2 Reasons to Buy Innovative Industrial Properties Stock, and 1 Reason to Sell

As one of the few cannabis stocks to beat the market over the last three years, with a return of 36.7% compared to the market’s 29.1%, there’s more than one way in which Innovative Industrial Properties (IIPR -0.83%) isn’t a typical marijuana business. Instead of selling buds or other cannabis products to consumers, it buys and leases out cultivation spaces that the industry’s growers need to compete. 

And that’s why it can sit back and collect rent from its tenants for years, whereas they need to constantly develop their brands and right-size their retail footprints in light of consumer preferences and shifting patterns of demand. Let’s look at two arguments for buying IIP’s shares and one for selling so that you’ll appreciate its wealth-building potential.

It’s an aggressive dividend hiker

At the moment, one of the biggest reasons to buy shares of Innovative Industrial Properties is its dividend, which has a decently high forward yield of 7.9%. As a real estate investment trust (REIT), the company pays for its dividend using rental income from its portfolio of cannabis cultivation properties. To get those cultivation spaces in the first place, it does sale-leaseback transactions wherein it buys real estate from cannabis businesses and then leases the new purchase back to the original owner, who then becomes a rent-paying tenant.

So, because rents roll in every month from tenants and annual rent increases are baked into each of IIP’s leases, its revenue performance is very reliable, as are its earnings. That forms the basis of financial stability that enables management to increase the dividend safely because tenants are typically on the hook for a lease term between 15 and 20 years. Over the last five years, IIP hiked its dividend by 620%, and it most recently grew its payout in Q3 by an impressive 25% year over year. And such a rapid pace of dividend growth is a major draw for investors, to say the least.

Businesses need to take a lot of damage before they default on rent

Investing in cannabis stocks is often frustrating because many of the largest pure-play marijuana companies are unprofitable or otherwise poorly performing. In recent years, major players like Aurora Cannabis and Tilray Brands have slashed their workforces and production capacity while reporting stiff losses for quarters and quarters on end.

But Innovative Industrial Properties doesn’t need to worry about whether consumers like its marijuana products because it doesn’t sell any. It only needs to concern itself with whether its tenants can continue to pay rent. And you can bet your hat that most cannabis businesses would prefer to cut costs by scaling down production, laying off workers, or any number of other fixes before they’d be willing to default on their rent or break their leases. 

Even if the industry gets hit hard by falling demand caused by a recession or by burdensome new regulations, IIP’s base of revenue will be somewhat insulated from negative impacts. Therefore, the company is a good option to buy for investors who want exposure to the growth potential of the marijuana industry without taking on as much direct exposure to the risks carried by the actual producers.

Now, let’s look at one argument for selling your shares.

A severe recession could easily prompt more defaults and harm the top line

Let’s confront the elephant in the room (and a decent reason to think about selling): the Kings Garden default. Earlier this year, Kings Garden, a marijuana cultivator, failed to pay its rent on time, and after Innovative Industrial Properties filed a lawsuit, the two businesses settled out of court on Sept. 11. Kings Garden’s rental income accounted for around 8% of IIP’s revenue in 2021, making it the REIT’s fourth-largest tenant.

The failure of Kings Garden might seem like it directly undermines the idea that IIP is a relatively stable place to park your money. After all, it’s pretty frightening to think that such a large portion of its top line could suddenly disappear. Plus, in the event of a severe recession in which consumers buy fewer cannabis products, it’s hard to see how the company’s tenants could remain in good enough shape to keep paying rent on time.

And while it’s impossible to predict whether any other tenants might skip out on rent (many are private and don’t disclose financial information publicly), skittish investors could avoid the problem entirely by selling their shares. But they’ll miss out on what might be decades of growth and dividend payments if they do, so it probably isn’t a good idea for most shareholders.

Alex Carchidi has positions in Innovative Industrial Properties. The Motley Fool has positions in and recommends Innovative Industrial Properties. The Motley Fool has a disclosure policy.