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Is Innovative Industrial Properties Stock a Buy?

By Keith Speights - May 16, 2020 at 6:32AM

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The answer is an easy one.

Let's cut to the chase. I think the answer to the question is "yes." Innovative Industrial Properties (IIPR -1.07%) stock is a smart pick to buy right now.

I don't expect you to jump to buy shares of Innovative Industrial Properties just because I like the stock, though. You shouldn't. However, I'll walk you through my rationale about IIP. My hunch is that, after reviewing the facts, many investors will reach the same conclusion that I have about this cannabis-focused real estate investment trust (REIT).

Tiny shopping cart with a cannabis leaf in it on top of a plastic card and $100 bills

Image source: Getty Images.

Overcoming the objections

Before we delve into why Innovative Industrial Properties is a great cannabis stock to buy, let's address the objections to the stock. Short-seller Grizzly Research raised concerns about IIP in April with a blistering report on the company. All of these concerns can pretty much be rolled up into one issue: IIP's revenue is in serious jeopardy because of the high risk of its tenants not being able to pay their rents.

There are a few things to keep in mind. First, Innovative Industrial Properties quickly refuted Grizzly Research's allegations. Second, Grizzly Research stated at the time that it had a short position in IIP and therefore had a financial incentive to make the stock appear as unattractive as possible. Third, investors seemed to completely disregard the short-seller's report, with IIP shares jumping more than 9% the day the report was released, well above the overall market gain that day.

But it's worth examining risks for any stock. The potential for revenue loss due to tenants failing to pay rents is the most significant risk for IIP. In fact, the company stated in its first-quarter update that it has temporarily deferred rent for three of its 21 tenants as they face uncertainties amid the COVID-19 pandemic.

That seems quite concerning -- until you learn the details. In March and April, IIP talked to all of its tenants to see if they needed assistance during the challenging times. For three of them, the company applied part of their security deposits to their April rent. It's also deferring their rent for May and June.

However, the rent deferrals are only temporary. The tenants expect to resume paying rent in July. What's more, they'll repay the security deposit applied to their April rent and the deferred rent in full over an 18-month period. Importantly, the total amount involved ($2.3 million) represents only 3% of IIP's total annualized revenue. 

This doesn't present a crisis for Innovative Industrial Properties. Actually, it's comforting to know that the company is able to weather an unprecedented economic situation so well. 

A remarkable growth story

The factors behind IIP's remarkable growth explain why the company is so resilient. IIP focuses on the medical cannabis industry. Americans have increasingly accepted the legitimate medical uses of cannabis, and medical marijuana has been legalized in 33 states so far.

Despite this acceptance, federal laws have made it difficult for medical cannabis businesses to obtain the capital needed to operate. IIP provides a solution by buying medical cannabis properties then leasing them back to the operators. The medical cannabis operators receive cash to fund operations, while IIP receives a steady revenue stream.

This business model has worked exceptionally well for IIP. The company's revenue more than tripled in the first quarter, with earnings soaring 249% year over year. Over the last three years, IIP's trailing-12-month revenue has increased by a whopping 1,240%. Its trailing-12-month earnings have skyrocketed more than 2,000% during the period.

Innovative Industrial Properties now owns 56 properties in 15 states. Over 99% of the square footage of these properties has been leased, with a weighted-average remaining lease term of around 16 years.   

A story that can continue

I like Innovative Industrial Properties stock first and foremost because I think this impressive growth story can continue. The medical cannabis markets in many of the states where the company operates are still in their early stages of growth. More states will likely legalize medical cannabis in the future as well. 

If IIP's earnings grow, its dividend will grow too. REITs are required by law to distribute at least 90% of taxable income to shareholders in the form of dividends. IIP's dividend yield already tops 5.6%. 

My view is that Innovative Industrial Properties is the marijuana stock most likely to double an initial investment within the next five years. The company should only have to add six to eight properties each year to make it happen. It's added 10 new properties in 2020 so far.

IIP might not be the kind of stock that every investor will like. But if you're looking for solid growth potential combined with a very attractive dividend, this is a stock to consider buying now.

Keith Speights owns shares of Innovative Industrial Properties. The Motley Fool owns shares of and recommends Innovative Industrial Properties. The Motley Fool has a disclosure policy.

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