The marijuana industry is blazing ahead, and investors certainly aren't missing a beat. Over the trailing two-year period, we've witnessed no shortage of triple- and quadruple-digit percentage gains from marijuana stocks.
In North America, legal cannabis sales shot higher by 33% in 2017 to $9.7 billion, and they're expected to continue growing at an average annual pace of 28% through 2021, according to research firm ArcView Group. In a decade, North American legal pot sales could eclipse $47 billion.
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What's more, there's been a clear shift in the way the public perceives cannabis. Gone are the days where discussing marijuana was considered taboo. As of October 2017, Gallup found that almost two out of three respondents in its annual survey supported legalization. By comparison, support for legalization stood at just 25% in 1995, the year before California became the first state to OK the use of medicinal marijuana.
More recently, excitement has been budding over the expected legalization of recreational marijuana in Canada. No other developed country has ever OK'd the sale of adult-use cannabis, which would truly vault Canada into a leadership position in terms of pot progressiveness. Not to mention, it would likely add $5 billion in annual sales, on top of what growers are already generating from medical marijuana sales and through exports.
Say what? A real estate investment trust in the marijuana industry?
Yet, there are far more ways for investors to "get their fix" of the cannabis industry than by purchasing companies that directly handle the plant. The ancillary market could deliver even more impressive growth, and one such company that may be worth a spot on your radar is real estate investment trust (REIT) Innovative Industrial Properties (IIPR +0.45%).
And no, your eyes aren't deceiving you. I really did say "real estate investment trust" when referencing the marijuana space.
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Traditionally, we think of REITs as high-yielding, somewhat low-volatility, investments that target a wide gamut of industries. There are apartment-based REITs that own rental communities and lease out their units, healthcare REITs that own medical properties and lease out to life science companies and hospitals, and mortgage REITs that purchase mortgage-backed securities and use leverage to generate income. Though nontraditional, the idea of a marijuana REIT does make sense.
Innovative Industrial Properties seeks to acquire real estate and facilities in the U.S. that can be used for medical cannabis harvesting, then leases those facilities out over long periods of time. In doing so, it generates predictable cash flow in a presumably high-growth industry. Also, as a REIT, the company is able to avoid the usual corporate income-tax rate in return for divvying out a majority of its profit in the form of a dividend to shareholders. Consistent cash flow and a high yield are usually a good formula for attracting investors.
The company currently owns a half-dozen properties spanning five states -- Arizona, Maryland, Minnesota, New York, and Pennsylvania -- which covers 706,000 rentable square feet of growing space. At the moment, all six facilities are leased. Of the five facilities that were owned and leased when the company released its fourth-quarter and full-year operating results on March 28, the weighted-average remaining lease term was 14.7 years (most initial leases are 15 years, with a handful of options for five-year extensions). As I said, cash flow here is considered to be consistent, and will likely grow as Innovative Industrial Properties expands its real estate portfolio.
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Furthermore, the company calculated its average initial yield on invested capital for these five properties to be 15.8% at the end of 2017. Even though companies directly involved in the cannabis industry are delivering higher short-term growth rates, the long-term yield on invested capital may actually be higher for a REIT-based business model like Innovative Industrial Properties.
Best of all, if this small-cap REIT can continue to pay $0.25 quarterly dividends ($1 annually), its 3.2% yield would handily top the broad-based S&P 500.
Warning: This REIT comes with risks
However, no investment is perfect, and even a 3.2%-yielding marijuana REIT comes with its own unique risks that investors should be aware of.
The first concern is as plain as day: Marijuana is illegal in the United States. Even though 29 states have broadly legalized medicinal weed for various ailments, the federal government still classifies pot as a Schedule I drug, putting it on par with LSD and heroin. This makes it entirely illegal, highly prone to abuse, and means it has no recognized medical benefits.
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The good news is that President Trump recently suggested that he supports the right of states to dictate their own cannabis laws and regulate their industries. Nevertheless, Attorney General Jeff Sessions is hell-bent on curtailing the expansion of the cannabis industry in any way possible. Until the federal government changes its scheduling on pot, there will always be that outside possibility that federal law can be reinstituted, outlawing the medical cannabis industry.
The other major concern as a relatively new REIT is that it's going to need capital in order to acquire new properties. The way that REITs often raise capital is by selling common stock. In fact, subsequent to the end of the fourth quarter, the company sold 3.22 million shares of stock, which included the underwriters' option to purchase an additional 420,000 shares, for net proceeds of $79.3 million. While it's had no trouble raising cash, these share offerings dilute the value of existing shares, potentially hurting shareholders.
It's probably also worth mentioning that the Federal Reserve is currently raising interest rates. Though dividend stocks are never truly "out of style," a rising rate environment can encourage some investors to swap out of traditional equities like stocks in favor of less volatile assets like bonds and CDs. This may weigh on Innovative Industrial Properties and other high-yielding REITs.
I'm not sure I'm ready to declare this marijuana REIT investment-worthy as of yet, but it's certainly worth adding to your watchlist.
