If you've spent time around other investors, it's likely you've heard the oft-asked question: "What's your largest stock position?" Admittedly, this has become more difficult for me to answer -- after first responding "it's technically not a stock," I disclose my largest position is in Innovative Industrial Properties (NASDAQ: IIPR).
If you would have told me a year ago that a real estate investment trust, or REIT, would be my largest holding, I would have thought you were crazy -- or that I had become so in the future. That's particularly after finding out this REIT has a 2.4% yield, only 1 percentage point above the S&P 500's payout.
However, that's how excited I am about Innovative Industrial Properties' prospects.
Growth and income
In today's market, it's rare to find investments paying above-average dividends with high growth potential. Many growth stocks have cut back on dividend payouts in favor of buybacks to return cash to shareholders.
While share buybacks are more efficient from a taxation standpoint, income investors prefer the stability of dividends, particularly in the current zero-rate environment.
Unlike other high-growth investments, Innovative Industrial Properties' investors need not worry about capital allocation strategic changes, as REITs must return 90% of taxable income to shareholders in the form of dividends.
Many investors consider REITs a boring, low-growth asset class. This is understandable, as they mostly invest in income-producing properties with negotiated rental escalators. However, this is where Innovative Industrial Properties differs from other REITs.
The company is a true growth juggernaut, recently posting massive 101% year-over-year revenue growth in the second quarter! Long-term investors have seen Innovative Industrial Properties shares explode 1,000% since its 2016 IPO of $20 per share, and its quarterly per-share dividend has increased 833% since the first payout of $0.15 to $1.40 last quarter.
A growth niche just getting started
The secret to Innovative Industrial Properties' growth is its narrow niche. The company focuses on properties in the medical marijuana space, leasing greenhouses and processing facilities to growers and cultivators.
It's a narrow niche but a profitable one. Federal laws restrict marijuana companies from obtaining traditional banking services, and fear among traditional banks acts as a barrier to entry.
This benefits IIPR. Not only does it work as a critical capital provider for these cultivators, but the focus allows IIPR to understand and shape this fast-evolving space.
The company continues to be a leader, taking advantage of increased legalization at the state level to expand its footprint. In the last quarter, the company added 859,000 rentable square feet across eight buildings in five states.
All told, the company has added nearly 1.6 million rentable square feet, a 30% increase from year-end 2020. Normally this type of growth is considered risky, but the company has done a superb job of keeping occupancy rates high, with all its properties leased as of the latest quarter.
Beware of risks
Like all investments, Innovative Industrial Properties presents risk. Foremost is the fact that its tenants grow a product technically illegal at the federal level. As such, the company is exposed to a much higher degree of legal and regulatory risk than other REITs.
Earlier I noted that many capital providers ignore the space altogether for fear of raising Washington's ire. Although it appears that both Republican and Democratic administrations have left the industry alone, the winds of Washington often change quickly.
Currently, however, the federal government is warming to legal pot, with Democratic senators recently authorizing a bill to legalize marijuana. Despite Politico calling the bill a "long shot," this would have been unheard of just a few years ago.
Interestingly, a long shot toward legalization could be in IIPR's favor as it finds itself in a "Goldilocks" legal environment. As noted above, it has a first-mover advantage in this niche because other capital providers avoid lending to marijuana cultivators. Legalization will increase competition.
Finally, the company recently closed on a $300 million debt offering. While leverage turbocharges returns, it adds risk for equity investors by being higher in the capital stack and having a higher-priority claim to assets. Additionally, IIPR has preferred shares, which rank above common shares.
The Millionacres bottom line
While there are risks in Innovative Industrial Properties, the upside as a critical capital provider in the fast-growth marijuana industry is simply too big to ignore. Long-term investors can look forward to generous dividend growth. It's rare to find strong growth and income investment, which is why it's my largest holding.