Innovative Industrial Properties' (IIPR 0.28%) business model isn't unique, but the sector in which it operates is. There are risks and rewards that need to be considered, just like with any investment. However, there's still a lot to like about this real estate investment trust (REIT) for long-term investors.
Let's start with the bad news
Innovative Industrial Properties owns marijuana grow houses, putting it squarely in the pot industry. That industry has been on the outs with Wall Street for a bit, so investor sentiment is very negative here. Given that Wall Street has an awful tendency to swing between irrational optimism and irrational pessimism, this is not a good thing. Even though marijuana is charting a path toward legality across the entire U.S., investor mood swings can lead to deep and painful downturns.
Image source: Getty Images.
To put a number on the pain here, Innovative Industrial Properties stock is down roughly 33% from its late 2021 highs. That's a huge decline. There are some company-specific reasons to expect the future to be less bright than the past, but they don't explain this kind of pullback at the REIT. That appears to be mostly about a change in perception.
However, as investment legend Benjamin Graham would note, Mr. Market's negative moods sometimes offer up opportunities. And for long-term types, that could be the case here -- even if there's more choppy stock trading over the near term that might unnerve some investors.
Growth slows, but it doesn't stop
One of the first things to note about Innovative Industrial Properties is that it has grown very rapidly, expanding from a single property at the time of its initial public offering in late 2016 to 103 properties today. It made 29 acquisitions in the fourth quarter of 2021 alone. But here's the thing: Buying one property when you only own one increases your portfolio size by 100%. Buying a third property drops that to 50%. The fourth gives you 33%. And those are big, though diminishing, numbers. Now, consider the impact of buying property 103, which amounts to less than a 1% change in portfolio size.
Clearly, there's more complexity here since the actual impact on the REIT's net income will be driven by the size of the property, the rent rate, the cost, and so forth. But the idea is the same: Unless Innovative Industrial Properties does something huge, growth is likely to be slower than in the past. But this is an industry that's still in growth mode. Specifically, the REIT expects sales in the marijuana sector to more than double between 2020 and 2025. There's ample room for Innovative Industrial Properties, a leading REIT in this niche, to grow even though it will likely be at a slower pace.
Dividends get reassessed but are still worthwhile
Another growth issue is tied to the dividend, which the company had been increasing aggressively. To put a number on that, the quarterly dividend was $0.15 per share in June 2017. By the end of 2021, after a series of quarterly increases, it was up to $1.50 per share per quarter, having been increased around a dozen times in just under five years. Before the Q4 2021 dividend, there were six consecutive quarterly dividend increases. When the company issued its Q3 dividend, however, Innovative Industrial Properties warned that the dividend would be reviewed semiannually going forward.
That may be a worry for investors who have gotten used to quarterly hikes. But given the portfolio growth, it's hard to believe that dividend growth will stop here. Sure, investors may see hikes that are less frequent and may not be quite as large as they were in the company's early days, but long-term dividend growth is highly likely to continue. Dividend growth investors shouldn't view this as a negative, just a reality of a company that's maturing.
IIPR Dividend Yield data by YCharts.
Valuation is down but looks reasonable
Innovative Industrial Properties doesn't have an incredibly long history; it only came public in 2016. That said, the current dividend yield is about 3.3%. The yield today is toward the high side of the REIT's historical range. It was notably higher during the worst of the 2020 pandemic-driven bear market, but that was an odd, one-off event.
And while dividend growth is likely to slow, the last hike was a huge 28% year-over-year increase. That's just not a sustainable number, but a third of that would still be an incredible outcome -- and, notably, would still make this a very desirable dividend growth stock.
IIPR Dividend Yield data by YCharts
As a reference point, giant warehouse REIT Prologis (PLD -1.69%) has a yield of 1.6% and a five-year annualized dividend growth rate in the high single-digit percentages. True, these two REITs operate in different areas, but they are both industrial REITs, so a comparison is still appropriate.
Compared to Prologis, Innovative Industrial Properties' higher yield with potential increases in the mid- to high single-digit percentages, would make it relatively attractive. And that's assuming dividend growth is lower than has been in recent years.
A walk on the marijuana side
Innovative Industrial Properties isn't for everyone, given that it is still relatively young, is focused on a specific niche, and investor sentiment runs to extremes in the marijuana sector. However, long-term dividend growth investors might want to do a deep dive here after the pullback. Wall Street's mood swings will probably be a big issue for years to come, given pot's uncertain legal status. But if the trends toward legalization remain in place, Innovative Industrial looks like it will be well-positioned to keep growing and rewarding investors as it does.
