IIPR - Innovative Industrial: I Feel Your Pain

2023-04-23 07:00:00 ET

Summary

• IIPR was founded in late 2016 and was the first and only REIT in the cannabis industry to be listed on the New York Stock Exchange.
• IIPR’s properties are leased on a triple-net basis where the tenant is responsible for property expenses including structural repairs, ongoing maintenance, taxes and insurance.
• I'm sure there aren't many writers who reveal their biggest losers, but I believe in full transparency.

Innovative Industrial Properties ( IIPR ) is an internally managed real estate investment trust ("REIT") that owns, acquires, and manages primarily industrial properties that are leased to state-licensed cannabis operators.

IIPR was founded in late 2016 and was the first and only REIT in the cannabis industry to be listed on the New York Stock Exchange .

IIPR was formed in part to fill a void in financing within the cannabis space. Through their sale-leaseback transactions they are able provide funds to cannabis operators that have limited access to capital through conventional financing means due to federal regulations.

IIPR's properties are leased on a triple-net basis where the tenant is responsible property expenses including structural repairs, ongoing maintenance, taxes and insurance.

The Portfolio

Innovative Industrial Properties owns 110 properties in 19 states that cover approximately 8.7 million rentable square feet. IIPR includes 108 of their properties in their operating portfolio which were 100% leased with weighted average remaining lease term of roughly 15.3 years as of year-end 2022.

The remaining 2 properties that are not included in their operating portfolio were previously leased to Kings Garden and were under development as of December 31, 2022.

Portfolio Growth

IIPR's has seen rapid growth since its initial public offering ("IPO") in 2016. The number of properties they own increased from 1 in 2016 to 110 in 2022.

Tenants increased from 1 to 29 over that same period and IIPR has expanded its footprint to 19 states in 2022 compared to just 1 in 2016. Similarly, IIPR's total assets increased from $63.3 million in 2016 to $2.4 billion in 2022.

Geographical Diversity and Asset Mix

IIPR has properties in 19 states with its largest concentration being in Pennsylvania with 15.9% of their capital invested in that state. IIPR has fairly high concentration in several states with its top 4 states all representing 12% or more of their invested capital.

In all, IIPR has properties in Pennsylvania, Arizona, California, Colorado, Florida, Illinois, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Nevada, New Jersey, New York, North Dakota, Ohio, Texas, Virginia and Washington.

By property type, IIPR primarily owns industrial properties (90% of their invested capital), followed by industrial / retail mixed properties (7%) and retail properties representing 3% of their invested capital.

Tenant Diversification

Innovative Industrial Properties had a total of 29 tenants as of December 31, 2022. They have high tenant concentration with their top 10 tenants representing 73.5% of their invested capital.

Their top tenant (PharmaCann) makes up 13.1% of their invested capital, followed by Parallel (8.7%), and Ascend Wellness (8.5%). No other tenant makes up more than 8% of their invested capital.

IIPR's high tenant concentration increases their risk profile as a single tenant default could have a significant impact on IIPR's rental revenue.

Tenant Defaults

Innovative Industrial Properties has had to deal with multiple tenant defaults within the past year. In July 2022, Kings Garden defaulted on its rent obligations at all 6 properties they lease from IIPR. Out of the 6 properties, 4 were operational and the other 2 were in development.

A lawsuit was filed and IIPR and Kings Garden entered into confidential and conditional settlement in September 2022. As part of the agreement, IIPR received $15.4 million from Kings Garden as a partial settlement payment and took back possession of the 2 properties that were in development. As of the most recent update, Kings Garden continues to occupy and pay rent at the 4 operational properties.

In November 2022, Parallel defaulted on its rent obligation for one property in Pennsylvania, and then in February 2023, defaulted on its rent obligation for one property in Texas.

In February of this year IIPR filed 2 lawsuits against Parallel for the default on their on their Pennsylvania and Texas properties. As of their most recent update Parallel is current on the 2 Florida properties they lease from IIPR.

Finally, in January of this year, IIPR delivered notices of default to Green Peek for defaulting on their lease payments for one property in Michigan. IIPR filed a lawsuit against Green Peek in February regarding the default on the Michigan property. On the earnings call in March, IIPR disclosed that Green Peek is current on their rent for the other properties they lease from them.

One important thing to note here is that IIPR's tenants cannot file bankruptcy because marijuana is still illegal at the federal level , businesses in the industry cannot file for bankruptcy protection, which takes place in federal court.

Debt Metrics

Innovative Industrial Properties is not rated by S&P or Moody's but they do have a BBB+ credit rating from Egan Jones. IIPR has no secured debt , they have a debt to total gross assets of approximately 12% and they have a 15.5x debt service coverage ratio.

