Innovative Industrial Properties Stock Forecast: The Cannabis REIT

Innovative Industrial Properties Stock Forecast: Cannabis-related sales are soaring, thanks to the legalization of both medical and recreational marijuana in multiple states. Changes to regulations around growing and producing hemp have added to the excitement, and cannabidiol (CBD) is showing up in everything from skin lotion to dietary supplements.

The massive influx of cash coming into the cannabis industry has investors scrambling to get on board, but not everyone wants shares in companies that rely on marijuana sales for revenue.

Aside from any philosophical issues they might have with the use of THC, the psychoactive chemical in marijuana plants, investors have real concerns about the risks faced by companies who violate the United States’ federal laws banning the substance.

Fortunately, buying stock in companies that grow cannabis plants isn’t the only way to invest in this expanding industry. Some have chosen alternative investments that focus on the infrastructure that supports cannabis growers. One example of such a company is Innovative Industrial Properties, which is a real estate investment trust (REIT).

Instead of farming the plants directly, Innovative Industrial Properties [NYSE: IIPR] is focused on securing the facilities growers need to produce cannabis. This option still comes with its own set of risks, but for many investors, it’s a great way to get a piece of the profitable cannabis pie without worrying about the future of cannabis-related legislation.

What is a Real Estate Investment Trust (REIT)? 

Real Estate Investment Trusts (REITs) are specifically designed to give individual investors access to the commercial real estate market.

Before REITs were developed, buying, operating, and selling commercial and industrial properties was limited to institutional investors – and the very rich.

The legislation establishing REITs passed in 1960, giving groups of smaller investors the opportunity to benefit from growth in the commercial real estate market.

Gains from REITs receive favorable tax treatment, so there are requirements that REITs must meet to qualify under this program:

  • At least 75 percent of total assets must be invested in real estate, US Treasuries, or cash
  • At least 75 percent of gross income must come from rents, mortgage interest, or real estate sales
  • At least 90 percent of taxable income must be distributed as shareholder dividends
  • After the first year, REITs must have at least 100 shareholders
  • No more than 50 percent of shares can be held by five or fewer individual investors

REITs often specialize in specific types of real estate investing. For example, some buy and operate income-producing properties like office buildings and residential buildings, and they generate income from rental payments.

Others are in the business of lending to real estate developers, and they get income from the interest on mortgages. Buying, refurbishing, and reselling properties may also be a part of an REIT’s strategy.

Innovative Industrial Properties [NYSE: IIPR] generally falls into the first category. Its strategy involves buying and managing income-producing properties that are critical to the cannabis industry.

IIPR: The Cannabis Producers REIT

Innovative Industrial Properties is a REIT that focuses on the real estate needs of cannabis producers.

Its goal is to expose investors to the cannabis market, without directly investing in growing and processing cannabis plants. Basically, Innovative buys and manages the facilities in which cannabis is grown. The land and buildings are leased to growers, and the REIT profits from lease payments.

The trust managers are confident that cannabis sales are poised for substantial growth, both in the short-term and the long-term.

In materials published for potential investors, the REIT cites projections from the ARCView Group that indicate state-regulated cannabis sales will increase from $8.6 billion in 2017 to $22.2 billion in 2022. Innovative is designed to take advantage of the industry’s profit potential, and pass those profits on to its investors.

Innovative Industrial Properties [NYSE: IIPR] held its IPO and purchased its first property in December 2016, and its portfolio has since grown to 32 properties.

All 32 are leased to state-licensed cannabis operators who produce the product for medical use. Before leasing to any operator, Innovative examines the leasee’s experience and expertise in the growth and production of medical marijuana. This ensures smooth operation and long-term income.

The business strategy is designed to keep investor risk at a minimum. The average length of Innovative’s property leases is 15 years, and a 3 percent to 4 percent annual rent increase is written write into the contract. In most cases, Innovative relies on a net lease model that puts responsibility for a majority of facility costs squarely on the lessees.

All of that sounds good – particularly in an area of the market that is growing rapidly. However, Innovative Industrial Properties isn’t a risk-free investment.

Risks of Buying Innovative Industrial Properties? 

Innovative faces the same risks that any REIT does.

Balancing growth with the demands of raising capital through new investment or taking on debt is complicated at best, and many REITs have failed to find the right mix.

In addition, due to its chosen area of focus, Innovative faces some unique challenges. The most pressing concern is this: Lessees are willing to work with Innovative on its terms, because there are limited funding sources for marijuana growers.

Traditional financial institutions simply won’t lend to businesses in this industry due to the complicated legal issues that come with contradiction between state and federal regulations.

When more REITs and other real estate investors get into this area – and if  traditional lenders decide to take the plunge – demand for Innovative properties could go down.

At the very least, contract terms will have to be more competitive. This could impact the REIT’s future profits.

Innovative Industrial Properties by the Numbers 

With that said, Innovative Industrial Properties [NYSE: IIPR] has demonstrated solid financial results, and for now, trust managers are successfully balancing growth with shareholder interests.

In the first half of 2019, rental revenues totalled $14.9 million, with $8.3 million of that coming in the second quarter alone. This represents a considerable year-over-year increase. The first half of 2018 brought total revenues of $5.9 million, with $3.2 million generated in the second quarter.

Second quarter net income was $3.1 million, which breaks down to $0.30 per share. Adjusted funds from operations (AFFO) was $5.8 million, and AFFO per diluted share was  $0.59. This represents a year over year increase in AFFO of 176 percent, with a year over year increase in AFFO per diluted share of 90 percent.

When first and second quarter 2019 results are combined, the year over year improvement in AFFO is 215 percent, and the AFFO per diluted share is 105 percent.

Overall, the benefits of investing in Innovative Industrial Properties currently outweigh the risks, making this a solid bet for those looking to enter the cannabis industry without investing directly in marijuana growing operations.