP. First, the company's business model is also triple net lease. This means its tenants are responsible for paying monthly base rent and insurance, maintenance, taxes, and utilities associated with leased properties. Second, NLCP's leases come with 2.7% weighted average annual lease escalators. Third, the company's dividend payout ratio of 82.5% in the second quarter leaves some breathing room to keep growing the dividend moving forward. Last but not least, NLCP boasts a lengthy weighted average lease term of 14.5 years. This should lead to reliable rent revenue as long as its tenants remain solvent.
And on that note, the REIT has yet to experience any tenant defaults, unlike IIP. This is despite the fact that the company has remained aggressive with acquiring properties in 2022, committing $84 million to property acquisitions in the first half of the year.
Investors can snatch up shares of NLCP's astonishing 10.7% dividend yield at a TTM AFFO-per-share ratio of just 9.9. Considering that the REIT is less proven and diversified than IIP, this is a reasonably attractive valuation for investors with a higher risk tolerance.
