Innovative Industrial Properties (IIPR -1.89%) hasn't escaped the sell-off the marijuana sector has experienced recently. Shares of the medical cannabis-focused real estate investment trust (REIT) are down by more than 60% in the past year. While that's a bad performance by almost any standard, there is a silver lining: The pot market in the U.S. is projected to grow rapidly in the coming years. Some estimates say it will register a compound annual growth rate of 14.9% through 2030.
Innovative Industrial Properties could be one of the businesses to profit from this lucrative opportunity. On the other hand, the company faces issues that could hinder its prospects. Should investors purchase shares of this REIT? Let's briefly consider the pros and cons of investing in Innovative Industrial Properties.
The bull case: A relatively steady play in a high-risk industry
Innovative Industrial Properties fills a valuable need for medical cannabis companies in the U.S. Since marijuana remains illegal at the federal level, these corporations typically have a tough time raising capital. Innovative Industrial Properties acquires real estate holdings from its clients and then leases them back, allowing cannabis companies to free up much-needed capital to run their day-to-day operations, invest in expansion efforts, etc.
The REIT owns real estate in 19 states and does business with some of the largest vertically integrated pot growers in the country, including Trulieve Cannabis and Cresco Labs. It currently has a total of 30 tenants, with an average lease length of 16 years. Medical cannabis is legal in 37 states and various other U.S. territories. That leaves plenty of room for the company to expand its operations, especially as the U.S. cannabis industry continues to grow.
Innovative Industrial Properties has a history of recording strong financial results. Its revenue jumped by 44.3% in the second quarter to $70.5 million. And its net income per share increased to $1.42, up from $1.17.
As a REIT, Innovative Industrial Properties is required to distribute at least 90% of its taxable income as dividends. The company currently offers an incredibly high dividend yield of 7.7%, and it has raised its payouts by 80% in the past three years.
Innovative Industrial Properties' status as a REIT and its solid business make it an excellent stock for income-seeking investors. It is also one of the best picks to profit from the expanding cannabis market due to its shrewd business model and consistent profits, which are rare in this industry.
The bear case: It might only be as strong as its high-risk tenants
Innovative Industrial Properties isn't without its risks. One of the most obvious is the possibility of cannabis being legalized at the federal level. That could undermine one of the reasons pot companies do business with the REIT, as they would have an easier time accessing the financial services they need.
Then there is a short-seller report published by the activist investment firm Blue Orca Capital. The report claimed Innovative Industrial Properties was merely a "marijuana bank masquerading as a REIT." Among many other allegations, Blue Orca Capital argues that Parallel, one of Innovative Industrial Properties' largest tenants, faces legal troubles, putting it at risk of defaulting on its leases. But Innovative Industrial Properties responded by saying the short-seller report contained false and misleading information.
However, it is worth noting that since the report was published in April, one of Innovative Industrial Properties' top 10 tenants has defaulted. The REIT released an SEC filing in July saying that Kings Garden had failed to pay rent and property management fees for July.
That does not prove that the short-seller report was correct. But the risk of defaulting tenants is one to consider for Innovative Industrial Properties, especially because many cannabis companies are struggling.
The verdict
Despite the struggles it has encountered lately, Innovative Industrial Properties remains a buy. Here's why.
First, cannabis legalization is not a sure thing in the U.S. Even if it were, it wouldn't eliminate the need for companies like Innovative Industrial Properties. On the contrary; the freed-up market would attract substantially more players, many of which would avoid banks' stringent standards for smaller businesses and instead rely on Innovative Industrial Properties' services.
As for the recent default by one of its tenants, that client occupies only 6.6% of Innovative Industrial Properties' portfolio (in terms of square feet). The company is well diversified, with no single tenant that could make or break its prospects.
The short-seller report has an air of a "he said, she said" case. Much of the information in it can't be verified, and Innovative Industrial Properties denied the allegations. Without third-party verification, it's best to ignore such reports.
That leaves investors with one of the most profitable cannabis companies, which boasts a solid footprint across the country, a strong dividend, and a firm position from which to cash in on the rapidly growing marijuana market.
