If you haven't realized it yet, marijuana is likely to become a very big business in North America. And there's a real estate angle, for those who don't want to try to pick the winners and losers in this emerging industry. The top real estate investment trust (REIT) name here is Innovative Industrial Properties (NYSE: IIPR). This is what you need to know before you hit the buy button.
1. A very big shift
The push to legalize marijuana has definitely picked up steam in recent years, with more and more U.S. states making it legal to use medically and recreationally. The drug has already been legalized throughout Canada. Meanwhile, sales of pot are expected to explode, more than doubling by 2024 from the $29 billion in sales inked during 2020. So this is a very real business opportunity with still-strong growth rates ahead.
2. Ups and downs
As with any hot new industry, there are a lot of companies trying to jump on the bandwagon here. So far, it hasn't been an easy ride, with major ups and downs in the stocks of marijuana growers. In fact, this year alone, the Global X Cannabis ETF, a rough proxy for the industry, rose 190% and then promptly lost 45% of its value. Sure, the ETF is still up around 50% overall, but that's more of a roller coaster ride than most people will likely be comfortable with. And we aren't even at the halfway mark in 2021 yet!
3. A different way to play
That price volatility is exactly why investors will want to look at real estate investment trust (REIT) Innovative Industrial Properties. The key is that the REIT leases its properties out to a number of different growers and distributors, so you don't have to pick between the winners and losers. And its business is about collecting rent, not the actual sale of the drug. So while investor sentiment may wax and wane, its rents will likely remain very steady throughout and continue to support the stock's dividend -- which has already been increased 10 times since 2017. Meanwhile, Innovative Industrial's growth prospects should expand right along with the broader industry.
4. Understand the business
At its core, Innovative is a pretty boring business, leasing out grow houses and other assets to marijuana companies. However, there's a couple of things to make sure you understand. For example, it uses the net lease approach, which means it owns the properties but its tenants are responsible for most of the costs of the assets they lease. It's a fairly low-risk way to own real estate. And Innovative Industrial usually buys properties directly from a company and then leases them right back, effectively providing the tenant with access to capital it can use to grow its business. This sale/leaseback arrangement is vital for the industry right now because the still-uncertain legal status of pot limits other financing options. All in, Innovative is a very interesting way to play the marijuana space for investors who might not be able to handle the volatility of an emerging growth sector.
5. At what price?
Right now Innovative Industrial is offering a 2.9% dividend yield. Compared to the roughly 1.3% yield that's being offered by the S&P 500 Index, that's pretty attractive. However, during the coronavirus-led bear market in 2020, the yield spiked to more than 6%. So it would be hard to suggest that the current yield is hinting at a great deal. Still, Innovative Industrial's dividend yield is about middle of the range over its short history, so it doesn't exactly look expensive, either. It is worth noting that the first-quarter dividend was 32% higher than the one paid in the first quarter of 2020, so there's clearly impressive dividend growth potential here. That pace of increase may not be sustainable, but you could cut that in half and it would still be impressive. Overall, investors are probably paying a fair price for this dividend growth stock right now.
Is it right for you?
So should you buy Innovative Industrial Properties? It's not as easy a question as you might think. First, you need to be okay buying into the marijuana industry and understand clearly that it is still early days here. That means investor sentiment will likely have an outsized impact on pot stocks, even ones that are focused on the more boring real estate side of things.
Second, if you go with Innovative, you need to be okay with the idea that dividend growth is a key metric, if not the key metric, of success. The stock probably won't skyrocket like a pot stock, although that also means it likely won't nosedive, either.
Third, you need to go in knowing that, at least right now, it appears you'll be paying full fare.
Value investors will probably want to keep this one on their wish list for a pullback, and investors looking to maximize current income will likely find the 2.9% yield less than compelling. The sweet spot here is really the dividend growth investor, who will probably find Innovative Industrial a fairly compelling story.