Innovative Industrial Properties Is ‘Growing Like A Weed’ (NYSE:IIPR)


Last December, fellow Dividend Kings founder Dividend Sensei wrote an article on Innovative Industrial Properties (IIPR). In it, he explained that it’s likely to be the fastest-growing real estate investment trust (REIT) of 2020.

Sure enough, IIPR has returned 100.4% so far in 2020:

(Source: FAST Graphs)

Think about it folks…

IIPR has returned more than 100% in the midst of a global pandemic, and we’re still buying! I know that sounds crazy, but the growth opportunities in legal cannabis – what its tenants operate in – is enormous.

In 2017 alone, U.S. sales were $8.6 billion, with $5.9 billion being of the medical variety. And ArcView Market Research estimates that, by 2022, it will be a $22 billion industry.

Many investors today focus on cannabis growers themselves. But that isn’t likely the best way to profit from this hyper-growth industry. The “weed” in question is a commodity product with unproven branding power that may end up being no more profitable than corn.

(Source)

With that said, spending by state-licensed cannabis operators is growing, creating a unique opportunity for a REIT like IIPR. Since roaring out of the gate in late 2016, it appears to have cracked the code on legally minting money from marijuana.

This triple net lease/industrial REIT has delivered some of the best total returns of any stock in America in the past four years. Shares are now trading at $124.79, drawing ever closer to their all-time high of $130.16 from July 1, 2019.

(Source: Yahoo Finance)

A Closer Look…

Innovative Industrial Properties is the NYSE’s first and only to provide real estate capital to the medical-use cannabis industry. As viewed below, it holds 61 properties amounting to 4.5 million square feet in 16 states.

Better yet, its portfolio is 99.2% leased with a weighted average lease term of 16.1 years.

(Source: Investor Presentation)

Keep in mind that when Dividend Sensei wrote on the company last year, IIPR owned 27 properties. So the portfolio has essentially doubled in size.

It’s also expanded into new states like Arizona, California, Colorado, Illinois, Maryland, Massachusetts, Michigan, Minnesota, Nevada, New York, Ohio, and Pennsylvania.

(Source: Investor Presentation)

As Hoya Capital Real Estate pointed out, IIPR:

“… serves as a de facto lender to the cash-strapped (and generally unprofitable) medical cannabis cultivators who struggle to finance their businesses due to the intensely challenging competitive and regulatory dynamics of marijuana cultivation.

“As the landlord to these multistate operators, IIPR has rapidly amassed a portfolio of properties primarily through sale-leaseback and development agreements with emerging cannabis growers, allowing these MSOs to raise capital to build facilities and fund their core business of seeding, planting, and cultivating their cannabis products.”

(Source: Hoya)

Essentially, IIPR acts as a source of capital to these state-licensed operators by acquiring and leasing back their real estate. This allows them to redeploy the proceeds into core operations, yielding a higher return than they would otherwise get.

IIPR sources deals with licensed operators across all product types: cultivation, processing, distribution, and retail.

What’s more, the initial base rent (capitalization rates) range from 10% to 16% (on total investment). And annual rent escalations are 3%-4.5%. IIPR often obtains security deposits and guarantees as well.

(Source)

Of course, we view IIPR as a higher-risk REIT because of its tenants/operators’ overall credit-quality. Most of them aren’t well capitalized.

But the fact that IIPR executes on investments at outsized cap rates of 11%-15% is enticing. Also, cannabis continues to grow despite the pandemic. You see, most states with medical and adult-use legislation consider it an essential service.

(Source: Investor Presentation)

IIPR’s Balance Sheet Looks Strong

Innovative Industrial maintains a conservative capital structure to provide flexible financing and growth initiatives. Capitalized almost entirely with equity, its only form of debt is a $137.7 million convertible issue held on its balance sheet.

At the end of Q2-20, the company had $385 million in cash and equivalents, primarily as a result of equity raises.

