Over the last five years, Innovative Industrial Properties (IIPR 0.28%) ranked as one of the hottest cannabis stocks in the industry. Its share prices grew by 307% from its IPO in late 2016 to its peak in March 2019, providing investors with a nearly 92% annualized return during that time.
But this once-hot stock has fallen hard as it faces a class action lawsuit and the default of one of its major tenants. The real estate investment trust (REIT), which leases industrial properties to medical marijuana operators, is down 69% from recent highs, and some investors believe it could keep falling.
Given the rockier ground the company sits on, here's a closer look at whether right now is the right time to buy Innovative Industrial Properties (IIP).
Where the company stands today
IIP was in good standing at the start of 2022. Its revenues and funds from operation, an important metric to show REIT profitability, were growing in the double digits year over year. That was until mid-April 2022. Short-seller Blue Orca Group filed a report against IIP for lack of disclosure about the state of collections and risk of default with its tenants. Innovative Industrial Properties declined all allegations and is preparing to battle the claim in a class action lawsuit.
Three months later, IIP's fourth-largest tenant, Kings Garden, defaulted. This is the first default the company has faced, and it certainly will impact its bottom line considering it contributes around 8% of its quarterly revenues. The back-to-back news coupled with general market volatility crushed its share prices as investors lost confidence in the future of the company. Today its share prices are nearing 2019 levels.
Is IIP a buy, given today's risk?
While Innovative Industrial Properties are certainly some big challenges today, the company isn't necessarily doomed. The REIT is still growing like crazy, and aside from the Kings Garden default, its rents for the second quarter were 99% collected.
Its latest earnings saw a 44% increase in revenues year over year. Its net operating income (NOI) and its adjusted funds from operations (AFFO) were up 21% and 30%, respectively. The REIT recently sold shares to help fund further growth, quickly putting that capital to good use.
Year to date, it's made four acquisitions in Arizona, Maryland, Massachusetts, and Texas, in addition to expanding its current contract with Curaleaf. Today it sits with around $45 million of cash and cash equivalents, which should be more than enough to help it float its current dividend payments until its next major debt obligation comes due in 2026.
There's a definite risk with IIP today. Its tenant base and likely expensive court battle with the class action lawsuit will hurt its financials as a small but fast-growing company. However, one tenant default doesn't mean the company will buckle altogether.
Its payout ratio of 81% doesn't put the company at significant risk for cuts in the near future, even considering the Kings Garden default. Plus, today's price-to-AFFO of 11 times and over 7% dividend yield makes it a steal of a deal for the cannabis industry.
I personally hold shares in IIP and don't plan on selling. Given the need for private financing in the cannabis industry, I believe the company will continue to achieve impressive growth. However, whether or not the company is a buy will ultimately be determined by your risk tolerance. If the company comes back from today's challenges, there's reason to believe it could provide similar returns as it did from 2016 to 2019, although there's no guarantee. If you have a low risk tolerance, it may be a good idea to wait this out and see how the company performs over the next year.
