Innovative Industrial Properties (IIPR -0.17%) was early to tap into the growth of the marijuana industry. The real estate investment trust (REIT) owned no properties when it held its initial public offering. Starting from zero means that growth has been robust. At least, it was; the company's portfolio growth appears to have ground to a halt. What's going on?
Innovative Industrial is building from the ground up
Innovative Industrial came public in late 2016, using the proceeds it raised to buy its first asset. From that point, it expanded its portfolio to include 108 properties at the end of the first quarter of 2023. The number of lessees increased from one to 29. And the number of states in which it operates jumped from one to 19. That's a pretty substantial amount of growth, but it came off of a small base.
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Still, the numbers are impressive. For example, net operating income grew from $6.3 million in 2017 (the REIT's first full year of operation) to $265.8 million in 2022. That's an 111% compound annual growth rate (CAGR). Funds from operations (FFO) expanded from $520,000 to $210.7 million over that time frame, a 232% CAGR. There's a reason why the stock rocketed higher along with the broader marijuana sector for a few years.
But then things turned south. And that's showing up in Innovative Industrial's portfolio.
Innovative Industrial is trying to overcome industry stagnation
The REIT's property count peaked in 2022 at 110. So the current total of 108 is actually a decline in the size of the portfolio. The number of tenants, meanwhile, has remained consistent with 2022 levels, though it is still early in the year. And the number of states in which it operates has been flat since 2021. What's going on?
The big-picture story is that a hot growth industry (marijuana) got too big, too fast, and now it is facing a shakeout. This isn't specifically a commentary on Innovative Industrial, which owns valuable and unique industrial assets. However, its customers are marijuana growers that have to deal with oversaturated markets. Thus, the REIT is dealing with tenants that aren't paying rent, an effort that has included selling properties and shifting assets to new lessees. The number of problem tenants is small, but it is clearly having a notable impact on the company's growth. Fears that the industry pullback will be a big headwind are at least partly responsible for the sizable drop in Innovative Industrial's shares.
So, basically, the number of tenants and buildings is currently in something of a state of flux during the industry shakeout. And then there's the fact that only so many states have legal marijuana markets that are worth investing in for the REIT. So growth is limited in that way, too.
To put some numbers on all of this, the company bought two properties in the first quarter. But it also sold four because of issues surrounding a troubled tenant. With rent collections at 98%, the portfolio is still operating well. But the slight shortfall suggests there's still some weakness that may need to be dealt with. To be fair, it's not unusual for a REIT to have some lessee issues. The problem is that growth had been so strong that investor sentiment quickly turned sour now that the marijuana story isn't as attractive as it once was.
Innovative Industrial has a big yield
For more aggressive investors, the marijuana industry retrenchment could be an opportunity to buy Innovative Industrial Properties while it is offering a huge 9.6% dividend yield. The adjusted FFO payout ratio, meanwhile, was a solid 80% in the first quarter. That leaves room for adversity before a cut would be needed and, notably, ample leeway to deal with troubled tenants during the industry shake-up. But given the short company history and the still-maturing marijuana market, the stock is probably not appropriate for conservative types.
