Innovative Industrial Properties Inc. (NYSE: IIPR) is one of my original cannabis recommendations. It’s one of my favorites, too – and not just because it’s given folks a chance at more than 200% in peak gains, either.
I like Innovative because of its increasing yield and its totally unique position in the cannabis sector. It doesn’t touch the plant, which frees it from the heaviest regulatory baggage, but as a real estate investment trust (REIT), it provides the real estate needed for cannabis companies to do business.
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In fact, Innovative buys the cannabis facilities from the companies that build them and leases those facilities back at a handsome premium. Innovative collects rents in excess of market rates, and the companies get the cash they need to grow their cannabis business.
But since last we spoke about it, IIPR shares are down by about 35%. And while folks who were following along closely already sold half their position when Innovative doubled (the first time), and thus own IIPR for “free,” it’s still important for me to tell you why I’m not too worried here…
Here’s What the Market Thinks of Innovative
Some of the reasons for Innovative’s decline make good sense. The truth is, Innovative began a monster run higher starting in May, and some folks are selling their shares; a bullish run is a natural opportunity for prudent investors to take profits off the table.
Simple profit-taking will knock shares down a peg, but the effect is usually only temporary.
But in this case, the market has some concerns – and it’s making some fundamental misjudgments, too.The major worry is actually something that would be a massive bullish catalyst for marijuana companies. I’m talking about the prospect of the SAFE Banking Act coming out of the Senate and landing on the president’s desk.
This just so happens to be a fair question. If big banks came rushing into the sector with capital, Innovative would likely face competition for the lucrative sale-leasebacks it arranges for its customers. That competition would lower Innovative’s returns; it could technically be worth less because of that.
The concern is real… but also exaggerated.
Even if the SAFE Banking Act passes, banks are unlikely to rush in en masse and start writing long-term notes to cannabis companies. As you know, most of these companies are not yet making profits. Rather, they’re still growing, and they’re vying for market dominance, investing even faster than revenue is growing.
Banks still don’t like to loan to as-yet-unprofitable companies, even when they know profits are just down the road. Should the Act pass, we’ll see some lending, but long-term mortgages to build cannabis facilities won’t happen.
Interestingly, Innovative’s CEO, Alan Gold, once built and sold a REIT specializing in labs and and offices for the biotechnology industry. That industry has always been legal – but only sporadically profitable – and for that reason, banks have never really been important, disruptive players there.
Then there’s the issue of dilution.
This Is Investors’ Other Big Innovative Worry
Innovative is an aggressive share issuer, but again, this isn’t surprising. Growing companies need capital, so new shares of IIPR are put up for sale frequently.
The thing is, these shares – so far – aren’t dilutive to current shareholders.
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As the cannabis industry sees the benefits of leasing, not owning, its real estate assets, Innovative is doing business with bigger, more creditworthy tenants using the same “economics” as it used previously with smaller, riskier tenants.
As shareholders, we should be thrilled to see the company raising bigger piles of money to employ under those circumstances.
Previous issuances haven’t hurt current shareholders a bit. This company has put increasing amounts of cash back in shareholder pockets; it’s quadrupled its dividend in just two years, and it’s done that by raising new money and putting it straight to work.
And that brings us to the dual challenges of yield and book value…
There Were Valid Concerns, but Not Anymore
Here, at least, it’s fair to say that the stock got ahead of itself. At IIPR’s peak price of $137.62, it yielded just 1.75%. Compared to the 3.85% forecast dividend yield of the Schwab REIT ETF (NYSEArca: SCHH)… that’s kind of skimpy.
Likewise, the price was over four times the published book value of its assets. REIT investors get pretty nervous when valuations get that high – these are supposed to be (relatively) conservative investments.
But after its recent decline, Innovative sports a much more reasonable, much more attractive forward yield of 2.8%.
That’s still less than the Charles Schwab ETF, but analysts share my belief that Innovative dividends will continue to grow faster than other REITs’. Book value is still high for a REIT, but with that large and growing dividend, I think most investors will get over their other valuation concern fairly easily.
The bottom line is this: Innovative has either addressed investors’ worries, or those worries have morphed into nonissues. The stock isn’t monstrously undervalued in the way that, say, global cannabis pure-play stocks are, but its excellent growth prospects – including an increasing dividend – make this a good buy at these levels. It’s also a much lower risk at these levels than it was at $137.
If you own it, add to your position. If you own it “free,” per my recommendation, buy even more, and if you’ve hesitated over the past four or five months, come on off the sidelines.
As I write this, the shares are up more than 4% on the day, so the opportunity to own the stock (and its dividend) at truly great prices is fading fast…
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