Real estate investment trust (REIT) Innovative Industrial Properties (NYSE: IIPR) is basically looked at as a marijuana landlord. This is absolutely true, but it isn't the whole story. Before you buy this REIT, you need to think carefully about its business model and what it means for the future. Here's a primer.
The easy story
Marijuana is being legalized in more and more U.S. states. Innovative Industrial owns roughly 60 or so properties across 16 states catering to companies in the marijuana sector. Most of the investments it has made are in grow houses, which are industrial properties specifically built to support hydroponic gardening. It's also bought some dispensary-related assets that would best be described as marijuana distribution and retail facilities.
The REIT has grown rapidly along with the marijuana sector, increasing from a single property in 2016 when it held its initial public offering. Investors were quickly enamored of the stock, which is up some 900% since its debut. There's good reason for that, given that Innovative Industrial Properties should be able to keep expanding along with the sector in which it operates.
But there's more to understand here than just marijuana is a growing sector. And before buying this niche real estate investment trust, you need to make sure you see the full picture and not just the hype.
The net lease thing
At its core, Innovative Industrial Properties is a net lease REIT focused on sale/leaseback transactions with marijuna-related companies. This is important. It buys properties from growers and then signs long-term leases with the companies. The lessees are responsible for most of the operating costs of the properties they occupy, which are clearly vital to their businesses. These are generally win/win transactions, but why would a company sell a vital asset just to lease it back?
The answer is that transactions like this are a way to raise cash while retaining access to key properties. So, Innovative Industrial Properties is much more than just a landlord. It's a source of capital for rapidly growing companies in the marijuana sector. There's another important piece of information here: Because there is still a great deal of ambiguity about the legality of marijuana at the federal level, it can be hard for companies in the space to get loans.
Innovative Industrial Properties has stepped into what has been a financing void for marijuana companies, and it's reaping the benefits of providing cash to an industry that others are avoiding. Investors are being rewarded, too, as the dividend has increased 680% since the REIT's IPO. That type of growth, though, is more than enough to grab the attention of dividend growth investors who may not take the time to consider the larger issues here.
Being a funding source to the industry is a huge tailwind right now, but it may not always be there. As marijuana becomes more accepted, more players are likely to enter the space, including traditional funding sources like banks. That could reduce the need for companies to do sale/leaseback deals and will likely lead to lower returns for Innovative Industrial Properties over time. Having built industry relationships, it will likely continue to be a strong competitor. But the trend toward legalization is both a positive and a potential negative.
Not as unique as you think
On the surface, Innovative Industrial Properties is a niche way to invest in marijuana-related properties. But the real way to think about this landlord is that it provides funding to marijuana companies that may not have access to other capital sources because of the unique nature of the sector today. So long as that dynamic remains in place, the REIT's growth should continue to be robust.
If, perhaps when, that changes, however, the story here will likely change as well -- and it probably won't be for the better. This nuance may seem minor today when growth is heady, but it's important for investors to understand before buying this highly focused landlord.