In roughly three months from now -- Oct. 17, to be precise -- the green flag will wave on recreational marijuana in Canada. With the passage of the Cannabis Act on June 19, Canada is set to become the first industrialized country in the world to allow adults to purchase cannabis and cannabis-related products.
The legalization of adult-use weed is a very big deal for a Canadian cannabis industry that's been investing a lot of money on capacity expansion, product development and diversification, and acquisitions. When fully ramped up, legal weed in Canada could add roughly $5 billion a year in revenue, atop what the industry is already bringing in via medical cannabis sales and exports to foreign countries where medical pot is legal.
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You're probably ignoring this marijuana gold mine of a stock in the U.S.
Yet, for all the attention being paid to our neighbor to the north, it's a marijuana stock operating in the U.S.A. that's making what could be the most lucrative deals of all. Ladies and gentlemen, if you haven't been keeping an eye on small-cap pot-based real estate investment trust (REIT) Innovative industrial Properties (IIPR +0.45%), this is your wake-up call to do so.
As with any REIT, the objective is to acquire real estate within a specific industry, lease that property out over a long period of time, reap the rewards of being a landlord, and sell that property down the road for a profit. In the case of Innovative Industrial Properties, it seeks to purchase medical marijuana grow facilities and greenhouses in states that've legalized the drug, then lease those facilities out for long periods of time.
And, like REITs in any other industry, it pays a healthy dividend. That's because in order to qualify as a REIT and escape normal corporate income tax rates, a company must return a good portion of its income to shareholders in the form of a dividend. Currently paying out $0.25 per quarter, Innovative Industrial Properties sports a nearly 3% yield. That's right, folks... a marijuana stock with a dividend!
According to the company's first-quarter operating results, released on May 9, it's done quite well for itself in the early going (its initial public offering was only 19 months ago). It generated $2.77 million in revenue, which was more than double the $1.29 million from the year-ago period. As a result, it turned a $591,000 net loss into a $607,000 net gain in first-quarter 2018.
But having ended the quarter with more than $42 million in cash and cash equivalents on its books, as well as $48.9 million in short-term investments, it's Innovative Industrial Properties' recent deals that are even more impressive.
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These two deals clearly show Innovative Industrial Properties' potential
Roughly a month and a half ago, on May 31, the company announced that it was expanding its existing partnership with PharmaCann by purchasing a property in Holliston, Massachusetts. Though the initial purchase price was only $3 million, Innovative Industrial Properties has agreed to supply $15.5 million in additional funding for PharmaCann's subsidiary to build a 26,000-square-foot industrial facility and a 32,000-square-foot greenhouse facility on the property.
What does this initial $18.5 million investment get the company? For starters, it'll net an annualized base rent of $2,682,500, payable monthly, which works out to 14.5% of the sum of the purchase price. In other words, even if this rent were static (which it's not), the company would have a complete payback of its initial investment in less than seven years. However, this base rent is subject to an annual increase of 3.25%, as well as a 1.5% property management fee based on the then-current rent amount. With the initial lease term equaling 15.25 years, Innovative Industrial Properties should come out well ahead on this deal.
Then, just last week, the company announced the acquisition of what'll become its eighth property. Located in Monson, Massachusetts, Innovative Industrial Properties acquired a 55,000-square-foot medical cannabis facility and entered into a triple-net lease agreement with Holistic Industries.
The purchase price for the property was $12.75 million, but the company will be receiving $1,912,500 in annual rent, which works out to 15% of the initial purchase price. Again, we're looking at less than seven years to complete payback of the company's initial investment. As with its other Massachusetts deal, a 3.25% annual increase in rent will be passed along, as well as 1.5% property management fee that's based on the then-current aggregate base rent.
What's really notable about this deal is the 20-year length of the lease. The company already had a 14.4-year average lease term on six properties at the end of the first quarter, and it's potentially lengthened that with its recently announced 15.25- and 20-year lease terms. Wall Street absolutely loves predictability, and that's what investors are getting with these long lease contracts.
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Two concerns to be wary of
Of course, no stock is without risk. There are two concerns that prospective investors in Innovative Industrial Properties would want to keep their eyes on.
To begin with, in order to raise the capital needed to purchase new facilities, the company has had to turn to selling shares of its common stock. To be fair, this is a pretty common practice of REITs, so I'm not faulting the company one bit for doing so. However, selling stock can have a dilutive effect on existing shareholders, depending on demand for the newly issued shares. Even with a relatively strong cash position at the moment, it's not out of the question that a share offering weighs on investors at some point in the intermediate future.
The second worry here is Attorney General Jeff Sessions. Sessions has made it clear that he doesn't support any expansion of the legal cannabis industry in the United States, and he's attempted to slow or halt that expansion numerous times. Then again, the threat Sessions poses appears to be minimal given that an overwhelming percentage of Americans supports the legalization of medical marijuana (93% in an April Quinnipiac University poll), and President Trump recently came out in favor of states' rights when regulating their cannabis industries.
While it won't be without an occasional speed bump, Innovative Industrial Properties is making hugely profitable deals at the moment, and smart investors should take notice.
