Are you looking for a cannabis stock with positive cash flows? How about a real estate investment trust (REIT) with a dividend payout that has rocketed more than 1,000% higher over the past five years? Innovative Industrial Properties (IIPR -0.82%) ticks both boxes. Now that it's 68% below the peak price it set last year, the stock offers a juicy 7.2% yield that's hard to ignore.
More people spending more time in their offices is part of the reason Innovative Industrial's stock price has fallen hard this year, but it isn't the only one. Investors are far more concerned with the fundamental nature of its business following news in July that one of its largest tenants is getting behind on rent payments.
Despite its flaws, Compass Point analyst Merrill Ross gave this stock an upgrade on Monday, Sep. 19, 2022, citing an increased dividend payment and a settlement with its most problematic tenant. Is it time to buy, or should investors remain cautious? Let's look at why it's down and why it could bounce back to see if this stock is worth the risk right now.
Why Innovative Industrial stock is down
Innovative Industrial is a real estate investment trust. This means it can avoid paying income taxes if it distributes at least 90% of profits to investors in the form of dividends. Innovative Industrial makes its partners sign net leases that transfer responsibility for variable costs of owning real estate, such as taxes and maintenance, to the lessee.
Investors are nervous about Innovative Industrial because the company makes high-interest loans to U.S. cannabis businesses that haven't always been able to honor the terms of their sale-leaseback deals. In early 2020, the stock tanked after a short seller accused the company of acquiring low-quality assets from companies that appeared destined for default.
As is usually the case with short-seller reports, the concerns were overblown but not necessarily wrong. This year, Innovative Industrial stock is tanking because a key tenant, Kings Garden, defaulted on rent in July, and investors are worried that more default announcements could be on the way.
Why the stock could rebound
By making tenants sign long-term net leases, Innovative Industrial's cash flows should be extremely predictable. The company doesn't make unsecured loans. Instead, it acquires the real estate assets that cannabis businesses need to run their operations, like their production facilities, and leases them back at high rates.
With leases that include annual payment escalators, the company can expect growing streams of high-margin revenue. This allows the REIT to grow its dividend payout even if its partners only earn enough to pay their rent.
Innovative Industrial recently hiked its quarterly payout this year by 17% to $1.75 per share. Meeting this increased obligation probably won't be an issue in the near term. The company reported adjusted funds from operations that reached $2.14 per share in Q2. That's enough to comfortably cover the dividend payout now and perhaps support another raise next year.
Image source: Getty Images.
Why I'm not buying
When you owe a bank $10, you've got a problem. If you owe $10 million, though, it's the bank that has a problem. I know better than to accuse any REIT of hiding its tenants' insolvencies. That said, this company could have a lot more problems than have come to light so far.
In Q2 alone, Innovative Industrial made $147 million worth of additional investments into existing properties that were worth just $175 million. Those additional investments are supposed to be used for facility upgrades. If they're being used to prop up failing businesses, though, we probably won't find out until it's too late to recover any losses.
The Kings Garden default could be the worst problem the company faces for years, but I doubt it. At the end of the day, Innovative Industrial's tenants are selling commoditized products hampered by heaps of government regulations. This is an interesting stock to watch but not one I'd buy.
