The Bull Case For Innovative Industrial Properties

Investors wanting exposure to the income-generating real estate market – but don’t want to buy or otherwise finance a portfolio of physical properties themselves – can instead buy shares in what is known as a Real Estate Investment Trust, or REIT. REITs are traded on numerous securities exchanges, just like normal stocks and shares, making them highly liquid assets that can be bought and sold during any open trading session.

The chief attraction of REITs is that they provide a steady stream of income for shareholders, and they are a good way to diversify a dividend generating portfolio. REITs return cash to investors via an annual dividend payout, and they are legally obliged to pay a minimum 90% of their taxable income to shareholders in the form of dividends every year.

REITs must also invest 75% or more of their total assets in real estate property, U.S. Treasuries or cash, and they must ensure that at least 75% of gross income is derived from real estate sales, or the rents and mortgages that pay for the real property that is managed on their portfolio.

What Is Innovative Industrial Properties?

A REIT will often specialize in one particular kind of property type, and then collect rents on the properties it owns. One of these specialist REITS is Innovative Industrial Properties, Inc. (IIPR), a property management company that focuses on cannabis-related real estate.

The drawback of owning shares in a REIT is that these investment vehicles rarely show strong growth over the long-term, as they have to pay 90% of profits to investors, leaving little left to either expand their portfolio or initiate share buyback schemes.

However, IIPR is different; its area of interest, the marijuana industry, is a new, rapidly growing market space, and the REIT has seen its share price soar recently on the back of this growth potential. Stock in Innovative Industrial Properties has risen 105% this last year, from $123 in September 2020, to $252 a year later.

IIPR Dividend Yield Is Enticing

IIPR’s dividend has also grown as the firm’s investment opportunities grow too. Its yield of 2.3% might not seem much just now, but it’s still close to double the S&P 500 average of 1.3%. However, the dividend has seen rapid increases of the past two years, going from a quarterly payout of $0.60 in 2019, to its present one of $1.40.

The REIT certainly has the benefit of being an early adopter when it comes to the legal weed space. While focusing principally on the marijuana market, Innovative Industrial Properties is also developing its expertise licensing drug growers under a triple net lease license. This helps spread the expensive costs of producing a cannabis farm.

Bigger REITs and more traditional financial institutions will enter the territory over time, but since cannabis manufacture does not yet have full federal approval, this could be quite some time away.

IIPR Growth Catalyst On The Horizon

Given that so few REITs are involved in the marijuana business at the moment, IIPR’s addressable market is huge. A year ago, the company had just 61 properties, spread across 16 states; today, that’s shot up to 73 properties in 18 states. But the weed industry isn’t legal in every state yet, and as mentioned before is not legal at the federal level either. 

As Innovative Industrial Properties is still only concerned with the medical-use cannabis market, the nascent recreational marijuana space could be a welcome catalyst for growth.

New York and New Jersey, for instance, have just given the nod to recreational-use of cannabis in their states. These two states occupy just 4.2% and 2.9% of IIPR’s of portfolio respectively, but when it starts moving away from the medical-only market this opportunity in New York, New Jersey and a raft of other jurisdictions will be a welcome revenue income generator.

Dividend Metrics

For typical investors unaccustomed to the intricacies of REIT dividend payouts, the first thing that might strike them off is the staggeringly high payout ratio that it currently runs at. The firm’s trailing twelve month non-GAAP dividend payout ratio is a massive 129!

Surely this is not a sustainable figure for a normal company to post, but as mentioned earlier, REIT dividends work differently. Since the REIT must payout a minimum of 90% of its profitable income to investors, the payout ratio is always at least this high. 

In fact, looking at Innovative Industrial Properties’ forward FFO payout ratio demonstrates this, as it currently stands at 91% exactly. The “FFO” here is short for funds from operations, which describes the cash flow that a REIT makes. 

Another quirk of REIT dividend payouts is that they can sometimes actually be higher than the business’s diluted earnings per share. This true for IIPR at the present time, as its quarterly earnings only come to $1.17, yet its dividend is $1.40.

This is explained by the fact that its FFO is $1.56 – which this quarter was a beat on analyst expectations which had only predicted an FFO of $1.49. As you can see, this easily covers the REIT’s dividend obligations by at least 11%.

Is Innovative Industrial Properties A Buy?

There are plenty of good REITs on the market, but few, if any, promise the kind of growth prospects that IIPR does. Since issuing its first dividend in 2017, Innovative Industrial Properties has increased its dividend in 10 out of 15 subsequent quarters. That on its own would be enough to make the REIT a highly attractive investment. 

But IIPR has even more going for it. The company’s share price is also surging on investor confidence that the trust is operating in one the highest margin sectors in the economy – and one the fastest growing too.

Indeed, the legal cannabis industry grew US sales 46% in 2020, with revenues surpassing $17.5 billion. Worldwide sales increased at an even faster rate of 48%, as buyers purchased $21.3 billion worth of weed last year.

In the US, much of that growth came from mature markets like California and Colorado, which suggests there’s plenty more growth when less well-developed markets begin to see sales take off.

With twin channels of growth in both dividend and share price, Innovative Industrial Properties is like no other REIT out there.

The cannabis market is only set to grow bigger, and IIPR, as a leader in the medical marijuana industry – and possibly soon the recreational one too – is perfectly positioned to capitalize on this. And with a market worth of still less than $6 billion, IIPR might very well be undervalued right now. In other words – IIPR stock is a Buy.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.