According to Bank of America, the global legal cannabis market grew 45% last year to $14.9 billion. That’s probably because, to date, 41 countries have legalized medical sales for adult.
The U.S. isn’t technically one of those countries. However, Arizona and New Jersey voters passed medical marijuana proposals this year. (Idaho was going to vote on it too, but the pandemic put that measure on hold.) And South Dakota and Montana approved it for any purpose.
Pre-election, over 30 states and D.C. already had gone there in some shape or form, either legalizing or decriminalizing it. As such, per 2019 U.S. Census Bureau population estimates, about 65% of the population had access to medical marijuana.
Source: BoA Securities
That immense momentum has led to a transformation in the way patients can obtain treatment for a wide spectrum of medical conditions. This has given hope to millions who truly do see it as representing relief, and opened up a wide array of investing opportunities.
But within the U.S. real estate investment trust sector, there’s only one “pure play” cannabis REIT focused on the field. Innovative Industrial Properties (IIPR) calls itself “the leading provider of real estate capital for the medical-use cannabis industry.”
And it could add “one very high-flying business” to that title.
(Source: IIPR Investor Presentation)
The Business Model
Founded in 2016, Innovative Industrial is the first – and only – publicly-traded company on the NYSE to provide real estate capital to the medical-use cannabis industry.
As of Nov. 16, it owned 64 properties, which were 99.3% leased (based on square footage) to state-licensed medical-use cannabis operators. All told, its portfolio consists of about 5.2 million rentable square feet, including around 1.9 million that’s under development or redevelopment.
And it’s very diversified geographically speaking, as shown below.
Source: IIP Investor Presentation
At iREIT, we classify IIPR as an industrial REIT, although it is slightly diversified in this area too. CEO Paul Smithers told me recently:
“… we do have some retail, some cannabis dispensaries. We have about 10 of them now. So it is a small percentage, but we’re just more focused on the larger growth and production facilities, mostly because of scale.”
Source: IIP Investor Presentation
There’s good reason for that since its industrial facilities offer greater lease terms, making them better investments as a result.
Now, keep in mind that IIPR’s tenants aren’t your run-of-the-mill net-lease signers like Walgreens, Amazon, FedEx, or UPS. They’re state-licensed operators that are seeking capital to expand.
And they’re pretty high-quality businesses, at that. As Smithers told me, they’re not bleary-eyed 30-somethings with wasted lives. “No. These are very sophisticated businesspeople, many of whom come from Wall Street.”
They come from well-respected corners of the financial, marketing, science, agricultural, and genetic fields. So they not only know what they’re doing. They take what they do seriously too.
The Balance Sheet
In that same interview, I asked Innovative Industrial’s CFO, Cat Hastings, about the company’s balance sheet. And she did point out the problem of raising capital thanks to the tenants they take:
“… being associated with the cannabis industry is limiting somewhat to our options even in raising capital. For instance, we do not have availability to the large warehousing line of credit, like a traditional REIT would.
“We do have a small preferred – about $15 million – that we did back in 2017. And we’re thrilled to get that done when we did. It was really important at that time.
“But having a retail platform and a clearing house willing to clear retail trades remains an issue. We have a convertible note that we did last year. We’re happy to have another avenue again instead of common equity. But as well as the stock has performed, that’s obviously been a great choice for us.”
Under those conditions, Innovative Industrial has done several follow-on common offerings. That and an at-the-market (ATM) program. Together, those have helped it bring in the money necessary to continue buying up properties and growing its portfolio.
As of Q3-20, IIPR had about $161.1 million in cash and cash equivalents. It also held approximately $451.2 million in short-term investments.
The other side of its balance sheet can be summed up just as easily, with approximately $143.7 million in unsecured debt. This consists solely of 3.75% exchangeable senior notes maturing in 2024 – representing a fixed cash interest obligation of around $5.4 million annually, or $1.3 million quarterly.
In short, it has about 9.4% debt to total gross assets, with more than $1.5 billion in total gross assets.
Straight From IIPR’s CEO’s Mouth
As Smithers told me, the lack of traditionally-available capital makes from banks and institutional lenders for an interesting situation. That’s mainly because of federal prohibitions, though Smithers does see another layer to that barrier.
