Innovative Industrial Properties: Expect An Annual Pre-Tax Return Of 20.5% (NYSE:IIPR)

Introduction

Innovative Industrial Properties, Inc. (NYSE:IIPR) (“IIP”) is a real estate investment trust (“REIT”) that has been plagued by short sellers since the beginning of this year. The stock is down 62% from its peak and the dividend yield is high (7%). Investors lost confidence when the Fed raised interest rates and because of high improvement allowances to its tenants.

IPP leases its industrial properties to companies in the cannabis space. The total addressable market for cannabis is huge, with an expected CAGR of 14.9% in the United States alone. With a sharply depressed share price and growth prospects in its favor, Innovative Industrial Properties is a strong buy.

Cannabis’ TAM Is Expected To Increase With A CAGR Of 14.9% In The U.S.

As more states legalize medical cannabis and the number of cannabis-based businesses increases, the demand for commercial properties is also expected to increase.

The total addressable market (“TAM”) for cannabis is significant and rapidly growing. As more and more countries and states legalize and regulate the use of cannabis for medical and recreational purposes, the demand for cannabis products is expected to increase significantly. In the United States alone, the cannabis market is projected to reach $40 billion by 2030 (CAGR of 14.9%). The global cannabis market was valued at $25.7 billion in 2021 and is expected to reach $148.9 billion by 2031, growing at a rate of 20.1% between 2022 and 2031.

The potential for growth in the cannabis industry is further fueled by the increasing recognition of the potential health benefits of cannabis, including its use as a treatment for a variety of medical conditions such as chronic pain, epilepsy, and multiple sclerosis. The growing acceptance of cannabis as a legitimate treatment option is expected to drive demand for a range of cannabis-based products, including oils, edibles, and topicals.

The demand for properties leased to medical-use cannabis facilities is likely to continue as the legal cannabis market continues to mature and expand. Innovative Industrial Properties will benefit greatly from the growing cannabis sector.

Strong Balance Sheet, Rising FFO And Dividends

In the third quarter of 2022, Innovative Industrial Properties reported revenue of $70.9 million, up 32% from the same period last year. The increase was primarily due to the purchase and lease of new buildings, additional infrastructure fees granted to tenants of certain buildings that resulted in base rent adjustments, and contractual rent increases in certain buildings.

Net income for the quarter was $37.3 million, or $1.32 per diluted share, compared to $30.09 million, or $1.20 per diluted share, in the third quarter of 2021. IIP generated funds from operations (“FFO”) (diluted) and FFO per diluted share of approximately $53.3 million and $1.89 (up 23% YoY), respectively.

The company paid a quarterly dividend of $1.80 per common share on Oct. 14, 2022. That amounts to an annual dividend of $7.20 per share, representing a high dividend yield of 7%.

The company has consistently increased its dividends since it began paying dividends in 2017. The company’s strong financial performance, including revenue and FFO growth, has allowed it to consistently increase its dividends and return value to shareholders, as dividends per share have increased 67% annually for the past four years.

Growth has stagnated, as dividends per share increased only 1.6% in 2021. Analysts expect dividends per share to rise to $7.95 per share in fiscal 2024, representing average annual growth of 5.1%. The company’s growing dividends could make it attractive for income-oriented investors looking for companies with a track record of dividend growth.

Furthermore, Innovative Industrial Properties’ balance sheet is strong, as they maintain one of the most conservative balance sheets in the commercial real estate industry, with 12% debt to total assets, no material repayments until 2026, and a debt service coverage ratio of more than 15x.

Looking ahead, Innovative Industrial Properties’ chairman Alan Gold stated that the company is well-positioned for continued growth in the cannabis industry.

We believe we have positioned ourselves well in this context with one of the strongest and most experienced teams of real estate professionals in the cannabis industry with a high quality portfolio, and arguably one of the most conservative flexible balance sheets across the real estate sector.