IIPR's debt metrics are outstanding. Just to make it easier to visualize, I put together the chart below showing the amount of assets vs the amount of debt IIPR has.

IIPR has a weighted average interest rate of 5.46% and a weighted average maturity of 3.4 years. I would like to see a longer term to maturity, but at the same time they have no debt due in 2023 and no significant debt due until 2026.

Earnings

IIPR has had outstanding growth in their earnings since their formation with a net operating income ("NOI") compound annual growth rate of 111% since 2017. Similarly they have had outstanding FFO growth since 2017.

From 2017 to 2018 FFO increased by 653%, and then increased by 155% in 2019. Now this type of growth cannot continue indefinitely and we've already started to see it normalize with growth rates of 31% and 24% in the years 2021 and 2022 respectively. Analysts expect FFO to increase by 4% in 2023 and by 5% in 2024.

Dividend

Innovative Industrial Properties has paid quarterly dividends since the second quarter of 2017 and has delivered a 75.62% average dividend growth rate since that time.

IIPR increased its dividend by 118.18% in 2018 and 135.83% in 2019. This too has started to normalize but IIPR still increased the dividend by 27.96% in 2021 and 24.13% in 2022.

IIPR pays a dividend yield of 10.30% that is well covered with an AFFO payout ratio of 84.02% . Since going public, IIPR has maintained a payout ratio under 90%. Their 2022 payout ratio of 84.02% is the lowest it's been since 2017.

Valuation

Currently IIPR is trading at a blended P/FFO of 9.05x which is far below their normal P/FFO of 36.98x. With the current tenant issues and slowing growth I don't expect IIPR to get back to this multiple, but at the same time a 9.05x multiple has gone too far in my opinion.

It's true that there are a lot of head winds facing IIPR with legislative uncertainty and more particularly the recent tenant defaults, but at the same time IIPR owns a lot of nice real estate and has very little debt.

I mention their real estate because while I consider IIPR a cannabis REIT, they are also an industrial REIT. As previously mentioned, 90% of their properties are industrial.

Now I don't see the cannabis industry going away anytime soon, as a matter of fact I think it will only grow from here, but even under the most drastic situation - let's say each state decides to criminalize cannabis, IIPR still has a lot of nice industrial properties.

These properties are fungible and can be converted to any type of industrial property if need be. Now please don't get me wrong, I don't think anything is going to happen to the cannabis industry, like I said, I think it will only grow from here.

I'm just trying to point out that even with all the recent difficulties, IIPR still has a lot of nice real estate and not much debt. The chart below shows how IIPR's valuation stacks up against the industrial REITs in our coverage.

Like mentioned above, I don't think IIPR will get back to a 36.98x multiple, but I think they could easily trade for a multiple similar to Plymouth Industrial ( PLYM ) at a P/FFO of 11.01x or even higher. My main point is that a current P/FFO of 8.78x makes this company very reasonably priced.

If you bought shares and held them at these prices and the multiple expanded to 11.0x over the next two years it would result in a total annual return of 26.29%.

Now I'll be the first to say that I can't predict the future, but I personally think aiming for an 11.0x multiple for a REIT in the fast-growing cannabis sector that owns mostly industrial properties is pretty conservative.

Regardless, I think a multiple of 8.78x is just too low. At iREIT we rate Innovative Industrial Properties a Spec Buy.

I'm sure there aren't many writers who reveal their biggest losers, but I believe in full transparency. Here are the worst six performers in one of my personal portfolios:

I Have a Conundrum...

In addition to IIPR, I own NewLake Capital ( NLCP ) and Chicago Atlantic ( REFI ), which means that I have over 5% cannabis exposure within my REIT portfolio.

I remember what happened to the prison REITs - CoreCivic ( CXW ) and GEO Group ( GEO ) back in 2017 and I'm glad that I didn't get too excited (overweight) recognizing the sector was extremely volatile.

While prisons and cannabis are political in nature (and highly correlated in terms of their benefits), there's a big difference that I want to point out...

This is what happens when a prison goes dark:

In other words, I would not want to be the landlord of a prison when it goes dark.... and here's what happens when a cannabis industrial property goes dark:

Here's my point: The property can be re-leased to another user and the buildings are generally equipped with enhanced lighting, electrical, plumbing, and HVAC.

So, from a real estate perspective, I'm much more comfortable owning cannabis properties than prisons - from a releasing perspective.

Thus, I'm perfectly content with my cannabis REIT exposure and I may increase it slightly in order to lower my basis. I also like the fact that I've spread the risk by owning shares in all 3 names (IIPR, NLCP, and REFI).

Good luck and I look forward to your comments below.

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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