Investors seeking a source of income that grows may have noticed a stock with some exciting features. Innovative Industrial Properties (IIPR 0.38%) has raised its payout by about 1,170% since it began offering a dividend in 2017.
Innovative Industrial Properties is a net lease real estate investment trust (REIT) with lots of dividend raises in its history, but zero reductions. Despite an impressive track record, the market is behaving as if a payout reduction is around the corner. The stock has fallen by more than three-quarters from its previous peak and offers an enormous 11.158% yield at recent prices.
NYSE: IIPR
Key Data Points
If you have much experience chasing ultra-high-yield dividend stocks, you know that what glitters isn't always gold. Here's a look at why this stock has been offering a double-digit yield to see if it could be a smart buy for folks seeking a new income-generating investment.
Why Innovative Industrial Properties' stock is down
In a nutshell, Innovative Industrial Properties' stock is way down because the REIT's largest tenant, PharmaCann, has fallen behind on rent. On Dec. 19, PharmaCann defaulted on obligations to pay rent for the month of December under six of 11 leases.
PharmaCann made good on $90,000 worth of rent for five of its leases, but this was of little consolation to investors. The rental payments it missed totaled $4.2 million.
Innovative Industrial was able to apply security deposits to make up the difference. With PharmaCann responsible for 16.5% of the REIT's total rental revenue, maintaining its dividend payout in the quarters ahead will be extremely challenging if the integrated cannabis producer doesn't quickly turn itself around.
During the third quarter of 2024, before PharmaCann defaulted, Innovative Industrial reported $2.25 per share in adjusted funds from operations (FFO), a proxy for earnings used to evaluate REITs. That's sufficient to meet a dividend obligation currently set at $1.90 per quarter, but there isn't much room to absorb a big rent default.
If Innovative Industrial loses any more of PharmaCann's incoming rental payments, FFO probably won't be sufficient to meet its dividend commitment. That means a significant dividend reduction could be around the corner.
Don't hold your breath waiting for a turnaround story
Innovative Industrial owns some retail properties but, to its credit, 98% of its properties are used to cultivate, process, or distribute cannabis products. When announcing PharmaCann's default in December, the REIT told investors it expected to aggressively enforce its rights, which could mean an eviction.
While there's a chance that Innovative Industrial can evict PharmaCann and replace it with a new tenant, it won't solve the key problem that led to PharmaCann's default: competition. Cannabis is a high-margin game for early movers, but only while they're one of a few licensed producers in their location.
High-margin cannabis sales are temporary situations that tend to end as soon as there's a healthy level of competition. Now that there are 24 states with recreational cannabis programs, I'll be very surprised if PharmaCann is the last big borrower that suddenly has trouble making rent payments to Innovative Industrial Properties.
Cannabis profit margins are getting slim, but they could shrink much further due to a legal rescheduling of cannabis at the federal level. While this would be great for consumers, an exploding number of new cultivators and processors no longer restricted by federal law will most likely cause profit margins for this REIT's already unprofitable tenants to shrink even further.
Keep looking
As a first mover in the cannabis industry, this net lease REIT put up a dazzling performance in past years. Unfortunately, it has more big tenants that could soon have a hard time making ends meet.
In descending order, PharmaCann, Ascend Wellness, Green Thumb Industries, Curaleaf Holdings, and Trulieve Cannabis are this REIT's largest tenants. While their operations have been generating enough cash to make rent payments, Green Thumb is the only one of these businesses reporting positive net income on a generally accepted accounting principles (GAAP) basis.
AAWH Net Income (TTM) data by YCharts
The vast majority of this REIT's tenants were having trouble reporting profits when competition in their respective locations was relatively light. Unfortunately for those producers, local prices on retail cannabis products can plummet once a handful of operations begin competing against each other.
Innovative Industrial's double-digit dividend yield percentage is tempting, but it's hard to see how it will maintain its payout if PharmaCann doesn't turn itself around immediately. With a lack of profitability among four of its five largest tenants, more problems seem likely. With this in mind, there are plenty of better ultra-high-yield stocks to consider.