IIP Has Great Short Squeeze Potential

Innovative Industrial Properties has a high short interest of 9%. This means that a significant number of investors are betting against the company, expecting the share price to decline. However, a sudden increase in the share price could trigger a short squeeze, as short sellers rush to buy shares to cover their short positions. This buying pressure could cause the share price to rise even further, leading to further panic among short sellers and potentially causing more share price increases. While it is impossible to predict with certainty if or when a short squeeze may occur, the potential for a short squeeze increases at high levels of short interest. The tremendous rise in GameStop shares earlier this year highlighted the importance of short interest for investors. Innovative Industrial Properties’ 9% short interest makes it interesting for investors to consider IIPR in their portfolio as the stock has short squeeze potential.

Expected Annual Pre-Tax Return Of 20.5%

To gain insight in the stock’s valuation, I use a different approach. While YCharts does not have the possibility to chart the price / FFO ratio, I prefer to use the average of the dividend yield to gain insight in the valuation of the stock.

The dividend yield is measured every December and the average dividend yield has been calculated at 2.5% over the past 4 years. Since the Fed is expected to raise interest rates to 5%, I do not expect the dividend yield of 2.5% at 5% to be realizable. I expect a dividend yield of 6% (1% premium) to be more appropriate because the cannabis business is riskier than government bond risk.

Analysts on the Seeking Alpha IIPR ticker page expect a dividend per share of $7.95 for fiscal 2024. Dividing the dividend rate for 2024 by the expected dividend yield of 6%, we arrive at an expected share price of $133 (14.5% average annual return). Including the 6% annual dividend, the expected annual pre-tax return is 20.5%.

With the Fed raising interest rates to 5%, investors must ask themselves whether they would invest in Innovative Industrial Properties with a dividend yield of 7% (rising 5% annually on average) or buy a government bond with a 5% yield? I think the answer is obvious.

Risks To Mention

As the stock price is down, investors are searching for risks associated with the business. Innovative Industrial Properties’ business is subject to a variety of risks that are common to the real estate industry as well as risks specific to the cannabis industry.

Increased interest rates and deteriorated economic conditions can impact the demand for industrial properties and the prices at which they can be sold or leased.

Management risks for Innovative Industrial Properties include the ability of the company to effectively manage and maintain its properties. As Seeking Alpha contributor Jeremy LaKosh wrote:

The company has disclosed $128 million in improvement allowance commitments to its tenants. These commitments can be requested at any time by the tenants during their multi-year lease. This creates additional pressure on the common share dividend as those commitments may hamper the company’s ability to pay dividends at their current level.

In addition, the cannabis industry is subject to a variety of regulatory risks, including the possibility of changes in the legal status of cannabis and the potential for increased competition as more states legalize and regulate the industry.

Investors should consider these risks before making an investment decision. The stock price has fallen significantly, and the risk/reward ratio has become favorable. Therefore, the stock is buy-worthy.

Key Takeaways

A few key points from my article:

• IPP leases its industrial properties to companies in the cannabis space. The total addressable market for cannabis is huge, with an expected CAGR of 14.9% in the United States alone.
• Innovative Industrial Properties’ chairman Alan gold stated that the company is well-positioned for continued growth in the cannabis industry.
• In the third quarter of 2022, Innovative Industrial Properties reported revenue of $70.9 million, up 32% from the same period last year.
• IIP generated funds from operations (FFO) (diluted) and FFO per diluted share of approximately $53.3 million and $1.89 (up 23% YoY), respectively.
• The company paid a quarterly dividend of $1.80 per common share on Oct. 14, 2022. That amounts to an annual dividend of $7.20 per share, representing a high dividend yield of 7%.
• Analysts expect dividends per share to rise to $7.95 per share in fiscal 2024, representing average annual growth of 5.1%.
• Innovative Industrial Properties’ 9% short interest makes it interesting for investors to consider IIPR in their portfolio as the stock has short squeeze potential.
• Innovative Industrial Properties is favorably valued, and the expected annual pre-tax return is 20.5%.
• Major risk to mention: The company has disclosed $128 million in improvement allowance commitments to its tenants. These commitments can be requested at any time by the tenants during their multi-year lease.
• If we weigh the risk/reward, the stock of Innovative Industrial Properties is worth the risks mentioned in my article.