While he does think the first problem will clear at some point, it’s a question of when:
“And we think it’s going to be a longer path than other people do. And again, what happens politically. Say it opened up tomorrow. I don’t think the big banks, the institutional guys, the REIT players are going to come running into the space, because cannabis is still a very controversial topic, and not a lot of money’s going to come in.”
What will that mean to Innovative Industrial?
“We’re probably to see a little compression on our rental yields. Getting back to something more normal for industrial REITs. But again, I think that’s going to take some time.
“I think the big point… is, we right now have zero leverage on our assets on our portfolio. So if the banks open up, I think the first person they’re going to want to deal with is us. And we’re going to be leveraging that portfolio and really get to operate like any other REIT in the space. And I think tremendous advantage for us. So, kind of a two-edged sword, if we get legalization if more money comes in.
“Yeah, we’re going to see a little competition. Yeah, some compressed rates. But we get to leverage the portfolio. So I think it’s a balancing (act).”
To see how that balancing is going, consider the data down below.
The Growth Machine
In Q3-20 IIPR generated total revenues of approximately $34.3 million, representing a 197% increase from Q3-19. AFFO was approximately $27.9 million, or $1.28 per share, +192% from Q3-19.
Also, in Q3-20 IIPR paid a quarterly dividend of $1.17 per share (on Oct. 15), representing ~10% increase over the Q2-20 dividend and a 50% increase over the Q3-19 dividend. Here’s a snapshot of IIPR’s AFFO per share history and estimates for 2020 and 2021:
As illustrated below, IIPR’s dividend history has been exceptional:
IIPR has done a great job of keeping the payout ratio below 90%, as illustrated below, the payout ratio in 2020 is around 86%:
As illustrated below, IIPR has the best AFFO per share growth rates in the REIT sector (we provide a list of the top 25 fastest growing REITs at iREIT on Alpha).
The Final Say
Back four years ago, when legal marijuana growers first began to go big, it was “just a huge land grab.” Those were Hastings’ words, as these various operators fed off of and into the craze.
The Canadian market was already “explosive,” and so it was easy for them to find investment capital. But by about mid-2019, that came to a halt. All of a sudden, their backers wanted proof of profits.
So they had to get serious. Fast.
And that’s perfectly fine for Innovative Industrial, a sentiment that Smithers very much agreed with. He says “the pipeline’s never been stronger,” thanks in large part to existing customers looking to expand.
“They need to double or triple their capacity. So they come back to us as their capital partner to expand the existing facility. Or they want to go into a new state, and they need capital for the new state. Or they’re doing an M&A (merger and acquisition), and they’re acquiring another company, and they want to expand on those facilities.
“So, tremendous organic demand just from the existing group.”
And don’t forget the new states that will be coming online. IIPR certainly hasn’t. It recognized the “tremendous demand” opportunities there, as well as other places looking to enter or grow their market share.
As illustrated below, IIPR returned 72% in 2019. And it’s already grown over 113% year to date:
Yet we’re maintaining a Spec Strong Buy anyway based on its exceptional growth prospects.
Shares of Innovative Industrial are now trading at $152.91, with a dividend yield of 2.78%
The latest election results mean more opportunities at the state level and a lower likelihood of sweeping federal legislation. So that reduces risk. Meanwhile, adult use and medical programs are likely to create additional sale/leaseback opportunities for IIPR.
With its 7.44% cost of capital, we see a pretty clear path forward for it to continue delivering best-in-class investment spreads.
For further proof of this, consider the recently closed deals from its turbo-charged investment pipeline:
- November 2020 – Tulieve (Massachusetts) for $2.8 million at a 11.2% cap rate
- November 2020 – PharmaCann (Pennsylvania) for $2 million at 12.2%
- October 2020 – Green Peak (Michigan) for $0.50 million at 11.2%
- October 2020 – Green Thumb (Ohio) for $25 million at 11.7%
Last but not least, I’d be remiss if I didn’t address the risk of owning shares in a cannabis REIT. While the opportunity set is strong, the potential for volatility is enhanced.
In other words, it has high headline risk.
While IIPR is on track to deliver another exceptional year for long investors, our speculative rating signals caution. That’s why we recommend maintaining adequate diversification within your intelligent REIT portfolio.
Don’t get so high on this stock that you lose focus of everything else.
Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
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Disclosure: I am/we are long IIPR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.