As an investor, it's easy to get caught up in the big story without fully understanding the nuances that can make an investment a good or bad one. Marijuana-focused Innovative Industrial Properties (NYSE: IIPR) is a great example, given that the ongoing effort to legalize pot is a frequent headline-grabber. Here are some of the key facts you need to know to understand why everyone is talking about this fast-growing real estate investment trust (REIT).
1. Yes, marijuana is important
Innovative Industrial's sole purpose is to buy marijuana-related assets, so it would be silly not to start with the obvious. Sales in the marijuana industry grew just over 50% in 2020 and are expected to more than double again by 2025. That suggests that there is plenty of runway for the industry and this REIT to keep expanding over at least the next few years.
This is the big-picture story most people turn to when discussing Innovative Industrial Properties. But it's just the surface here.
2. First-mover advantage
One of the reasons it's so easy to get lost in the big picture is that Innovative Industrial was really the first REIT to get exclusively into this space. And, because it was so early, its growth has been massive.
When it went public in 2016, it had an agreement to buy one property. Today, the REIT owns 73 assets and works with some of the biggest names in the sector. These are important relationships that provide the potential for future growth via acquisitions, expansion, and ground-up construction. Given that Innovative Industrial has already proven itself to these partners, it's highly likely to get a prime seat at the table when tenants look at additional property options.
3. The net lease thing
It's also important to note how Innovative Industrial buys property to understand what is going on here. It engages in what are known as sale-leaseback transactions, in which a company sells a property and then instantly signs a long-term lease for it. Further, the leases are structured as net leases, which means the lessee is responsible for most of the property's operating costs.
The real goal in these transactions is for Innovative Industrial to provide growth capital to marijuana companies via the acquisition of properties that are vital to their businesses but that are tying up cash. It allows pot players to avoid dealing with banks, issuing stock, and/or selling bonds. It's a win-win deal, with Innovative getting the benefit of loyal, long-term tenants.
4. Change could be trouble
So far Innovative Industrial has had a great run, and it has rewarded investors well along the way. For example, it has increased its dividend from $0.15 per share per quarter when first initiated in 2017 to $1.40 in the second quarter of 2021. But investors need to take this early success with a grain of salt.
When Innovative started, it had few competitors. There are more now, and it wouldn't be shocking to see even more rivals in the future. That would likely lead to less advantageous deals and lower returns on investment for Innovative.
Also, Innovative Industrial is much larger than when it launched, which means new acquisitions won't be as big a boost to performance in the future as they have been in the past. And as regulations surrounding marijuana change, so, too, could the REIT's investing landscape.
Notably, banks have been reluctant to deal with pot growers because of the murky legal environment. If that clears up, working with Innovative Industrial (or any net lease landlord) might not be as high up on the list of corporate options.
In other words, despite the big story and early success, there are risks that investors need to monitor here.
The key takeaway with this REIT is that the big-picture story, the one everyone is talking about, is not the whole story. Innovative Industrial is a very interesting REIT that has put up great results. It will likely continue to perform well, though perhaps not quite as well as before, for the foreseeable future. But unless you understand why that is and why the trends here could change, you don't really know enough to add this fast-growing REIT to your portfolio.