(Source: Investor Presentation)

IIPR recently acquired a 65,000 square-foot property in Lakeland, Florida, from an affiliate of one tenant, Parallel, for ~$19.6 million. Parallel itself expects to develop an additional ~155,000 square feet.

So that’s a total of ~220,000 square feet of industrial and indoor cultivation space.

IIP has agreed to provide reimbursement for this development of up to approximately $36.8 million. Assuming full reimbursement, the total investment in the property will be $56.4 million.

As illustrated below, IIPR has demonstrated exceptional earnings and dividend growth since going public:

(Source: Investor Presentation)

As illustrated below, we’ve modeled adjusted funds from operations (AFFO) per share growth based on analyst input. There are seven involved in the consensus estimates for 2020 and 2021, and two for 2022.

(Source: Wide Moat Research)

It’s no wonder then that, on Sept. 15, IIPR increased its dividend from $1.06 to $1.17 – its eighth hike since going public.

(Source: Wide Moat Research)

Its dividend growth has been exceptional, as illustrated below:

(Source: Wide Moat Research)

Furthermore, the company’s payout ratio (based on AFFO) is around 88%:

(Source: Wide Moat Research)

We previously listed IIPR as a diversified REIT, but we’ve changed that to industrial only. In which case, here’s how its weighted average cost of capital compares with its peers:

(Source: Wide Moat Research)

This profitability score validates its robust growth model. Innovative Industrial clearly has superior investment returns over any other REIT in our coverage spectrum.

Or anywhere!

Management Matters, and So Does Valuation

IIPR has an experienced management team led by CEO Alan Gold. Along with Gary Kreitzer, vice chairman of the board, Gold founded BioMed Realty Trust Inc. (formerly BMR), which was sold to The Blackstone Group (BX) in 2016.

The key to IIPR’s early success has been management’s focus on becoming the go-to landlord source for anything cannabis. By utilizing an enhanced equity-capitalization model, it’s proven it can deliver extraordinary returns – even during a global pandemic.

Furthermore, changing public attitudes and increased legalization momentum in various states has created an enduring catalyst for future profitability.

As seen below, the stock is trading at a 28% discount to its normal valuation range. That puts it in line with peers AmeriCold (COLD), EastGroup (EGP), and First Industrial (FR).

(Source: Wide Moat Research)

I’m fairly confident that many buying IIPR aren’t doing so for the dividend yield. But just in case you care, its 3.7%.

(Source: Wide Moat Research)

At the end of the day, Innovative Industrial’s extraordinary growth can’t be ignored, though neither can the legalization battles it continues to face.

On the political side, I view cannabis as neutral. Both Biden and Trump have said that states should decide their own commerce laws here. This is actually advantageous because, under federal legislation, there would be more competition for capital.

As Hoya Capital Real Estate pointed out:

“IIPR currently fills a clear void as a well-capitalized landlord and financier to emerging cannabis cultivators. If shareholders continue to award IIPR premium multiples, IIPR can theoretically continue to issue equity to acquire properties that are accretive to FFO, whereby return on invested capital exceeds its cost of capital.”

Even so, the rent checks it’s collecting are high risk. So where does that leave us as investors?

In Closing…

As Hoya also pointed out:

“While it has rapidly improved over the last two years, IIPR still derives 50% or more of NOI (net operating income) from its five top tenants. Further, tenants operate in the same underlying industry and are impacted by similar macroeconomic and regulatory forces.”

(Source: Hoya Capital Real Estate)

And even though we’ve moved it to a more definable peer group, there’s really no way to compare this REIT to any other.

Shares have indeed returned over 100% year-to-date. And we do still like how they look. Yet we have to maintain a Speculative Strong Buy.

We’re forecasting another 50% run over the next 12 months. Our 2020 year-end price target is $140, all based around the fact that IIPR is growing like a weed.

Pun or not, it’s proven true.

(Source: FAST Graphs)

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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