IIPR - Innovative Industrial Properties: Our Favorite REIT Trading At A Discount

Summary

• Innovative Industrial Properties has been heavily punished by the market despite continuing to execute well.
• Investors appear to be concerned about potential tenant defaults.
• We believe that the risk of a large wave of tenant defaults is low.
• The company has low debt and is trading at a significant discount.
• We view the risk/reward in Innovative Industrial Properties to be favorable at these levels.

Thesis

We believe the selloff in Innovate Industrial Properties ( IIPR ) is unjustified. The company is trading at an attractive valuation, has low debt levels, and has been growing consistently. We view the risk of a major wave of tenant defaults as being low.

Valuation

Innovative Industrial Properties is currently trading at a significant discount to its historic multiples.

The company is trading pretty close to its book value, which is relatively uncommon for REITs. In fairness, book value isn't too important when looking at REITs, especially when their assets are given an accounting value that is either much too low or too high relative to what their real estate assets are actually worth. Even still, it's likely that investors have a decent long-term margin of safety in this name and that their real estate assets will not see a catastrophic decline in value.

IIPR is has been steadily growing FFO and is currently trading at a P/FFO of 11.58. This represents a significant discount to where U.S. Equity REITs trade as a whole. This discount is likely the product of investor pessimism and a risk-off environment. We believe that Innovative Industrial Properties deserves to trade at a minimum P/FFO of 15, which would put it more in line with the average U.S. based equity REIT.

Innovative Industrial Properties boasts an impressive dividend yield of 8.47%. This dividend yield gives investors something while they wait for the business to continue to grow and (hopefully) become more attractive in the eyes of the market.

Low Debt

Innovative Industrial Properties also has a debt to equity ratio of just 0.1499. This not only de-risks the company, it also means that there will be more free cash flow available to equity holders over the long term.

Healthy Growth

In Q3 Innovative Industrial Properties reported 31.6% revenue growth and 25.2% net income growth. These are solid growth numbers, especially considering the challenging macroeconomic environment.

Despite strong fundamentals, consistent growth, and a low debt load, Innovative Industrial Properties appears to be trading at a steep discount. This could be due to investor's concerns that their tenants are not in good financial health. While there are certainly some concerns, we find it unlikely that there will be a massive increase in tenant defaults.

Tenant Health

In a press release that Innovative Industrial Properties released on January 18, the company stated:

• No tenant represents more than 14% of the total portfolio.

• No state represents more than 16% of the total portfolio.

• Multi-state operators ('MSOS') represent 85% of the operating portfolio.

• Public company operators represent 55% of the operating portfolio.

• Industrial (cultivation and/or processing), retail (dispensing) and combined industrial/retail represent 90%, 3% and 7% of operating portfolio, respectively.

• Rent collection for IIP’s operating portfolio (calculated as base rent and property management fees collected over contractually due amounts) was as follows:

  • 92% collected as of today for the month ending January 31, 2023 (including approximately $324,000 of a security deposit applied for payment of rent for IIP’s lease with Holistic Industries Inc. (Holistic) at IIP’s Michigan property (see discussion below) and receipt of the full rent payment from Sozo Health, Inc. (Sozo));
  • 94% collected for the three months ended December 31, 2022 (including approximately $541,000 of security deposits applied for payment of rent for IIP’s lease with Sozo); and
  • 97% collected for the year ended December 31, 2022 (including an aggregate of approximately $2.7 million of security deposits applied for payment of rent for IIP’s leases with Kings Garden Inc. (Kings Garden) and Sozo).

And finally,

• As of January 18, 2023:

  • SH Parent, Inc. (Parallel) was in default on its obligations to pay rent at one of IIP’s Pennsylvania properties (approximately 2.9% of invested / committed capital).
    • Rent was paid in full through January 31, 2023 on all other IIP properties leased by Parallel.
  • Green Peak Industries, Inc. (Skymint) was in default on its obligations to pay rent at one of IIP’s Michigan properties under construction (approximately 2.7% of invested / committed capital).
    • Rent was paid in full through January 31, 2023 on all other IIP properties leased by Skymint.
  • Affiliates of Medical Investor Holdings, LLC (Vertical) were in default on their obligations to pay rent at IIP’s California properties (approximately 0.7% of invested / committed capital).

While there are some problematic tenants, the majority of their tenants are still paying rent. Even in a scenario where Innovative Industrial Properties is only able to collect from 75% of their tenants, the company is likely still significantly undervalued. In the unlikely event that they are unable to fill vacancies, the buildings could be repurposed for other uses. This would be difficult but plausible. At the end of the day the stock is trading at such a discount that a great deal of the worst case scenario is already priced in and we think investors have a decent margin of safety.

Price Action

Innovative Industrial Properties is now trading near its pre-covid levels despite seeing a great deal of growth in their fundamentals since then. This selloff appears to be risk-off in nature and we believe it has given investors a great opportunity to buy the stock.

Risks

The major risk to this bullish thesis is the financial health of their tenants. If the economy enters a prolonged period where funding becomes difficult it may drive some of their tenants into bankruptcy.

Another risk is potential federal or state legislation or actions regarding cannabis that adversely impact the operations of either Innovative Industrial Properties or their tenants.

Lastly, the illicit market could continue to thrive and even take share from the legal market. This would damage the financial health of Innovative Industrial Properties' tenants which would lead to defaults or the inability for the tenants to absorb rent increases.

We view the risk/reward as favorable here, but this investment should not be made by those with a low risk tolerance or those who are wary of investments in the cannabis sector.

Key Takeaway

All things considered, Innovative Industrial Properties appears to be undervalued at these levels. We like their consistent growth and low debt load and don't believe there will be a massive wave of tenant defaults. This is a great price for investors who are comfortable with the risks associated with the cannabis sector to buy IIPR.

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