Innovative Industrial Properties (IIPR -0.17%) is the first publicly traded company on the New York Stock Exchange to provide capital to cannabis companies through leasebacks. Operating as a real estate investment trust (REIT), it provides capital to companies that usually can't get traditional financing because of federal laws regarding cannabis. It does so by buying marijuana companies' facilities, then leasing them back with triple-net leases that put nearly all upkeep expenses on the tenant.
IIPR's shares are down more than 66% this year. There's a good reason for that, as the company's fifth-largest tenant, Kings Garden, defaulted on its rent of its six properties. With cannabis stocks reeling this year, investors were already jittery and the result was a plunging share price for IIPR.
However, I see this as a market overreaction that provides a great opportunity for investors to get in on a first-to-market company with big advantages and a high-yielding dividend. Growth for the overall cannabis market is seen as inevitable. With a current value of $27.7 billion, it's expected to become a $82.3 billion market over the next five years, with a compound annual growth rate of 24.3%, according to a report by MarketsandMarkets.
Taking a closer look at IIPR's strengths
While the Kings Garden default was concerning, the tenant's properties represent only 8% of IIPR's $2.4 billion portfolio. IIPR owned 111 properties as of Sept. 1, and there's probably not going to be much difficulty in finding another tenant to replace Kings Garden. IIPR just added a $21.5 million property in Webster, Massachusetts, and will do a leaseback on it to Curaleaf Holdings. IIPR already has lease deals for seven other properties with Curaleaf.
IIPR has made the most of its early to-market position. Over the past five years, the company's stock price has increased 382% while funds from operations (FFO) per share have grown 2,690%. It has also boosted its dividend 620% since the company began offering one in 2017. IIPR just raised its dividend again to $1.80 a share, a 25% gain over what it was this time last year. At its current lowered stock price, that represents a yield of 7.48%.
In the second quarter, IIPR's revenue was reported as $70.5 million, up 44% year over year. More importantly, adjusted FFO (AFFO) was $60.1 million, up from $42.7 million in the same period last year, and AFFO per share was $2.14, compared to $1.64 in the second quarter of 2021. Even with the Kings Garden default, the company said it collected 99% of its rent in the quarter.
IIPR's initial leases with companies are long-term, usually between 15 and 20 years, and the weighted average remaining period on the company's current leases is 16 years.
Potential pitfalls ahead
As already mentioned, the default doesn't fundamentally change much for IIPR as Kings Garden is easily replaceable as a tenant. The bigger concern, with several cannabis companies showing declining earnings, would be if Kings Garden's default is just the tip of the iceberg.
But looking at IIPR's top tenants, I don't see much weakness there. Six of IIPR's top 10 tenants are public companies and all of them are among the top 11 cannabis companies in terms of quarterly revenue: Curaleaf Holdings, Trulieve Cannabis, Green Thumb Industries, Cresco Labs, Columbia Care, and Ascend Wellness Holdings.
Another concern that could send investors to the exits is a possible dividend cut, because that's currently the best thing about the stock. Again, I don't see that happening. The company has shown a commitment to its dividend, and its AFFO payout ratio is 82%, well within safety guidelines for REITs.
The last concern is competition. There are only two other publicly traded cannabis REITs that do leasebacks. The next-closest cannabis REIT in terms of size, New Lake Capital Partners, had AFFO of only $8.7 million last quarter, about 14% of IIPR's quarterly AFFO.
The price is right
It's hard to guess when IIPR's shares will stop falling, just as in the current climate it's hard to tell when the market overall will begin to bounce back. It may be impossible to time it exactly, but with the decline in IIPR's share price, right now is a good opportunity to get a quality stock that will eventually climb. Its fundamentals are too strong for it not to. Its price-to-earnings (P/E) ratio is 17.65, meaning a share can be had for only 17 times earnings. Comparing that P/E to other REITs, it's well below average.
IIPR may or may not be a great investment in the short term. However, in the long term, it has too much going for it with the expected growth of the cannabis market.
