If you're investing in a stock with a dividend that yields 8% or more, you should be careful and take a close look at its business. While monster-sized payouts may look attractive, the danger is that they may not end up lasting. Even real estate investment trusts (REITs) that generate recurring revenue from their tenants are by no means safe bets.
Innovative Industrial Properties (IIPR -0.92%) is a cannabis-focused REIT that pays a yield of 8.2% right now. But with some of its clients struggling, could the company's dividend be in danger, and should investors be thinking twice about buying the pot stock?
Multiple tenants have defaulted
A big concern for investors in REITs is the safety of the tenants. If tenants are struggling and are unable to pay rent, that impacts the REIT's bottom line. That in turn can impact its ability to continue to pay the same dividend as it has in the past.
On Jan. 18, Innovative Industrial Properties (IIP) issued a press release updating investors about its operating, investment, and capital markets activities. One thing that stood out was the number of defaults that the company noted. SH Parent, Green Peak Industries, and Affiliates of Medical Investor Holdings, LLC, were in default involving at least one IIP property. Last year the company also said that Kings Garden, a key tenant, had also defaulted. IIP now says Kings Garden is currently "exploring potential merger transactions."
Among the other things IIP highlighted in the press release was that no tenant represented more than 14% of its portfolio, and that multi-state operators accounted for 85% of it. It also noted that rent collection was 92% for the month of January. That's down from 97% for all of 2022. The news sent the stock into a tailspin, and ultimately to a new 52-week low.
How safe is the dividend?
News of the defaults comes ahead of the company's upcoming earnings numbers, which the REIT is likely to release sometime in February. When it last reported earnings in November, the REIT reported that its funds from operations (FFO) per share were $1.89 for the period ending Sept. 30, 2022. That's higher than the $1.80 that IIP currently pays out in dividends. And if the situation has worsened since then, it would be surprising if the FFO didn't come in even lower than that.
The positive is that in the past the company's free cash flow has normally been higher than its cash dividend payments. But the buffer hasn't always been all that large:
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While IIP has aggressively increased its dividend payments over the years, the danger is that could now be coming back to hurt the stock -- many cannabis companies are struggling and may not make for safe tenants to be relying on.
Given that this could be a tough year for cannabis companies as inflation and a worsening economy hurt demand, it wouldn't surprise me if at some point in 2023 IIP decided to reduce its dividend. REITs are obligated to pay 90% of their profits, and so while the dividend probably won't be eliminated, investors should prepare for the possibility that the days of the generous increases to the dividend are over. And there's the potential that even the current payout could come down.
Investors are better off steering clear of Innovative Industrial Properties stock
IIP made for a good growth story when the cannabis industry looked unstoppable and multi-state operators were generating impressive growth. But now as things have slowed down significantly, the risk involved with investing in cannabis companies and businesses that rely on them is becoming more evident.
Unless you have a high risk tolerance, IIP is a stock you should avoid, as there's a ton of risk within it right now. Although it may look cheap trading at 17 times earnings and down more than 50% in just the past year, if its bottom line declines and investors lose confidence in IIP's tenants, the stock could sink much lower.
