When it comes to real estate investment trusts (REITs) in the cannabis industry, Innovative Industrial Properties (IIPR -0.04%) is the first among equals. IIP holds 76 marijuana-cultivation properties, and I like to joke that it's the industry's landlord. It's also one of my highest-conviction stocks. 

The prospect of marijuana legalization has profound impacts for every player in the business, and IIP is no exception. I've spoken with a few of the stock's skeptics, and their refrain is always the same: Things are great right now, but legalization will wipe it out, so don't touch it. As a shareholder, I don't believe that this argument is true -- but let's break the issue down into bite-sized pieces to analyze it. 

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The bears might have a point

To appreciate how legalization might impact Innovative Industrial's stock, it's necessary to understand why it's so successful under the current legal scheme. One of the persistent problems for cannabis companies in the U.S. is that it's hard to raise money to expand, as major financial institutions are leery of the legality of working with the industry.

That's why IIP is a lifesaver for those businesses. In case you aren't familiar, Innovative Industrial's business model is to run sale-leaseback transactions that result in cannabis companies getting liquid capital. 

For the uninitiated, sale-leasebacks are a type of real estate deal in which a company with working property sells it to a buyer like Innovative Industrial, which then promptly rents it right back to the seller. Leasebacks are a win-win because the cannabis business gets cash up front without any disruption to their production floor, and IIP gets another piece of property in its portfolio, as well as a trickle of rental income. Thanks to its steady drumbeat of signing new leasebacks, IIP has grown its quarterly revenue by more than 1,000% over the last three years and expanded its dividend by 328.6%. 

If the law eventually changes such that cannabis companies can get access to financing through traditional institutions like investment banks, they won't need to raise funds by doing sale-leaseback transactions with IIP. Though the option will remain on the table, it'll probably be easier to take on debt, which doesn't entail sacrificing ownership of property. 

In theory, that means IIP won't be able to expand its holdings as rapidly as it has in the past. But that doesn't spell disaster whatsoever, nor is it a guaranteed outcome.

Legalization could just as easily open the door to new customers

The thing about raising money as a business is that it's extremely helpful to have more than one source of financing. 

For example, many companies issue new shares of stock and then also take out debt to generate even more capital. The fact that they can issue stock doesn't preclude taking out debt, or vice versa. Nonetheless, if a company's stock is already diluted or its shares aren't priced at an appealing level, that avenue might be off-limits. Likewise, eventually, a debt load can grow so large as to scare off new creditors. 

In a nutshell, it's highly unlikely for IIP to be without any new leaseback targets, even if marijuana is fully legalized. And if it needs to find a niche by working with indebted or highly diluted cannabis growers, there will still be an audience for its services. 

Then there's the prospect of the cannabis industry exploding nationwide when the legal floodgates are finally opened. In such a gold rush-like environment, it's entirely possible that more companies than ever would be clamoring for funding from IIP to fuel their new operations. While some of these players would doubtlessly be poached by banks, it's very hard to believe that IIP would be kicked to the curb with its investment dollars still waiting in hand. 

Either way, its existing group of tenants have a weighted average lease length of 16.7 years, so it should be able to keep paying out to shareholders for quite some time if it takes a while to settle into a new business model after legalization.

The issue's on pause again

At the moment, the prospect of federal legalization of cannabis isn't on the national agenda, so shareholders can rest easy. 

But the SAFE Banking Act was on the table for a brief period. The Act, if passed, would prohibit banks that work with marijuana businesses from facing prosecution for doing so. Though there's been persistent bipartisan support for the bill, efforts to attach it as a rider to other pieces of legislation, like the recently passed National Defense Authorization Act (NDAA), have failed. 

It looks like things will be staying the same for now. Cautious investors could still probably argue that IIP's stock is worth avoiding. For everyone else, the dividends are going to keep piling up whether or not legalization happens in the next few years. There's plenty of upside stemming from IIP's positioning in the industry.