Innovative Industrial Properties: Investors Are Rewarded For Their Patience (NYSE:IIPR)

Innovative Industrial Properties (NYSE:IIPR) stock has underperformed the S&P 500 (SPX) (SP500) (SPY) since we urged investors to wait for a pullback before adding exposure.

Thanks to the Fed’s hawkish stance, as telegraphed by Fed Chair Jerome Powell at the FOMC’s December presser, it has led to a sharp retracement in the S&P 500, dragging down most sectors we have analyzed.

IIPR was also not immune, with the sellers starting to take profits pre-FOMC based on our price action analysis. With IIPR gaining nearly 45% (in price-performance terms) from its October lows through its recent December highs, a pullback is welcome, helping to improve reward/risk for investors to add more positions.

Innovative Industrial Properties is a triple-net lease REIT. Therefore, investors don’t have to worry about “reoccurring CapEx” and property expenses. But, despite that, the rental profile for its tenant base could still impact the company’s operating performance and, thus, its distribution strategy.

Essentially IIPR’s tenants need to be able to pay rent, which could be impacted by worsening macroeconomic conditions, exacerbated by the Fed’s rate hikes. IIPR also cautioned investors in its filings, as the company highlighted:

Many of our existing tenants are, and we expect that many of our future tenants will be, companies with limited histories of operations that are not profitable when they enter triple-net leasing arrangements with us and therefore, may be unable to pay rent with funds from operations. (IIPR 10-Q)

Therefore, the recent Kings Garden issue also triggered investors into panic selling, as discussed in our previous articles. However, the market is forward-looking, and we assessed significant damage had already been inflicted on IIPR’s valuation.

With IIPR down nearly 60% YTD, it last traded at an NTM dividend yield of 7.14%, close to the two standard deviation zone over its 5Y average. We believe IIPR bulls have a valid argument that investors should look ahead.

IIPR remains well-positioned as the largest publicly traded cannabis REIT, providing a specialized vehicle to help accelerate the growth of cannabis operators, where 85% are multi-state operators. The company believes it operates in a high-growth legalized cannabis market with a 12% revenue CAGR through 2030.

As a specialized REIT focusing on the cannabis industry, it’s likely more challenging for investors to assess the attractiveness of its valuation against its industrial REIT peers.

However, given the limited access to funding due to federal regulations, we believe IIPR remains well-primed to serve the needs of the growing legal cannabis market, providing tremendous rental visibility for its holders without taking direct underlying operating risks.

Bloomberg reported that “legislation to open banking services to marijuana businesses was left out of a must-pass government funding package.” As such, the federal impasse continues, which has also hurt the stock performance of marijuana operators recently.

Hence, the long-term downtrend in Cannabis ETFs like AdvisorShares Pure US Cannabis ETF (MSOS) or Roundhill Cannabis ETF (WEED) has received no sustained respite from keen selling pressure.

The industry continues to face significant headwinds from the pandemic-induced craze as prices have continued to fall. Notably, it has been worsened by the illicit market, forcing “legal retailers to keep prices low, and [it’s] making it hard for growers to get the supply-demand balance right.” BDSA (a cannabis-data firm) also articulated: “The industry today is facing a number of headwinds. The most existential is pricing.”

As such, we believe the operating performances of IIPR’s tenant base could continue to suffer if we enter a potentially deeper recession, which Powell has also refused to rule out, emphasizing that it’s “not knowable.“

With that in mind, investors must be prepared for more volatility if they decide to add IIPR at the current levels.

However, we believe the recent pullback (nearly 20% from its recent highs) proffer investors another lower-risk entry zone to add more positions. As always, layer in over time as we assessed that the near-term headwinds in the cannabis industry are far from over.

Revising from Hold to Buy.