What happened

Shares of industrial real estate investment trust (REIT) Innovative Industrial Properties (IIPR -1.61%), which owns marijuana-related assets, fell a sharp 16% in the first hour or so of trading on Feb. 25. The reason for the dour mood on Wall Street was the company's after-the-close earnings release on Feb. 24. Only the numbers were pretty good. 

So what

Innovative Industrial Properties reported a year-over-year revenue increase of roughly 110% in the fourth quarter of 2020, a massive increase for a REIT. Its adjusted funds from operations (FFO), a REIT metric similar to earnings for industrial companies, rose to $1.29 per share from $1.18 per share in the final quarter of 2019. And the landlord raised its dividend again during the quarter, marking the fourth consecutive quarterly hike. The current rate, meanwhile, is a huge 24% greater than it was a year ago. Much of this success was driven by continued portfolio expansion, with the earnings release outlining a string of acquisitions made in 2020.  

A marijuana leaf on a hand.

Image source: Getty Images.

Only investors were clearly looking for more. For example, analysts had been projecting adjusted FFO in the range of $1.40 to $1.50 per share. A piece of the problem here is that Innovative Industrial Property's swift growth has been funded with stock issuances and an exchangeable senior note (which can be converted into shares and thus affects the share count). So the bottom-line improvement here is being spread over more shares, hampering adjusted-FFO-per-share growth. And while the REIT still has a relatively small portfolio of around 67 properties, more acquisitions will be needed if it hopes to keep up with its historically impressive growth rate. That could be a tall order, given it added 22 properties over the past 14 months or so -- increasing its portfolio size by nearly 50%. Even if management can repeat that number of deals in 2021, its building count would grow "just" 33%.  

Now what

Innovative Industrial Properties has a unique niche and is prospering by serving as a funding source for the marijuana industry. Notably, the stock is up around 880% since its late-2016 IPO, so a pullback here isn't exactly shocking given that investors have clearly priced in a lot of good news. Indeed, while there's likely more growth to come as the REIT expands its portfolio, the REIT's growth rate will naturally start to decline as it gains scale. Investors appear to be confronting that fact today.