The marijuana sector has not been kind to investors lately; this stock, although not a pure weed play, is worthy of closer consideration.
Dec. 16, 2020
One would need nerves of steel to go long on any marijuana stock as the industry has taken investors on quite an emotional ride in the last few years. While the enthusiasm of the green rush has wavered, the most resilient companies are trying hard to maintain profitability but finding it difficult thanks to black market competition. One company, a real estate investment trust (REIT), is making out quite nicely, however, and is the focus of our discussion. Should you invest in Innovative Industrial Properties (NYSE: IIPR)?
The bull case for Innovative Industrial Properties
Innovative Industrial Properties provides triple-net (NNN) lease spaces to marijuana growers, filling the federal void of legality and financing available to the industry. This type of lease means that it’s not responsible for taxes, maintenance, or insurance on the properties; that falls on the tenants and they need to pay their rent no matter what. This has helped Innovative’s stock price grow nearly 125% year-to-date (YTD) and it’s still climbing, scratching at annual highs.
The company’s lease contracts average about 15.6 years in duration, with annual rent increases falling in the 3% to 4.5% range and an average return on invested capital of 13.3%. It’s a good, low-risk business model that guarantees a steady revenue stream and investors have benefitted as Innovative has raised its dividend payment by nearly 700% in the last two years to $1.17 in the last quarter. Four states have legalized recreational marijuana and one legalized it medicinally in the last election; that means that the company will continue to grow as the only source of real estate financing in the cannabis sector.
As legislators realize the potential revenues to be gained from taxing cannabis sales and that their citizens are traveling to neighboring states, more legalization is sure to follow. Hedge funds have taken note of Innovative’s potential and the company is currently held by 20 funds, an all-time high. Tailwinds from the pandemic like lower interest rates and categorizing the marijuana industry as an essential business have boosted the company’s revenue nearly threefold in the last quarter year-over-year (YOY).
The bear case for Innovative Industrial Properties
As good as Innovative looks on paper, there are some caveats to consider and one of them is progressive leadership in the White House that can potentially legalize marijuana federally. Should this happen, banks will be able to finance growers’ operations and Innovative will suffer as a result. Aside from this worst-case scenario, there is the question of tenant turnover. If the company loses a tenant, its best bet would be to lease to another grower, but if that doesn’t happen, then the company loses money in lower lease rates (as it charges a hefty premium), repurposing, or resale of the space.
The reason Innovative charges such high rates is because it employs a sale-buyback lease paradigm that charges a base rent that is 10% to 16% of its total investment per property. The company charges more per foot than logistics companies in Los Angeles and to tenants that are for the most part not profitable. In that sense, the company walks a tightrope in a shaky industry.
So, should I invest in Innovative Industrial Properties?
As the only dividend-paying, exceptionally growing company in the marijuana sector, absolutely. Joe Biden is not a fan of federal legalization and financing efforts like the SAFE Banking Act of 2019 are still on the backburner in the U.S. Senate. Having said that, be ready to dump shares should federal legalization become a reality.
1. How many states have legalized marijuana?
Recreationally, 11; medicinally, 34.
2. When did Innovative Industrial Properties go public
3. Who is the CEO of Innovative Industrial Properties?
Paul Smithers, since 2016.
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MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in companies mentioned above.