The big attraction right now with Innovative Industrial Properties (NYSE: IIPR) is likely to be its huge 10%+ dividend yield. That’s a really high yield for a real estate investment trust (REIT). There are both opportunities and risks to examine here when considering whether or not this highly focused landlord is a millionaire maker in the making.
Innovative Industrial Properties is an industrial REIT, which means it owns physical properties with industrial purposes and leases those assets out to tenants. That’s not unusual. What makes Innovative stand out is that it is specifically focused on owning marijuana-related properties, especially grow houses. These are highly specialized industrial assets that require material additional investment.
This is where things get interesting, because the marijuana industry’s legal status is a bit murky. It is legal in some states, but not all. And it isn’t legal at the federal level. Banks and other lenders have been reluctant to lend marijuana related companies money. Innovative has stepped into the void, effectively helping to finance its tenants’ expansion efforts. This is a big deal.
Given the heavy investment needed to make a grow house, Innovative not only buys the building but often also pays for the upgrades. These costs get rolled into the lease deal, meaning that Innovative can generally charge very high rental rates. Given that its tenants have few other financing options, they are willing to pay higher rents. However, there’s a risk here, since a tenant that gets in financial trouble could risk leaving Innovative with assets that it can’t easily release at the same terms.
Right now, Wall Street is highly worried about Innovative Industrial’s business model. It has been dealing relatively well with tenant issues for a while now. But at the end of 2024 the REIT’s largest tenant, PharmaCann, defaulted on the leases for 11 properties. That was a big blow to Innovative’s investment story.
The two companies have since come to an agreement over the issue, in which two of the properties will be transitioned to new tenants (assuming new tenants can be found) and PharmaCann will pay reduced rent for the remaining properties. PharmaCann will also issue Innovative an interest-bearing note, presumably to make up for at least a portion of the rent lost in this transaction.
This is a reasonable outcome, but it highlights the risks inherent in Innovative’s highly focused approach. That said, the marijuana sector is expected to continue expanding and to be quite large. Innovative believes it will be larger than the beer and spirits industries, each taken individually, by 2028. Being one of the largest players in this niche, Innovative could be a huge beneficiary of that growth.
Assuming the REIT doesn’t continue to face tenant challenges as the still-young industry matures, the stock could rise back toward previous highs (most likely slowly and over time). And then there’s the huge yield that investors can collect. It could compound quickly if reinvested in the stock. And don’t forget that 10% is roughly the return investors expect from the broader market over time. Investors are getting that with Innovative’s dividend alone right now.
If things go well, Innovative could indeed be a millionaire-maker stock. But that assumes that things will go well. Tenant issues have been an ongoing problem and are likely the biggest risk to the stock’s long-term investment thesis. So far, management has managed the issue reasonably well, but there’s no guarantee that will continue. If things get worse the dividend could be at risk, which would upend the investment thesis.
Conservative dividend investors should probably sit on the sidelines with Innovative Industrial Properties. There are material risks that are, very clearly, impacting the REIT’s business. That said, the business model has largely held up to the stress so far, helped along by a very conservatively managed balance sheet.
More aggressive investors may want to consider adding Innovative to their portfolios. Just go in understanding that a dividend cut is a possibility if tenant problems continue. That seems like it is priced into the stock, however, so it may not derail the upside potential in the share price as Innovative looks to grow along with the highly specific industry it serves.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Innovative Industrial Properties. The Motley Fool has a disclosure policy.
Innovative Industrial Properties Stock: A Millionaire Maker in the Making? was originally published by The Motley Fool