Innovative Industrial Properties (IIPR 2.21%) is the largest owner of commercial marijuana properties in the United States. At last count (in May 2022) the company owned 8.1 million square feet of marijuana fields, spread out across 109 properties in 19 states.
Innovative acquires all of its property via a sale-leaseback arrangement. A marijuana grower sells their land to Innovative in order to raise cash. And Innovative turns around and leases the land back to the marijuana grower. In this manner the grower has access to funds -- which is important as much of the marijuana industry is shut off from the banking system because of federal laws.
This week, one of Innovative's renters, Kings Garden, defaulted on its rent payment. Is this the start of a wave of bad news about to hit this landlord to the pot industry? Or is it a blip on the chart? Two Fools put forth the bear and bull cases for Innovative Industrial Properties.
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Bear case: IIP's tenants could face big challenges
Keith Noonan: Innovative Industrial Properties offers a diversified way to play the growth of the marijuana space, but investors could be in for a bumpy ride. The cannabis REIT's stock price sank double digits after news emerged that one of its 10 large-scale tenants had defaulted on this month's rental obligations and property management fees. The stock already looked cheap before the big sell-off, and it's now trading even deeper in value territory. However, there may be deeper issues with its tenant composition, and big risks remain.
While IIP has made it easy for growers to start out and scale by specially tailoring its properties to the industry and providing resources and capital that would otherwise be difficult to secure because marijuana is still illegal on the federal level, tenants are paying pricing premiums over long contract periods. That can still be an attractive trade-off for growers when the industry is booming, but the economics have started to shift in unfavorable directions.
The marijuana industry is becoming increasingly competitive, which is pushing sale prices lower. At the same time, the industry will likely face some sustained headwinds amid the current macroeconomic climate. Marijuana prices are moving in the wrong direction while inflationary pressures including rising costs for fertilizers, pesticides, energy, and distribution are adding to expenses. That sets up a challenging dynamic for IIP's tenants, and it could lead to more of them defaulting on contracts and going out of business.
While the REIT's low funds from operations (FFO) multiples and big dividend yield look attractive, the picture could change rapidly if IIP's tenants continue to struggle.
Bull case: While risks remain, Innovative owns the sweet spot in the marijuana space
Taylor Carmichael: Innovative is far and away the most profitable marijuana stock I know. This cannabis financier enjoys sweet 54% profit margins, and even in this bear market is growing revenues at a 50% clip. Its dividend yield is 6%.
This week a dark cloud appeared when Innovative's fourth-largest tenant, Kings Garden, failed to pay its rent when it was due. The default in question was in regard to a $2.2 million payment that was supposed to be made on July 13.
Of course, shorts whacked the stock when the default was announced, and Innovative stock dropped 14% on Friday. Roughly $400 million in market capitalization was shed. That seems like overkill to me, particularly since the stock has already gotten a lot cheaper this year.
Kings Garden operates 11 production facilities in California, by far the largest regulated cannabis market in the U.S. The opportunity is massive. Innovative reports there were $5.2 billion in marijuana sales in the state last year. And the company says there are estimates that the illegal market in California is even bigger, perhaps $8 billion in annual sales.
The conference call is really on point, as management spends some time talking about its underwriting in general and the Kings Garden investment specifically. Kings Garden has no dispensaries yet.
My feeling is that cannabis continues to be a fast-growing industry, and weak hands are likely to be acquired by stronger players. As management noted on the conference call, "A number of our top 10 tenants became our top 10 tenants through M&A activity in the past few years, acquiring other tenants in the portfolio." Innovative is already in talks with other companies that might be interested in the Kings Garden portfolio.
Is Innovative a great buy at these prices?
The big question is whether you want to invest in marijuana. As Noonan points out, the industry is facing some headwinds, and some weaker players might be in trouble in the near term. On the other hand, if you do want to invest in this high-growth industry, Innovative is a great way to do it. The financier is deeply profitable and has multiple tenants across the cannabis industry.
