How to Harness Mad Cannabis Growth Without the Risk

"During the gold rush, it's a good time to be in the pick-and-shovel business." Mark Twain said that. And while Twain himself was a horrible investor, his aphorism is just as applicable in the 21st century as it was in the 19th. Sometimes you want to avoid the industry that's causing irrational exuberance, and look to invest instead in companies that profit from the irrational exuberance.

You can find "pick-and-shovel" investments all over: in biotechnology, in cryptocurrency, in energy. The idea is that you can make a lot of money investing in the tools and services a hyper-growth industry needs, and avoid the risk of trying to figure out which of the competitors in the industry is actually going to win the mad dash.

Demand for marijuana in the U.S. is expected to more than double over the next three years, to an estimated $22 billion in revenue. A huge number of start-ups are trying to participate in that bonanza. While there are likely to be some winners (and a lot of losers) in this quest for riches, the sheer number of competitors can overwhelm an investor. Is there a way to profit from all this bullishness? 

Source: Getty Images.

Innovative Industrial Properties (IIPR +5.47%) is providing the one thing that every cannabis company desperately needs -- money. Under federal law, banks are forbidden from loaning money to marijuana start-ups, even as the companies are providing a product that is legal under state law. This has given IIP a near-monopoly as a funding source for the marijuana industry.

IIP is a real estate investment trust (REIT) that buys up marijuana properties from companies that are stressed for cash, and then turns around and rents them right back to the sellers. Thanks to IIP, the needy marijuana start-up now has millions of dollars that it can use to grow its business. And what does IIP receive in return? It gets long-term rental agreements from its new Properties -- with escalation clauses, creating a flood of future cash for the trust. And, of course, IIP now owns the marijuana farms.

source: Getty Images

This business model has made IIP very wealthy. The company now owns 2.2 million square feet of marijuana properties, making it the largest cannabis-space owner in the United States. Contrast this with the biggest cannabis stock in the world, Canopy Growth (CGC 2.87%), which owns 5.6 million square feet of marijuana space in Canada.  A comparison of the two stocks is striking.

IIP has all the mad growth of a cannabis producer, without all the mad risk. With its wonderful business model, IIP has been able to acquire marijuana properties left and right, and yet its debts are slight ($133 million). And unlike the vast majority of pot stocks, Innovative Industrial Properties is profitable. Indeed, its bottom line is so wonderful, the company is starting to look like a small-cap version of Visa (V +0.17%).

Now for the bad news. IIP's quasi-monopoly over marijuana funding is about to come to an end.

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Congress is now debating legislation that would allow banks to loan money to the cannabis industry. The legislation has passed the House, and its supporters are optimistic about the Senate.

The banking bill, if it becomes a law, would allow any and all bankers to loan money to companies in the marijuana industry. Such a bill would likely open a flood of dollars to the start-ups who are desperate for financing. It would also likely cause the value -- and price -- of marijuana farms to go up. 

What this means for IIP and its investors is that the company's ability to pick up marijuana properties for a song will soon be over. The business is likely to face a whole roster of financing competition that had previously been excluded from the market. This will make it much more expensive for IIP to acquire future marijuana properties.

On the other hand, if and when this bill becomes law, IIP's existing marijuana properties will be that much more valuable. And as the U.S. slowly makes its way toward full legalization, the largest owner of marijuana farms in the U.S. should start to see a market cap that rivals that of Canopy Growth.

So while it's likely to be a bumpy ride, this stock should see incredible growth going forward. Even if it's not able to match the 461% return investors have seen since its IPO two years ago, the future looks bright for IIP.