IIPR - Innovative Industrial: A Cannabis REIT Rising Star

2023-07-26 10:00:00 ET

Summary

• Innovative Industrial Properties operates in the thriving cannabis industry, with a strong presence in legalized states. It expects significant growth with an 11% CAGR and promising dividend growth.
• The cannabis REIT maintains a stable and adaptable financial position, experiencing solid growth with a diverse portfolio in the cannabis industry.
• IIPR demonstrates strong growth potential with above-average AFFO growth and an attractively priced stock, making it appealing for both growth- and income-focused investors.
• IIPR faces concentration risk with its top ten tenants and strict regulatory challenges in the cannabis industry.

Investment Thesis

Innovative Industrial Properties, Inc. ( IIPR ) is a robust cannabis Real Estate Investment Trust that has carved a niche in thriving legalized states. Despite the challenges, Innovative Industrial remains a top contender in the cannabis REIT landscape, being the only publicly traded cannabis REIT on the New York Stock Exchange.

The article delves deep into the fundamental dynamics driving IIPR's success, strategic investments, and financial performance. Finally, IIPR offers investors an attractive risk/reward profile looking for a good blend of growth and value in the cannabis market.

Cannabis Industry's Rising Star

Innovative Industrial operates in the thriving cannabis industry, which is expected to experience substantial long-term growth. The cannabis industry is projected to expand, with estimated legal cannabis sales reaching $71 billion by 2030 and promising wholesale pricing dynamics in certain states like California and Missouri. This implies a compound annual growth rate ((CAGR)) of 11%, presenting significant opportunities for IIPR to capitalize on the sector's growth prospects.

Further, Innovative Industrial has a strong presence in states where cannabis is legal, with properties in 68% of U.S. states with legalized cannabis. This widespread footprint positions the REIT to benefit from diverse markets and regulatory environments. The average 5-year estimated CAGR for cannabis sales in the states where Innovative Industrial operates its properties is 9%. This suggests that the REIT's properties are in regions with robust growth potential, aligning with Innovative Industrial's long-term growth objectives.

Also, IIPR has demonstrated exceptional dividend growth with a 5-year CAGR of 48% , significantly outpacing the S&P 500's average of 9%. This attractive dividend growth rate enhances the REIT's appeal to income-oriented investors. As of Q1 2023, Innovative Industrial achieved a commendable % rent collection rate of 98% with an invested capital of $2.4 billion . It signifies an improvement from the previous year's 97% rent collection rate of $2.3 billion in invested capital. The high rent collection rate indicates the stability and reliability of Innovative Industrial Properties' cash flow streams.

Likewise, the thriving cannabis industry's projected growth presents Innovative Industrial with ample opportunities to expand its real estate portfolio. As cannabis sales rise, demand for suitable properties will likely increase, allowing the company to secure more long-term lease agreements and generate consistent rental income.

With a presence in states covering a significant portion of the U.S. population, Innovative Industrial is well-diversified across various cannabis markets. IIPR has no single tenant representing more than 14% of its total invested capital and no state representing more than 17%. The REIT's diversified portfolio of 108 properties across 19 states and its strong tenant roster, comprising 89% MSOs and 58% public tenants, provide a stable foundation for future growth. Therefore, geographic diversification mitigates risks associated with regulatory changes in any single state and enhances the REIT's resilience.

Moreover, the anticipated 9% average CAGR in cannabis sales in Innovative Industrial property-owned states sets the stage for the REIT's revenue growth. Coupled with its impressive dividend growth rate, Innovative Industrial Properties has the potential to deliver attractive shareholder returns. Innovative Industrial's high rent collection rate showcases its financial stability and ability to secure consistent tenant rental income. This stability enables the REIT to invest in strategic acquisitions and fund further expansion.

Adaptive Growth & Financial Stability

Innovative Industrial's prudent approach to financing and its conservative and flexible balance sheet enable it to adapt to changing market conditions and capitalize on opportunities while mitigating risks. By prioritizing generating positive free cash flow, Innovative Industrial may ensure financial stability and reinvest in the growth of its portfolio. Also, with only $304 million in debt, it positioned itself favorably among publicly-traded REITs, maintaining its investment-grade credit rating. Furthermore, Innovative Industrial's strong credit metrics and debt service coverage ratio over 16 times provide financial stability.

While the cannabis industry's capital availability has been affected, larger multistate operators ((MSOS)) have focused more on generating positive free cash flow than growth through M&A. Capital raises for U.S. cannabis operators were down 86% in Q1 2023 compared to the prior year, with the majority in debt.

Also, Innovative Industrial reported solid performance in Q1 2023, with total revenues of $76 million, marking an 18% increase from the previous year. The growth was driven by new property acquisitions, additional funding for building improvements leading to base rent increases, and contractual rental escalations.

Additionally, Innovative Industrial's investment activity in Q1 2023 included acquiring a 157,000-square-foot industrial facility under development in Ohio and executing a long-term lease with Battle Green. This move indicates the REIT's strategic focus on states like Ohio, which is expected to adopt an Adult-Use program in the near term.

