Cannabis has become a huge talking point among investors; legal U.S. cannabis sales were $17.5 billion in 2020. According to a report by Business Insider, this number could grow to as much as $100 billion by 2030.
Among the various cannabis stocks out there, don't overlook Innovative Industrial Properties (IIPR 0.28%), a real estate investment trust (REIT) that works with medical cannabis operators across America. Here's why the stock's a winner that you might regret not buying more of when you had the chance.
The cannabis landlord company
Cannabis is being legalized steadily across the U.S., especially for medical use, which is allowed in 36 states. However, it remains illegal at the federal level; the government seems to be content letting individual states make their own rules. However, the problem is that its federal illegal status prevents cannabis businesses from obtaining financing to fund their operations because traditional banks cannot lend to them.
Image source: Getty Images.
Innovative Industrial Properties was founded in 2016 to help solve that obstacle. This REIT acquires specialized industrial and retail properties from state-licensed medical cannabis operators and then leases the property back under a long-term agreement.
In other words, cannabis growers can convert their real estate into the capital to invest in funding their business, buying equipment, or hiring employees. The leases are triple net, which means that the tenants (the cannabis operators) are responsible for all of the maintenance expenses of the property, insurance, taxes, etc. In essence, Innovative Industrial Properties is playing the role of a bank.
Strong investor returns
A REIT is a unique business structure designed to give investors the ability to benefit from real estate without owning it outright. REITs don't pay corporate income tax provided they pass through at least 90% of their taxable income to investors as dividends. Innovative Industrial Properties is an outstanding dividend stock; its current dividend yield is 3.2%.
The best way to see how a REIT is performing is to focus on the cash that the company produces; REITs refer to this as funds from operations, or FFO. Think of this as earnings per share for a typical stock.
This chart shows how the company's FFO per share has grown from virtually nothing to $5.71 per share in just a few years since the company went public. This type of growth is rare for REITs, but Innovative Industrial Properties virtually pioneered this cannabis real estate model, so it's reaped the rewards of that.
IIPR FFO Per Share (TTM) data by YCharts
Strong future growth opportunities
Naturally, investors want to know if the company's rapid growth will continue. Innovative Industrial Properties now owns 75 properties in 19 states and has nearly 80% of its capital in just six states: Pennsylvania, Illinois, Michigan, Massachusetts, California, and Florida.
With the U.S. cannabis market expected to grow so much over the coming decade, there are multiple levers of growth for Innovative Industrial Properties. The company can both expand in states that it's already operating in and enter new states where medical cannabis is already legal (or once it becomes legal).
It's unlikely that Innovative Industrial Properties can maintain its past expansion rate, growing FFO more than 2,000% since 2018. The company started from nothing and has grown to a sizable business in a pretty short amount of time. Still, there seem to be plenty of opportunities for expansion, which could fuel enough growth to generate market-beating returns.
A significant risk to consider
Lack of competition has been an essential ingredient to the company's success. Innovative Industrial Properties is arguably the leading show in town for the cannabis industry. It's a big, reputable business for cannabis operators to work with, which might give the company leverage to negotiate favorable terms for its leases.
While cannabis remains illegal at the federal level right now, if that were to change, the company would face competition from deep-pocketed banks that might pressure Innovative Industrial Properties by offering favorable loan terms to property owners.
It's hard to know what the future holds, especially in politics when elections happen every few years, so it's something to be aware of if you invest in Innovative Industrial Properties. Aside from this political threat, it's a high-growth REIT that has more room to expand over the coming decade.
