IIPR - Innovative Industrial Properties: 8.4% Yield Strong Growth Good Coverage

2023-03-14 11:07:24 ET

Summary

• Innovative Industrial Properties is a specialty REIT with a fast-growing portfolio.
• The trust easily covers its dividend with adjusted funds from operations.
• Aggressive AFFO growth implies upside in the trust’s valuation.

The well-run specialty REIT Innovative Industrial Properties Inc. ( IIPR ) specializes in cannabis-related properties. The real estate investment trust is rapidly expanding its portfolio, and IIPR uses adjusted funds from operations to pay its dividend.

Since 2016, the trust has been able to grow its net operating income, AFFO, and dividend very quickly in line with a quickly expanding real estate footprint.

I believe that IIPR is especially appealing to passive income investors who want to combine a high dividend yield with the potential for a dividend pay-out that is expected to grow quickly.

Aggressively Growing Real Estate Footprint In The Cannabis Industry

An internally managed commercial REIT with a focus on the cannabis industry, Innovative Industrial Properties has experienced explosive growth in the past few years, largely as a result of acquisitions.

The largest pure-play cannabis REIT in the nation, IIPR leases its specialized real estate to state-licensed operators of cannabis facilities.

By the end of 2022, the trust had 110 properties under its ownership and operations in 19 states. In 2016, the trust had just one tenant and one piece of real estate.

Innovative Industrial Properties prioritizes long-term leases with an initial length of 15-20 years and has committed billions of dollars to growing its industrial real estate footprint.

Innovative Industrial Properties' lease arrangement differs from that of non-cannabis industries. The typical entry barrier is the need for tenants to satisfy state licensing standards. Due to this, IIPR is able to persuade tenants to sign triple net leases with much longer lease terms (15–20 years) than those that are typical for industrial leases.

Related key metrics, such as net operating income and adjusted funds from operations, have also increased dramatically as a result of the trust's appetite for acquisitions and rising property count since 2016.

In the last five years, IIPR's net operating income, a crucial metric for real estate investors because it reveals the net profit from a property's lease activity, increased by an average of 111% per year, reaching $265.8 million in 2022.

Over the same period, the trust's adjusted funds from operations soared 151% annually to $233.7 million. The aggressive property acquisition strategy employed by IIPR is directly responsible for the growth in important metrics like NOI and AFFO.

Dividend Coverage

In 2022, Innovative Industrial Properties had adjusted funds from operations per share of $8.44 and paid out $7.10 in dividends, for a dividend payout ratio of 84%. The trust's dividend pay-out ratio has consistently been between low and mid 80% over the past year, and the third-quarter dividend was increased by 3%.

AFFO Multiple And Dividend

In 2022, Innovative Industrial Properties increased its AFFO by 34% and its earnings per share by 27%. I believe IIPR could earn adjusted funds from operations of $9.30 to $9.50 per share, representing 10-12% YoY growth.

Based on a AFFO midpoint estimate of $9.40 per share, IIPR is valued at an AFFO multiple of 9.2x. I find the valuation multiple to be very compelling, especially in light of the trust's aggressive AFFO growth and dividend coverage.

For 9.2x adjusted funds from operations, passive income investors are not only getting an 8.4% dividend yield (which is covered by AFFO), but also strong dividend growth prospects. In the last five years, IIPR has grown its dividend pay-out 48% per annum.

Why IIPR Could See A Lower Valuation

Specialty real estate investment trusts like Innovative Industrial Properties are subject to certain risks.

Since Innovative Industrial Properties has grown to a size where it is now difficult to double its real estate footprint, changing cannabis regulation is a risk factor for IIPR, and the trust may not expand as quickly going forward as it did in the past.

There are no immediate risks to the dividend because AFFO fully covers it.

My Conclusion

A fascinating specialty REIT, Innovative Industrial Properties has performed well in terms of increasing funds from operations, net operating income, and its dividend.

The trust's adjusted funds from operations more than cover the dividend itself, and the portfolio is expanding quickly thanks to acquisitions.

I believe that IIPR stock's 8.4% yield and its expansion potential in the cannabis market are compelling factors to take into account for a passive income portfolio, along with its strong dividend coverage and compelling valuation based on AFFO.

Additionally, I find IIPR to be particularly compelling due to its high current dividend yield of more than 8% and the likelihood of above-average dividend growth.

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