Further, Innovative Industrial has committed over $90 million in additional investments year-to-date, demonstrating its commitment to expanding its portfolio. Although the cannabis industry faces challenges such as price compression and cost inflation, the overall growth potential of the industry in the United States remains strong.

Regarding federal legislation, the reintroduction of the SAFE Act in both the House and Senate is an encouraging sign, and various officials and commercial organizations have shown support for federal cannabis regulation. While the timing and scope of federal reform remain uncertain, these developments indicate progress toward positive regulatory changes. The potential legalization of adult-use cannabis in Pennsylvania and the government's proactive measures to combat the illicit market in California could unlock further growth opportunities for Innovative Industrial in these markets.

Despite challenges in the cannabis industry, Innovative Industrial's ability to generate consistent cash flows from operations and its commitment to sharing cash flows with investors is evident in the 10% increase in adjusted funds from operations ((AFFO)) per share in Q1 2023 compared to Q1 2022.

Looking forward, the REIT's mission-critical real estate portfolio and relationships with experienced operators contribute to its confidence in weathering challenges and capitalizing on growth opportunities in the industry.

An Unrivaled Advantage

As the only publicly traded cannabis REIT on the New York Stock Exchange, IIPR has a unique opportunity to provide growth capital to the industry and capitalize on the increasing demand for cannabis real estate. Innovative Industrial's investment-grade credit rating further reinforces its financial stability.

Over the long term, being ten times larger than its competitors gives Innovative Industrial a competitive edge and affords the luxury of time to assess the industry and economic conditions before raising additional capital. Diversifying Innovative Industrial Properties' portfolio across different states and markets reduces exposure to potential fluctuations in specific regions.

Finally, Innovative Industrial's proactive approach to amendments and supporting tenant expansions positions the REIT as a reliable partner for its clients, strengthening tenant relationships and ensuring long-term stability. Including cross-default language in leases provides an added layer of security for the REIT.

Why Innovative Industrial Stands Out Among Cannabis REITs

Innovative Industrial Properties' forward AFFO growth of 8.55% surpasses the sector median of 4.57%. It indicates the REIT's ability to generate increasing cash flows from its operations, which bodes well for its financial health. Also, Innovative Industrial's year-over-year AFFO growth of 26.88% significantly outperforms the sector median of 7.76%.

The impressive growth rate showcases the REIT's capacity to adapt and expand in a competitive market. With a forward Price/AFFO ratio of 9.35 , Innovative Industrial trades at a more favorable valuation than the sector median of 15.35, highlighting its undervaluation.

Additionally, Innovative Industrial's forward dividend yield of 9.15% exceeds the sector median of 4.57%. A high dividend yield indicates that the REIT distributes a significant portion of its earnings to shareholders, making it an appealing option for income-focused investors. The REIT's solid AFFO growth rates indicate strong operational performance, while its attractive valuation and generous dividend yield make it an enticing proposition for investors seeking a good mix of growth and income.

With above-sector-average AFFO growth rates, Innovative Industrial will likely sustain its growth trajectory, fostering increased investor confidence. The REIT's ability to generate strong cash flows will enable it to reinvest in its properties and expand its portfolio. Additionally, Innovative Industrial's robust YoY AFFO growth suggests that the REIT is well-managed and experienced at capitalizing on market opportunities. This could lead to outperformance against its sector peers, attracting more investors and increasing its stock price.

Balancing High Risks With High Rewards

Innovative Industrial's significant reliance on its top ten tenants, representing approximately 72% of its invested capital, poses a concentration risk . Any adverse developments affecting these major tenants, such as business disruptions or financial difficulties, could substantially impact the REIT's cash flow and overall financial performance.

Additionally, the cannabis industry operates under strict regulations, and Innovative Industrial's success is closely tied to the licensing, zoning, and regulatory landscape in the states where it operates. Obtaining proper licensing for cannabis facilities is a complex and competitive process that varies from state to state.

Moreover, the REIT must navigate zoning and permitting requirements at the county and city levels, which could challenge finding suitable locations for cannabis properties. Complying with extensive regulatory measures, including security, fire protection, and seed-to-sale tracking, adds operational complexity and costs.

Further, Innovative Industrial's long-term success is contingent upon the growth of the cannabis industry and increasing demand for specialized real estate properties. Any slowdown in the cannabis market's expansion or changes in consumer behavior could impact the demand for Innovative Industrial Properties and potentially affect its growth trajectory.

Takeaway

In conclusion, Innovative Industrial is a robust cannabis REIT with solid progress in the thriving cannabis industry. Its impressive dividend growth demonstrates its potential for substantial expansion. The REIT's financial stability, diverse portfolio, and proactive approach to growth make it an attractive option for both growth- and income-focused investors.

While concentration risk and regulatory challenges are present, its proactive stance and investment-grade credit rating ensure its ability to weather challenges and capitalize on opportunities. As the cannabis market continues to evolve, Innovative Industrial's strategic position, strong cash flows, and appealing valuation make it a bullish choice for investors seeking long-term growth and value.

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