The cannabis industry is growing rapidly. When it comes to investing in the cannabis market, investors have a lot of interesting options. Companies that grow and sell cannabis in the U.S. have shown impressive revenue growth in the last couple of years.
Cannabis investing, however, is not for the faint of heart. Investors with a lower risk appetite can choose businesses that collaborate with cannabis companies. Innovative Industrial Properties (IIPR -0.73%) (IIP) enters the picture here. Innovative is not a pure-play cannabis company. It does not cultivate or sell cannabis. In fact, it is a real estate investment trust (REIT) that buys property intending to lease it to medical cannabis companies.
Let’s take a look at three reasons why smart investors think IIP is a good investment.
1. Innovative is a safer option for cannabis investing
Marijuana remains illegal at the federal level in the United States, which is why many investors are hesitant to invest directly in marijuana companies. IIP, as a REIT, is a safer way to enter the marijuana sector without being directly linked to cannabis. The drug’s illegality makes it difficult for cannabis companies to set up larger production facilities. Innovative purchases these properties and then leases them to pot companies under a sale-leaseback agreement, earning a rental income in return.
This rental income (its only source of revenue) has been more than enough to keep IIP afloat. Recently, the company reported another solid quarter. Total revenue increased 32% year over year to $71 million in the third quarter, while net income increased to $37 million from $29 million in the previous quarter. However, REIT investors are more concerned with adjusted funds from operations (AFFO).
AFFO, like net income for non-REITs, determines how much money is available for dividend payments. Innovative’s AFFO increased by 33% in the quarter to $60 million. IIP currently yields 6.4%, significantly higher than the S&P 500‘s average dividend yield of 1.8%. REITs typically have a high dividend yield because they are required by law to pay out 90% of their taxable income as dividends.
But when choosing dividend stocks, what matters is consistency in dividend payments. IIP increased its quarterly dividend payout by 25% year over year to $1.80 per share in September. It was the company’s 14th dividend increase since its initial public offering. Its rising AFFO allows it to increase dividends regularly.
2. Tenant default is possible
The majority of Innovative’s tenants include well-known cannabis companies like Trulieve Cannabis, Curaleaf Holdings, Cresco Labs, and Green Thumb Industries. These multi-state players are expanding aggressively, bringing in more business for Innovative. And Innovative has a long triple net lease with these tenants. Furthermore, its weighted-average lease term is 15.5 years, implying that it will continue to generate revenue for many years to come. However, there is always the possibility of tenants defaulting.
Recently, one of its tenants — Kings Garden — defaulted on $2.2 million in rent and property management fees. However, investors understand that tenant default is common in commercial real estate and is not an earth-shattering issue for Innovative. With the cannabis industry burgeoning, it can always find new tenants.
In the last five years, Innovative has significantly increased its revenue and FFO. It currently owns 111 properties in 19 states, all of which are 100% leased.
Innovative also maintains a healthy balance sheet while increasing revenue and profits. It had $77 million in cash and equivalents at the end of the quarter. It has a $6.4 million principal amount of 3.75% exchangeable senior debt note due in 2024. Aside from that, it has no debt to pay until 2026. Its debt-to-asset ratio of 12% is manageable, allowing it to secure capital for future acquisitions.
3. Federal cannabis legalization will not ruin Innovative’s business
U.S. marijuana legalization is very likely within the next decade. Many investors worry that if this occurs, Innovative’s business will be obsolete. However, this may not be the case. Federal legalization will boost the number of players in the American cannabis market. Even if banks and other financial institutions offer capital to cannabis companies after legalization, many smaller companies may not meet certain financing criteria. These companies can use Innovative’s assistance in establishing their businesses, so I believe Innovative will remain in the picture.
The global cannabis market is expected to grow at a compounded rate of 24%, reaching $82 billion by 2027. Street analysts expect IIP’s stock to rise by 44% in the next 12 months and recommend a strong buy. Rising revenue, AFFO, consistent dividend payouts, and a robust balance sheet make Innovative an appealing pick for both growth and income investors.
Sushree Mohanty has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Cresco Labs Inc., Green Thumb Industries, Innovative Industrial Properties, and Trulieve Cannabis Corp. The Motley Fool has a disclosure policy.