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Innovative Industrial Properties(IIPR-N)

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Bull Market and Beyond: Innovative Industrial Properties May Be a Buy, but Is It Right for You?

Motley Fool - Fri Aug 11, 2023

A huge 9.1% yield is the big story these days at Innovative Industrial Properties(NYSE: IIPR), the cannabis-focused real estate investment trust (REIT) -- and it may well draw the interest of some dividend investors. Yet, while the business continues to perform reasonably well, this landlord's yield is high for a reason.

If you are looking at Innovative Industrial's stock, make sure that it is the right fit for you before you buy it. Let's take a closer look.

Some reasons to buy Innovative Industrial

The most obvious reason an investor might want to own Innovative Industrial is the huge 9.1% dividend yield. But that's not the only good news on the dividend front. For example, this REIT has increased its dividend every year since it started paying one in 2017. That's roughly five years, which may not seem like a long time, but the company only held its initial public offering in December 2016. So the dividend has been on a steady upward climb since, basically, the very first day.

A stamp with dividends on it.

Image source: Getty Images.

Meanwhile, the company reported adjusted funds from operations (FFO) of $2.26 per share in the second quarter of 2023. That was up roughly 5% from the same quarter of 2022. And given the dividend payment of $1.80 per share, results in an adjusted FFO payout ratio of about 80%.

That's a reasonable payout ratio, particularly given that Innovative Industrial uses a net lease approach. Essentially, the REIT's tenants are responsible for most property-level operating expenses. This materially reduces Innovative Industrial's cost structure and frees up extra cash for dividends.

IIPR Dividend Per Share (Annual) Chart

IIPR Dividend Per Share (Annual) data by YCharts

In addition, the company's focus is on sale/leaseback deals in the marijuana sector. Pot is increasingly being legalized across the United States. Marijuana sales are expected to nearly double between 2022 and 2030. If more states legalize the drug, industry sales could go even higher.

This is a particular opportunity for Innovative Industrial because marijuana companies have limited access to traditional financing relationships. With pot still illegal at the federal level, banks are often reluctant to provide growers with capital. So long as this situation remains, marijuana companies will find the sale/leaseback deals that Innovative Industrial offers particularly attractive as a means to fund their growth initiatives.

Not all the news is good

So far, Innovative Industrial sounds like a pretty attractive investment opportunity. But then why is the stock down 70% from its high-water mark in 2021?

One reason is that the broader marijuana sector has fallen out of favor with investors. When investors lose interest in a story they often sell indiscriminately. So this marijuana REIT, despite a still-growing business, is no longer on investors' radar screens.

IIPR Chart

IIPR data by YCharts

However, there's more to it than just that. The marijuana industry went through a rapid growth phase, where lots of new companies entered the space. Now it is going through a consolidation phase, where companies are merging or going out of business. A smaller number of stronger companies will likely be left behind, but getting to that point may take some time and result in quite a bit of pain along the way.

Innovative Industrial, for example, has had trouble collecting rent from a small number of tenants. It has renegotiated leases and sold off assets that were no longer desirable, which is exactly what you would expect it to do. Investors, however, seem to think that there could be more problem children in the portfolio. That's not an unreasonable expectation.

And that brings up the big negative with regard to Innovative Industrial Properties: a lack of industry and property type diversification. If you buy this REIT you are going all in on the pot sector, largely grow houses, which might not be the best call for more conservative investors. That's doubly true as marijuana companies struggle in a consolidating industry that still faces material competition from illegal cannabis sales.

This stock is most appropriate for more aggressive investors who have very long investment horizons and who are willing to sit through periods of worrying uncertainty. This isn't something that all investors can do comfortably.

Not for everyone

There are a lot of things to like about Innovative Industrial Properties, like a fat yield, a growing dividend, and solid financial results. But even desirable stocks aren't always a great choice for every investor. In this case, the company's unique industry focus opens up a lot of risks that conservative income investors might not want to take on.

Don't feel bad if you can't get yourself to pull the trigger; it is much better to buy a stock you can stick with than one that you're likely to sell at the first sign of adversity.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Innovative Industrial Properties. The Motley Fool has a disclosure policy.

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