Innovative Industrial Properties (IIPR 0.38%) -- often known as IIP -- quickly became one of the hottest growth stocks in the cannabis industry. The REIT, short for real estate investment trust, buys and leases industrial properties to licensed medical marijuana operators. At its peak in February 2021, it had grown 916% in five years.
But its stellar growth has come to a screeching halt. Concern over the legalization of cannabis, followed by a class action lawsuit, and now a default from its largest tenant have pushed shares down 64% from recent highs.
Investors rightfully are wondering if the stock is going up in flames, or if it's bound to recover. Here's what's going on, and where the stock could be headed in the future.
What's going on?
Innovative Industrial Properties directly serves the high-growth cannabis industry, purchasing existing industrial properties from licensed medical marijuana operators through sale leaseback agreements. This unique lease structure offers liquidity to companies in a rather illiquid industry (thanks to regulations limiting access to capital through traditional sources like banks), and creates passive income for IIP.
Until 2021, business was booming. The company was seeing funds from operations (FFO), net operating income (NOI), and revenue grow by double and sometimes triple digits each year. Leasing momentum was strong and it was expanding its portfolio rapidly.
But 2022 is showing the business model's first sign of weakness. On July 13, IIP reported to the Securities Exchange Commission (SEC) that one of its largest tenants, Kings Garden -- which accounts for roughly 8% of its revenue -- defaulted on its lease. The default is approximately $2.2 million in aggregate, and has caused a lot of investor concern.
This news followed a class action lawsuit brought by the securities law firm Bronstein, Gewirtz & Grossman, after a report filed by Blue Orca Capital in mid-April 2022. Both the report and the lawsuit asserted that IIP failed to disclose its financial standing with its tenants and misled investors from 2020 through early 2022.
What does this mean for IIP?
IIP has been 100% leased for years; this exceptional track record became the norm for the company. But it's hardly the norm for most commercial real estate: Vacancy rates typically range from 3% to 10% or more depending on the industry and market conditions. In other words, having properties sit vacant or tenants fail to pay rent is a part of doing business.
The default by King's Garden is less than ideal, and will definitely affect the company's business until the tenant is replaced by a new one, or King's Garden becomes current. However, it's not a nail to the coffin for IIP. The company's latest earnings report showed a 44% increase in revenue year over year, while its collections were at 99%.
The company has no debt maturities until 2026, with $45 in cash and cash equivalents giving it a low debt-to-EBITDA (earnings before interest, taxes, amortization, and depreciation) ratio of under 2. This is an extremely low multiple, considering the REIT norm for debt-to-EBITDA is 5.
The lawsuit will continue to financially strain the company, which is a challenge it will have to overcome, particularly as one of the lawsuit claims has come to fruition. And this default is the first of what could be many for IIP, as the cannabis industry faces its first big headwinds. But I still think there's a lot of upside to IIP over the long term.
The company is in a strong financial position, even with the recent default, in a high-growth industry where its customers have little access to alternative financing solutions. Even if legalization happens on a federal level, I don't see companies like IIP becoming obsolete.
IIP's dividend yield is nearing 7% today, and its payout ratio is 82%. It's maintained 13 dividend raises in 5 years and consistently sees its revenue grow.
I personally own shares in IIP and don't plan on selling anytime soon. For risk-tolerant investors looking for a value buy that could pay off handsomely in the future, the stock looks like a worthy buy today. Risk-averse investors who are looking for more stability might want to wait until IIP's tenant challenges and lawsuit claims are settled. However, if those are resolved in the company's favor, you could be paying notably more for the stock in the future.
